ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 44  October 2022 CPA Licensure Examination

RFBT-02
REGULATORY FRAMEWORK for BUSINESS TRANSACTIONS J. DOMINGO  N. SORIANO

LAW ON CONTRACTS
A. IN GENERAL

DEFINITION – A contract is a meeting of minds between two persons whereby one binds himself, with respect to the other,
to give something or to render some service. (Art. 1305)

ELEMENTS OF CONTRACTS
a. ESSENTIAL - those without which the contract cannot exist, i.e., Consent, object, consideration. In some contracts, form
and delivery is essential too.
b. NATURAL - those which exist as part of the contract even if the parties do not stipulate it because the law is deemed
written therein.
c. ACCIDENTAL - those which are agreed upon by the parties and which cannot exist without being stipulated.

STAGES OF A CONTRACT
a. NEGOTIATION (PREPARATION OR CONCEPTION OR GENERACION) – here the parties are progressing with their
negotiation, prior to the arrival on a definite agreement. Here is where the parties provide for their offers and bargain with
each other.
b. PERFECTION (OR BIRTH) – when the parties have already come to a definite agreement and all the essential elements
are present (which includes form or delivery in some).
c. CONSUMMATION (OR DEATH OR TERMINATION) – the terms of the contract have already been performed.
B. ESSENTIAL ELEMENTS OF CONTRACTS
1. CONSENT OF CONTRACTING PARTIES
Consent: the meeting of the offer and the acceptance upon the thing and the cause which are to constitute the contract.
Offer and Acceptance:
a. The offer must be certain
b. The acceptance must be absolute.
c. A qualified acceptance constitutes a counter-offer.
d. An acceptance may be express or implied.
e. The person making the offer may fix the time, place, and manner of acceptance, all of which must be complied with.
Cognition Theory vs. Manifestation Theory:
a. Cognition Theory – follows that the acceptance takes effect from the time the offeror knew (or has knowledge) of the
acceptance of the offeree.
b. Manifestation Theory – on the other hand, follows that the acceptance will take effect once it is manifested by the
offeree.
In the Philippines, we abide by the Cognition Theory, since Art. 1319 provides that: “Acceptance made by letter or telegram
does not bind the offeror except from the time it came to his knowledge. The contract, in such a case, is presumed to have
been entered into in the place where the offer was made.”
Intervening events: An offer becomes ineffective upon the death, civil interdiction, insanity, or insolvency of either party before
acceptance is conveyed.
Option Agreement: When the offeror has allowed the offeree a certain period to accept, the offer may be withdrawn at any
time before acceptance by communicating such withdrawal, except when the option is founded upon a consideration, as
something paid or promised.
Advertisements: Unless it appears otherwise, business advertisements of things for sale are not definite offers, but mere
invitations to make an offer. Advertisements for bidders are simply invitations to make proposals, and the advertiser is not
bound to accept the highest or lowest bidder, unless the contrary appears.
SITUATIONS CONCERNING CONSENT OF THE PARTIES:
a. Both parties gave consent their consent as to the essential elements of the contract – the contract is valid.
b. Simulation: when one or both the parties did not intend to be bound by the contract (absolute simulation), the same is
void. Otherwise, if the parties merely conceal their true agreement (relative simulation), they shall be bound by their real
agreement.
c. Incapacity of one of the parties:
Kinds of Capacity:
i. Juridical capacity - is the fitness to be the subject of legal relations, is inherent in every natural person and is lost only
through death.
If incapacity pertains to juridical capacity the contract is void.

ii. Capacity to act (or legal capacity) - is the power to do acts with legal effect, is acquired and may be lost.

If incapacity pertains to capacity to act or legal capacity, it can be:

i. Absolute Incapacity – the party cannot give consent in any contract, with anyone, in whatever capacity, over
anything.

The following cannot give consent to a contract:

a. Unemancipated minors;
b. Insane or demented persons (except if consent is given during lucid interval);
c. Deaf-mutes who do not know how to write; and
d. Drunks or hypnotized.
Here the contract would be voidable as to the party who is incapacitated.

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Those who are “incompetent” under the Rules of Court who may be placed under guardianship:
a. Those suffering civil interdiction
b. Hospitalized lepers
c. Prodigals
d. Deaf and dumb who are unable to read and write
e. Those of unsound mind even though they have lucid intervals
f. Those who by reason of age, disease, weak mind, and other similar causes, cannot without outside aid, take
care of themselves and manage their property, becoming thereby an easy prey for deceit and exploitation.
Note that these people (save for those suffering the penalty of civil interdiction) can still enter into contracts if not
placed under guardianship. However, it can still be proven that intelligent consent was not given and thus, may
still render the contract voidable.
ii. Relative Incapacity – a person may be prohibited from entering specific contracts or that in a contract, he may be
prohibited in a certain capacity, e.g., prohibited to be the buyer, or to specific things, or to specific persons.
Examples:
• An alien is prohibited under the Constitution from acquiring private lands. EXCEPT: when acquired through
(1) succession; or (2) sale of residential land to a former natural born Filipino citizen.
• Husbands and wives cannot enter into a contract of sale, unless they agreed to a Separation of Property
marital property regime or they have been legally separated.

d. Both are incapacitated: the contract is unenforceable.

e. Both parties gave their consent, but such consent was vitiated:
Vices of consent: would render the contract voidable.
a. Mistake

