INTRODUCTION (3) Cause of the obligation which is established.
Meaning and scope of credit transactions.
 Credit transactions include all transactions involving the
purchase or loan of goods, services, or money in the
present with a promise to pay or deliver in the future.
 By the use of credit, more exchanges are possible,
persons are able to enjoy a thing today but pay for it
later, and through the banking system, actual money
transfer is eliminated by cancellation of debts and credits.
 Bailment contracts, together with the other related
subjects such as usury (Act No. 2655, as amended [The
Usury Law].), the contracts of guaranty and suretyship,
mortgage, antichresis, and concurrence and preference of
credits (Arts. 2236-2251.), all make up the so-called
“credit transactions.
 Credit transaction may consist of a principal contract and
contracts of security.
Security
Security — something given, deposited, or serving as a means to
ensure the fulfillment or enforcement of an obligation or of
protecting some interest in property.
Secured creditor — one who holds a security from his debtor for
payment of the latter’s debts.
Two types of credit transaction in terms of security
1. Secured transactions or contracts of property or real
security — those supported by a collateral or an
encumbrance of property or some other security intended
to secure the fulfillment of the principal obligation
Example: mortgage, pledge, antichresis, charge or lien or other
device used to have property held
2. Unsecured transactions or contracts of personal security
— those the fulfillment of which by the principal debtor
is secured or supported only by a promise to pay or the
personal commitment of the debtor.
Example: surety or guarantor
Bailment.
 Comes from the French word “bailler” which means “to
deliver.”
 It is the delivery of property of one person to another in
trust for a specific purpose, with a contract, express or
implied, that the trust shall be faithfully executed and the
property returned or duly accounted for when the special
purpose is accomplished or kept until the bailor reclaims
it.
 Bailment signifies a situation in which one person holds
personal property, the ownership of which is in another.
- The person who has possession is under obligation to
return the same goods, either in the same or in an altered
form, to the owner, or dispose of them for his benefit,
when the purpose of the bailment shall have been
accomplished.
 Bailment may be said to be a contractual relation
involving an agreement between the parties that the
property ultimately is to be returned by the bailee to the
bailor or is to be delivered to a designated third party.
Creation of bailment
It does not necessarily mean that an agreement is always necessary
to create bailment. It may be created by operation of law.
Article 1996. A deposit is necessary:
(1) When it is made in compliance with a legal obligation;
(2) When it takes place on the occasion of any calamity, such
as fire, storm, flood, pillage, shipwreck, or other similar events.
To be legally enforceable, it must contain all the elements of a
valid contract.
Article 1318. There is no contract unless the following requisites
concur:
(1) Consent of the contracting parties;
(2) Object certain which is the subject matter of the contract;
Elements of bailment
1. The bailor retains title of the personal property
2. The possession or temporary control of the property is
delivered or transferred to the bailee
3. The bailee accepts possession of the property
4. The possession of the bailee is for a specific purpose
5. The parties intend that the identical property (or tangible
goods of the same quantity and quality) will be returned
to the bailor at the end of the bailment unless the bailor
directs that it be given to another person or its disposal
by bailee.
Parties in bailment
Bailor (Comodatario) — the giver - the party who delivers the
possession or custody of the thing bailed.
Bailee (Comodante) — the recipient - the party who receives the
possession or custody of the thing thus delivered.
Kinds of contractual bailment
 In every bailment, there is an obligation on the part of the
bailee to restore the subject of the bailment in the same
or in altered form or to account therefor.
 The classification is generally with reference to
compensation under which bailments are divided into
three heads:
1. Those for the sole benefit of the bailor – includes
gratuitous deposit (Art. 1965) and mandatum
- Mandatum – a bailment of goods without recompense
where the mandatory or person to whom the property is
delivered undertakes to do some act with respect to the
same; as simply to carry it, or keep it, or otherwise to do
something with respect to it gratuitously.
- For the reason that the bailor derives the entire benefit,
the bailee is liable for damages to the goods in his
possession only in case of gross negligence.
- The bailee is required to use the slight care and is liable
only for gross negligence.
2. Those for the sole benefit of the bailee – commodatum
and mutuum or gratuitous simple loan (Art. 1933)
- The bailee is liable for damages, even in case he is guilty
only of simple negligence since he derives the sole
benefit.
- The bailee is required to use great care.
NOTE: The first two kinds are the gratuitous bailments. In such
bailments, there is really no consideration for they are considered
more as a favor by one party to the party benefited but the law
imposes definite obligations upon both the bailor and the bailee.
3. Those for the benefit of both parties – deposit for a
compensation (Art. 1965.), including involuntary deposit
(Arts. 1996[2], 1997[2]), pledge (Arts. 2085|2903.) and
bailments for hire (locatio et conductio).
A. Bailments of mere keeping (e.g.
warehousemen/agents)
B. Bailments of goods delivered to another to do work
upon (e.g. watch left for repair)
C. Bailments of goods delivered to another to work
with (e.g. baggage is checked)
D. Bailments for security (e.g. pledge)
E. Bailments of vendor in possession after sale
- The third type includes deposit for a compensation and
which usually results from bailments involving business
transactions.
- These bailments are known as mutual-benefit
bailments.
- Mutual benefit bailee is required to use ordinary care,
and is, therefore, liable for ordinary negligence.
4. Fortuitous bailments (bailments arising out of finding, salvage,
theft, etc.)
- This includes a miserable deposit (Art. 1996[2])
5. Extraordinary bailments – cover businesses that peculiarly serve
the public
- This includes common carrier (Art. 1754) and the duty of an
innkeeper to serve all who come (Art. 1998)
Kinds of bailment for hire
Bailment for hire (locatio et conductio) — arises when goods are
left with the bailee for some use or service by him and is always for
some compensation.
1. Hire of things (locatio rei)— where goods are delivered
for the temporary use of the hirer (i.e., lease, Arts. 1642,
1643.)
2. Hire of service (locatio operis faciendi)— where goods
are delivered for some work or labor upon it by the bailee
(i.e., contract for a piece of work [Art. 1713])
3. Hire for carriage of goods (locatio operis mercium
vehendarum)— where goods are delivered either to a
common carrier (Art. 1732.) or to a private person for the
purpose of being carried from place to place
4. Hire of custody (locatio custodiae)— where goods are
delivered for storage. (Arts. 1507-1520; Act No. 2137
[The Warehouse Receipts Law])
LOAN
ART. 1933. By the contract of loan, one of the parties delivers to
another, either something not consumable so that the latter may
use the same for a certain time and return it, in which case the
contract is called a commodatum; or money or other consumable
thing, upon the condition that the same amount of the same kind
and quality shall be paid, in which case the contract is simply
called a loan or mutuum.
Commodatum is essentially gratuitous.
Simple loan may be gratuitous or with a stipulation to pay interest.
In commodatum the bailor retains the ownerships of the thing
loaned, while in simple loan, ownership passes to the borrower.
Contract of Loan
The contract of loan is governed by the rules as to the requisites
and validity of contracts in general.
