Law on Obligations and Contracts Chapter 4

CHAPTER 4  - EXTINGUISHMENT OF OBLIGATIONS

Article 1231 - Obligations are extinguished: (1) By Payment or performance; (2) By loss of the thing due; (3) By the condonation or remission of the debt; (4) By the confusion or merger of the rights of creditor and debtor; (5) By compensation; (6) By novation. Other causes of extinguishment of obligations, such as annulment, rescission, fulfillment of a resolutory condition, and prescription, are governed elsewhere in this code.

Causes of extinguishment of obligations:

• Death of a party (if obligation requires personal service)
• Mutual desistance or withdrawal
• Arrival of resolutory period
• Compromise
• Impossibility of fulfillment
• Happening of a fortuitous event

SECTION 1 - PAYMENT OR PERFORMANCE

Article 1232 - Payment means not only the delivery of money but also the performance, in any other manner, of an obligation.

Payment

• In ordinary parlance - it means delivery of money
• In legal mode of extinguishing an obligation - it means not only delivery of money but also giving of a thing, the doing of an act or not doing of an act.

Article 1233 - A debt shall not be understood to have been paid unless the thing or service in which the obligation consists has been completely delivered or rendered, as the case may be.

Debt - obligation to deliver money, deliver a thing, to do an act or not to do an act

Requisites that a debt is considered paid

• Integrity of prestation - debt to deliver a thing or to render service is not understood to have been paid unless the thing or service has been completely delivered or rendered.
• Identity of prestation - the very prestation due must be delivered or performed.

Article 1234 - If the obligation has been substantially performed in good faith, the obligor may recover as though there had been a strict and complete fulfillment, less damage suffered by the oblige

Requisites for the application of Article 1234

• There must be substantial performance (the important or essential part of the contract has been performed and only a minor part thereof has not been carried out)
• The obligor must be in good faith

Doctrine of substantial performance - embodied by Article 1234

Article 1235 - 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.

Recovery allowed when incomplete or irregular performance is waived

• If the payment is incomplete or irregular, creditor may properly reject it
• In case of acceptance, the law considers that he waives his right        

Requisites of article 1235

• Obligee knows that the performance is incomplete or irregular
• Obligee accepts the performance without any protest or objection

Article 1236 - The creditor is not bound to accept payment or performance by a third person who has no interest in the fulfillment of the obligation, unless there is a stipulation to the contrary.

Whoever pays for another may demand from the debtor what he has paid, except that if he paid without the knowledge or against the will of the debtor, he can recover only insofar as the payment has been beneficial to the debtor.

Persons from whom the creditor must accept payment

• The debtor
• Any person who has an interest in the obligation (ex. Guarantor)
• Third person who has no interest in the obligation when there is stipulation that he can make payment

Creditor may refuse the payment by a third person - creditor should not be compelled to accept payment from a third person whom he dislike or distrust

Effect of payment by a third person

• If made without the knowledge or against the will of the debtor - the payer can recover from the debtor insofar as the payment has been beneficial to the latter (recovery is only up to the extent or amount of the debt at the time of the payment)
• If made without the knowledge of the debtor - payer shall have the rights of reimbursement and subrogation (to recover what he has paid and acquire all the rights of the creditor)

Article 1237 - Whoever pays on behalf of the debtor without the knowledge or against the will of the latter cannot compel the creditor to subrogate him in his rights, such as those arising from a mortgage, guaranty, or penalty

Subrogation and reimbursement distinguished

• Subrogation - person who pays for the debtor is put into the shoes of the creditor. Acquires not only the right to reimbursed for he has paid but also acquired all other rights which the creditor could have exercised
• Reimbursement - third person is entitled by reason of payment has merely the bare right to be refunded to the extent provided in the 2nd paragraph of article 1236

Article 1238 - Payment made by a third person who does not intend to be reimbursed by the debtor is deemed to be a donation, which requires the debtor’s consent. But the payment is in any case valid as to the creditor who has accepted it.

Donation - when the paying third person which have the debtor’s consent does not intend to be reimbursed

If the creditor accepts the payment, it shall be valid as to him and the payor although the debtor did not give his consent to the donation.

Article 1239 - In obligations to give, payment made by one who does not have the free disposal of the thing due and capacity to alienate it shall not be valid, without prejudice to the provisions of article 1247 under the title on “Natural Obligations”

Free disposal of the thing due - the thing to be delivered must not be subject to any claim or lien or encumbrance (ex. mortgage, pledge) of a third person

Capacity to alienate - person is not incapacitated to enter into contracts and for that matter, to make a disposition of the thing due. (You should only deliver your thing and not from others)

Article 1240 - Payment shall be made to the person in whose favor the obligation has been constituted, or his successor in interest, or any person authorized to receive it.

Payment shall be made to:

• The creditor or obligee (person in whose favor obligation has been constituted) - must be the creditor at the time the payment is to be made, not at the constitution of the obligation
• His successor in interest (heir or assignee)
•  Any person authorized to receive it - not only a person authorized by the creditor, but also a person authorized by law

Article 1241 - Payment to a person who is incapacitated to administer his property shall be valid if he kept the thing delivered, or insofar as the payment has been beneficial to him.

