MODULE 5: EXTINGUISHMENT OF OBLIGATIONS

Modes of extinguishing obligations

Art. 1231, CC. Obligations are extinguished:
1. Payment or performance;
2. Loss of the thing due;
3. Condonation or remission of debt;
4. Confusion or merger;
5. Compensation;
6. Novation (NCC, Art. 1231).

Other Modes (PARF)

7. Annulment;
8. Rescission;
9. Fulfillment of a resolutory condition;
10. Prescription (NCC, Art. 1231).

NOTE: The enumeration is not exclusive.

Other causes not expressly mentioned (Rabuya, 2017)

11. Death – in obligations which are of purely personal character;
12. Arrival of resolutory period;
13. Mutual dissent;
14. Change of civil status;
15. Happening of unforseen events.

Mutual desistance as another mode of extinguishing obligations

It is a concept derived from the principle that since mutual agreement can create a contract,
mutual disagreement by the parties can likewise cause its extinguishment (Saura v.
Development Bank of the Phils., G.R. No. L-24968, April 27, 1972).

1.PAYMENT OR PERFORMANCE

Payment may consist not only in the delivery of money but also the giving of a thing (other than
money), the doing of an act, or not doing of an act (NCC, Art. 1232).

Payment is the fulfillment of the obligation by the realization of the purposes for which it was
constituted (Jurado, 2010)

Characteristics of payment
1. Integrity – The payment of the obligation must be completely made;
2. Identity – The payment of the obligation must consist the performance of the very thing due;
3. Indivisibility – The payment of the obligation must be in its entirety.
Integrity
General Rule: Payment or performance must be complete (NCC, Art. 1233).

Exception:
1. Substantial performance performed in good faith (NCC, Art. 1234);
2. When the obligee accepts the performance, knowing its incompleteness or
irregularity and without expressing any protest or objection; (NCC, Art. 1235); or
3. Debt is partly liquidated and partly unliquidated, but the liquidated part of the debt
must be paid in full.

Substantial Performance Doctrine

It provides the rule that if a good-faith attempt to perform does not precisely meet the
terms of an agreement or statutory requirements, the performance will still be
considered complete if the essential purpose is accomplished (Black’s Law Dictionary,
2009).

Requisites
1. Attempt in good-faith to comply with obligation;
2. Slight deviation from the obligation; and the omission or defect of the performance is
technical and unimportant; and does not pervade the whole, or is not material that the
object which the parties intended to accomplish is not attained (Tolentino, 2002).

Identity of the thing

General Rule: Thing paid must be the very thing due and cannot be another thing even if
of the same or more quality and value.

Exception:
1. Dation in payment;
2. Novation of the obligation; and
3. Obligation is facultative.

NOTE: In an obligation to do or not to do, an act or forbearance cannot be substituted

by another act or forbearance against the obligee’s will.

Indivisibility
GR: Debtor cannot be compelled by the creditor to perform obligation in parts and
neither can the debtor compel the creditor to accept obligation in parts.

Exception:

When:
1. Partial performance has been agreed upon;
2. Part of the obligation is liquidated and part is unliquidated; or
 3. To require the debtor to perform in full is impractical.

Acceptance by a creditor of a partial payment NOT an abandonment of its demand for full
payment
When creditors receive partial payment, they are not ipso facto deemed to have
abandoned their prior demand for full payment.

To imply that creditors accept partial payment as complete performance of their

obligation, their acceptance must be made under circumstances that indicate their
intention to consider the performance complete and to renounce their claim arising
from the defect.

NOTE: While Art. 1248 of the Civil Code states that creditors cannot be compelled to
accept partial payments, it does not prohibit them from accepting such payments
(Selegna Managem ent and Development Corp. v. UCPB, G.R. No. 165662, May 3, 2006).

Requisites of a valid payment

1. The person who pays the debt must be the debtor;

2. The person to whom payment is made must be the creditor;
3. The thing to be paid or to be delivered must be the precise thing or the thing required to be
delivered by the creditor;
4. The manner (if expreslly agreed upon), time, and place of payment, etc.; and
5. Acceptance by the creditor.

Kinds of payment

1. Normal - When the debtor voluntarily performs the prestation stipulated;

2. Abnormal - When he is forced by means of a judicial proceeding, either to comply with the
prestation or to pay the indemnity (Tolentino, 1991).