Cause or consideration in a contract of loan
In a contract of loan, the cause is:
1. as to the borrower – the acquisition of the thing
2. as to the lender – the right to demand its return or its
equivalent
Kinds of loan
1. Commodatum — where the bailor (lender) delivers to the
bailee (borrower) a non-consumable thing so that the
latter may use it for a certain time and return the identical
thing
- Commodatum is a loan of use because there is a transfer
of the use of the thing borrowed
- Commodatum is derived from the word “commodore”
which means “to loan”
- In a commodatum, the bailee returns the same thing to
the bailor
2. Mutuum (simple loan) — where the lender delivers to the
borrower money or other consumable thing upon the
condition that the latter shall pay the same amount of the
same kind and quality (tantundem eiusdem generis)
- Mutuum is a loan of consumption because there is a
transfer of the ownership of the thing which is generally
received for consumption
- A thing is consumable when it is consumed when used in
a manner appropriate to its purpose or nature, like rice,
gasoline, money, fruit, firewood, etc. (Art. 418.)
- Mutuum is a derived from “meum y tuum (me and you),
because under this contract, a transfer of ownership
occurs and “what is mine becomes yours.”
- Mutuum is also believed to be derived from “mutare”
which means “to change” or “to swap” – ownership of
the object lent is passed to the borrower, who becomes
obligated to the lender not to return the very things he
had received, but (in the case of money) an equal sum, or
(as far as other fungibles were concerned), objects of the
same kind, quality and quantity.
Loans distinguished from credit
 Credit of an individual – ability to borrow money or
things by virtue of the confidence or trust reposed by a
lender that he will pay what he may promise within a
specified period.
 Loan (mutuum) – the delivery by one party (lender/
creditor), and the receipt by the other party
(borrower/debtor) who become the owner, of a given
sum of money or other consumable thing upon an
agreement, express or implied, to repay amount of the
same kind and quality, with or without interest.
 The concession of a “credit” necessarily involves the
granting of “loans” up to the limit of the amount fixed in
the “credit.”
Meaning of credit as opposed to debt
 The term “credit,” in its usual meaning, is a sum credited
on the books of a company to a person who appears to be
entitled to it.
 It presupposes a creditor-debtor relationship, and may be
said to imply ability, by reason of property or estates, to
make a promised payment.
 It is the correlative to debt or indebtedness, and that
which is due to any person as distinguished from that
which he owes.
 It is a debt considered from the creditor’s standpoint. It
may consist of money, goods, or services.
Distinguished commodatum and mutuum (simple loan)
1. Commodatum ordinarily involves something not
consumable, while in mutuum, the subject matter is
money or other consumable thing.
2. In commodatum, ownership of the thing loaned is
retained by the lender, while in mutuum, the ownership is
transferred to the borrower;
3. Commodatum is essentially gratuitous, while mutuum
may be gratuitous or it may be onerous, that is, with
stipulation to pay interest;
4. In commodatum, the borrower must return the same
thing loaned, while in mutuum, the borrower need only
pay the same amount of the same kind and quality.
5. Commodatum may involve real or personal property,
while mutuum refers only to personal property.
6. Commodatum is a loan for use or temporary possession,
while mutuum is a loan for consumption.
7. In commodatum, the bailor may demand the return of the
thing loaned before the expiration of the term in case of
urgent need, while in mutuum, the lender may not
demand its return before the lapse of the term agreed
upon.
8. In commodatum, the loss of the subject matter is suffered
by the bailor since he is the owner, while in mutuum, the
borrower suffers the loss even if caused exclusively by a
fortuitous event and he is not, therefore, discharged from
his duty to pay.
9. It may also be said that while commodatum is purely
 personal in character, mutuum is not so.
Kinds of commodatum
1. Ordinary commodatum
2. Precarium — one whereby the bailor may demand the
thing loaned at will.
ART. 1934. An accepted promise to deliver something by way of
commodatum or simple loan is binding upon the parties, but the
commodatum or simple loan itself shall not be perfected until the
delivery of the object of the contract.
Delivery Essential to Perfection
 Delivery is necessary in view of the purpose of the
contract which is to transfer either the use or ownership
of the thing loaned.
 An accepted promise to make a future loan is a
consensual contract and, therefore, binding upon the
parties but it is only after delivery, will the real
contract of loan arise.
 In reciprocal obligations, the obligation or promise of
each party is the consideration for that of the other, and
when one party has performed or is ready and willing to
perform his part of the contract, the other party who has
not performed or is not ready and willing to perform
incurs in delay.
Chapter 1. COMMODATUM
SECTION 1. — Nature of Commodatum
ART. 1935. The bailee in commodatum acquires the use of the
thing loaned but not its fruits; if any compensation is to be paid by
him who acquires the use, the contract ceases to be a
commodatum. (1941a)
Commodatum
 Commodatum is essentially gratuitous. Hence, the
contract ceases to be a commodatum if any compensation
is to be paid by the borrower who acquires the use. In
such a case, there arises a lease contract.
 If the consideration is the rendering of some service, an
innominate contract will result.
Illustrative Case:
Facts: B borrowed from L (Bureau of Animal Industry) three bulls
for breeding purposes for a period of one year, later on renewed for
another year as regards one bull. The loan was subject to the
payment by the borrower of breeding fee of 10% of the book value
of the bulls. B kept and used the bull (the loan of which was
renewed) for four years after the period stipulated in the contract
until it was killed during a Huk raid by stray bullets. B contends
that the contract was commodatum, and that, for that reason, as L
retained ownership or title to the bull, it should suffer the loss.
Issue: As the death of the bull was due to force majeure, is B
relieved from the duty of paying its value?
Ruling: No. A contract of commodatum is essentially gratuitous. If
the breeding fee be considered compensation, then the contract
would be a lease of the bull. Under Article 1671 of the Civil Code,
the lessee would be subject to the responsibilities of a possessor in
bad faith because she had continued possession of the bull after the
expiration of the contract. And even if the contract be
commodatum, still B is liable under Article 1942(2, 3).
Characteristics of the contract
The contract of loan is a:
1. real contract – (with respect to perfection) because the
delivery of the thing loaned is necessary for the
perfection of the contract (Art. 1934/Art. 1316)
2. unilateral contract – (with respect to persons obliged)
because once the subject matter has been delivered, it
creates obligations on the part of only one of the parties
(i.e., the borrower)
3. nominate contract – (with respect to nomenclature)
because it has been given a specific name by the Civil
Code.
4. principal contract – (with respect to dependency on
another contract) because its existence is not dependent
on another contract
5. informal contract – (with respect to form) because no
particular form is required in the contract
6. gratuitous contract – (with respect to cause) as the bailee
does not pay the bailor for the use of the thing
Essential requisites of the contract
The contract of commodatum must have all the essential requisites
of a contract:
1. consent of the contracting parties
- Consent is manifested by the meeting of the offer and the
acceptance upon the thing and the cause which are to
constitute the contract.
- Consent must be given by parties who have capacity to
give consent.
2. object certain which is the subject matter of the contract
- A commodatum covers things that are not consumable,
otherwise the bailee will not be able to comply with the
obligation to return the thing received.
- The subject matter of the contract is either movable or
immovable, determinate and not impossible.
- The object of the contract must be within the commerce
of men.
- The fruits of the thing loaned do not form part of the
object of the contract, unless otherwise agreed upon by
the parties.
3. cause of the obligation which is established
- Commodatum is essentially gratuitous, the cause of
which is the mere liberality of the benefactor (bailor)
- The contract ceases to be commodatum if any
compensation is to be paid by the borrower who acquires
the use. In such case, a lease contract arises.
