V.

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

Compensation
–Two persons or two parties are debtors and creditors of each other.
(Not necessarily reciprocal, but it is bilateral)

–Not the same as confusion. In confusion, there is only one obligation

involved, while in compensation, there are at least two obligations
involved. In confusion, there is only one party involved because the
characters of debtor and creditor meet in one and the same person.
Whereas in compensation, there are two parties involved.
EXAMPLE
There are two debts: 1) the debt of A
A owes B P1,000. 2) the debt of B
B owes A P1,000. Since they are of the same amount, there is a
TOTAL compensation.
The obligation is therefore extinguished
between them.

A owes B P1,000 Here, there is a PARTIAL compensation.

B owes A P5,000 A shall be liable to B for only P500.
Kinds of Compensation

1. Legal
– takes place by operation of law

2. Conventional
– takes place by agreement of the parties

3.  Judicial
– decreed by the court

4. Facultative
– a party is entitled to oppose it when compensation is
invoked by the other but the one who can oppose is not
precluded from invoking compensation.
Art. 1279. In order that compensation may be proper, it is
necessary: refers to a Legal Compensation

(1) That each one of the obligors be bound principally, and that
he be at the same time a principal creditor of the other;

EXAMPLES

A owes B P1,000 There is compensation.

B owes A P1,000 A and B are principal debtors and creditors of each other.

A owes B P1,000 with C as guarantor.
B owes C P1,000.
There is no compensation.
B is principally liable to C, but C is only
subsidiarily liable to B.
They are not principal debtors and
creditors of each other.
(2) That both debts consist in a sum of money, or if the things due
are consumable, they be of the same kind, and also of the same
quality if the latter has been stated;
EXAMPLE

A owes B P5,000 There is no compensation.

B owes A a cellphone The debts are not of the same kind.

(3) That the two debts be due;

Example

A owes B P1,000 due June 15.

B owes A P1,000 due June 30. There is no compensation.
Both debts are not due and demandable yet.
(4) That they be liquidated and demandable;
A owes B P1,000.
B owes A a share in a business which amount is not known yet.
There is no compensation because the debt of B is not yet liquidated.

(5) That over neither of them there be any retention or

controversy, commenced by third persons and communicated in
due time to the debtor.

A owes B P5,000.
B owes A P5,000.
B also owes C P5,000. C causes to garnish the credit of B against A
and tells A not to pay B first because C has a better right to the
amount. There is no compensation because of the controversy caused by C.
Art. 1280. Notwithstanding the provisions of the preceding
article, the guarantor may set up compensation as regards what
the creditor may owe the principal debtor.

• Compensation also benefits the guarantor.

• The extinguishment of the principal obligation also carries
with it the extinguishment of accessory obligations (such as
contract of guaranty).

EXAMPLE
There is compensation between
A owes B P1,000 with G as guarantor. the two debts of A and B.
B owes A P1,000. Therefore, the contract of
guaranty is also extinguished.
 ART. 1283 JUDICIAL COMPENSATION

EXAMPLE

A owes B P5,000. A failed to pay B. Thus, B damaged the fence of

A to the extent of P3,000.
A can set off the obligation of B to pay him damages. A will only
owe P2,000 to B.
** Compensation my also happen in rescissible or voidable debts. (Art. 1284)

Rescissible and voidable obligations – valid UNTIL they are judicially rescinded or
avoided (by the court).

EX: A owes B P5,000.

B, through fraud, made A sign a promissory note saying that A is indebted to B
for P5,000.
The debt of A is valid. The debt of B is voidable.
But, before the debt of B is declared voidable, both debts can be compensated.
 VI. NOVATION
Art. 1291. Obligations may be modified by:
(1) Changing their object or principal conditions;(2)
Substituting the person of the debtor;(3) Subrogating a
third person in the rights of the creditor.

** While novation extinguishes an obligation, it creates a new one to

take the place of the extinguished one.
** Novation should never be presumed.
Novation may either be:
1. Extinctive - old obligation is extinguished and a new one is created
2. Modificatory - no extinguishment of obligation. It simply modified the
obligation.
 REQUISITES OF A NOVATION

1. Old valid obligation

2. Agreement of all parties to the new contract
3. Extinguishment of the old contract
4. The validity of the new one (Art. 1297)

What is the test tot determine whether there is a Novation?

The test is whether they can stand together. If they cannot, the
second obligation novates the first (incompatible with each other).

EX: X agreed to deliver a car to Y on June 15. Later, a second

agreement was made wherein S would deliiver a truck on June 15. Is
there a novation? (na-extinguish ba yun unang obligasyon na mag-
deliver ng car?)

