M

O
D MODES OF EXTINGUISHMENT OF
U OBLIGATION – PAYMENT OR PERFORMANCE
& SPECIAL FORMS OF PAYMENT (ART. 1231 – 1261)
L EDMAR JAMES I. SEBUA, CPA

E
7

LAW 101 (LAW ON OBLIGATIONS & CONTRACTS)||AY. 2022-2023 1st

semester
 MODES TO EXTINGUISH OBLIGATIONS
& INTRODUCTION TO PAYMENT OR PERFORMANCE

EXTINGUISHMENT OF OBLIGATIONS
Cause of extinguishment of obligations (PALOCOMECONO ARFP)
1. Payment or performance 2. Loss of the thing due
3. Condonation or remission of debt 4. Merger or confusion of the rights
5. Compensation 6. Novation
7. Annulment 8. Rescission
9. Fulfillment of resolutory condition 10. Prescription
11. Bankruptcy 12. Other causes

Payment or performance
Meaning of payment
Payment means not only the delivery of money but also the performance, in
any other manner, of an obligation (Art. 1232)
Thus, if the obligation is to paint a portrait, payment consists in the performance
of the service. Or if the obligation is to deliver a certain ring, payment consists in the
delivery of the thing.
 
 PAYMENT – HOW TO BE MADE?
How the payment must be made
1. There must be delivery of the thing or the rendition of the service that was contemplated.
a. The debtor of a thing cannot compel the creditor to accept a different one although
the latter may be of the same value as, or more valuable than that, which is due. (Art. 1244)
Example: D is obliged to give C a Seiko wristwatch. D cannot compel C to accept a Rolex
wristwatch even if the latter is more valuable than a Seiko.
 
b. In obligations to do or not to do, an act or forbearance cannot be substituted by
another act or forbearance against the will of the creditor. (Art. 1244).
Example: (1) D is obliged to paint C’s car. He cannot substitute it with an obligation to paint
C’s house.
(2) D borrowed P10,000 from C. C gave D one year to pay provided D must not enter a
casino before he has paid the debt. D cannot ask C that the obligation “not to enter a casino” be
substituted with “not to drink and smoke” during the term of the loan.
 
c. In obligations to give a generic thing whose quality and circumstances have not
been stated, the creditor cannot demand a thing of superior quality. Neither can the debtor
deliver a thing of inferior quality. The purpose of the obligation and other circumstances
shall be taken into consideration. (Art. 1246)

 
 PAYMENT – HOW TO BE MADE?
d. If the obligation is a monetary obligation, the payment must be in legal tender.
Legal tender – is the money or currency which the debtor may compel his creditor to
accept in payment of his debt in money (whether public or private)

Medium of payment
Payment of debts in money must be made in the currency which is legal tender in the
Philippines. However, the parties may stipulate that the payment may be made in currency other
than Philippine legal tender at the time of payment. (RA 8183)
Under the New Central Bank Resolution, the following are legal tender in the Philippines:
1) One hundred pesos (P100) for denominations of 1centimos, 5centimos, 10centimos, and
25centimos coins.
2) One thousand pesos (P1000) for denominations of 1-Piso, 5-Piso, and 10-Piso coins.
3) All bills are legal tender up to any amount.
 
Inflation and deflation, concept; value to be used when payment is made
Inflation is the increase in the currency in circulation or a marked expansion of credit,
resulting in a fall in currency value, and a sharp rise in prices. It is the opposite of deflation, or
the sharp sudden decrease in money or credit or both without a corresponding decrease in
business transactions.
 
 PAYMENT – HOW TO BE MADE?
When extraordinary inflation (or deflation) exists.
In order that the effects of extraordinary inflation (or deflation) are to be applied, there
should an official pronouncement or declaration by competent authorities of the existence of
extraordinary inflation (or deflation) during a given period.
 
Check not legal tender
A check is not legal tender and, therefore, cannot constitute a valid tender of payment.
Since a negotiable instrument is only a substitute for money, and not money, the delivery of such
an instrument does not by itself, operate as payment. The obligation is not extinguished and
remains suspended until the payment by commercial document is actually realized.