- If the consideration is the rendering of some service, an
innominate contract shall arise
NOTES:
 Commodatum is a real contract, therefore, it is not
perfected by mere consent of the parties. Delivery of the
thing is required for the perfection of the contract.
 An accepted promise to deliver something, but not yet
followed by delivery will constitute a contract of loan,
but not of commodatum which is characterized by,
among others, the obligation to return the thing received.
c. Parties to the contract
1. Bailor
- The bailor need not be the owner of the thing loaned as he does
not transfer the ownership of the thing loaned.
2. Bailee
- The bailee is sopped from asserting title to thing received as
against the bailor
Commodatum as a unilateral contract
 The obligation of the bailee do not arise upon perfection
of the contract but may arise after the perfection of the
contract.
 The obligation of the bailor may or may not arise, only
the bailee has the obligation at the time of the perfection
of the contract, thus, a commodatum should be classified
as a unilateral contract.
1. The obligation of the bailor to respect the duration of the
loan is a necessary consequence of the contract of
commodatum. The bailor is generally obligated to allow
the bailee to use the thing during the time agreed upon or
during the period needed for the use of the thing. This is
the necessary consequence of the grant itself.
2. The bailor has the right to demand the return if the thing
under certain instances (he should have urgent need of
the thing, he may demand its return or temporary use).
3. The obligation of the bailor under a commodatum arises
from:
 a. The bailee incurred extraordinary expenses for the
preservation for the preservation of the thing loaned, in
which case the bailor is obligated to refund such
extraordinary expenses.
b. The bailee suffered damages because the bailor, knowing
the flaws of the thing loaned, did not advise the bailee of
the same, in which case, the bailor will be liable to the
bailee for the damages.
Form of the contract
 There is no required form for a commodatum and only
the delivery of the thing perfects the contract.
 A commodatum may be made orally or written.
 If a contract involves immovable property, then the
agreement must be written and in a public instrument.
However, the requirement of public instrument is only
for the convenience of the parties and will not affect the
validity of the contract.
Contract similar to donation
Commodatum is similar to a donation in that it confers a benefit to
the recipient. The presumption is that the bailor has loaned the
thing for having no need therefor. (Art. 1946[2]).
Extent of bailee’s right of use
 The right to use is limited to the thing loaned but not to
its fruits unless there is a stipulation to the contrary.
 As owner of the thing loaned, the bailor is naturally
entitled to its fruits.
Purpose of the contract
 The purpose of the contract of commodatum must be the
temporary use of the thing loaned. If the bailee is not
entitled to the use of the thing, the contract may be a
deposit and not a commodatum.
 It is an essential feature of the contract of commodatum
that the use of the property of another shall be “for a
certain time.” (Art. 1933[2])
Extinguishment of the contract
1. The expiration if the stipulated period or accomplishment
of the use for which the thing was given.
2. The return by the bailee of the thing after demanded by
the bailor in the event that the bailor has urgent need of
the thing
3. The return of the thing in case of precarium or in the
event that the bailee committed any acts of ingratitude
4. The loss of the thing
5. The death of the bailor or the bailee
ART. 1936. Consumable goods may be the subject of
commodatum if the purpose of the contract is not the consumption
of the object, as when it is merely for exhibition.
ART. 1937. Movable or immovable property may be the object of
commodatum
Subject Matter of the Contract
In commodatum, the subject matter is generally non-consumable
things, whether real or personal. This but conforms to reality, for
the bailee cannot use and return something which is consumed
when used.
a. An example of commodatum involving real property is
when a person allowed another to build a warehouse on
the former’s land so that the latter may use the property
for a certain period without any payment of rentals. If no
time for use of the land is specified, the contract would
be that specie of commodatum called “precarium”
expressly recognized in Article 1947. If rental is paid, the
contract would be one of lease.
b. There are instances where a commadatum may have for
its object a consumable thing. Consumable goods may be
the subject of the commodatum if the purpose of the
contract is not the consumption of the object as when it is
merely for exhibition.
Example:
L lends to B an oversized bottle of wine to be used as a sample or
for advertisement. If the intention of the parties is to have the
consumable goods loaned returned at the end of the period agreed
upon, the loan is a commodatum and not a mutuum.
ART. 1938. The bailor in commodatum need not be the owner of
the thing loaned
Bailor Need Not Be Owner
In commodatum, the bailor need not be the owner of the thing
loaned since by the loan, ownership does not pass to the
borrower.
- A mere lessee of the thing (Arts. 1643, 1650) or the
usufructuary (one entitled to the use and the fruits of
property belonging to another [Art. 562]) may lend
- A lessee may sublet the thing leased, when there is no
express prohibition in the contract of lease. If the lessee,
by a contract of sublease, may transfer to another the
enjoyment of the thing leased for a consideration, there is
no reason why he should be unable to cede gratuitously
its use by way of commodatum.
- The borrower or bailee himself may not lend nor lease
the thing loaned to him to a third person. (Art. 1939[2])
ART. 1939. Commodatum is purely personal in character.
Consequently:
The death of either the bailor or the bailee extinguishes the
contract;
The bailee can neither lend nor lease the object of the contract to a
third person. However, the members of the bailee’s household may
make use of the thing loaned, unless there is a stipulation to the
contrary, or unless the nature of the thing forbids such use
Commodatum – Purely Personal in Character
Commodatum is a purely personal contract, the lender having in
view the character, credit, and conduct of the borrower. Hence, the
death of either party terminates the contract.
Exceptions:
1. There is a stipulation to the effect that the commodatum
is transmitted to the heirs of either or both parties. Such
stipulation is valid for par. [1] presupposes the absence of
any contrary stipulation.
2. If there are two or more borrowers, the death of one does
not extinguish the contract in the absence of stipulation
to the contrary.
Right of bailee to lend thing loaned to third persons
The bailee can neither lend nor lease the object of the contract to a
third person.
Exceptions:
1. The parties have some understanding or agreement to the
effect that the bailee can lend nor lease the object of the
contract to a third person.
2. The use of the thing loaned (e.g., television set) may
extend to the members of the bailee’s household (who
are not, therefore, considered third persons).
Exceptions to the exception:
a. there is a stipulation to the contrary
b. the nature of the thing (e.g., dress) forbids such use
ART. 1940. A stipulation that the bailee may make use of the fruits
of the thing loaned is valid.
Contrary Stipulation as to Fruits
 The bailee is entitled only to the use of the thing loaned
and not to its fruits.
 The right to use a thing is distinct from the right to enjoy
the fruits since, as a rule, the fruits pertain to the owner
of the thing producing the fruits. Thus, where an animal
is the thing loaned, its young subsequently born is not
included in the contract. However, the parties may
 stipulate that the bailee may also make use of the fruits of
the thing, but such stipulation cannot be presumed.
 The enjoyment of the fruits must only be incidental to the
use of the thing itself for if it is the main cause, the
contract may be one of usufruct.
SECTION 2. — Obligations of the Bailee
ART. 1941. The bailee is obliged to pay for the ordinary expenses
for the use and preservation of the thing loaned.
