z

COMPENSATION
 z

DEFINED

A figurative operation of weighing two obligations simultaneously in order to

extinguish them to the extent in which the amount of one is covered by the
amount of the other.

_______________________________________________________________

Compensation may be total or partial. (Art. 1281)

_______________________________________________________________

It may also be LEGAL or VOLUNTARY

 z
Requisites of Compensation

1. There must be two parties, who, in their own right, are principal creditors and
principal debtors of each other

2. Both debts must consist in money, or if the things due are fungibles
(consumables), they must be of the same kind and quality

3. Both debts must be due. (Unless agreed by the parties – Art. 1282)

4. Both debts must be liquidated and demandable

5. There must be no retention or controversy commenced by third persons over

either of the debts and communicated in due time to the debtor

6. The compensation must not be prohibited by law

z
1st requisite

There must be two parties, who, in their own right, are principal
creditors and principal debtors of each other.
z
General Rule

The parties must be creditor and debtor of each other.

z
Exception

In case of a guarantor.

The guarantor may set up compensation as regards what the

creditor may owe the principal debtor. (Art. 1280)
z

Example

A obtained a loan to B amounting to 1M payable on demand. Said

loan was guaranteed by X.

B obtained a loan to X in the amount of 1M.

In this case, X may validly set up compensation as far the loan

obtained by A to B when the latter demanded payment unto him for
the loan obtained by A which he is a guarantor.
z

FACTS:

A borrowed from B 10,000 payable in one year. When X was in the

province, B’s son, X who is 17-years old borrowed 5,000 from A for
his school tuition. However, X spent it instead in purchasing stuffs
for his online game.

When the debt to B fell due, A tendered only 5,000, claiming

compensation on the 5,000 borrowed by X.
z

QUESTION

Is there legal compensation?

 z

Answer

There is no legal compensation. Under the code, it is essential that there must
be two parties, who in their own right, are principal creditors and principal
debtors of each other.

In the case given, B cannot be considered as a party to the act of X in borrowing

5,000 from A.

Hence, B is not the principal debtor of A in the transaction that transpired

between A and X, therefore, legal compensation is not tenable.
 z

Question

Suppose X actually used the money for school tuition, would the answer be
different?
 z

Answer

There would be no difference in the answer. Still legal compensation is not

tenable. The fact that X actually used the 5,000 for school tuition did not make B
a party to the contract between A and X.

Therefore, B is not the principal debtor of A with respect to said amount.

z

2nd requisite

Both debts must consist in money, or if the things due are fungibles
(consumables), they must be of the same kind and quality
 z
Facts

A borrowed from X 10,000 payable on demand. Later on, X obtained a loan from
A in the form of fertilizers amounting to 10,000.

When X demands for the payment of 10,000 cash, A refuses to pay and claims
for legal compensation.
z
Question

Is there a valid legal compensation?

 z
Answer

Legally, there is no valid legal compensation as the code provides, both debts
must consists in money or if things due are fungibles, it must be of the same
kind and quality.
 z
4th Requisite

The debts to be compensated must be liquidated and demandable.

 z
General Rule

In compensation debts must be demandable.

z
Exception

Rescissible or voidable debts may be compensated with each

other, before they are judicially rescinded or avoided.
z
Example

A, a minor, obtained a loan to X amounting to 1M.

Subsequently, X bought a parcel of land registered in the name of A

for 1M.

In this case, both contracts are voidable since one of the parties
has no legal capacity, therefore the same is not demandable.

However, under 1284, the same may be compensated before

either or both debts be judicially declared as such.
 z
Facts

A and X are siblings. A borrowed 1M from X payable on demand.

Later on, parents of the siblings died and left and estate.

Before partition, A wanted to waive his share to the estate in favor of X and to
set-off his debt to the latter.
 z
Question

Can there be legal compensation?

 z

No. the code provides that the debt must be liquidated. In the case give, the
share of A in the estate is yet to be liquidated, therefore, legal compensation is
not tenable.
 z
5th Requisite

There must be no retention or controversy, commenced by third persons and

communicated in due time to the debtor, over either of the debts.
 z
Facts

A obtained a loan to X amounting to 500K. A uses the money to purchase a car

worth 1M. A loaned the deficiency of 500k with LoanBank of Palayan (LBP).