Person who pays

The following persons may effect payment and compel the creditor to accept the payment:
1. Debtor himself;
2. His heirs and assigns;
3. His agents and representatives; or
4. Third persons who have a material interest in the fulfilment of the obligation ([NCC, Art. 1236
(1)].

Payment by a third person

General Rule: The creditor is not bound to accept payment or performance by a third
person who has no interest in the fulfillment of the obligation [Art. 1236, CC]
Exception: Stipulation to the contrary [Art.1236, NCC]

Reimbursement for Payment Made by a

Third Person
The third party The third party pays
pays with the without the
consent of the knowledge or
debtor consent
of the debtor
The third party The third party may
may claim only
reimbursement claim insofar as the
for the full payment has been
amount. [Art. beneficial to the
1236, CC] debtor.
[Art. 1236, CC]
The third party is The third party cannot
presumed to be compel the creditor to
legally subrogate him on his
subrogated [Art. rights. [Art. 1237, CC]
1302, CC]

Reimbursement & Subrogation Distinguished

Reimbursement Subrogation

Personal action to Includes

recover amount paid reimbursement, but
also the exercise of
other rights attached
to the original
obligation (e.g.
guaranties,
securities)

Rights of a third person who made the payment

1. If the payment was made with knowledge and consent of the debtor:
a. Can recover entire amount paid (absolute reimbursement); or
b. Can be subrogated to all rights of the creditor.
2. If the payment was made without knowledge or against the will of the debtor – Can
recover only insofar as payment has been beneficial to the debtor
Person to whom payment is made
Persons entitled to receive the payment:
1. The person in whose favor the obligation has been constituted;
2. His successor in interest; or
3. Any person authorized to receive it (NCC, Art. 1240).

NOTE: Payment made to one having apparent authority to receive the money will, as a
rule, be treated as though actual authority had been given for its receipt. Likewise, if
payment is made to one who by law is authorized to act for the creditor, it will work a
discharge (Sps. Miniano v. Concepcion, G.R. No. 172825, October 11, 2012).

General Rule
1. Valid insofar as it has redounded to the benefit of the creditor [par. 2, Art. 1241, CC]
2. Proof that such payment has redounded to the benefit of the creditor is required.

Exceptions: [par. 2, Art. 1241, CC]

1. If after the payment, the third person acquires the creditor's rights (SUBROGATION);
2. If the creditor ratifies the payment to the third person (RATIFICATION);
3. If by the creditor's conduct, the debtor has been led to believe that the third person had
authority to receive the payment (ESTOPPEL). [Art. 1241, CC]

PLACE OF PAYMENT
1. In the place designated in the obligation.
2. In the absence of stipulation—
a. If obligation is to deliver a determinate thing: wherever the thing might be at
the moment the obligation was constituted.
b. In any other case: domicile of debtor Art. 1251]

TIME OF PAYMENT
General Rule: Upon demand

Exceptions:
1. When time is of the essence
2. When the debtor loses the benefit of the period
3. When the obligation is reciprocal

FORM OF PAYMENT

Art. 1249, CC. The payment of debts in money shall be made in the currency
stipulated, and if it is not possible to deliver such currency, then in the currency which is
legal tender in the Philippines. The delivery of promissory notes payable to order, or bills
of exchange or other mercantile documents shall produce the effect of payment only
 when they have been cashed, or when through the fault of the creditor they have been
impaired. In the meantime, the action derived from the original obligation shall be held
in the abeyance.

1. Payment in cash – all monetary obligations shall be settled in Philippine currency.

However, the parties may agree that the obligation be settled in another currency at the
time of payment (R.A. 8183, Sec. 1).

2. Payment in check or other negotiable instrument – not considered payment, they are
not considered legal tender and may be refused by the creditor except when:
a. the document has been encashed; or
b. it has been impaired through the fault of the creditor (NCC, Art. 1249).

When payment is made in money/ legal tender

General Rule: pay in the currency stipulated

Exception: payment not possible in such currency, then pay in legal tender.

Legal Tender
Such currency which in a given jurisdiction can be used in the payment of debts, and
which cannot be refused by the creditor.

The legal tender covers all notes and coins issued by the Bangko Sentral ng Pilipinas and guaranteed
by the Republic of the Philippines. The amount of coins that may be accepted as legal tender are:
1. One-Peso, Five-Pesos, 10-Pesos coins in amount not exceeding P1,000.00
2. 25 centavos or less – in amount not exceeding P100. 00 (BSP Circular No. 537, Series of
2006, July 18, 2006).