Obligations of the Bailee
1. Take good care of the thing with the diligence of a good
father
 This obligation springs from the fact that the bailee has
the obligation to return the thing to the bailor
 The bailee shall be liable for the loss or deterioration of
the thing if there was fault or negligence on his part or
his representatives.
2. Use the thing loaned only for the purpose for which it
was loaned and for no other purpose
The bailee does not answer for the deterioration of the thing loaned
due only to the use thereof and without his fault. But if he uses
the thing for another purpose, his liability is compounded as he is
liable for his fault as well as for any fortuitous event.
3. Pay ordinary expenses for the use and preservation of the
thing and a portion of extraordinary expenses arising
from the actual use of the thing.
The obligation to pay ordinary expenses for the use and
preservation of the thing arises from his obligation to return the
identical thing.
4. Return and not retain the thing loaned except under
certain circumstances
a. Misappropriation – if the bailee did not return the thing
borrowed because the bailee misappropriated the thing,
he can be held criminally liable (e.g. estafa)
b. Retention of thing – if the bailee did not return the thing
because the bailee wants to use the thing beyond the
agreed period, the bailee commits a breach of contract
and becomes liable for loss of the thing even if the loss
should be through a fortuitous event, as well as for the
damages suffered by the bailor.
c. Loss of the thing – If the bailee did not return the thing
because it was lost without the fault of the bailee, the
bailee is not liable.
Exception: If the thing loaned was delivered with an appraisal of its
value, the bailee is liable even in the case of a fortuitous event
(unless there is a stipulation to the contrary)
Manner of return
1. What – the bailee must return the same thing borrowed
2. When – the bailee must generally return the thing upon
the expiration of the period stipulated, or after the
accomplishment of the use for which commodatum has
been constituted.
Exceptions:
a. The bailee must return the thing upon demand of the
bailor in cases when the latter has urgent need of the
thing
b. The bailee must return the thing in case of precarium –
when he committed any act of ingratitude
3. Where –
a. If the parties agreed on the place of return, the return
must be made in the place stipulated.
b. If no place of return is stipulated the delivery must be
made at the place where the thing might be at the
moment the obligation was constituted.
ART. 1942. The bailee is liable for the loss of the thing, even if it
should be through a fortuitous event:
1. If he devotes the thing to any purpose different from that for
which it has been loaned;
2. If he keeps it longer than the period stipulated, or after the
accomplishment of the use for which the commodatum has been
constituted;
3. If the thing loaned has been delivered with appraisal of its value,
unless there is a stipulation exempting the bailee from
responsibility in case of a fortuitous event;
4. If he lends or leases the thing to a third person, who is not a
member of his household;
5. If, being able to save either the thing borrowed or his own thing,
he chose to save the latter
Risk of Loss of Thing Loaned
General Rule: the bailor bears the risk of loss or damage to the
thing borrowed as a result of a fortuitous event. The reason is that
the bailor retains the ownership of the thing loaned.
Exceptions:
1. If he devotes the thing to any purpose different from that
for which it has been loaned – the bailee acts in bad faith.
2. If he keeps it longer than the period stipulated, or after
the accomplishment of the use for which the
commodatum has been constituted – the bailee incurs in
delay
3. If the thing loaned has been delivered with appraisal of
its value, unless there is a stipulation exempting the
bailee from responsibility in case of a fortuitous event –
the law presumes that the parties intended that the
borrower shall be liable for the loss of the thing even if it
is due to a fortuitous event for otherwise they would not
have appraised the thing
4. If he lends or leases the thing to a third person, who is
not a member of his household – commodatum is purely
personal
5. If, being able to save either the thing borrowed or his
own thing, he chose to save the latter – the bailee shows
his ingratitude after the thing is gratuitously loaned to
him
ART. 1943. The bailee does not answer for the deterioration of the
thing loaned due only to the use thereof and without his fault
Liability for Deterioration of Thing Loaned.
1. Due to ordinary wear and tear – The parties to the
contract know that the thing borrowed cannot be used
without deterioration due to ordinary wear and tear.
Hence, in the absence of agreement to the contrary, the
depreciation caused by the reasonable and natural use of
the thing is borne by the bailor.
2. Due to bailee’s fault and negligence – The bailee is liable
if he is guilty of fault or negligence or if he devotes the
thing to any purpose different from that for which it has
been loaned.
ART. 1944. The bailee cannot retain the thing loaned on the
ground that the bailor owes him something, even though it may be
by reason of expenses. However, the bailee has a right of retention
for damages mentioned in Article 1951.
Obligation to Return Thing Loaned
Except for a claim for damages suffered because of the flaws of the
thing loaned, the borrower has no right to retain the thing loaned as
security for claims he has against the lender, even though they may
be by reason of extraordinary expenses.
1. Ownership remains in bailor — The borrower acquires
only the use of the thing the ownership of which remains
in the lender. It would be extremely harsh if the bailor,
after benefiting the bailee, and the use having been
accomplished, should be deprived of its enjoyment on the
excuse of the expenses more or less certain or just.
2. Only temporary use given to bailee — The bailee would
be violating the bailor’s trust in him to return the thing as
soon as the period stipulated expires or the purpose has
been accomplished. Therefore, the law imposes upon him
the obligation to return the same.
Effect of retention or adverse claim by bailee
1. The mere failure of the bailee to return the subject matter
of commodatum to the bailor does not constitute adverse
possession on the part of the bailee who holds the same
in trust.
2. In a case, the bailee declared the lots in question in its
name for taxation purposes. It was held that the action of
the bailee by such adverse claim could not ripen into title
by way of ordinary acquisitive prescription because of
the absence of just title.
Right of retention for damages
The bailee’s right extends no further than to the retention of the
thing loaned until he is reimbursed for the damages suffered by
him. He cannot lawfully sell the thing to satisfy said damages.
ART. 1945. When there are two or more bailees to whom a thing is
loaned in the same contract, they are liable solidarily
Liability of Two or More Bailees
The reason for imposing solidary liability where there are two or
more borrowers is to safeguard effectively the rights of the lender.
The law presumes that the bailor takes into account the personal
integrity and responsibility of all the bailees and that, therefore, he
would not have constituted the commodatum if there were only one
bailee.
Exception:
The he concurrence of two or more parties in the same obligation
gives rise only to a joint obligation.
SECTION 3. — Obligations of the Bailor
ART. 1946. The bailor cannot demand the return of the thing
loaned till after the expiration of the period stipulated, or after the
accomplishment of the use for which the commodatum has been
constituted. However, if in the meantime, he should have urgent
need of the thing, he may demand its return or temporary use.
In case of temporary use by the bailor, the contract of
commodatum is suspended while the thing is in the possession of
the bailor
Obligation to Respect Duration of Loan
 The primary obligation of the bailor is to allow the bailee
the use of the thing loaned for the duration of the period
stipulated or until the accomplishment of the purpose for
which the commodatum was constituted. The reason is
that the bailor is bound by the terms of the contract of
commodatum which is “for a certain time.”
 Commodatum has a term equivalent to (1) the period
stipulated or (2) the period necessary for the
accomplishment of the use for which the commadatum
has been constituted. In the absence of the term, the
contractual relation is precarium and the bailor may
demand the thing at any time.
 However, if he should have an urgent need of the thing
(e.g., he needs the car loaned by him to bring a sick
member of his household to a hospital) or if the borrower
commits an act of ingratitude, he may demand its return
or temporary use. This right of the bailor is based on the
fact that commodatum is essentially gratuitous.