The following mistakes will make the contract voidable:

i. If the mistake pertains to the object of the contract;
ii. If the mistake pertains to the conditions which have principally moved one or both parties to enter into the contract.
iii.Mistake as to the identity or qualifications of one of the parties when such identity or qualifications have been the
principal cause of the contract.
iv. Mutual error as to the legal effect of an agreement when the real purpose of the parties is frustrated, may vitiate
consent.
Mistake does NOT vitiate consent:
i. Mistake or error as to motive
ii. A simple mistake of account – which shall give rise to its correction only
iii. If the party alleging it knew the doubt, contingency or risk affecting the object of the contract.
b. Violence - when in order to wrest consent, serious or irresistible force is employed.
c. Intimidation - when one of the contracting parties is compelled by a reasonable and well-grounded fear of an
imminent and grave evil upon his person or property, or upon the person or property of his spouse, descendants or
ascendants, to give his consent.
To determine the degree of intimidation, the age, sex and condition of the person shall be borne in mind.
A threat to enforce one's claim through competent authority, if the claim is just or legal, does not vitiate consent.
d. Undue Influence - when a person takes improper advantage of his power over the will of another, depriving the latter
of a reasonable freedom of choice.
The following circumstances shall be considered: the confidential, family, spiritual and other relations between the
parties, or the fact that the person alleged to have been unduly influenced was suffering from mental weakness, or
was ignorant or in financial distress.
e. Fraud - when, through insidious words or machinations of one of the contracting parties, the other is induced to enter
into a contract which, without them, he would not have agreed to.
In order that fraud may make a contract voidable, it should be serious and should not have been employed by both
contracting parties.
Incidental fraud only obliges the person employing it to pay damages.
There is NO vitiation of consent on the ground of fraud in the following instances:
i. Failure to disclose facts, when there is NO duty to reveal them. But if there is a duty to reveal them, failure to
disclose the facts constitutes fraud as when the parties are bound by confidential relations.
ii. The usual exaggerations in trade, when the other party had an opportunity to know the facts.
iii. A mere expression of an opinion does not signify fraud; UNLESS made by an expert and the other party has relied
on the former's special knowledge
iv. Misrepresentation by a third person does not vitiate consent; UNLESS such misrepresentation has created
substantial mistake and the same is mutual.
v. Misrepresentation made in good faith is not fraudulent but may constitute error.
2. OBJECT CERTAIN WHICH IS THE SUBJECT MATTER
Object (Subject Matter) of the Contract: is really to create or to end obligations, which, in turn, may involve things, rights
or services.
Requisites:
a. The thing, right or service must be within the commerce of man;
b. It must be transmissible;
c. It must not be contrary to law, morals, good customs, public order or public policy;
d. It must not be impossible;
e. It must be determinate as to its kind or determinable without the need of a new contract or agreement.

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Future Inheritance: cannot be the subject matter of a valid contract. This is because the seller owns no inheritance while his
predecessor lives. Public policy demands that if you’re going to sell, you have the right to do so, but not necessarily requiring
that the seller is the owner.
3. CAUSE
Cause is the essential or impelling reason why a party assumes an obligation.
a. Onerous – for each contracting party, the prestation r promise of a thing or service by the other;
b. Gratuitous – mere liberality of the benefactor
c. Remuneratory – service or benefit already rendered.
Rules on Cause:
a. Contracts without cause, or with unlawful cause, produce no effect whatever. The cause is unlawful if it is contrary to law,
morals, good customs, public order or public policy
b. The statement of a false cause in contracts shall render them void, if it should not be proved that they were founded upon
another cause which is true and lawful.
c. Although the cause is not stated in the contract, it is presumed that it exists and is lawful, unless the debtor proves the
contrary.
d. As a rule, inadequacy of the price will not affect the contract. Except:
(1) When expressly provided by law, e.g., rescissible contracts;
(2) When there has been fraud, mistake or undue influence.
e. The particular motives of the parties in entering into a contract are different from the cause thereof.
Exception: if it predominates the purpose of the party to enter into a contract. E.g., sale to defraud creditors.
4. OTHER ESSENTIAL ELEMENTS:
Real Contracts: are those which are perfected by delivery, thus, delivery is an essential element to its perfection. Real
contracts include:
1. Deposit
2. Pledge
3. Commodatum
4. Simple Loan or Mutuum

Formal Contracts: where the execution of the required formality is also an essential element for perfection.
C. FORMS OF CONTRACT
GENERAL RULE: no form is required for the validity or perfection of a contract.
Exceptions: Formalities required for VALIDITY:
1. Donations of real property which requires a public instrument.
2. Donations of personal property which exceeds P5,000 which requires that the donation be written.
3. Stipulation to pay interests on loans or for the use of money, which must be in writing.
4. Sale or transfer of large cattle which requires that it be in a public instrument, registered and that there should be a
certificate of transfer.
5. Contribution of real property in a partnership, which requires that there be an inventory attached to a public instrument.
Formalities required for ENFORCEABILITY (STATUTE OF FRAUDS): The following are unenforceable, unless they are in
writing, or some note or memorandum and subscribed by the party charged, or by his agent:
1. An agreement that by its terms is not to be performed within a year from the making thereof;
2. A special promise to answer for the debt, default, or miscarriage of another;
3. An agreement made in consideration of marriage, other than a mutual promise to marry;
4. An agreement for the sale of goods, chattels or things in action, at a price not less than five hundred pesos, unless the
buyer accept and receive part of such goods and chattels, or the evidences, or some of them, of such things in action or
pay at the time some part of the purchase money; but when a sale is made by auction and entry is made by the auctioneer
in his sales book, at the time of the sale, of the amount and kind of property sold, terms of sale, price, names of the
purchasers and person on whose account the sale is made, it is a sufficient memorandum;
5. An agreement of the leasing for a longer period than one year, or for the sale of real property or of an interest therein;
6. A representation as to the credit of a third person.
Formalities required for CONVENIENCE: to bind third persons, the following are required to appear in a public instrument:
1. Acts and contracts which have for their object the creation, transmission, modification or extinguishment of real rights over
immovable property; sales of real property or of an interest therein a governed by the Statute of Frauds.
2. The cession, repudiation or renunciation of hereditary rights or of those of the conjugal partnership of gains;
3. The power to administer property, or any other power which has for its object an act appearing or which should appear in
a public document, or should prejudice a third person;
4. The cession of actions or rights proceeding from an act appearing in a public document.
Remedy to require a specific form: if the law requires a document or other special form if the contract is VALID and
ENFORCEABLE, as in the acts and contracts required to appear in a public instrument for convenience (where the requirement
that they must be in writing for validity, if applicable, is met), the contracting parties may compel each other to observe that
form, once the contract has been perfected.
REFORMATION OF INSTRUMENTS
Reformation: is the remedy by means of which a written instrument is made or construed so as to express or conform to the
true intention of the parties when some error or mistake has been committed.
Requisites:
1. There is a meeting of the minds;
2. There is a written instrument; and
3. The written instrument does not reflect the true intention of the parties.
When may reformation be had:
1. Mutual mistake of the parties. If one party was mistaken and the other acted fraudulently or inequitably in such a way that
the instrument does not show their true intention, the former may ask for the reformation of the instrument
2. When one party was mistaken and the other knew or believed that the instrument did not state their real agreement, but
concealed that fact from the former.