2. The payment or performance must be complete (Art. 1233). The following are the
exceptions:
a. If the obligation has been substantially performed in good faith, the obligor may
recover as though there had been strict and complete fulfillment, less damages suffered by
the obligee. (Art. 1234)
Example: S agreed to deliver 20 fire extinguishers to B. After S delivered 18 fire
extinguishers to B, there are no more fire extinguishers available. He wants to complete the
delivery but there is no more stock available. S can recover the cost of 20 fire extinguishers less
damages suffered by B.
 
 PAYMENT – HOW TO BE MADE?
b. When the obligee accepts the performance knowing its incompleteness or
irregularity, and without expressing any protest or objection, the obligation is deemed fully
complied with. (Art. 1235)
Example: D agreed to repair the car of C and to paint it red. D repaired the car but painted
it maroon. C accepted the car without any objection. D’s obligation is fully complied with
notwithstanding the irregularity of the performance.

When partial payments be made

The creditor cannot be compelled to receive, and the debtor cannot be compelled to
make, partial payments, except:
a. When there is an agreement to that effect. (Art. 1248)
However, the payment must still be made in full at some future time in accordance with
the agreement, to extinguish the obligation.

b. When the debt is in part liquidated (i.e. the amount is fixed) and in part
unliquidated, the creditor may demand and the debtor may effect the payment of the
former without waiting for the liquidation of the latter (Art. 1248)
The unliquidated part, once it is finally determined, must also be paid, to extinguish the
obligation.
 PAYMENT – WHO MUST DO IT?
Who must make payment

Payment must be made by the debtor who must possess the following:

1. The free disposal of the thing due.

Free disposal of the thing due means that the property delivered should not be subject to
any claim by, or encumbrances in favor of, third persons.
Thus, if a property mortgaged is used as payment by the debtor to a creditor other than the
mortgagee, the payment is not valid. The said property can be made to answer for the debt
secured in case of foreclosure of the mortgage.
 
2. The capacity to alienate the thing
The debtor must be capable of giving consent.

Effect on payment in obligations to give if debtor does not have free disposal and capacity
to alienate.
The payment shall not be valid except in cases provided by law. (Art. 1239) If the
payment is made, the guardian of the incapacitated person (during the incapacity), or the
incapacitated person himself when he regains or attains his capacity, may seek annulment of the
payment. (Art. 1397). In case the debtor does not have the free disposal of the thing due, the
injured party may seek to recover the payment.
 PAYMENT – WHO MUST DO IT?
Payment made by the debtor after court has ordered him to retain debt
Payment made to the creditor by the debtor after the debtor has been judicially ordered
to retain the debt shall not be valid. (Art. 1243). The court order is known as garnishment.

Example: D owes C P50,000. On due date, C demands payment but D cannot pay. C, however,
learns that D has a receivable from X so he files a court action against D and asks the court to
order X not to make any payment to D. The court issues the order. If X pays D, the payment will
not be valid because there is an order of retention from the court. Should the court favor C in its
judgment in the case filed by C against D, X can be required to pay again, this time to C.

Payment by a third person

1. Creditor not bound to accept payment by a third person.
The creditor is not bound to accept payment or performance by a third person except in
the following cases:
a. When there is a stipulation to that effect.
b. When the third person has an interest in the fulfillment of the obligation such as a
guarantor or a co-debtor. (Art. 1236).
Example: D borrowed P20,000 from C with G as guarantor. G, as a person who has an
interest in the fulfillment of the obligation, may compel C to accept the payment from him.
 PAYMENT – WHO MUST DO IT?
2. Right of a third person who makes the payment

a. Payment with knowledge and consent of the debtor.