 Under this article, the return may be only temporary or it
may be permanent because the law uses “its return”
(meaning permanent) or “temporary use.” In case of
temporary use of the thing by the bailor, the rights and
duties of the parties are likewise temporarily suspended.
ART. 1947. The bailor may demand the thing at will, and the
contractual relation is called a precarium, in the following cases: If
neither the duration of the contract nor the use to which the thing
loaned should be devoted, has been stipulated; or If the use of the
thing is merely tolerated by the owner.
Precarium
Precarium is a kind of commodatum where the bailor may demand
the thing at will. It has been defined as a “contract by which the
owner of a thing, at the request of another person, gives the latter
the thing for use as long as the owner shall please.”
Cases when contract is precarium
In either of the two cases mentioned in Article 1947, it is presumed
that use of the thing has been granted subject to revocation by the
bailor at any time, whether or not the use for which the thing has
been loaned has been accomplished.
Example: Gratuitous use of furniture was subject to the condition
that lessee would return them upon lessor’s demand but
notwithstanding such demand, former continued to use furniture
until expiration of lease.
In the ordinary commodatum, the possession of the bailee is more
secure for he has the right to retain the thing loaned until the
expiration of the period agreed upon, or the accomplishment of the
use for which the commodatum has been constituted.
ART. 1948. The bailor may demand the immediate return of the
thing if the bailee commits any acts of ingratitude specified in
Article 765.
Right of Bailor to Demand Return of Thing for Acts of
Ingratitude
 Article 765 is applicable because like a donation,
commodatum is essentially gratuitous.
 The bailee who commits any of the acts of ingratitude
makes himself unworthy of the trust reposed upon him
by the bailor. Hence, the right given to the bailor to
demand the immediate return of the thing.
 Based on Article 765 of the Civil Code, any of the
following constitutes act of ingratitude:
1. If the bailee should commit some offenses against the
person, the honor or the property of the bailor, or of his
wife or children under his parental authority;
2. If the bailee imputes to the bailor any criminal offense, or
any act involving moral turpitude, even though he should
prove it, unless the crime or the act has been committed
against the bailee himself, his wife or children under his
authority; and
3. If the bailee unduly refuses the bailor support when the
bailee is legally or morally bound to give support to the
bailor.
ART. 1949. The bailor shall refund the extraordinary expenses
during the contract for the preservation of the thing loaned,
provided the bailee brings the same to the knowledge of the bailor
before incurring them, except when they are so urgent that the
reply to the notifi cation cannot be awaited without danger.
If the extraordinary expenses arise on the occasion of the actual use
of the thing by the bailee, even though he acted without fault, they
shall be borne equally by both the bailor and the bailee, unless
there is a stipulation to the contrary.
Obligation of the Bailor
1. Obligation to pay damages for known hidden flaws.
2. Obligation to refund extraordinary expenses for the
preservation of the thing loaned
Obligation to refund extraordinary expenses
1. Extraordinary expenses for the preservation of the thing
loaned — Such expenses shall be borne by the bailor
(e.g., expenses for repairing borrowed house damaged by
a typhoon). The reason is that it is the bailor who profits
by said expenses.
 If they are incurred by the bailee, the bailor must refund
them provided the bailee brings the same to the
knowledge of the bailor before incurring them.
 As a rule, notice is required because it is possible that the
bailor may not want to incur the extraordinary expenses
at all. He should be given discretion as to what must be
done with his property.
Exception: where they are so urgent that the reply to the
notification cannot be awaited without danger.
 2. Extraordinary expenses arising from actual use of the
thing loaned. — Such expenses (caused by fortuitous
event) arising on the occasion of the actual use of the
thing loaned (e.g., expenses for repairing a borrowed jeep
damaged in a collision) shall be borne by the bailor and
bailee alike on a 50-50 basis.
 “The foregoing is an equitable solution. The bailee pays
one-half because of the benefit derived from the use of
the thing loaned to him and the bailor pays the other one-
half because he is the owner and the thing will be
returned to him.’’
 The parties, however, may, by stipulation, provide for a
different apportionment of such expenses, or that they
shall be borne by the bailee or bailor only.
ART. 1950. If, for the purpose of making use of the thing, the
bailee incurs expenses other than those referred to in Articles 1941
and 1949, he is not entitled to reimbursement.
No Obligation to Assume All Other Expenses
Summary rules on expenses
1. Ordinary expenses for use of the thing – bailee
2. Ordinary expenses for the preservation of the thing –
bailee
3. Extraordinary expenses for the preservation of the thing –
equally shared by the bailor and the bailee
4. Other expenses for the use of the thing – bailee
ART. 1951. The bailor, who, knowing the flaws of the thing
loaned, does not advise the bailee of the same, shall be liable to the
latter for the damages which he may suffer by reason thereof.
Liability to Pay Damages for Known Hidden Flaws
The following are the requisites which must concur for the
application of the above article:
1. There is flaw or defect in the thing loaned;
2. The flaw or defect is hidden;
3. The bailor is aware thereof;
4. He does not advise the bailee of the same; and
5. The bailee suffers damages by reason of said flaw or
defect.
NOTES:
 The bailor is made liable for his bad faith.
 The bailee is given the right of retention until he is paid
damages.
 The same responsibility of a bailor in commodatum is
imposed on a pledgor.
EXAMPLE: If L lends to B his car without informing the latter
that its brake is not working properly, L will be liable in case B is
injured by reason thereof. The liability imposed by law is a just
sanction for the bad faith committed by L. Of course, if the defect
is patent or could have been known to B after inspection or L was
not aware of the defect, L is not liable. (see Art. 1944.) In the first
case, it is presumed that B will adopt the necessary precautions or
is willing to take the risk incident to the use of the car. In the
second case, L is not liable for the reason that commodatum is
gratuitous.
Where flaw unknown to bailor
 Where the defect is not known to the bailor, he is not
liable because commodatum is gratuitous.
 The rule is different in sale (see Art. 1547.) and lease
(see Art. 1653.) for in these contracts, valuable
consideration is received by the vendor (see Art. 1458.)
and the lessor. (see Art. 1643.)
ART. 1952. The bailor cannot exempt himself from the payment of
expenses or damages by abandoning the thing to the bailee.
No Right of Abandonment for Expenses and Damages
The reason for the above rule is that the expenses and/or damages
may exceed the value of the thing loaned, and it would, therefore,
be unfair to allow the bailor to just abandon the thing instead of
paying for said expenses and/or damages.
Chapter 2. SIMPLE LOAN OR MUTUUM
ART. 1953. A person who receives a loan of money or any other
fungible thing acquires the ownership thereof, and is bound to pay
to the creditor an equal amount of the same kind and quality.
Simple Loan or Mutuum
 Simple loan or mutuum is a contract whereby one of the
parties delivers to another money or other consumable
thing with the understanding that the same amount of the
same kind and quality shall be paid.
 It involves the return of the equivalent only and not the
identical thing because the borrower acquires ownership
thereof. A loan of money, however, may be payable in
kind.
 A simple loan is a loan without interest; with or without
stipulations to pay interest.