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3. Ignorance, lack of skill, negligence or bad faith on the part of the person drafting the instrument or of the clerk or typist.
4. If two parties agree upon the mortgage or pledge of real or personal property, but the instrument states that the property
is sold absolutely or with a right of repurchase.
Who can ask for reformation:
1. If the mistake was mutual, reformation may be ordered at the instance of either party or his successor in interest;
2. Otherwise, the injured party, or his heirs and assigns.
No reformation is allowed:
a. Simple donations inter vivos wherein no condition is imposed;
b. Wills;
c. When the real agreement is void.

Likewise, when one of the parties has brought an action to enforce the instrument, he cannot subsequently ask for its
reformation.
D. FUNDAMENTAL CHARACTERISTICS/ PRINCIPLES OF CONTRACTS
1. CONSENSUALITY OF CONTRACTS
Perfection of a contract: is generally by the meeting of the minds or consensual, save for some cases where delivery or form
is required for its perfection.
Contract entered into by an unauthorized person: is unenforceable since the rule is that no one may contract in the name
of another without being authorized by the latter, such as an agent, or unless he has by law a right to represent him, such as
a guardian.
The same is true if the person, while authorized or has legal representation, acted beyond his powers.
Unless, in both cases, the contract is ratified, expressly or impliedly, by the person on whose behalf it has been executed, before
it is revoked by the other contracting party.
CONTRACT OF ADHESION - one where there is already a prepared form containing the stipulations desired by one party
whereby the latter only asks the other party to agree to them if he wants to enter into a contract.
Consent is necessary for there to be a contract: as such, in the case of PLDT, the SC held that the government cannot
compel PLDT to enter into an interconnection agreement with it without the latter’s consent and there is no claim under a
contract without such consent.
However, the government may exercise its sovereign power of eminent domain and compel PLDT to allow the use of its facilities
subject to just compensation. In this case, the Court treated the action as one of expropriation. (Republic vs. PLDT)
2. AUTONOMY OF CONTRACTS (FREEDOM OR LIBERTY TO CONTRACT)
The contracting parties may establish such stipulations, clauses, terms and conditions as they may deem convenient, provided
they are not contrary to law, morals, good customs, public order, or public policy.
Contrary to Law: note that the law is deemed part of every contract and must thus be not contrary to the same.
a. Waiver for future fraud.
b. Partnership: Pactum Leonina – a stipulation which excludes one or more partners from any share in the profits or losses
c. Mortgage/Pledge: Pactum Commissorium – a stipulation where the creditor appropriates the things given by way of pledge
or mortgage, or dispose of them.
d. Mortgage/Pledge: Pactum de non aliendo – a stipulation forbidding the owner from alienating the immovable mortgaged.
Contrary to Public Policy:
a. Refund of tuition fees during the time a student is covered by a scholarship if such student transfers schools. Scholarships
are granted not to attract and to keep brilliant students in school for their propaganda mine but to reward merit or help
gifted students in whom society has an established interest or a first lien. (Cui vs. Arellano)
b. Prohibiting a losing candidate in a convention to run as an independent candidate is contrary to constitutionality protected
right to be elected in public office and the right of the electorate to choose. (Saura vs. Sindico)
Contrary to Morals: in a contract of loan, where the interest rate is 50%, is void (and reduced) for being contrary to morals,
the same being unconscionable, confiscatory, exorbitant, excessive or inequitable, not because of it is usurious.
3. MUTUALITY
a. The contract must bind both contracting parties;
b. its validity or compliance cannot be left to the will of one of them.
Consequences of Mutuality:
a. One party cannot revoke or renounce a contract without the consent of the other, nor have it said aside on the ground that
he had made a bad bargain.
b. Potestative suspensive conditions dependent upon the sole will of the debtor voids the obligation. If the potestative condition
is resolutory, it would not affect the validity of the contract, as such, extinguishment can be left to the will of one of the
parties.
c. The determination of the performance may be left to a third person:
(1) Whose decision shall not be binding until it has been made known both contracting parties
(2) The determination shall not be obligatory if it is evidently inequitable. In such case, the courts shall decide what is
equitable under the circumstances.
ESCALATION CLAUSE: where one increases/decreases compensation of one of the parties.

When Void: when the increase is dependent solely upon the will of one of the parties.

The unilateral determination and imposition of increased interest rates by the bank is obviously violative of the principle of
mutuality of contracts ordained in Article 1308 of the Civil Code. (Sps. Florendo vs. CA)
When Valid: when the increase/decrease is dependent on valid and reasonable standards, independent of the parties’ will.
Contract for a piece of work: where the compensation of the contractor may be increased on the basis of minimum wage or
as to materials, based on the consumer price index.

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Contract of Lease: where the rental would be increased or decreased based on the movement (increase or devaluation) of
foreign exchange – valid. (Del Rosario vs. Shell)
4. OBLIGATORY FORCE OF CONTRACTS – ARTS. 1159, 1315-1316, 749
Art. 1159. Obligations arising from contracts have the force of law between the contracting parties and should be complied
with in good faith.