Said car was encumbered by the LBP.

X demanded for the payment of 500K. A offered the car to X to set-off the loan
the former obtained to the latter.
 z
Question

May X be compelled to COMPENSATION?

 z
Answer

No. LBP has an interest over the subject car and in fact the same was
encumbered unto it. The code provides that for compensation to take in effect,
there must be no controversy or retention commenced by third person over the
object.

In the case given, the car has controversy as it was encumbered to LBP and the
latter has retention rights over the subject car.

Therefore, compensation is not tenable.

z

Art. 1285, Assignment of Rights

 z

When compensation has taken place without any intervention on the part of the
interested parties, obligation is extinguished.

- The debtor cannot be held liable for the assignment.

 z
When compensation has not yet taken
place
With Consent of the Debtor With knowledge but Without Without Knowledge and
the Consent of the Debtor consent

The debtor cannot set up
against the assignee the
compensation against the
assignee. However, if the
debtor notified the assignor of
his reservation of his right to
the compensation, the debtor
can still set up compensation
The debtor may set up
compensation for debts PRIOR
to the assignment, but not
subsequent ones.
The debtor may set up
defense of compensation
of all credits until he is
notified of such
assignment
 z
Debts which cannot be subject to
compensation

1. Debts arising from contracts of depositum

2. Debts arising from contracts of commodatum

3. Claims for support due by gratuitous title

4. Obligations arising from criminal offenses, and

5. Certain obligations in favor of the government, such as taxes, fees, duties and
others of a similar nature.
z
When Compensation takes effect

Compensation takes effect by operation of law.

It will take effect from the moment all of the essential requisites
prescribed by law are present.

Note: This rule is applicable only in LEGAL Compensation. As

regards Voluntary compensation, it takes effect upon the
agreement of the parties.
z

NOVATION
z
What is Novation?

Novation is the SUBSTITUTION or CHANGE of an obligation by

another, resulting in its extinguishment or modification, either by
changing its OBJECT or PRINCIPAL CONDITION, or by
SUBSTITUTING another in place of the debtor, or by
SUBROGATING a third person in the rights of the creditor.
z
Effect of Novation

It extinguishes the OLD obligation through the CREATION of NEW

one.

In other words, Novation extinguishes the obligation, it also gives

birth to another obligation

(Two-fold purpose of Novation)

 z
REQUISITES

1. A previous VALID obligation

2. Agreement of the parties to the new obligation

3. Extinguishment of the old obligation

4. Validity of the NEW obligation

z

Classification of Novation
 z EXTINCTIVE

When an OLD obligation is terminated by the creation of a NEW obligation that

takes the place of the former.
 z MODIFICATORY

When the OLD obligation subsists to the extent it remains compatible with the
amendatory agreement.
z

KINDS of NOVATION
 z
As to its essence

1. Objective or Real - change either in the cause, object or principal conditions

of the obligations.

2. Subjective or Personal Novation – The substitution of the person o f the

debtor or to the subrogation of a the person of the debtor or to the
subrogation of a third person in the rights of the creditor.

Note: PASSIVE – substitution of the person of the debtor. ACTIVE – subrogation

in the rights of the creditor)

3. Mixed – Combination of Objective and Subjective

 z
As to FORM

1. EXPRESS – when it is declared in unequivocal terms that the old obligation

is extinguished by the new one

2. IMPLIED/TACIT - when the old and the new obligations are incompatible
with each other on every point, the novation is tacit or implied.
 z
As to Extent/Effect

1. TOTAL – there is an absolute extinguishment

2. PARTIAL – there is merely a modification

z
Facts

Let us say that under the judgment obligation, the liability of the
judgment debtor is for the amount of P6,000, but both judgment
debtor and judgment creditor subsequently entered into a contract
reducing the liability of the former to only P4,000.
 z

Is there NOVATION?
 z
Answer

Novation results in two stipulations — one to extinguish an existing obligation, the

other to substitute a new one in its place.