Characteristics of the contract
The contract of mutuum is a:
1. real contract – (with respect to perfection) because the
delivery of the thing loaned is necessary for the
perfection of the contract (Art. 1934/Art. 1316)
2. unilateral contract – (with respect to persons obliged)
because once the subject matter has been delivered, it
creates obligations on the part of only one of the parties
(i.e., the borrower)
3. nominate contract – (with respect to nomenclature)
because it has been given a specific name by the Civil
Code.
4. principal contract – (with respect to dependency on
another contract) because its existence is not dependent
on another contract
5. informal contract – (with respect to form) because no
particular form is required in the contract
6. gratuitous contract – (with respect to cause) as the bailee
does not pay the bailor for the use of the thing
Essential requisites of the contract
The contract of mutuum must have all the essential requisites of a
contract:
1. consent of the contracting parties
- Consent is manifested by the meeting of the offer and the
acceptance upon the thing and the cause which are to
constitute the contract.
- Consent must be given by parties who have capacity to
give consent.
- Delivery is an essential element (in real contracts) and is
not perfected by mere consent.
- Delivery of the thing is essential so that the borrower
may be able to consume the thing.
2. object certain which is the subject matter of the contract
- A mutuum covers things that are not consumable, such as
money.
- The contract may also cover fungible things - able to
replace or be replaced by another identical item.
- The subject matter of the contract is either movable or
immovable, determinate and not impossible.
If the object of the contract is a non-fungible thing and
the borrower has the obligation to give things of the same
kind, quantity and quality, the contract is BARTER.
- The object of the contract must be within the commerce
of men.
- The fruits of the thing loaned do not form part of the
object of the contract, unless otherwise agreed upon by
the parties.
3. cause of the obligation which is established
- Mutuum is essentially gratuitous, the cause of which is
the mere liberality of the benefactor (bailor)
- There is no obligation to pay interest unless expressly
stipulated in writing.
Parties to the contract
1. Borrower
2. Creditor – transfers the ownership of the thing loaned,
hence, must be the owner of the thing.
Mutuum as a unilateral contract
 The obligation of the borrower arises ex uno latere and
all imposed on the borrower.
 After the delivery of the thing borrowed to the borrower,
the creditor does not have any obligation.
Exception: where creditor failed to released the full
amount of the loan amount, the loan becomes a bilateral
contract that imposes reciprocal obligations on the parties
– the creditor to release the full amount of the loan and
the debtor to pay the loan when it becomes due and
demandable.
Form of contract
 There is no required form for mutuum. Since it is a real
contract, the delivery of the thing perfects the contract.
 No interest shall be due unless it is expressly stipulated in
writing.
 Contract where the amount involved exceeds P500.00
must appear in writing. However, this requirement is
only for convenience of the parties and will not affect the
validity of the contract.
Obligations of borrower
1. Pay the lender an equal amount of the same kind and
quality
2. Pay interest if expressly stipulated in writing
Obligation of borrower to pay
 The law uses the word “pay” and not the word “return”
because the consumption of the thing loaned is the
distinguishing character of the contract of mutuum from
that of commodatum.
 This obligation “to pay” may include the accessory duty
to pay interest (Article 1956.)
 The promise of the borrower to pay is the consideration
for the obligation of the lender to furnish the loan. A loan
is thus a bilateral contract.
1. What
a. Payment should be made in the currency stipulated.
- In the absence of stipulation, payment should be made in
the currency in which the money was delivered.
- If it is not possible to deliver the relevant currency,
payment should be made in the currency which is the
legal tender in the Philippines.
- The borrower must generally pay the same amount of the
principal loaned.
b. If the loan of a fungible thing is other than money,
payment should be a thing of the same kind, quantity and
quality.
If it is not possible to deliver the same kind, quantity and
quality, its value at the time of the loan shall be paid
2. When
 If the parties agreed on a period, then the thing borrowed
must be returned at the end of such period.
 Borrower may lose the right to use period (e.g.
insolvency)
3. Where
 If the parties agreed on the place of payment, payment
shall be paid in the place agreed upon.
 If the parties had stipulated no place of payment,
payment shall be made at the domicile of the debtor.
No criminal liability for failure to pay
 In simple loan or mutuum, the borrower acquires
ownership of the money, goods, or personal property
borrowed. Being the owner, the borrower can dispose of
the thing borrowed and his act will not be considered
misappropriation thereof.
 No estafa is committed by a person who refuses to pay
his debt or denies its existence because of the absence of
fiduciary relationship (trust)
Simple loan distinguished from contract of rent
1. A contract of loan signifies the delivery of money or
some other consumable thing to another with a promise
to repay an equivalent amount of the same kind and
quality, but not a promise to return the same thing loaned
which becomes the property of the obligor.
The contract of rent is a contract by which one of the
parties delivers to another some non-consumable thing in
order that the latter may use it during a certain period and
return it to the former. In a contract of rent, the owner or
lessor of the property does not lose his ownership. He
simply loses his control over the property rented during
the period of the contract;
2. In a contract of loan, the relation between the parties is
that of obligor and obligee, while in a contract of “rent,”
the relation is that of landlord and tenant; and
In a contract of loan, the creditor receives “payment” for
his loan, while in a contract of “rent,” the owner of the
property rented receives “compensation” or “price” either
in money, provisions, chattels, or labor from the
occupant thereof in return for its use.
Meaning of fungible things
Fungible things are those which are usually dealt with by number,
weight, or measure such as rice, oil, sugar, etc. so that any given
unit or portion is treated as the equivalent of any other unit or
portion.
Example: one cavan of “wagwag” rice of a particular quality is, to
all intents and purposes, the same as any other portion of the same
kind, quality, and quantity.
Illustrative Case:
Standing crops given as security for a loan of money were
destroyed due to a fortuitous event.
Facts: B received money as a loan with interest from L secured by
a chattel mortgage on the standing crops on B’s land. The crops
were destroyed due to a fortuitous event.
Issue: Is the obligation of B to pay the loan extinguished?
Held: No. The obligation of B is not to deliver a determinate thing,
namely: the crops to be harvested on his land, but to pay a generic
thing, the amount of money representing the loan with interest. (see
Art. 1263.) The loss of the mortgaged crops did not extinguish his
obligation to pay, because it could still be paid from other sources
aside from the crops. The chattel mortgage simply stood as a
security for the fulfillment of his obligation. (Republic vs. Grijaldo,
15 SCRA 681 [1965].)
Distinction between fungible and consumable things.
Whether a thing is consumable or not depends upon its nature and
whether it is fungible or not depends upon the intention of the
parties. Thus, while wine is consumable by its nature, it is non-
fungible if the intention is merely for display or exhibition because
the same wine must be returned.
Extinguishment of contract
1. Confusion – if the debtor succeeds the creditor in the
thing loaned
 2. Condonation of the debt
3. Compensation
4. Novation
The loss of the thing will not extinguish the obligation (unless
otherwise provided in the contract). The debtor is obligated to
deliver a generic thing and genus non periit – genus never perishes.
Risk of loss and deterioration
In mutuum, the loss of the thing borrowed (money) does not affect
the debtor’s obligation to pay.
ART. 1954. A contract whereby one person transfers the
ownership of non-fungible things to another with the obligation on
the part of the latter to give things of the same kind, quantity, and
quality shall be considered a barter
Mutuum and Commodatum Distinguished From Barter
By the contract of barter or exchange, one of the parties binds
himself to give one thing in consideration of the other’s promise to
give another thing.