When payment is not in legal tender

General Rule: The creditor may refuse to accept payment (e.g. checks) not made in legal
tender [Philippine Airlines v. Court of Appeals, G.R. No. L-49188 (1990)].

BRAIN EXERCISE:
Northwest Airlines, through its Japan Branch, entered into an International Passenger Sales Agency Agreement
with CF Sharp, authorizing the latter to sell its air transport tickets. CF Sharp failed to remit the proceeds of the
ticket sales, thus, Northwest Airlines filed a collection suit before the Tokyo District Court which rendered judgment
ordering CF Sharp to pay 83,158,195 Yen and damages for the delay at the rate of 6% per annum. Unable to
execute the decision in Japan, Northwest Airlines filed a case to enforce said foreign judgment with the RTC of
Manila. What is the rate of exchange that should be applied for the payment of the amount? .

Rule on tender payment as to checks

Q: When does payment by a negotiable instrument produce the effect of payment?
A: (1) Only when it is cashed, or (2) when through the fault of the creditor, they have been impaired [NCC, Art.
1249 (2)].

A check does not constitute a legal tender, thus a creditor may validly refuse it. However, this does not prevent
a creditor from accepting a check as payment – the creditor has the option and the discretion of refusing or
accepting it (Far East Bank & Trust Company v. Diaz Realty, Inc., G.R. No. 138588, August 23, 2001).

NOTE: While it is true that the delivery of a check produces the effect of payment only when it is cashed,
pursuant to Art. 1249 of the CC, the rule is otherwise if the debtor is prejudiced by the creditor's
unreasonable delay in presentment. The payee of a check would be a creditor under this provision and if
its non-payment is caused by his negligence, payment will be deemed effected and the obligation for which
the check was given as conditional payment will be discharged (Papa v. Valencia & Co., Inc., G.R. No. 105188,
January 23, 1998).

Extraordinary Inflation or Deflation

Art. 1250, CC. In case an extraordinary inflation or deflation of the currency stipulated should
supervene, the value of the currency at the time of the establishment of the obligation shall be
the basis of payment, unless there is an agreement to the contrary

Requisites for application of Art. 1250, NCC

1. That there was an official declaration of extra-ordinary inflation or deflation from the BSP;
2. That the obligation was contractual in nature; and
3. That the parties expressly agreed to consider the effects of the extraordinary inflation or deflation.

Extraordinary inflation
Exists when there is a decrease or increase in the purchasing power of the Philippine currency which is unusual or
beyond the common fluctuation in the value of said currency and such decrease or increase could not have been
reasonably foreseen or was manifestly beyond the contemplation of the parties at the time of the establishment of
the obligation (Tolentino, 2002).

PLACE OF PAYMENT
General Rule: Payment must be made in the place designated in the obligation (NCC, Art. 1251).

Exception: If there is no express designation or stipulation in the obligation:

1. At the place where the thing might be at the time the obligation was constituted – If the obligation is to
deliver a determinate thing;
2. At the domicile of the debtor – In any other case (NCC, Art. 1251).

APPLICATION OF PAYMENTS
It is the designation of the debt to which the payment must be applied when the debtor has several
obligations of the same kind in favor of the same creditor (NCC, Art. 1252).
Requisites:
1. There is only one debtor and creditor;
2. The debtor owes the creditor two or more debts;
3. Debts are of the same kind or identical nature;
e.g. both debts are money obligations obtained on different dates;
4. All debts are due and demandable, except:
a. When there is mutual agreement between the parties (Tolentino, 2002);
b. The application is made by the party for whose benefit the term has been constituted [NCC, Art. 1252(1]).
5. The payment made is not sufficient to cover all obligations. Right of the debtor in the application of
payments.
General Rule: The law grants the debtor a preferential right to choose the debt to which his payment is to be applied.
But the right of the debtor is not absolute; he cannot impair the rights granted by law to the creditor (Tolentino,
2002).

Limitation upon right to apply payment

If the debt produces interests, payment of the principal shall not be deemed to have been made until the
interest have been covered (NCC, Art. 1253).

NOTE: This applies only in the absence of a verbal or written agreement to the contrary; in other words, it is
merely directory, and not mandatory (Magdalena Estates, Inc. v. Rodriguez, G.R. No. L-18411, December 17,
1966).

Legal application of payment

If both the creditor and the debtor failed to exercise the right of application of payment or legal application
(the law makes the application) of payment will be now govern.