Fundamentally, it is that novation effects a substitution or modification of an obligation

by another or an extinguishment of one obligation by the creation of another.

In the case given, there is no new or modified obligation arose out of the payment of
the reduced amount, as the two obligations are not in unequivocal terms with each
other neither was there complete and substantial incompatibility between the two
obligations.

(Sandico vs Piguing)
z
Facts

A obtained a loan to X payable on demand.

Upon demand from X, A pleaded to be given a year to pay.
z

 Is there Novation?
 z

Yes there is novation. There is change or alteration of the principal condition

and because of the fact that the two obligations are incompatible.
 z
Novation by Substitution of Debtor

Novation consisting in substituting a new debtor in the place of the original

one, may be made even without the the knowledge or against the will of the
latter, but not without the consent of the creditor.
 z

EXPROMISION - Substitution of debtor WITH the CONSENT of the Creditor at

the instance of the new debtor, even without the knowledge or against the will
of the older debtor. The substitution emanates from the NEW DEBTOR.
 z

DELEGACION – Substitution of debtors with the consent of the creditor at the

instance of the OLD Debtor with the concurrence of the NEW Debtor.
 z
Effect in DELEGACION and
EXPROMISION

The rules on payment of third person shall apply.

WITH CONSENT/KNOWLEDGE of the old debtor – Reimbursement of the

entire amount paid with subrogation in the rights of the creditor.

WITHOUT THE CONSENT/KNOWLEDGE of the old debtor – Reimbursement

of the amount beneficial to the old debtor.
 z
Effect in DELEGACION and
EXPROMISION

DELEGACION – Insolvency of the NEW debtor shall not revive the action of
the Creditor against the OLD Debtor. Except when such insolvency was already
existing and of public knowledge or known to the debtor when he delegated his
debt.

EXPROMISION – insolvency of the NEW debtor or non-fulfillment of the

obligation shall not give rise to any liability on the part of the OLD debtor,
provided the latter have not consented thereto nor have knowledge therein.
Otherwise, the OLD debtor shall be held liable for the insolvency of the NEW
debtor.
z
Effect upon Accessory Obligations

When the principal obligation is extinguished in consequence of a

novation, accessory obligations may subsist only insofar as they
may benefit third persons who did not give their consent to such
novation.

(Art. 1296)
z

Effect If the OLD OBLIGATION is VOID?

 z

There is no Novation. In novation it is essential that the OLD obligation must

be VALID.

Therefore, there is nothing to novate, the new obligation cannot produce any
effect.
z

Effect if the NEW obligation is VOID?

 z

There is no new obligation. In novation the NEW obligation must also be valid.
z

What will happen to the OLD obligation?

z

General Rule:

The OLD obligation shall still subsists.

Exception:

The OLD obligation is deemed extinguished if the parties intended

to such effect in any event.
 z
Effect If Old Obligation Is Conditional

General Rule:

If the original obligation was subject to a suspensive or resolutory

condition, the new obligation shall be under the same condition.

Exception:

If stipulated otherwise.
 z
Novation By Subrogation

There are two kinds of Subrogation:

1. Conventional – Subrogation which takes place by the agreement of the

Original Creditor, Third Person and the Debtor.

2. Legal – Subrogation which takes place by operation of law. It is never

presumed.
 z

When is Legal subrogation presumed?

 When a creditor pays another creditor who is preferred, even without the
debtor’s knowledge;

 When a third person, not interested in the obligation, pays with the express
or tacit approval of the debtor;

 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.
 z
Example

A borrowed money from X, secured by a real property.

A also borrowed money from Y without any security.

-If Y paid to X the amount loaned by A, it is presumed that Y is

subrogated in the rights of X against A.
z

Effect of PARTIAL Subrogation

A creditor, to whom partial payment has been made, may exercise

his right for the remainder, and the Creditor shall be preferred to the
person who has been subrogated in his place in virtue of the partial
payment of the same credit.