1. The distinction between mutuum and barter lies in the
subject matter. In the former, it is money or any other
fungible things; in the latter, non-fungible (non-
consumable) things.
2. In commodatum, the bailee is bound to return the
identical thing borrowed when the time has expired or
the purpose has been served. In barter, the equivalent
thing is given in return for what has been received.
3. Mutuum may be gratuitous and commodatum is always
gratuitous. (Art. 1933, pars. 2, 3.) Barter, on the other
hand, is an onerous contract. It is really a mutual sale.
(see Art. 1641.)
ART. 1955. The obligation of a person who borrows money shall
be governed by the provisions of Articles 1249 and 1250 of this
Code.
If what was loaned is a fungible thing other than money, the debtor
owes another thing of the same kind, quantity and quality, even if it
should change in value. In case it is impossible to deliver the same
kind, its value at the time of the perfection of the loan shall be paid.
Form of payment.
The object of simple loan may be either money or consumable or
fungible things.
1. Loan of money. — If the thing loaned is money, payment
must be made in the currency stipulated, if it is possible
to deliver such currency; otherwise, it is payable in the
currency which is legal tender in the Philippines and in
case of extraordinary inflation or deflation, the basis of
payment shall be the value of the currency at the time of
the creation of the obligation.
- Presently, all notes and coins issued by the Bangko
Sentral ng Pilipinas are legal tender in the Philippines for
all debts, both public or private. A check is not a legal
tender and, therefore, cannot constitute valid tender of
payment.
EXAMPLE:
D borrowed from C P5,000.00 payable after five years. On the
maturity of the obligation, the value of P5,000.00 dropped to
P2,500 because of inflation.
In this case, the basis of payment shall be the equivalent value of
the currency today five years ago. Hence, D is liable to pay C
P10,000.00 unless there is an agreement to the contrary.
2. Loan of fungible thing. — If what was loaned is a
fungible thing other than money, the borrower is under
obligation to pay the lender another thing of the same
kind, quality, and quantity. In case it is impossible to do
so, the borrower shall pay its value at the time of the
perfection of the loan.
EXAMPLE:
D borrowed from C two sacks of rice of a certain kind and quality.
At the time the loan was perfected, the price of each sack was
P400.00.
D should return to C two sacks of rice of the same kind and quality
although at the time of payment, the price had increased to
P500.00. If on the due date of the obligation, the same kind of rice
could not be delivered by D because it was not available for some
reason, then D should pay C the sum of P800.00 instead, the value
of the rice at the time of the perfection of the loan.
ART. 1956. No interest shall be due unless it has been expressly
stipulated in writing.
Interest
Interest may be paid either as compensation for the use of money
(monetary interest) or imposed by law or by courts as penalty or
indemnity for damages (compensatory interest) for breach of
contractual obligations.
Kinds of interest
1. Simple interest – that which is paid for the principal at a
certain rate fixed or stipulated by the parties
2. Compound interest – that which is imposed upon interest
due and unpaid. The accrued interest is added to the
principal sum and the whole (principal + accrued
interest) is treated as a new principal upon which interest
for the next period is calculated.
3. Legal interest – that which the law directs to be charged
in the absence of any agreement as to the rate between
the parties (6% per annum)
4. Lawful interest – that which the law allows or does not
prohibit – the interest rate within the maximum
prescribed by law
5. Unlawful or usurious interest – that which is paid or
stipulated to be paid beyond the maximum fixed by law.
Requisites or recovery of interest
In order that interest may be chargeable, the following are the
requisites:
1. The payment of interest must be expressly
2. The agreement must be in writing
3. The interest must be lawful.
Absence of stipulation to pay interest
No interest shall be due unless it is expressly stipulated in writing.
Thus, the collection of interest without any stipulation reduced in
writing is prohibited by law.
Existence of stipulation to pay interest
1. If a particular rate of interest has been expressly
stipulated by the parties, that interest, not the legal rate of
interest, shall be applied.
2. If the exact rate of the interest is not mentioned, the legal
rate of 12% shall be payable.
3. No increase in interest shall be due unless such increase
has also been expressly stipulated.
4. Sales invoices or slips issued by a store to its customers,
stating interests and attorney’s fees in the usual printed
forms as terms and conditions, without the signature of
the obligor, do not constitute the express stipulation
required by Article 1956. Therefore, the obligor is not
liable for the interest except only the legal interest (6%)
under Article 2209 (infra.) on the amount due in case he
incurs in delay.
5. The receipt by the creditor of interest payment up to a
certain date on a loan that has already matured does not
ipso facto result in the renewal or extension of maturity
period of the loan up to said date. Whether or not a loan
may be renewed does not solely depend on the debtor but
more so on the discretion of the creditor.
6. Vendor and vendee are legally free to stipulate for the
payment of either the cash price of a subdivision lot or its
installment price. Should the vendee opt to purchase a
subdivision lot via the installment payment system, he is,
in effect, paying interest on the cash price, whether the
 fact and rate of such interest payment are disclosed in the
contract or not. The contract for the purchase and sale of
a piece of land on the installment plan is not only lawful;
it also reflects a very widespread usage or custom in our
present-day commercial life.
Exception: Liability for interest even in the absence of
stipulation
Article 1956 is subject to two exceptions:
1. Indemnity for damages. — The debtor in delay is liable
to pay legal interest (6%) as indemnity for damages even
in the absence of stipulation for the payment of interest.
- Under Article 2209, the appropriate measure for damages
in case of delay in discharging an obligation consisting of
the payment of a sum or money, or in cases involving
default in the payment of price or consideration under a
contract of sale and an action for damages for injury to
persons and loss of property and an action for damages
arising from unpaid insurance claims, is:
a. the payment of the penalty interest at the rate agreed
upon
b. in the absence of a stipulation of a particular rate of
penalty interest, then the payment of additional interest at
a rate equal to the regular monetary interest
c. if no regular interest had been agreed upon, then payment
of legal interest which is 6% annually or, in the case of
loans or forbearances of money, 12% per annum as
provided for in Central Bank Circular No. 416
- Under Article 2213, interest “cannot be recovered upon
unliquidated claims or damages except when the demand
can be established with reasonable certainty.’’
If the suit were for damages, unliquidated and not known
until definitely assessed and determined by the courts,
after proof, interest at rate of 6% per annum should be
from the date the judgment of the court is made, at
which time the qualification of damages may be deemed
to be reasonably ascertained.
2. Interest accruing from unpaid interest. — Interest due
shall earn interest from the time it is judicially demanded
although the obligation may be silent upon this point.
- This only applies where interest has been stipulated by
the parties. In cases where no interest had been stipulated
by the parties, no accrued conventional interest could
further earn interest upon judicial demand.
- Where the court’s judgment which did not provide for
the payment of interest has already become fi nal, no
interest may be awarded. What remains is the ministerial
execution of the judgment.
Liability for surcharges and penalties.
 Surcharges and penalties agreed to be paid by the debtor
in case of default partake of the nature of liquidated
damages.
 Liquidated damages, whether intended as an indemnity
or penalty, shall be equitably reduced if they are
iniquitous and unconscionable. In exercising this vested
power to determine what is iniquitous and
unconscionable, the Court must consider the
circumstances of each case.