Rules on legal application of payment

The payment should be applied to the more onerous debts:
1. When a person is bound as principal in one obligation and as surety in another, the former is more onerous.
2. When there are various debts, the oldest ones are more burdensome.
3. Where one bears interest and the other does not, even if the latter is the older obligation, the former is
considered more onerous.
4. Where there is an encumbrance, the debt with a guaranty is more onerous than that without security.
5. With respect to indemnity for damages, the debt which is subject to the general rules on damages is less
burdensome than that in which there is a penal clause.
6. The liquidated debt is more burdensome than the unliquidated one.
7. An obligation in which the debtor is in default is more onerous than one in which he is not (Tolentino,
2002).

PAYMENT BY CESSION
Cession

The assignment or cession contemplated here is the abandonment of the universality of the property of the
debtor for the benefit of his creditors in order that such property may be applied to the payment of the
credits.

The initiative comes from the debtor, but it must be accepted by the creditors in order to become effective. A
voluntary assignment cannot be imposed upon a creditor who is not willing to accept it.
If the offer is not accepted by the creditors, the same end may be attained by a proceeding in insolvency instituted
in accordance with Insolvency Law.

Circumstances evidencing payment by cession

Debtor abandons all of his property for the benefit of his creditors in order that from the proceeds thereof,
the latter may obtain payment of credits.
Requisites:
1. Plurality of debts;
2. Partial or relative insolvency of the debtor; and
3. Acceptance of the cession by the creditors

Consignation
Act of depositing the object of the obligation with the court or competent authority after the creditor has
unjustifiably refused to accept the same or is not in a position to accept it due to certain reasons or
circumstances (Pineda, 2000).
NOTE: Once the consignation has been duly made, the debtor may ask the judge to order the cancellation of
the obligation (NCC, Art. 1260).

Requisites of consignation
1. There was a debt due ;
2. The consignation of due obligation was made because of some legal cause provided under NCC, Art. 1256;
3. The previous notice of the consignation had been given to the person interested in the performance of the
obligation;
4. The amount or thing due was placed at the disposal of the court; and
5. That after the consignation had been made the persons interested were notified thereof.

Consignation is necessarily judicial. Art. 1258 of the CC specifically provides that consignation shall be made by
depositing the thing or things due at the disposal of judicial authority. The said provision clearly precludes
consignation in venues other than the courts (Sps. Oscar and Thelma Cacayorin v. Armed Forces and Police Mutual
Benefit Association, Inc., G.R. No. 171298, April 15, 2013).

Consignation shall produce effects of payment only if there is a valid tender of payment.

TENDER OF PAYMENT CONSIGNATION

Nature
Antecedent of consignation or Principal or consummating act for the
preliminary act to consignation. extinguishment of the obligation.
Effect
It does not by itself extinguish the It extinguishes the obligation when
obligation. declared valid.
Character
Extrajudicial. Judicial for it requires the filing of a
complaint in court (Pineda, 2000).

2. LOSS OF THE THING DUE

Loss here is not contemplated in its strict and legal meaning and is not limited to obligations to give, but extends to
those which are personal, embracing therefore all causes which may render impossible the performance of the
prestation. In some Codes, this is designated as impossibility of performance.

When a thing is considered lost:

1. It Disappears in such a way that its existence is unknown;
2. It goes Out of commerce;
3. It Perishes; or
4. Its Existence is unknown or if known, it cannot be recovered.

Effect of loss of the thing/object of the obligation

If the obligation is a:
1. Determinate obligation to give:
The obligation is extinguished when the object of the obligation is lost or destroyed (NCC, Art. 1262).

Exception:
a. Law provides otherwise (NCC, Art. 1262);
b. Nature of the obligation requires the Assumption of risk;
c. Stipulation to the contrary;
d. Debtor Contributed to the loss;
 e. Loss the of the thing occurs after the debtor incurred in Delay;
f. When debtor Promised to deliver the same thing to two or more persons who do not have the same
interest (NCC, Art. 1165);
g. When the debt of a certain and determinate thing proceeds from a Criminal offense (NCC, Art.
1268); and
h. When the obligation is Generic (NCC, Art. 1263).

2. Generic obligation to give:

The obligation is not extinguished because a generic thing never perishes (genus nun guam perit (NCC,
Art. 1263).

Exception:
a. In case of generic obligations whose object is a particular class or group with specific or
determinate qualities (delimited generic obligation);
b. In case the generic thing has already been segregated or set aside, in which case, it has become
specific.