5. RELATIVITY OF CONTRACTS
RELATIVITY (OR PRIVITY) OF CONTRACTS: means that the contract takes effect only between the parties, their assigns
and heirs which are referred to as privies.
Third Parties: as a general rule do not have a cause of action to enforce or annul a contract nor are they bound by the terms
thereof.
Exceptions:
a. Third person may be bound by the contract: In contracts creating real rights, third persons who come into possession
of the object of the contract are bound thereby, subject to the provisions of the Mortgage Law and the Land Registration
Laws
b. A creditor may initiate an action against the contracting parties
Creditors are protected in cases of contracts intended to defraud them. The following actions are allowed for creditors,
effectively interfering in contracts to which they are not parties to:
Accion Pauliana: is the action of the creditor to rescind the contract entered into by the debtor to defraud him.
Accion Directa: is the action of a creditor to sue on a contract entered into by his debtor, whenever authorized by law,
such as:
i. Those who put labor upon or furnish materials for a piece of work undertaken by the contractor have an action against
the owner up to the amount owing from the latter to the contractor at the time the claim is made.
ii. The sublessee is subsidiarily liable to the lessor for any rent due from the lessee. However, the sublessee shall not be
responsible beyond the amount of rent due him, in accordance with the terms of the sublease, at the time of the
extrajudicial demand by the lessor.
c. Third persons may be liable under a contract
Malicious interference by third persons: A third person who induces another to violate his contract shall be liable for
damages to the other contracting party. As the name implies, there should be malice or a malicious inducement by the
third person as a result of which, the debtor does not comply with his obligation under the contract, which necessarily
implies that such third person has knowledge of the existence of the contract. (Art. 1314)
d. Third persons may be benefited by a contract – 2nd paragraph of Art. 1311, otherwise known as a stipulation
pour atrui.
If a contract should contain some stipulation in favor of a third person, he may demand its fulfillment provided he
communicated his acceptance to the obligor before its revocation. A mere incidental benefit or interest of a person is not
sufficient. The contracting parties must have clearly and deliberately conferred a favor upon a third person.
Stipulation pour atrui: is a stipulation in favor of a third person conferring a clear and deliberate favor upon him, and which
stipulation is merely part of a contract entered into by the parties, neither of whom acted as agent of the third person.
Communication of acceptance to the obligor is required. No form is required. It can even be implied from the acts of the
third person.
Revocation: cannot be done by one party alone. The Supreme Court has held that if this revocation is a unilateral act of
one of the parties, it is void for violation of the principle of mutuality of contracts. For a revocation to take effect, it must
be with consent of both parties (obligor and oblige) and should be done before the communication of acceptance to the
obligor.
E. CLASSIFICATION OF CONTRACTS
1. ACCORDING TO DEGREE OF DEPENDENCE
a. PRINCIPAL – a contract which can stand on its own, such as a contract of sale, barter, lease, loan.
b. ACCESSORY – those which cannot stand on its own and are dependent upon other contracts for its validity. E.g.,
guaranty, suretyship, mortgage and antichresis.
c. PREPARATORY – a contract is a means to achieving an end, such as an option contract, a contract of partnership and
that of agency.
2. ACCORDING TO PERFECTION
a. CONSENSUAL – are those perfected by mere consent.
b. REAL – those which are perfected only upon delivery of the thing subject of the contract. E.g., deposit, pledge,
commodatum and mutuum.
c. FORMAL – those which require a certain form for its validity. E.g., antichresis
3. ACCORDING TO PURPOSE
a. TRANSFER OF OWNERSHIP – Donation, Sale and Barter
b. CONVEYANCE OF USE – Usufruct, Lease and Loan
c. RENDITION OF SERVICE – Lease and Agency
4. ACCORDING TO NATURE OF OBLIGATION PRODUCED
a. BILATERAL – where both parties are reciprocally obligated, e.g., lease (where the lessor is obliged to allow the use of
the thing and the lessee is obliged to pay rent) and sale (where the buyer is obliged to pay the price and the seller
obliged to deliver the thing) (ARTS. 1642, 1458)
b. UNILATERAL – only one party is obliged. E.g., guaranty and pledge. (ARTS. 2047, 2093)
5. ACCORDING TO CAUSE
a. ONEROUS – such as a contract of sale, barter, lease and simple loans or mutuum with stipulation for interest.
b. GRATUITOUS OR LUCRATIVE – such as a donation and commodatum.
c. REMUNERATORY – where one prestation is given for a benefit or service that had been rendered previously.

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6. ACCORDING TO RISK
a. COMMUTATIVE – where the parties contemplate real fulfillment, therefore, equivalent values (presumably) are given,
such as sales (where the price is presumably the equivalent of the thing to be delivered) or lease (where the rental
payments is presumably the value of the use of the thing)
b. ALEATORY – where the fulfillment of the cause as to one party is dependent upon chance, such as an insurance contract
(where the payment will depend on the happening of the event insured against)
7. ACCORDING TO NAME
a. NOMINATE – those contracts for which a particular name has been designated and rules particular to them are
applicable such as sales, commodatum, partnership, agency, deposit, etc.
b. INNOMINATE – those which do not have particular designation, such as do ut des (I will give that you may give), do
ut facias (I will give that may do), facio ut des (I will do that you may give) and facio ut facias (I will do that you may
do).
8. ACCORDING TO SUBJECT MATTER
a. THING
b. RIGHT
c. SERVICE
F. INTERPRETATION OF CONTRACTS

Art. 1370. If the terms of a contract are clear and leave no doubt upon the intention of the contracting parties, the literal
meaning of its stipulations shall control.