NO. The two obligations can stand together. Novation should not
be presumed by the parties unless there was an agreement.
Art. 1293. Novation which consists in substituting a new
debtor in the place of the original one, may be made even
without the knowledge or against the will of the latter, but
not without the consent of the creditor. Payment by the
new debtor gives him the rights mentioned in Articles 1236
and 1237.

Art. 1297. If the new obligation is void, the original one shall
subsist, unless the parties intended that the former relation
should be extinguished in any event.
**There must be a new valid obligation

Art. 1298. The novation is void if the original obligation was

void, except when annulment may be claimed only by the
debtor or when ratification validates acts which are voidable.
**There must be also a old valid obligation
3 ways by which novation may take place
1. Changing the object or any other principal conditions of the obligation
  –principal, not accessory condition. This is called real or objective novation, which
refers to a change in the (a) cause of the obligation; (b) object of the obligation; (c) any
of the principal conditions of the obligation
 
2. Subsititution of the person of the debtor : (ARTICLE 1293)
a. Expromision
– initiative for the change of debtor comes from the 3rd person. Consent of
creditor and 3rd person are necessary.
b. Delegacion
– initiative comes from the debtor himself. Consent of all parties is necessary.

*Effect of insolvency of substitute: (ARTICLE 1294 - 1295)

*In expromision, the old obligation will not be revived.
*In delegacion, Gen. Rule is the old obligation will also not be revived, Exceptions are:
(1) if at the time of substitution, the new debtor is already insolvent and such is of
public Knowledge; or (2) if at the time of the substitution, insolvency of the new
debtor was already existing, although such is not publicly known, yet it is known to the
debtor.
Example
D (debtor) owes money to C (creditor). T (third person / substitute) tells
C that will be the one to pay D’s debt. So, D will no longer be liable to C. C
agrees.

Here, there is a substitute in the person of the debtor. Since it is in

the initiative of the third person, it is a case of EXPROMISION.

Remember there must be consent of the creditor and third person.

What if T is insolvent?

The old obligation of D will not be revived. D is no longer liable to C.

 Example
D (debtor) owes money to C (creditor). D tells C that T (third person /
substitute) will be the one to pay D’s debt. So, D will no longer be liable to C.

Here, there is a substitute in the person of the debtor. Since it is in

the initiative of the Debtor, it is a case of DELEGACION.

Remember there must be consent of ALL: debtor, creditor, third person

What if T is insolvent?

The general rule is that D’s obligation to C will not be revived.

BUT if the insolvency of T was already existing at the time of substitution and was
publicly known, then D’s obligation will be revived.

OR if at the time of substitution, T was already insolvent and was KNOWN to the
debtor, then the obligation of D will be revived.
3. Subrogating a 3rd person into the rights of the creditor

Art. 1300. Subrogation of a third person in the rights of the

creditor is either legal or conventional. The former is not
presumed, except in cases expressly mentioned in this Code; the
latter must be clearly established in order that it may take effect.

Subrogation
- It is the transfer of all the rights of the creditor to a third person, who
substitutes him in all his rights.

Kinds of subrogation
1. Legal – takes place by operation of law
2. Conventional – by agreement of all parties
- requires the consent of the parties: original creditor,
the new creditor, and the debtor
 Art. 1302. It is presumed that there is legal
subrogation:
(1) When a creditor pays another creditor who is
preferred, even without the debtor's knowledge;
EXAMPLE

A owes B P10,000 which is secured by a mortgage on A’s land. (Ibig sabihin, kapag
hindi nabayaran ni A si B, pwede niya remata ang lupa ni A).

A also owes C P10,000 without any mortgage.

In the example above, B is the preferred creditor, while C is merely an ordinary

creditor.
So, if C pays the debt of A to B, C will be subrogated to the rights of B.
If A will not be able to pay C, can be the one to foreclose the land of A. (he
stepped into the shoes of B as creditor).
(2) When a third person, not interested in the
obligation, pays with the express or tacit approval of the
debtor;

EXAMPLE

A owes B P10,000. C pays the debt of A to B with A’s consent.

Note that C is not a person interested in the fulfillment of the
obligation.

In this case, C will be subrogated in the rights of B. (Art. 1236 –

1237)
(3) When, even without the knowledge of the debtor, a
person interested in the fulfillment of the obligation
pays, without prejudice to the effects of confusion as to
the latter's share.

EXAMPLE

A owes B P10,000. C is the guarantor of A. Note that C is a

person INTERESTED in the fulfillment of the obligation.

If C pays the debt of A to B, even without the knowledge of A, the

debtor, C is subrogated in the rights of B.