3. An obligation to do – The obligation is extinguished when the prestation becomes legally or physically
impossible without the fault of the obligor (NCC, Art. 1266).

Types of impossibility to perform an obligation to do

1. Legal impossibility – Act stipulated to be performed is subsequently prohibited by law.
2. Physical impossibility – Act stipulated could not be physically performed by the obligor due to reasons
subsequent to the execution of the contract (Pineda, 2000).

Effect of partial loss

1. Due to the fault or negligence of the debtor :
Creditor has the right to demand the rescission of the obligation or to demand specific performance,
plus damages, in either case.

2. Due to fortuitous event:

a. Substantial loss – Obligation is extinguished.
b. Unsubstantial loss – The debtor shall deliver the thing promised in its impaired condition
(NCC, Art. 1264).

Effect when the thing is lost in the possession of the debtor:

General RUle: It is presumed that loss is due to debtor’s fault. The obligation is not extinguished.
Exception: Presumption shall not apply in case loss is due to earthquake, flood, storm, or other natural
calamity (NCC, Art. 1262).

Effect of unforeseen difficulty of fulfilment:

When the service has become so difficult as to be manifestly beyond the contemplation of the parties, the obligor
may also be released therefrom, in whole or in part (NCC, Art. 1267). The impossibility of performance of an
obligation to do shall release the obligor.

Rebus sic stantibus

A principle in international law which means that an agreement is valid only if the same conditions prevailing at the
time of contracting continues to exist at the time of performance. It is the basis of the principle of unforeseen
difficulty of service (NCC, Art. 1267).
Debt which proceeds from a criminal offense:

General Rule: Debtor shall not be exempted from the payment of his obligation regardless of the cause of the
loss.
Exception: The thing having been offered by debtor to the person who should receive it, the latter refused without
justification to accept it (NCC, Art. 1268).

3. CONDONATION OR REMISSION OF DEBT

An act of liberality by virtue of which the creditor, without receiving any price or equivalent, renounces the
enforcement of the obligation, as a result of which it is extinguished in its entirety or in that part or aspect of the
same to which the condonation or remission refers (Pineda, 2000).

Requisites of condonation
1. Must be Gratuitous;
2. Acceptance by the debtor;
3. Must not be Inofficious;
4. Formalities provided by law on Donations must be complied with if condonation is express; and
5. An Existing demandable debt at the time the remission is made.

Manner and kinds of remission:

1. Total – Refers to the remission of the whole of the obligation;

2. Partial – Remission of the part of the obligation: to the amount of indebtedness or to an accessory
obligation only (such as pledge or interest), or to some other aspect of the obligation (such as solidary);
3. Inter vivos - Effective during the lifetime of the creditor;
4. Mortis causa - Effective upon death of the creditor. In this case, the remission must be contained in a will or
testament (Tolentino, 1991);
5. Express – When it is made formally, it should be in accordance with the forms of ordinary donations with
regard to acceptance, amount, and revocation; and
6. Implied – When it can be inferred from the acts of the parties

Effect of remission in general:

It extinguishes the obligation in its entirety or in the part or aspect thereof to which the remission refers
(Jurado, 2010).

Effect of the remission of the principal debt with respect to the accessory obligation and vice vers:
The renunciation of the principal debt shall extinguish the accessory but the waiver of the latter shall leave the
former in force (NCC, Art. 1273).

4. CONFUSION OR MERGER OF RIGHTS

There is a confusion when there is a meeting in one person of the qualities of a creditor and debtor of the
same obligation (4 Sanchez Roman 421).

Requisites of confusion or merger of rights:

1. It must take place between the creditor and the principal debtor (NCC, Art. 1276);
2. The very same obligation must be involved (for if the debtor acquires rights from the creditor, but not the
particular obligation in question, there will be no merger);
3. The confusion must be total or as regards with the entire obligation.

CONFUSION OR MERGER OF RIGHTS

 There is a confusion when there is a meeting in one person of the qualities of a creditor and debtor of
the same obligation (4 Sanchez Roman 421).

Requisites of confusion or merger of rights

1. It must take place between the creditor and the principal debtor (NCC, Art. 1276);
2. The very same obligation must be involved (for if the debtor acquires rights from the creditor, but
not theparticular obligation in question, there will be no merger);
3. The confusion must be total or as regards with the entire obligation.

Effect of confusion or merger of rights

The creditor and debtor becomes the same person involving the same obligation. Hence, the obligation is
extinguished (NCC, Art. 1275).

