Compensation

Another mode to extinguish obligation and novation

Art. 1278. Compensation shall take place when two persons, in their own right, are creditors and
debtors of each other.

As already mentioned, compensation does not refer to the salary or wage of an

employee/laborer
This is a term which being used as mode to extinguish an obligation
Compensation is defined as a mode to extinguish an obligation, or the extinguishment to the
concurrent amount of the debts of two persons, who in their own right, who are debtors and
creditors of each other
When it comes to compensation this involved two persons, and this persons, in their own right,
are creditors and debtors of each other.
This may involve two transactions between this two persons being referred to in this article,
Transaction 1, A and B, B is the creditor, A is the debtor, and then there’s another transaction
which follow the first transaction, A now is the creditor and B is the debtor, so they are debtors
and creditors of each other

The illustration in the book, A owes B an amount of 1 thousand and B owes also an amount of
700 pesos, and if both debts are due and payable say today, compensation may take place
partially that is to concurrent amount of 700 pesos (the illustration in the book)

Another illustration, the corporation has liabilities in its books, that’s the first transaction, when
the liabilities were incurred by the corporation,
Now the corporation will issue shares of stock in favor of creditors, the creditors once they
subscribe to shares of stocks, will have to pay the consideration, it could be in cash will be their
payment,
They could use those liabilities in favor of the creditor as payment for their subscription, so
there will be offsetting or there would be compensation that may happen in that transaction
mentioned.
The first transaction is there is a credit in favor of creditors, liability on the part of corporation,
And then the second transaction, would be the issuance of shares of stock, the payment would
be by way of the liabilities,
if the transaction happen, compensation shall take place, there will be issuance of share in
exchange for the liability, the liabilities would be use as payment for the issuance of shares
Art. 1279. In order that compensation may be proper, it is necessary:

1. That each one of the obligors be bound principally, and that he be at the same time a principal
creditor of the other;
One of the obligors be bound principally, and that he be at the same time a principal creditor of
the other
Debtor, creditor, then the creditor now becomes the debtor, the debtor becomes the creditor
First transaction and second transaction respectively.

2. That both debts consists in a sum of money, or if the things due are consumable, they be of the
same kind, and also of the same quality if the latter has been stated ;
That both debts consists in a sum of money (in the illustration in book, A owes B 1 thousand and B
owes A 700 pesos, both obligation consists in the sum of money,
in another illustration, the amount involve is also money and it is going to be paid also in money,
only that the liability is recorded and so that would be equivalent also to money because the
corporation will be paying money, if it will not be for shares of stocks,
that’s why we have here or if the things due are consumable, they be of the same kind, and also
of the same quality if the latter has been stated
example of “if the thing is due are consumable”, farmer A and farmer B, farmer A extended seeds
to farmer B, and in return farmer B will be also paying seeds, it could be of greater amount by the
time harvest was already in place or harvest has already been done, so that both debts consists in
a sum of money or if the things due are consumable they be of the same kind, and also of the
same quality if the latter has been stated
3. That the two debts be due;
4. That they be liquidated and demandable;
in previous illustration, there could be a quantity that will be return by farmer 2 after his harvest
or it’s already provided in their agreement, that the two debts be due (meaning it’s already due
for delivery, already due for payment, that they be liquidated and demandable, there’s already
exact amount when you say liquidated. And when you say due, it goes that its already
demandable

5. That over neither of them there be any retention or controversy commenced by third persons
and communicated in due time to the debtor
There’s no claim of a third person as o retention or there’s no controversy that is being filed
against the subject of the object of the contract
Art. 1280. Notwithstanding the provisions of the preceding article, the guarantor may set up
compensation as regards what the creditor may owe the principal debtor,

This is about the right of a guarantor, or contract of guarantee,

e.g., The debtor borrowed an amount from the creditor, then it’s guaranteed by the guarantor,
the payment is guaranteed by the guarantor, so the contract of guarantee is between the creditor
and the guarantor,
the creditor will go against the guarantor for collection if the creditor cannot collect against the
debtor,
so, what will happen here if there would be no payment by the guarantor, the guarantor will be
now the be the creditor of the debtor
so, the guarantor may set up compensation as regards what the creditor may owe the principal
debtor, its because the liability of the guarantor is subsidiary (there should be prior exhaustion
first of all the assets or properties of the principal debtor, before the creditor can go against the
guarantor

Art. 1281.Compensation may be total or partial. when the two debts are of the same amount, there is a
total compensation.