If the words appear to be contrary to the evident intention of the parties, the latter shall prevail over the former. (1281)
Primordial Consideration: is the intention of the parties. Such that even if the terms of the contract are clear, but does not
reflect the intention of the parties, it is the intention which would prevail.

Art. 1371. In order to judge the intention of the contracting parties, their contemporaneous and subsequent acts shall be
principally considered. (1282)
Contemporaneous and Subsequent Acts: may be considered to determine if the parties’ intentions are different from the
clear words of the agreement.
In a case where a Deed of Assignment was issued as payment for the obligation of the debtor in an indemnity agreement by
way of dacion en pago, the debtor thereafter made subsequent installment payments and executed a mortgage, the SC held
that clearly the subsequent acts of the debtor do not reflect his claim that the deed of assignment was by dacion en pago. The
deed of assignment was a form of security for the indemnity agreement.
Specific rules in interpretation of contracts:
1. However general the terms of a contract may be, they shall not be understood to comprehend things that are distinct and
cases that are different from those upon which the parties intended to agree.
2. If some stipulation of any contract should admit of several meanings, it shall be understood as bearing that import which
is most adequate to render it effectual.
3. The various stipulations of a contract shall be interpreted together, attributing to the doubtful ones that sense which may
result from all of them taken jointly.
4. Words which may have different significations shall be understood in that which is most in keeping with the nature and
object of the contract.
5. The usage or custom of the place shall be borne in mind in the interpretation of the ambiguities of a contract, and shall fill
the omission of stipulations which are ordinarily established.
6. The interpretation of obscure words or stipulations in a contract shall not favor the party who caused the obscurity
When none of the above rules will apply:
When it is absolutely impossible to settle doubts by the rules established in the preceding articles, and the doubts refer to
incidental circumstances of:
1. a gratuitous contract - the least transmission of rights and interests shall prevail.
2. If the contract is onerous, the doubt shall be settled in favor of the greatest reciprocity of interests.

If the doubts are cast upon the principal object of the contract in such a way that it cannot be known what may have been
the intention or will of the parties, the contract shall be null and void. (Art. 1378)
G. DEFECTIVE CONTRACTS
1. RESCISSIBLE CONTRACTS
Rescission: is a process designated to render inefficacious a contract validly entered into and normally binding, by reason
of external conditions, causing an economic prejudice to a party or his creditors.
Resolution: is the proper term for “rescission” which is a remedy under Art. 1911 in reciprocal obligations. Unlike the proper
rescission for rescissible contracts, resolution is a primary remedy which can be availed of by the parties and does not
require lesion as a ground therefor but will require non-performance or non-fulfillment of the obligation or when there is
substantial breach.
Rescissible Contracts:
Art. 1381. The following contracts are rescissible:
(1) Those which are entered into by guardians whenever the wards whom they represent suffer lesion by more than
one-fourth of the value of the things which are the object thereof;
(2) Those agreed upon in representation of absentees, if the latter suffer the lesion stated in the preceding number;
(3) Those undertaken in fraud of creditors when the latter cannot in any other manner collect the claims due them;
(4) Those which refer to things under litigation if they have been entered into by the defendant without the knowledge
and approval of the litigants or of competent judicial authority;
(5) All other contracts specially declared by law to be subject to rescission. (1291a)
Lesion – is the damage or injury to the party asking for rescission, which represents the difference between the price and
the actual value of the property. Lesion, as a ground for rescission must be MORE THAN ONE-FOURHT of the value.

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In fraud of creditors: which is properly termed “accion pauliana,” through which the creditor can interfere and have the
contract entered into by the debtor rescinded. This presupposes that the creditor cannot in any other manner collect the
claims due. Thus, if the debtor entered into a contract of sale with a third person in order to have enough money to pay
the creditor, the latter cannot rescind such contract of sale since the sale was precisely entered into to pay him his due.
Things under litigation: is rescissible whenever entered into without the knowledge and approval of:
a. The litigants; or
b. Competent judicial authority (such as the court under which the thing is subject to litigation).
Other contract subject to rescission under the law:
a. Rights of an unpaid seller;
b. In obligations to deliver a specific thing, where the same deteriorates with the fault of the debtor before the suspensive
condition is fulfilled (or suspensive term arrives);
c. Lesion of at least one-fourth in partition.
d. In sale of real estate for a certain price per unit of measure and the real estate delivered is deficient by more than 1/10
or when the buyer would not have entered into the contract knowing the actual area of the real estate.
e. Payments made in a state of insolvency for obligations whose fulfillment the debtor could not be compelled at the time
they were effected.
Rescission as a remedy:
a. The action for rescission is subsidiary; it cannot be instituted except when the party suffering damage has no other
legal means to obtain reparation for the same
b. Rescission shall be only to the extent necessary to cover the damages caused
c. Restitution - rescission creates the obligation to return the things which were the object of the contract, together with
their fruits, and the price with its interest.
d. It can be carried out only when he who demands rescission can return whatever he may be obliged to restore
e. Rescission shall not take place when the things which are the object of the contract are legally in the possession of third
persons who did not act in bad faith. In which case, indemnity for damages may be demanded from the person causing
the loss.
f. If the sale of the property of the guardian or the absentee is approved by courts, rescission is not an available remedy.
Presumption of Fraud:
a. Alienations by gratuitous title: presumed to have been entered into in fraud of creditors, when the donor did not
reserve sufficient property to pay all debts contracted before the donation.
b. Alienations by onerous title: presumed fraudulent when made by persons against whom some judgment has been
issued. The decision or attachment need not refer to the property alienated, and need not have been obtained by the
party seeking the rescission.