Effect of confusion or merger in relation to the guarantors:

1. Merger which takes place in the person of the principal debtor or principal creditor
benefits the guarantors. The contract of guaranty is extinguished;
2. Confusion which takes place in the person of any of the guarantors does not extinguish the
obligation (NCC, Art. 1276).

Effect of confusion or merger in one debtor or creditor in a joint obligation:

Joint obligation is not extinguished since confusion is not definite and complete with regard to the
entire obligation. A part of the obligation still remains outstanding.

Exception: Obligation is extinguished with respect only to the share corresponding to the debtor or creditor
concerned. In effect, there is only partial extinguishment of the entire obligation (NCC, Art. 1277; Pineda,
2000).

Effect of confusion or merger in one debtor or creditor in a solidary obligation:

If a solidary debtor had paid the entire obligation, the obligation is totally extinguished without prejudice
to the rights of the solidary debtor who paid, to proceed against his solidary co-debtors for the latter’s
individual contribution or liability (NCC, Art. 1215).

5. COMPENSATION

It is a mode of extinguishing obligations that take place when two persons, in their own right, are
creditors and debtors of each other (NCC, Art. 1278).

It is the offsetting of the respective obligation of two persons who stand as principal creditors and debtors
of each other, with the effect of extinguishing their obligations to their concurrent amount.

Requisites of compensation :

1. Each one of the obligors must be bound principally, and that he be at the same time a principal
creditor of the other except guarantor who may set up compensation as regards what the creditor
may owe the principal (NCC, Articles. 1279-1280);
2. Both debts consist in 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. Both debts are due;
4. Both debts are liquidated and demandable;
5. Neither debt must be retained in a controversy commenced by third person and
communicated in due time to the debtor (neither debt is garnished) (NCC, Art. 1279); and
6. Compensation must not be prohibited by law. (NCC, Art. 1290).

Effects of compensation:
1. Both debts are extinguished;
2. Interests stop accruing on the extinguished obligation or the part extinguished;
3. The period of prescription stops with respect to the obligation or part extinguished; and
4. All accessory obligations of the principal obligation which has been extinguished are alsoextinguished
(4 Salvat 353).

Compensation v. COMPENSATION PAYMENT

Payment BASIS
Definition A mode of Payment means not
extinguishing to the only delivery of money
concurrent amount, the but also performance of
obligations of those an obligation
persons who in their
own right are
reciprocally debtors
and creditors of each
other.
As to the necessity of Capacity of parties not Debtor must have
the capacity of the necessary capacity to dispose of
parties Reason: Compensation the thing paid; creditor
operates by law, not by must have capacity to
the act of the parties. receive payment.

As the susceptibility of There can be partial The performance must

partial extinguishment of the be complete and
extinguishment obligation. indivisible unless
waived by the creditor.

As to the operation of Legal compensation Takes effect by the act

extinguishing the takes place by of the parties and
obligation operation of law involves delivery or
without simultaneous action.
delivery.

As to the relationship Parties must be It is not necessary that

of the parties mutually debtors and the parties be mutually
creditors of each other. debtors and creditors
of each other.

Debts or obligations not subject to compensation :

1. Debts or obligations arising from contracts of depositum (NCC, Art. 1287);
2. Debts arising from obligations of a depositary;
3. Debts arising from obligations of a bailee in commodatum;
4. Claims for support due by gratuitous title;
5. Obligations arising from criminal offenses (NCC, Art. 1288); and
6. Certain obligations in favor of government.
e.g. Taxes, fees, duties, and others of a similar nature.
 Under 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. Neither can compensatin be set up against a
creditor who has a claim for support due by gratuitous title without prejudice to the provisions of Art. 301
(2).

KINDS OF COMPENSATION
1. Legal compensation – by operation of law;
2. Conventional – by agreement of the parties;
3. Judicial (set-off) – by judgment of the court when there is a counterclaim duly pleaded, and the
compensation decreed; and
4. Facultative – may be claimed or opposed by one of the parties.

a) Conventional compensation
It is one that takes place by agreement of the parties.

Effectivity of conventional compensation

For compensation to become effective:

General Rule: The mutual debts must be both due (NCC, Art. 1279).
Exception: The parties may agree that their mutual debts be compensated even if the same are not
yet due. (NCC, Art. 1282).

b) Judicial compensation
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 (NCC, Art.
1283).

All the requisites mentioned in Art. 1279 must be present, except that at the time of filing the pleading,
the claim need not be liquidated. The liquidation must be made in the proceedings.