In the previous illustration, A owes B 1 thousand, if B in the next transaction owes A 1 thousand,
there could be total compensation, but partial considering that 1 thousand, B is 700 pesos are the
amount due between the parties who are debtor and creditor of each other
the parties may agree upon the compensation of debts, which are not yet due, previously when
we have this provision (art. 1279), one of the requisite in order that compensation may be proper
is that the two debts are already due, but that could be subject to exemption agreement of the
parties under article 1282

Art. 1282. The parties may agree upon the compensation of debts which are not yet due.

The parties may agree that the compensation shall take place even the two debts are not yet
due

Art. 1283. If one of the parties to a suit over an obligation has a claim for damages against the other; the
former may set it off by proving his right to said damages and the amount thereof .

Damages could also be subject of compensation, that’s why the former may set it off by proving
his right to said damages and the amount thereof, the party entitled of damages may prove that
it’s really or actually entitled to said damages and may prove the amount of such damages
Art 1284. When one or both debts are rescissible or voidable, they may be compensated against each
other before they are judicially rescinded or avoided.

As already mentioned, rescissible contracts are valid until they are rescinded by the court
The same with voidable contracts, voidable contracts are valid until they are annulled or avoided
by the court
And compensation may also take place according to 1284, before they are judicially rescinded or
avoided.

Art. 1285. The debtor who has consented to the assignment of rights made by the creditor in favor of a
third person, cannot set up against the assignee the compensation which would pertain to him against
the assignor, unless the assignor was notified by the debtor at the time he gave his consent, that he
reserved his right to the compensation.

E.g., A is indebted to C, then C assign the credits in favor of D, the creditor now is D, supposing
compensation can be set off by A against C, can that be claim against the new creditor?
According to 1285, no, but if the debtor notified the new creditor at the time he give his
consent, and the notifications states that he reserve his right to the compensation, then that
would be the time that the debtor can set up against the new creditor or the assignee the
compensation which would have pertain to him against the original creditor or the assignor

If the creditor communicated the cession to him but the debtor did not consent thereto, the latter may
set up the compensation of debts previous to the cession, but not of subsequent ones.

It was communicated to the debtor that there will be cession of the credits in favor of a new
creditor, it did not set up/ he did not give his consent, the debtor may still set up the
compensation of debts previous to the cession
The cession that’s being referred to here is the transfer by the creditor in favor of a new
creditor, the assignee now is the new creditor, the assignor is the old creditor,
If the assignment is made without the knowledge of the debtor, he may set up the
compensation of all credits prior to the same and also latter ones until he had knowledge of the
assignment

If the assignment is made without the knowledge of the debtor, he may set up the compensation of all
credits prior to the same and also later ones until he had knowledge of the assignment.

The assignment of the creditor is without the knowledge of the debtor,

The rule when it comes to compensation, he can still set up the compensation of all the credits
prior to the same and also latter ones until he had knowledge of the assignment.
Art. 1286.Compensatian takes place by operation of law, even though the debts may be payable at
different places, but there shall be an indemnity for expenses of exchange or transportation to the place
of payment.

There are provisions of law, which compensation is taking place by operation of law.

Art. 1287.Compensation shall not be proper when one of the debts arises from a depositum or from the
obligations of a depositary or of a bailee in commodatum.

E.g., A went to the mall, deposited an umbrella, so that’s a contract of deposit

A deposited his umbrella in the front desk or countertop before he will be allowed to enter,
It was loss, that could not be subject of compensation, say it was loss due to the fault of counter
staff
or of a bailee in commodatum e.g., book of atty. Sales is borrowed by one of his students, that
student loss it, atty. Sales has a debt in that student, could be subject of compensation? NO ,
that student will really have to return that book of the same kind if it cannot be recovered
anymore

Neither can compensation be set up against a creditor who has a claim for support due by gratuitous
title, without prejudice to the provisions of paragraph 2 of Article 201.

Support due by gratuitous title, e.g., the donee is receiving an amount from the donor, and the
donee is indebted to the donor, the donor cannot set up the compensation against the donee,
that’s prohibited under second paragraph of 1287