SECTION 5: COMPENSATION

Article 1278
Compensation
– often called simplified payment because it provides a more convenient and less expensive effectuation of
payments between 2 persons who are reciprocally creditors and debtors
– the extinguishment to the concurrent amount of the debts of 2 persons who, in their own right, are debtors
and creditors of each other.

Object of Compensation
The prevention of unnecessary litigations and payments as this is accomplished through the mutual
extinguishment by operation of law of concurring debts of 2 persons.

Compensation and Confusion Distinguished

Compensation
- 2 persons involved, each of whom is a
debtor and a creditor of the other
- there are 2 obligations
- indirect payment
Confusion
- only 1 person who is a creditor and debtor
of himself
- there is but one obligation
- impossibility of payment

Kinds of Compensation
1. By its effect or extent
(a) Total – obligations are of the same amount and are entirely extinguished
(b) Partial – 2 obligations are of different amounts and a balance remains
2. By its cause or origin
(a) Legal – takes place by operation of law even without the knowledge of the parties
(b) Voluntary – takes place by agreement of the parties
(c) Judicial – takes place by order from a court in a litigation
(d) Facultative – when it can be set up only by one of the parties

Article 1279
Requisites of Legal Compensation
1. the parties are principal creditors and debtors of each other
2. both debts consist in a sum of money, or of consumable things of the same kind and quality
3. the 2 debts are due and demandable
4. the 2 debts are liquidated
5. no retention or controversy commenced by a third person, negative

Article 1280
Notwithstanding the provisions of the preceding article, the guarantor may set up compensation as regards
what the creditor may owe the principal debtor.
The guarantor may be only subsidiarily, not principally bound but he is given the right to set up compensation.
The reason is that the extinguishment of the principal obligation as a consequence of compensation carries
with it the accessory obligations such as guaranty.

Article 1281
Compensation may be total or partial when the 2 debts are of the same amount, there is a total compensation.

Article 1282
The parties may agree upon the compensation of debts which are not yet due.
This provision is an exception to the general rule that only debts which are due and demandable can be
compensated.

Article 1283
Judicial compensation takes place when so declared by a final judgement of a court in a suit.
A party may set off his claim for damages against his obligation to the other party by providing his right to said
damages and the amount.

Article 1287
Compensation shall not be proper when one of the debts arises from a depositum or from the obligations of a
depositary or of a bailee in commodatum.
Neither can compensation be set up against a creditor who has a claim for support due by gratuitous title,
without prejudice.

Article 1288
Neither shall there be compensation if one of the debts consists in civil liability arising from a penal offense

Instances when Legal Compensation is Not Allowed by Law

1. where one of the debts arises from a depositum – a loan which creates the relationship of a debtor and
creditor.
2. where one of the debts arises from a commodatum – a gratuitous contract whereby one of the parties
delivers to another something not consumable so that the latter may use the same for a certain time and
return it.
3. where one of the debts arises from a claim for support due by gratuitous title
4. where one of the debts consists in civil liability arising from a penal offense

Article 1289
If a person should have against him several debts which are susceptible of compensation, the rules on the
application of payments shall apply to the order of the compensation.

Rules on Application of Payments apply to order of Compensation

Compensation is similar to payment. If a debtor has many debts which are susceptible of compensation, he
must inform the creditor which of them shall be the object of compensation because if he fails to do so, then
the compensation shall be applied to the most onerous obligation.

Article 1290
When all the requisites are present, compensation takes effect by operation of law, and extinguishes both
debts to the concurrent amount, even though the creditors and debtors are not aware of the compensation.
Consent of Parties Not Required in Legal Compensation
1. compensation takes place automatically by mere operation of law
2. full legal capacity of parties not required