One of the parties has a choice of claiming or opposing the compensation but waives his objection
thereto such as an obligation of such party is with a period for his benefit alone and he renounces the
period to make the obligation become due.

c) Facultative compensation

One of the parties has a choice of claiming or opposing the compensation but waives his objection
thereto such as an obligation of such party is with a period for his benefit alone and he renounces the
period to make the obligation become due.

Effects of assignment on compensation of debts

1. After the compensation took place

General Rule: Ineffectual; useless act since there is nothing more to assign
Exception: When the assignment was made with the consent of the debtor.

Exception to exception: At the time he gave his consent, he reserved his right to the
compensation.
 2. Before compensation took place
a. With the consent of the debtor – Compensation cannot be set up except when the right to
compensation is reserved.
b. With the knowledge but without consent of the debtor – Compensation can be set up
regarding debts previous to the cession or assignment but not subsequent ones.
c. Without the knowledge of debtor - Can set up compensation as a defense for all debts
maturing prior

Renunciation of compensation:

Compensation can be renounced expressly or impliedly. It can also be renounced either at the time an
obligation is contracted or afterwards. It rests upon a potestative right, and a unilateral declaration of
the debtor would be sufficient renunciation.

6. NOVATION
It is the substitution or change of an obligation by another, resulting in its extinguishment or modification,
either by changing the object or principal conditions, or by substituting another in the place of the debtor
or by subrogating a third person to the rights of the creditor (Pineda, 2000).

Requisites of novation (OIC –SN)

1. Valid Old obligation;

Exception:
a. When the annulment may be claimed only by the debtor and he consented to the novation; and
b. When ratification validates acts which are voidable.

2. Intent to extinguish or to modify the old obligation;

3. Capacity and consent of all the parties to the new obligation (except in case of expromission where the old
debtor does not participate);

4. Substantial difference of the old and new obligation – on every point incompatible with each other (implied
novation); and

5. Valid New obligation.

NOTE: If the new obligation is void, the original one shall subsist as there is no novation. However, even if the new
obligation turns out to be void, the original obligation does not subsist if the parties clearly intended that the former
relation should be extinguished in any event (NCC, Art. 1297).

Express novation
Takes place only when the intention to effect a novation clearly results from the terms of the agreement or is
shown by a full discharge of the original debt (Jurado, 2010).

Implied novation
It is imperative that the old and new obligations must be incompatible with each other.

Two-fold functions of novation

1. It extinguishes the old obligation; and
2. Creates a new obligation in lieu of the old one.

Kinds of novation
1. As to essence
a. Objective or real novation – Changing the object or principal conditions of the obligation (NCC, Art. 1291).
NOTE: In payment of sum of money, the first obligation is not novated by a second obligation that:
(1) Expressly recognizes the first obligation;
(2) Changes only the terms of payment;
(3) Adds other obligation not incompatible with the old ones; or
(4) Merely supplements the first one.

b. Subjective or personal novation – Change of the parties.

i. Substituting the person of the debtor (passive novation) – may be made without the knowledge of or
against the will of the latter, but not without the consent of the creditor.

a) Delegacion – The substitution is initiated by the old debtor himself (delegante) by convincing
another person (delegado) to take his place and to pay his obligation to the creditor.
b) Expromission – The substitution of the old debtor by a new debtor is upon the initiative or
proposal of a third person (1996, 2001 Bar).

NOTE: If it is the creditor who initiated the change of debtor, it is considered expromission
ii. Subrogating a third person to the rights of the creditor (active novation)

c. Mixed – Combination of the objective and subjective novation.

3. As to form of their constitution

a. Express – The parties declared in unequivocal terms that the obligation is extinguished by the new
obligation.
b. Implied – No express declaration that the old obligation is extinguished by the new one. The old and new
obligation is incompatible on every material point (NCC, Art. 1292).

4. As to extent of their effects

a. Total or extinctive – Obligation is originally extinguished.

NOTE: Four requisites of extinctive novation:
(1) A previous valid obligation;
(2) An agreement of all parties concerned to a new contract;
(3) The extinguishment of the old obligation; and
(4) The birth of a valid new obligation (Iloilo Traders Finance, Inc., v. Heirs of Soriano, G.R. No.
149683, June 16, 2003).

The extinctive novation would thus have the twin effects of first, extinguishing an existing obligation
and second, creating a new one in its stead.

b. Partial or modificatory – Original obligation is not extinguished but merely modified.