Whoever acquires in bad faith the things alienated in fraud of creditors shall indemnify the latter for damages suffered on
account of the alienation, whenever, due to any cause, it should be impossible for him to return them.
Prescriptive Period: the action to claim rescission must be commenced within 4 years. For persons under guardianship
and for absentees, such four year period shall begin upon termination of the ward’s incapacity or when the absentee’s
domicile is known.
Sale of land, 4 years is counted from the time of registration: When a transaction involves registered land, the four-year
period fixed in Article 1391 within winch to bring an action for annulment of the deed, shall be computed from the
registration of the conveyance.
The registration of the document is constructive notice of the conveyance to the whole world. (HSBC vs. Pauli)
2. VOIDABLE CONTRACTS
Voidable Contracts: are those which are valid until they have been annulled by proper action in court. However, they are
likewise subject to ratification to cure the defect.
The following are voidable contracts:
a. Those where one of the parties is incapable of giving consent;
b. Those where the consent is vitiated by mistake, violence, intimidation, undue influence or fraud.
c. Those entered into by those hypnotized or under a state of drunkenness
Prescriptive Period: shall be four years.

Ground Counted from:

Intimidation, violence or undue influence The defect of the consent ceases
Mistake or fraud Discovery
Minority or incapacity Guardianship ceases

Ratification: extinguishes the action to annul a voidable contract.

a. Ratification may be effected by the guardian of the incapacitated person
b. It does not require the conformity of the contract party who has no right to bring the action for annulment.
c. It cleanses the contract from all the defects from the moment it was constituted.
d. It may be done:
i. Expressly – either oral or written; or
ii. Tacitly (impliedly) – when the reason which renders the contract voidable has ceased, the person who has a right
to invoke annulment should execute an act which necessarily implies an intention to waive such right.
Annulment: renders the contract non-existing, as if it was never entered into.
a. Only the injured party (the victim, whether principal or subsidiary party) may ask for annulment.
b. Creditors of the injured party cannot ask for the annulment of the contract for they are not parties thereto.
c. In case of minority, and the minor misrepresents his age, and the other party was led to believe the same, there can
be no annulment, for here, the minor would be estopped.
d. Those who are capacitated cannot allege the incapacity of those with whom they contracted with nor those who exerted
intimidation, violence or undue influence, or employed fraud, or caused mistake.

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e. Effects of loss of the thing:
i. The action for annulment of contracts shall be extinguished when the thing which is the object thereof is lost
through the fraud or fault of the person who has a right to institute the proceedings.
ii. If the right of action is based upon incapacity, the loss of the thing shall not be an obstacle to the success of the
action, unless said loss took place through the fraud or fault of the incapacitated person.
f. Effects of annulment:
i. Generally, the parties are obliged to restore to each other the things which have been the subject matter of the
contract, with their fruits and the price with its interest.
ii. In obligations to render service, the value thereof shall be the basis for damages.
iii. In case of incapacity, the person incapacitated is not obligated to make any restitution except insofar as he has
been benefited by the thing or price received by him.
iv. Whenever the person who is obliged to return the thing cannot do so because it has been lost through his fault, he
shall return:
1) the fruits received and
2) the value of the thing at the time of loss
3) with interest from the same date.
v. When one party does not return what is due him by virtue of the annulment, he cannot compel the other to comply
what is incumbent upon him.
3. UNENFORCEABLE CONTRACTS
Unenforceable contracts – are those which have no effect until they are ratified.
Kinds of Unenforceable Contracts:
a. Unauthorized contracts – those entered into in the name of a person by one who has been given no authority or
legal representation, or who has acted beyond his powers.ill
b. Those that do not comply with the Statute of Frauds – these are agreements that are required to be in writing in
order to avoid fraud.
Statute of Frauds: in order to be enforceable, the following must be in writing, or in some note or memorandum:
i. An agreement that by its terms is not to be performed within a year from the making thereof.
ii. A special promise to answer for the debt, default, or miscarriage of another;
iii. An agreement made in consideration of marriage, other than a mutual promise to marry;
iv. An agreement for the sale of goods, chattels or things in action, at a price not less than five hundred pesos, unless
the buyer accept and receive part of such goods and chattels, or the evidences, or some of them, of such things
in action or pay at the time some part of the purchase money; but when a sale is made by auction and entry is
made by the auctioneer in his sales book, at the time of the sale, of the amount and kind of property sold, terms
of sale, price, names of the purchasers and person on whose account the sale is made, it is a sufficient
memorandum;
v. An agreement of the leasing for a longer period than one year, or for the sale of real property or of an interest
therein.
vi. A representation as to the credit of a third person.
Rules Applicable to Statute of Frauds:
a. It applies only to executory contracts, and not those which have been partially or completely executed.
b. The list is exclusive, that is, it applies only to the agreements or contracts enumerated above.
c. The defense of Statute of Frauds may be waived.
d. The Statute of Frauds is a personal defense, that is, an agreement infringing it cannot be assailed by third persons.
e. If oral evidence is presented to prove the agreement, and the other does not object thereto, there is deemed a
waiver of the defense of Statute of Frauds. The same is true if the other party has already accepted the benefits
of the contract.
c. Those where both parties are incapable of giving consent.
4. VOID OR INEXISTENT
Void Contracts are those which are either inexistent (as when the required formalities are not complied with for its
perfection, which produces no legal effects), or illegal or illicit.
Art. 1409. The following contracts are inexistent and void from the beginning:
(1) Those whose cause, object or purpose is contrary to law, morals, good customs, public order or public policy;
(2) Those which are absolutely simulated or fictitious;
(3) Those whose cause or object did not exist at the time of the transaction;
(4) Those whose object is outside the commerce of men;
(5) Those which contemplate an impossible service;
(6) Those where the intention of the parties relative to the principal object of the contract cannot be ascertained;
(7) Those expressly prohibited or declared void by law.
These contracts cannot be ratified. Neither can the right to set up the defense of illegality be waived.
Rules Applicable:
a. The action or defense for the declaration of the contract as inexistent does not prescribe.
b. The contract cannot be ratified.
c. The defense of illegality of contract is not available to third persons whose interests are not directly affected
Legal Effects of a Void Contract:
GENERAL RULE: It cannot give rise to valid subsequent contracts if the same are based on it. Generally, produces no effect
and no action to declare them void is needed.
EXCEPTIONS:
a. When money is paid or property delivered for an illegal purpose, the contract may be repudiated by one of the parties
before the purpose has been accomplished, or before any damage has been caused to a third person. In such case,
the courts may, if the public interest will thus be subserved, allow the party repudiating the contract to recover the
money or property.
b. Where one of the parties to an illegal contract is incapable of giving consent, the courts may, if the interest of justice
so demands allow recovery of money or property delivered by the incapacitated person.