1) He can recover what he has paid. (Art. 1236)
2) He is entitled to be subrogated in the rights of the creditor such as those arising from
mortgage, guaranty or penalty. (Art. 1237)
 
Example: D owes C P10,000. The obligation is secured by a mortgage on D’s lot. T, a third
person, pays C the amount of P10,000 with the consent of D. T can recover the amount of
P10,000 from D. If D cannot pay, T, having been subrogated in the rights of C, can foreclose the
mortgage.
 
b. Payment without the knowledge or against the will of the debtor
He can recover only insofar as the payment has been beneficial to the debtor. He is not
entitled to subrogation. (Art. 1236 and 1237)
Example: D borrowed P20,000 from C with G as guarantor. D pays C P2,000. T, a third
person, pays C P20,000 believing that D still owed C P20,000. The payment is without the
consent of D. In this case, T can only recover P18,000 from D, the amount that was beneficial to
D. If D cannot pay, T cannot go after G because he is not entitled to be subrogated in the rights of
C.
 PAYMENT – TO WHOM IT MUST BE DONE?
3. Payment by a third person who does not want to be reimbursed
a. The payment shall be deemed to be a donation which requires the debtor’s consent.
b. If the debtor does not consent, the payment shall nevertheless be valid to the creditor
who has accepted it. (Art. 1238). In such a case, the third person can only recover insofar as the
payment has been beneficial to the debtor; he is also not entitled to subrogation. (Art. 1236 and
1237)

To whom payment shall be made

1. To the creditor (the person in whose favor the obligation has been constituted)
 Payment to an incapacitated creditor
The creditor must be capacitated to receive the payment. Payment to an incapacitated
creditor is not valid except in the following cases:
a. If he has kept the thing delivered.
Example: D borrowed P10,000 from C. On due date, D paid the debt to C who has become
insane. If C kept only P4,000 and threw away P6,000, then payment will be valid only up to
P4,000.
 
b. Insofar as the payment has been beneficial to him. (Art. 1241)
Example: In the above example, if C used P3,000 to buy his food, and lost the balance,
payment will be valid only up to P3,000, the amount beneficial to him.
 PAYMENT – TO WHOM IT MUST BE DONE?
2. To the creditor’s successors in interest, such as his heirs or assigns
 
3. To any person authorized to accept payment
 Payment to an unauthorized third person
As a general rule, payment to an unauthorized third persons is not valid, except:

a. If the payment has redounded to the benefit of the creditor, which benefit need
not be proved in the following cases (Art. 1241):

1. If after payment, the third person acquires the creditor’s rights (such as when the
third person becomes the assignee of the instrument evidencing the credit).

2. If the creditor ratifies the payment to the third person

3. If by the creditor’s conduct, the debtor has been led to believe that the third person
had the authority to receive payment (such as when a water service company gives a
collector’s uniform to a third person who is not its employee and the debtor gives his payment to
such third person believing that he is the authorized collector).
 PAYMENT – SPECIAL FORMS
b. If the payment is made in good faith to a third person in possession of the credit.
(Art. 1242)
In this case, the third person should be both in possession of the instrument and the
credit.
Example: M makes a note payable to bearer and delivers it to P. The note, however, is lost
by P and is picked up by A. A goes to M to collect on the note. M pays A believing in good faith
that A is the intended bearer. M is released from liability.

Special forms of payment

1. Dation in payment (dacion en pago)
2. Payment by cession
3. Application of payment
4. Tender of payment and consignation

Dation in payment
Dation in payment (dacion en pago, adjudicacion en pago or datio in solutum) is a special
form of payment where the ownership of property is transferred to his creditor to pay a debt
in money. (Art. 1245). It is governed by the law of sales since it partakes in a sense the nature
of a sale with the creditor in effect buying the property of the debtor.
 PAYMENT – SPECIAL FORMS
What actually takes place in dacion en pago is an objective novation of the obligation
where the thing offered as an accepted equivalent of the performance of an obligation is
considered as the object of a contract of sale, while the debt is considered the purchase price. In
any case, common consent is an essential prerequisite, be it sale or novation, to have the effect of
totally extinguishing the debt or obligation
 
Example: D owes C P10,000. On due date, D proposes to C to accept a ring in payment of
D’s debt of P10,000. C agrees to D’s proposal and accepts the ring. D’s monetary obligation is
extinguished by dacion en pago.