5. As to their origin
a. Legal novation – By operation of law (NCC, Art. 1300 & 1302).
b. Conventional novation – By agreement of the parties (NCC, Arts. 1300-1301).

6. As to presence of absence of condition

a. Pure – New obligation is not subject to a condition.
b. Conditional – When the creation of the new obligation is subject to a condition.
Novation by substitution of debtor:

The consent of the creditor is mandatory both in delegacion and expromission (NCC, Art. 1293). It may be express or
implied from his acts but not from his mere acceptance of payment by a third party, for there is no true transfer of
debt.

Requisites of delegacion:

1. Substitution is upon the initiative or proposal of the old debtor himself by proposing to the creditor the
entry of another (third person) as the new debtor who will replace him in payment of the obligation;
2. The creditor accepts and the new debtor agrees to the proposal of the old debtor; and
3. The old debtor is released from the obligation with the consent of the creditor.

Requisites of expromission:

1. Substitution is upon the initiative or proposal of a third person who will step into the shoes of the debtor;
2. Creditor must give his consent to the proposal of the third person; and
3. Old debtor must be released from the obligation with the consent of the creditor.

Effects of novation
1. Extinguishment of principal also extinguishes the accessory, except:
a. Mortgagor, pledgor, surety or guarantor agrees to be bound by the new obligation (Tolentino, 1999); or
b. Stipulation made in favor of a third person such as stipulation pour atrui (NCC, Art. 1311) unless beneficiary
consents to the novation (NCC, Art. 1296).

2. If old obligation is:

a. Void – Novation is void (NCC, Art. 1298)
b. Voidable – Novation is valid provided that the annulment may be claimed only by the debtor or when
ratification validates acts (NCC, Art. 1298).
c. If the old obligation was subject to a suspensive or resolutory condition, the new obligation shall be under
the same condition, unless it is otherwise stipulated. (NCC, Art. 1299).

3. If old obligation is conditional and the new obligation is pure:

a. If resolutory and it occurred – Old obligation already extinguished; no new obligation since nothing to
novate.
b. If suspensive and it did not occur – It is as if there is no obligation; thus, there is nothing to novate.

4. If the new obligation is:

a. Void – Original one shall subsist, unless the parties intended that the former relation should be extinguished
in any event (NCC, Art. 1297).
b. Voidable – Novation can take place, except when such new obligation is annulled. In such case, old
obligation shall subsist.
c. Pure obligation – Conditions of old obligation deemed attached to the new, unless otherwise stipulated
(Tolentino, 1999).
d. Conditional Obligation:
i. If resolutory – Valid until the happening of the condition (NCC, Art. 1181).
ii. If suspensive and did not materialize – No novation, old obligation is enforced. (NCC, Art. 1181).

Subrogation
It is the active subjective novation characterized by the transfer to a third person of all rights appertaining to the
creditor in the transaction concerned including the right to proceed against the guarantors or possessors of
mortgages and similar others subject to any applicable legal provision or any stipulation agreed upon by the parties
in conventional subrogation.

Kinds of subrogation
1. As to their creation
a. Legal subrogation – Constituted by virtue of a law (NCC, Articles 1300 and 1302);
b. Voluntary or conventional subrogation – Created by the parties by their voluntary agreement (NCC,
Art. 1300);

2. As to their extent
a. Total subrogation – Credits or rights of the creditor in the transaction are totally transferred to the
third person.
b. Partial subrogation – Only part of the credit or rights of the creditor in the transaction are
transferred to the third person.

BASIS CONVENTIONAL ASSIGNMENT OF

SUBROGATION
Governing law Article 1300-1304
Effect It extinguishes the
original obligation and
creates a new one.
CREDITS OR RIGHTS
Article 1624-1627
The transfer of the credit
or right does not
extinguish or modify the
obligation. The
transferee becomes the
new creditor for the
same obligation.

Need for consent of The consent of the The consent of the

debtor debtor is necessary (NCC, debtor is not necessary.
Art. 1301). Notification is enough for
the validity of the
assignment
(NCC, Art. 1626).

Effectivity Begins from the moment Begins from notification

of subrogation.
Curability of defect or The defect in the old
vice obligation may be cured
such that the new
obligation becomes valid.
of the debtor.
The defect in the credit
or rights is not cured by
its mere assignment to a
third person.

Defense Debtor cannot set up a The debtor can still set

defense against the new up the defense (available
creditor which he could against the old creditor)
have availed himself of against the new creditor.
against the old creditor.