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c. When the agreement is not illegal per se but is merely prohibited, and the prohibition by the law is designated for the
protection of the plaintiff, he may, if public policy is thereby enhanced, recover what he has paid or delivered.
d. In case of a divisible contract, if the illegal terms can be separated from the legal ones, the latter may be enforced.
Illegal Contracts: can either be that which involves a criminal offense or where there is no criminal offense.
a. When there is a criminal offense and both parties are at fault/guilty (in pari delicto) they shall have no shall have no
action against each other; they shall both be prosecuted; the effects of the crime shall be confiscated in favor of the
government.
b. When there is no criminal offense, same rights as to recovery, except no prosecution will be involved. As such, if both
are at fault, no recovery can be made by either. But if only one party is at fault, the innocent party may demand the
return of what he has given, without any obligation to comply with his promise.

1. These are elements of a contract which are derived from the nature of the contract and ordinarily accompany the same.
A. Natural C. Special
B. Essential D. Accidental

2. It is a contract where each of the parties acquires an equivalent of his prestation and such equivalent is pecuniarily
appreciable and already determined from the moment of the celebration of the contract.
A. Aleatory C. Commutative
B. Nominate D. Innominate

3. It refers to the principle that once a contract is perfected, it shall be of obligatory force upon both of the contracting
parties.
A. Obligatory force C. Mutuality
B. Autonomy D. Relativity

4. It refers to the principle that the contracting parties are free to enter into a contract and to establish such stipulations,
clauses, terms, and conditions as they may deem convenient.
A. Obligatory force C. Mutuality
B. Autonomy D. Relativity

5. It refers to the essential equality of the contracting parties whereby the contract must bind both of them.
A. Mutuality C. Autonomy
B. Obligatory force D. Relativity

6. It refers to the principle that the contract takes effect only between the parties, their assigns and heirs.
A. Obligatory force C. Relativity
B. Autonomy D. Mutuality

7. It is a stipulation in a contract, clearly and deliberately conferred by the contracting parties as a favor upon a third
person, who must communicate his acceptance of the favor or benefit to the obligor before it could be revoked.
A. Stipulation pour autrui C. Contract of adhesion
B. Stipulation au pair D. Contra bonos mores

8. In an offer to sell, parties failed to agree on the size of the land to be sold. Is there a meeting of the minds of the parties
that would perfect a contract?
A. There is no consent that would perfect a contract as there is no agreement on the exact area to be sold.
B. There is consent because the land is still identified.
C. There is consent because there is agreement to sell and to buy.
D. The information given is insufficient to answer the question.

9. A contract of adhesion is generally:

A. Void C. Unenforceable
B. Voidable D. Valid

10. Under this theory, a contract is perfected from the moment the acceptance is declared or made.
A. Expedition Theory C. Manifestation Theory
B. Reception Theory D. Cognition Theory

11. In the Philippines, which theory on perfection of contracts is followed?

A. Cognition Theory C. Expedition Theory
B. Reception Theory D. Manifestation Theory

12. On March 5, 1956, A wrote a letter to B offering him the lease of a building. On March 6, 1956, at 1:00PM, B sent a letter
of acceptance which was received by A at 4:00PM that day. But at 2:00PM, A had already sent B a letter of withdrawal
of the offer which was received by B at 5:00PM. When was the contract perfected?
A. At 1:00PM C. At 2:00PM
B. At 4:00PM D. The contract has not been perfected.

13. What is the effect of the death, civil interdiction, insanity, or insolvency of the either the offeror or offeree before
acceptance is conveyed?
A. The offer becomes ineffective.
B. The offer is still effective.
C. As against the offeror only, the offer becomes ineffective.
D. As against the offeree only, the offer becomes ineffective.

14. A contract entered into by a minor who misrepresents his age is:
A. Void C. Voidable
B. Valid D. Unenforceable

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15. A contract entered into by and between two deaf-mutes is:
A. Void C. Voidable
B. Valid D. Unenforceable

16. A contract entered into by and between two persons of who both insane is:
A. Valid C. Voidable
B. Void D. Unenforceable

17. If a person prohibited to enter into a contract, enters into a contract, such contract is:
A. Void C. Voidable
B. Valid D. Unenforceable

18. What is the difference between a mistake of fact and a mistake of law?
A. A mistake of law vitiates consent which renders a contract voidable; while a mistake of fact does not render a
contract voidable.
B. Both mistakes of fact and of law render a contract voidable.
C. Both mistakes of fact and of law do not render a contract voidable.
D. A mistake of fact vitiates consent which renders a contract voidable; while a mistake of law does not render a
contract voidable.

19. Is there any exception to the rule that a mistake of law cannot vitiate consent rendering the contract voidable?
A. Mistake as to the object of the contract (error in re)
B. Mistake as to person (error in persona)
C. Mutual error as to the legal effect of an agreement when the real purpose of the parties is frustrated, may vitiate
consent.
D. There is no exception.

20. When is an instrument not capable of reformation?

A. Simple donations inter vivos wherein no condition is imposed
B. When a mutual mistake of the parties causes the failure of the instrument to disclose their real agreement.
C. If one party was mistaken and the other acted fraudulently or inequitably in such a way that the instrument
does not show their true intention.
D. When one party was mistaken and the other knew or believed that the instrument did not state their real
agreement, but concealed the fact from the former.