Payment by cession
Payment by cession is the abandonment or assignment by the debtor of all his property
in favor of his creditors so that the latter may sell them and recover their claims out of the
proceeds (Art. 1255)
The cession or assignment operates only to authorize the creditors to sell the debtor’s
property, hence, ownership is not transferred to them. Unless agreed upon, the cession
releases the debtor from his responsibility only to the extent of the net proceeds of the thing
assigned. (Art. 1255)
 PAYMENT – SPECIAL FORMS
Kinds of payment by cession
a. Voluntary or conventional – agreed upon by the parties.
b. Legal – cession by operation of law
 
Requisites of payment by cession
a. There must be two or more creditors.
b. The debtor is insolvent.
c. The debtor abandons all his properties except those which are exempt from
execution.
d. The creditors accepts the abandonment.
 
Illustration
D owes X, P50,000; Y, P20,000; and Z, P30,000. All the obligations are due but D has
assets worth P80,000 only. D offers to assign his assets to X, Y, and Z so that they may sell them
and apply the proceeds to their respective claims. X,Y, and Z accept the offer. If the assets are
sold for P70,000, then D will be released from his obligations only up to that amount, unless the
creditors agreed to release him completely of his debts.
PAYMENT – SPECIAL FORMS
PAYMENT BY CESSION vs. DACION EN PAGO
Payment by cession
1. There must be two or more
creditors
2. The debtor is insolvent
3. Affects all the debtor’s
properties, except those exempt
from execution
4. The creditors are authorized to
sell only the debtor’s properties
5. The debtor is not released as a
rule
Dacion en pago
1. Plurality of creditors is not
required
2. The debtor may not be
insolvent
3. Does not affect all the debtor’s
properties
4. The creditors becomes the
owner of the properties given as
payment
5. The debtor is released as a rule
 PAYMENT – SPECIAL FORMS
Application of payment
It is the designation of the debt to which payment shall be applied when the debtor owes
several debt in favor of the same creditor. (Art. 1252)
 
Requisites of application of payment
a. There must be two or more debts
b. The debts must be of the same kind
c. The debts are owed by the same debtor to the same creditor.
d. All debts are due, except:

1) When the parties have stipulated that payment may be applied to a debt not
yet due, or
2) When the application of payment is made by the party for whose benefit the term
has been constituted. (Art. 1252)
 PAYMENT – SPECIAL FORMS
How application is made
a. The debtor who is given the preferential right to apply the payment, designates the debt to
be paid.

b. If the debtor does not make the designation, the creditor makes it by indicating the debt
being paid in his receipt. If the debtor accepts the receipt from the creditor, the debtor
cannot complain unless there is a just cause of invalidating the contract.

c. If neither the debtor nor creditor makes the designation, nor application cannot be
inferred from the circumstances, payment shall be applied by operation of law as follows:

1) Payment shall be applied to the debt, among those due, which is the most onerous to
the debtor.

2) If the debts are of the same nature and burden, payment shall be applied to all due
debts proportionately. (Art. 1252, 1254)
 
Note: In all instances, if the debt produces interest, payment of the principal shall not be
deemed to have been made until the interests have been covered. (Art. 1253)
 PAYMENT – SPECIAL FORMS
Illustration 1:
D owes C the following distinct debts: P1,000 due on May 1, P1,000 due on May 5,
P1,000 on May 10, P1,000 on May 15, and P1,000 on May 20.

a. If today is May 16, and D has only paid P1,000 but wants to pay C, D may apply the
payment to any of the debts due on May 1, May 5, May 10, or May 15. He cannot apply the
payment to the debt on May 20 because it is not yet due unless he is allowed by stipulation with
C or the benefit of the period was given to him (D).

b. If D does not apply the payment, the right to apply it is shifted to C. C may apply the
payment to any of the debts due on May 1, May 5, May 10 or May 15. He cannot apply the
payment to the debt due on May 20 because it is not yet due unless he is allowed by stipulation
with D or the benefit of the period was given to him (C).

c. If neither D nor C applies the payment, payment shall be applied proportionately to the
debts due on May 1, May 5, May 10 and May 15 at P250 each. In case the debt due on May 5 is
secured by a pledge, then payment shall be applied to such debt because it is the most onerous to
D.
 PAYMENT – SPECIAL FORMS
Illustration 2:
D owes C P7,000 due on May 1, 5 sacks of rice worth P5,000 on May 5, and P5,000 due
on May 8. If none of the debts have been paid as of May 8 and D has P5,000, D cannot apply the
payment to the debt consisting of 5 sacks of rice because it is not payable in money (it is of a
different kind). D may not apply the payment to the debt due on May 1 because the payment
would not be complete unless C consents. D may, however, apply the payment to the debt due on
May 8.