Interest separate and distinct from surcharges and penalties
 A penalty stipulation is not necessarily preclusive of
interest, if there is an agreement to that effect, the two
being distinct concepts which may separately be
demanded. What may justify a court in not allowing the
creditor to impose full surcharges and penalties, despite
an express stipulation therefor in a valid agreement, may
not equally justify non-payment or reduction of interest.
 The charging of interest for loans forms a very essential
and fundamental element of the banking business, which
may truly be considered to be at the very core of its
existence or being. It is inconceivable for a bank to grant
loans for which it will not charge any interest at all.
Escalation clause
 An escalation clause is a stipulation allowing an increase
in the interest rate originally agreed upon by the parties
 A de-escalation clause is a stipulation allowing a
decrease in the interest rate originally agreed upon by the
parties
- An escalation clause is generally valid
Example: A stipulation that the interest rate will be
increased if the Bangko Sentral raises its discounting
rates
- Escalation clause must not be solely potestative. – An
escalation clause that grants the creditor an unbridled
right to adjust the interest independently and upwardly,
completely depriving the debtor of the right to assent to
an important modification in the agreement is void.
Example: A stipulation that the bank can increase the
stipulated interest per annum within the limits allowed by
law at any time depending on whatever policy the bank
may adopt in the future.
- Other requirement for validity
1. The escalation clause must be paired with a de-escalation
clause.
2. The escalation clause must be pegged to the prevailing
markets, and not merely to make a generalize reference
to any increase or decrease in the interest rate in the
event a law or a Central Bank regulation is passed.
3. The proposed agreement must be the result of an
agreement between the parties.
4. The repricing takes effect only upon creditor’s written
notice to the borrower of the new interest rate.
5. The borrower has the option to prepay its loan if the
borrower and the creditor do not agree on the new
interest rate.
- Consequence of invalid escalation clause
 An invalid escalation clause, being separable from the
other stipulations of a contract of loan, does not affect the
validity of the agreement.
 The interest rate payable by the borrower should be the
original interest rate agreed upon by the parties.
Interest to be based on the prevailing market rate
 The contractual provision which authorizes the creditor
to correspondingly increase the rate of the interest in the
event of changes in the prevailing markets could not be
considered an escalation clause for it neither states an
increase nor a decrease in interest rate. Said clause does
not expressly stipulate a reduction in interest rate, it
nevertheless provides a leeway for the interest rate to be
reduced in case the prevailing market dictates a
reduction.
 If the interest rate is designed to be based on the
prevailing market rate. There should always be a
reference rate upon which to peg such variable interest
rates.
Borrower’s ability to prepay the loan
 If the escalation clause is valid and the borrower does not
agree to the increase rate determined in accordance with
the escalation clause, the borrower should have the
option to prepay the loan.
 If the escalation clause is void, the lender cannot take
refuge in the right given to the borrower to prepay the
loan without penalty if the borrower is not agreeable to
the new interest rate.
ART. 1957. Contracts and stipulations, under any cloak or device
whatever, intended to circumvent the laws against usury shall be
void. The borrower may recover in accordance with the laws on
usury.
Usurious Contracts Declared Void.
1. Form of contract not conclusive. — The form of the
contract is not conclusive. Parol evidence is admissible to
show that a written document though legal in form was in
fact a cloak or device to cover usury if from a
construction of the whole transaction it becomes apparent
there exists a corrupt intention to violate the laws on
usury.
2. Contract void only as to interest involved. — A usurious
contract is void only as to the interest involved. It is only
the stipulation on usurious interest which should be
treated as void so that the loan becomes without
stipulation to pay interest. Therefore, the nullity of the
stipulation on the usurious interest does not affect the
lender’s right to receive back the principal amount of the
loan.
3. Right of debtor. — The debtor may recover the amount
paid as interest under a usurious agreement since the
payment is deemed to have been made under restraint,
rather than voluntarily.
ART. 1958. In the determination of the interest, if it is payable in
kind, its value shall be appraised at the current price of the products
or goods at the time and place of payment.
Determination of Interest Payable in Kind
Example: B borrowed P1,000.00 from L payable in palay in one
(1) year which shall be appraised at the current market price at the
time and place of payment. When the contract was entered into, the
price per cavan of palay was P500.00. On the due date of the loan,
the price increased to P600.00. In this case, the value of the palay
shall be appraised at P600.00 per cavan.
ART. 1959. Without prejudice to the provisions of Article 2212,
interest due and unpaid shall not earn interest. However, the
contracting parties may by stipulation capitalize the interest due
and unpaid, which as added principal, shall earn new interest.
so, there can be no recovery as in the case of natural
obligations. (Art. 1423)
ART. 1961. Usurious contracts shall be governed by the Usury
Law and other special laws, so far as they are not inconsistent with
this Code.
Usurious Transactions Governed by Special Laws
The Usury Law and other special laws apply only so far as they are
not inconsistent with the Civil Code.
However, according to Article 1175, “usurious transactions shall be
governed by special laws.’’
Usury legally non-existent
 Usury is now legally non-existent. The interest legally
chargeable depends upon the agreement between the
lender and the borrower.
 Central Bank Circular No. 905 removed the Usury Law
ceiling on interest rates for secured and unsecured loans,
regardless of maturity, rendering it legally ineffective.
 The parties are now free to stipulate the interest to be
paid on monetary obligations, and absent any evidence of
fraud, undue influence or any vice of consent exercised
by one party against the other, the interest rate agreed
upon is binding upon them.
 While the Usury Law ceiling on interest rates was lifted
by C.B. Circular No. 905, nothing in said circular grants
lenders carte blanche authority to raise interest rates to
levels which will either enslave their borrowers or lead to
a hemorrhaging of their assets.’’ When the agreed rate is
found to be iniquitous and unconscionable, the courts
may reduce the same as reason and equity demand.

Unpaid Interest Earns Interest

General Rule: As a general rule, accrued interest (interest due and
unpaid) shall not earn interest
Exceptions:
1. When judicially demanded as provided for in Article
2212
2. When there is an express stipulation made by the parties
to wit: that the interest due an unpaid shall be added to
the principal obligation and the resulting total amount
shall earn interest. This practice is called compounding
interest and it is allowed by the Usury Law if there is
express stipulation – the stipulation as to compound
interest must be in writing.

Stipulation to pay both interest and penalty in case of default

 The parties may stipulate on the imposition of both
interest and penalty in case of default on the part of the
borrower.
 Under Article 1959, the compounding of not only of the
monetary interest but also of the penalty charge, also
called penalty or compensatory interest is allowed.
Hence, the borrower may be held liable to pay the
interest on the total amount of principal, the monetary
interest and the penalty interest.

ART. 1960. If the borrower pays interest when there has been no
stipulation therefor, the provisions of this Code concerning solutio
indebiti, or natural obligations, shall be applied, as the case may be.

Recovery of Unstipulated Interest Paid

 If unstipulated interest (it is, therefore, not due) is paid by
mistake, the debtor may recover as this would be a case
of solutio indebiti or undue payment. (Art. 2154)
 Where the unstipulated interest, or interest stipulated,
there being a stipulation but it is not in writing, is paid
voluntarily because the debtor feels morally obliged to do