21. When is an instrument not capable of reformation?

A. When through the ignorance, lack of skill, negligence or bad faith on the part of the person drafting the instrument
or of the clerk or typist, the instrument does not express the true intention of the parties.
B. Wills
C. If 2 parties agree upon the mortgage or pledge of real or personal property, but the instrument states that the
property is sold absolutely, or with a right of repurchase.
D. Where the real agreement is voidable.

22. Where shall the action for reformation of instrument be instituted?

A. Ordinary action for declaratory relief C. Ordinary action for quo warranto
B. Ordinary action for reformation of instrument D. Special civil action for declaratory relief

23. X, of age, entered into a contract with Y, a minor. X knew and the contract specifically stated the age of Y. May X
successfully demand annulment of the contract?
A. No, the party who has capacity cannot allege the incapacity of the party with whom he contracted.
B. No, the annulment will prejudice the interests of the minor.
C. Yes, since Y is a minor, the contract is voidable.
D. Yes, as long as Y joins X in asking for annulment.
24. A and B entered into a verbal contract whereby A agreed to sell to B his only parcel of land for P10,000 and B agreed
to buy at the aforementioned price. B went to the bank, withdrew the same amount and returned to A for the
consummation of the contract. A, however, had changed his mind and refused to go through with the sale. Will an
action by B against A for specific performance prosper?
A. No, A and B must seek to resolve the dispute first before going to the court.
B. Yes, because B already withdrew the money from the bank.
C. No, it is not evidenced by anything in writing properly signed by A.
D. Yes, A has already agreed with B which made the agreement binding to both parties.

25. Under this principle, when the defect of a void contract consists in the illegality of the cause or object of the contract, and
both of the parties are at fault, the law refuses them every remedy and leaves them where they are.
A. In pari delicto C. Caso fortuito
B. Contra bonos mores D. Res ipsa loquitur

26. What is an example of a natural element of a contract?

A. Warranty against eviction C. Consent
B. Form D. Consideration

27. The limitations upon the right of the contracting parties to establish such stipulations, clauses, terms, and conditions as
they may deem convenient are:
A. Law, morals, good customs, and public order only
B. Law, morals, and good customs only
C. Law, morals, and public order only
D. Law, morals, good customs, public order, and public policy

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28. Under this theory, a contract is perfected from the moment the acceptance comes to the knowledge of the offeror.
A. Reception Theory C. Expedition Theory
B. Cognition Theory D. Manifestation Theory

29. A contract entered into by an incapacitated person is:

A. Void C. Valid
B. Voidable D. Unenforceable

30. It means that the object should be susceptible of appropriation and transmissible from one person to another.
A. The object is real or possible.
B. The object is licit.
C. The object is within the commerce of men.
D. The object is determinate, or at least, possible of determination, as to its kind.

31. If parties enter into a contract with respect to things outside the commerce of men, the contract is:
A. Void C. Valid
B. Voidable D. Unenforceable

32. It refers to the doctrine that “When the true intention of the parties to a perfected and valid contract are not expressed
in the instrument purporting to embody their agreement, by reason of mistake, fraud, inequitable conduct or accident,
one of the parties may ask for the reformation of the instrument so that such true intention may be expressed.
A. Doctrine of interpretation of instruments C. Doctrine of reformation of instruments
B. Doctrine of resolution of instruments D. Doctrine of expression of instruments

33. It is a remedy granted by law to the contracting parties, and even to third persons, to secure the reparation of damages
caused to them by a contract, even if the same should be valid, by means of the restoration of things to their condition
prior to the celebration of the contract.
A. Rescission C. Reformation
B. Annulment D. Declaratory relief

34. How is rescission different from resolution?

A. In rescission, the action may be instituted not only by a party to the contract but even by third persons; whereas in
resolution, the action may be instituted only by a party to the contract.
B. In rescission, the only ground is failure of one of the parties to comply with what is incumbent upon him; whereas in
resolution, several grounds are lesion, fraud and others expressly specified by law.
C. In rescission, the law expressly declares that courts shall have the discretionary power to grant an extension for
performance provided that there is a just cause; whereas in resolution, the court has no power to grant an extension of
time for the performance of the obligation so long as there is ground for resolution.
D. In rescission, only reciprocal contracts may be rescinded; whereas in resolution, any contract, whether unilateral or
reciprocal may be resolved.

35. What is the nature of an action for rescission?

A. Primary C. Subsidiary
B. Secondary D. Ordinary

36. When should an action for rescission be filed?

A. Within 4 years C. Within 6 years
B. Within 5 years D. Within 10 years

37. What is the period of prescription for an action for annulment of a voidable contract?
A. 4 years C. 6 years
B. 5 years D. 10 years

38. It refers to the act or means by virtue of which efficacy is given to a contract which suffers from a vice of curable
nullity.
A. Resolution C. Annulment
B. Prescription D. Ratification (or confirmation)

39. Arnie, husband of Marika, sold paraphernal property in her name without her consent. The sale is:
A. Valid C. Voidable
B. Void D. Unenforceable

40. A and B entered into a verbal contract whereby A agreed to sell to B his only parcel of land for P10,000 and B agreed
to buy at the aforementioned price. B went to the bank, withdrew the same amount and returned to A for the
consummation of the contract. A, however, had changed his mind and refused to go through with the sale. The
agreement to sell the land to B is:
A. Void C. Voidable
B. Valid D. Unenforceable
1. A 11. A 21. B 31. A
2. C 12. D 22. D 32. C
3. A 13. A 23. A 33. A
4. B 14. C 24. C 34. A
5. A 15. B 25. A 35. C
6. C 16. D 26. A 36. A
7. A 17. A 27. D 37. A
8. A 18. D 28. B 38. D
9. D 19. C 29. B 39. D
10. C 20. A 30. C 40. D

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