Tender of payment and consignation

Tender of payment is the act of the debtor of offering to his creditor what is due him.

Consignation, on the other hand, is the act of depositing the sum or thing due with the
judicial authorities whenever the creditor refuses without just cause to accept the same, or in
the cases when the creditor cannot accept it.

Illustration of tender of payment and consignation

D borrowed P50,000 from C. On due date, D tendered payment in P20 bills totaling
P50,000 to C. C refused to accept the payment demanding that he be paid in higher
denominations. Since the payment tendered by D was legal tender, C was not justified in refusing
to accept it. D may thus consign the payment.
 PAYMENT – SPECIAL FORMS
Requisites (steps) for tender of payment and consignation to extinguish an obligation
a. There must be a valid tender of payment (Art. 1256)
Thus, the payment being tendered must be the thing contemplated, in legal tender,
complete, on the day it falls due, among other requisites for a valid payment.
 
b. The creditor refuses without just cause to receive the payment. (Art. 1256)
 
c. The persons interested in the fulfillment of the obligation must be notified by the
debtor of his intention to deposit the sum or thing due with the judicial authorities. (Art.
1256)
The notice will enable the creditor, mortgagees, guarantors, sureties, solidary debtors,
among others, to reconsider accepting the payment and avoid litigation. The notice is also
required to give the creditor the opportunity to accept the payment because the expenses of
consignation will be charged to him for his non-acceptance of the payment. This notice is
mandatory. Without it, the consignation is void.

d. The sum or thing due is deposited with judicial authorities (Art. 1258)
 
e. The persons interested in the fulfillment of the obligation must again be notified by
the debtor that the consignation has been made. (Art. 1258).
Without this subsequent notice, the consignation is void.
 PAYMENT – SPECIAL FORMS
Effect of consignation duly made
If the consignation has been duly made, the debtor may ask the judge to order the
cancellation of the obligation. The obligation shall be extinguished after the creditor has
accepted the consignation or the judge has declared that the consignation has been properly
made. (Art. 1260)
 
Debtor’s right to withdraw the sum or thing consigned
a. Before acceptance by the creditor of the consignation or the declaration by the
judge that the consignation has been made properly –
The debtor may withdraw the sum or thing consigned as a matter or right, i.e., the
creditor’s consent is not required. Such withdrawal produces the following effects:
1) The obligation shall remain in force. (Art. 1260)
2) The co-debtors, guarantors, and sureties are not-released. (Art. 1261)

b. After acceptance by the creditor of the consignation or the declaration by the

judge that the consignation has been properly made –
The debtor may withdraw the sum or thing consigned only with the consent of the creditor.
Such withdrawal produces the following effects:
1) The obligation shall be revived. (Art. 1260)
2) The creditor shall lose every preference which he may have over the thing.
 PAYMENT – SPECIAL FORMS
3) The guarantors, and sureties are released unless they consented. If there are
several debtors and their obligation is solidary, such obligation will become a
joint obligation.

 Thus, the creditor can no longer proceed against the guarantor or surety if later
on the debtor cannot pay. As regards the co-debtors, they are not released from
liability they being principal debtors. Their obligation becomes joint if it was
previously solidary.

When consignation, without a previous tender of payment, will produce the same effect
a. When the creditor is absent or unknown or does not appear at the place of
payment.
b. When he is incapacitated to receive the payment at the time it is due.
c. When, without just cause, he refuses to give a receipt.
d. When two or more persons claim the same right to collect.
e. When the title of the obligation has been lost. (Art. 1256)
END OF MODULE
7
Source: Notes in Business Law 2016 edition (Author: Fidelito R. Soriano)