Payment made to a third person shall be valid insofar as it has redounded to the benefit of the creditor. Such benefit to the creditor need not be proved in the following cases:

• If after payment, the third person acquires the creditor’s rights;
• If the creditor ratifies the payment to the third person;
•  If by the creditor’s conduct, the debtor has been led to believe that the third person had authority to receive the payment

When will payment will be valid to incapacitated person

• If the person accepted and kept the payment
• If the person benefited by the payment (in the absence of the benefit, debtor may be made to pay again by the creditor’s guardian or by the incapacitated person himself when he acquires or recovers his capacity. Proof of such benefit is incumbent upon the debtor who paid)

Debtor is relieved from proving benefit to the creditor in case of:

• Subrogation of the payer in the creditor’s rights
•  Ratification by the creditor
• Estoppel on the part of the creditor. (an admission or representation is rendered conclusive upon the person making it and cannot be denied or disproved as against the person relying thereon)

Article 1242 - Payment made in good faith to any person in possession of the credit shall release the debtor

Possession - referred to as possession of the credit itself and not merely of the document or instrument evidencing the credit

Good faith is presumed

Article 1243 - Payment made to the creditor by the debtor after the latter has been judicially ordered to retain the debt shall not be valid

Action against the debtor who is creditor of another, the latter (debtor-stranger), during the pendency of the case, may be ordered by the court to retain the debt until the right of plaintiff, the creditor in the main litigation is resolved.

Payment made subsequently by the debtor-stranger shall not be valid if the plaintiff wins the case

Articled 1244 - The debtor of a thing cannot compel the creditor to receive a different one, although the latter may be of the same value as, or more valuable than that which is due

In oblgiations to do or not to do, an act or forbearance cannot be substituted by another act or forbearance against the obligee’s will

Article 1245 - Dation in payment whereby property is alienated to the creditor in satisfaction of a debt in money, shall be governed by the law of sales

Four special payments

• Dation in payment
• Application of payment
• Payment by cession
• Tender of payment and consignation

Dation in payment (adjudication or dacion en pago) - conveyance of ownership of a thing as an accepted equivalent of performance

Article 1246 - When the obligation consists in the delivery of an indeterminate or generic thing, whose qualityand 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

Article 1247 - Unless it is otherwise stipulated, the extrajudicial expenses required by the payment shall be for the account of the debtor. With regard ro judicial cost, the rules of court shall govern

If the parties have stipulation as to who will bear the expenses, then their stipulation shall be followed

Judicial costs - statutory amounts allowed to a party to an action for his expenses incurred in action

Article 1248 - Unless there is an express stipulation to that effect the creditor cannot be compelled partially to receive the prestations which the obligation consists neither may the debtor be required to make partial payments (unless there’s an agreement).

However when the debt is in part liquidated and in part unliquidated, the creditor may demand and the debtor may effect the payment of the former without waiting for liquidation of the latter.

When partial performance allowed

• When there is an express stipulation to that effect
• When the debt is in part liquidated and in part unliquidated
• When the different prestations in which the obligation consists are subject to different terms or conditions which affect some of them

Article 1249 - The payment of debts in money shall be made in the currency stipulated, and if it is not possible to deliver such currency, then in the currency which is legal tender in the Philippines.

The delivery of promissory notes payable to order, or bills of exchange or other mercantile documents shall produce the effect of payment only when they have been cashed, or when through the fault of the creditor they have been impaired.

In the meantime, the action derived from the original obligation shall be held in the abeyance.

Legal tender (bills and coins) - currency which if offered by the debtor in the right amount, the creditor must accept in payment of a debt in money.

Payments by means of instruments of credits

• Right of creditor to refuse or accept - promissory notes, checks, bills of exchange and other commercial documents are not legal tender and therefore the creditor cannot be compelled to accept them
• Effect on obligation - payment by means of mercantile documents does not extinguish the obligation

Article 1250 - In case an extraordinary inflation or deflation of the currency stipulated should supervene, the value of the currency at the time of the establishment of the obligation shall be the basis of payment, unless there is an agreement to the contrary.

Inflation - sharp sudden increase of money or credit or both without corresponding increase in business transactions

Deflation - reduction in volume and circulation of the available money or credit

Article 1251 - Payment shall be made in the place designated in the obligation.

There being no express stipulation and if the undertaking is to deliver a determinate thing, the payment shall be made wherever the thing might be at the moment the obligation was constituted.

In any other case the place of payment shall be the domicile of the debtor.

If the debtor changes his domicile in bad faith or after he has incurred in delay, the additional expenses shall be borne by him.

These provisions are without prejudice to venue under the Rules of Court.

Place where obligation shall be paid:

• If there is a stipulation, the payment shall be made in the place designated
•  If there is a stipulation and the thing to be delivered is specific, the payment shall be made at the place where the thing was, at the perfection of the contract
• If there is no stipulation and the thing to be delivered is generic, the place of payment shall be the domicile of the debtor

Venue - place where a court suit or action must be filed or instituted

Domicile - place of a person’s habitual residence

Residence - element of domicile

SUBSECTION 1 - APPLICATION OF PAYMENTS

Article 1252 - He who has various debts of the same kind in favor of one and the same creditor, may declare at the time of making the payment, to which of them the same must be applied. Unless the parties so stipulate, or when the application of payment is made by the party for whose benefit the term has been constituted, application shall not be made as to debts which are not yet due.

If the debtor accepts from the creditor a receipt in which an application of the payment is made, the former cannot complain of the same, unless there is a cause for invalidating the contract.

Application of payments - designation of the debt to which should be applied the payment made by a debtor who has various debts of the same kind in favor of one and the same creditor

Requisites of application of payments:

• 1 debtor and 1 creditor
• 2 or more debts
• Debts must be of the same kind
• Debts to which payment made by the debtor has been applied must be due
• Payment made must not be sufficient to cover all the debts

Rules on application of payments

• Debtor has the first choice
• Right to make the application once exercised is irrevocable unless the creditor consents to the change
• If debtor does not apply payment, creditor may make the designation by specifying in the receipt which debt is being paid
• If the creditor has not also made the application or if the application is not valid, the debt, which is most onerous to the debtor among those due, shall be deemed to have been satisfied
• If debts due are of the same nature and burden, payment shall be applied to all of them proportionately.

Article 1253 - If the debt produces interest, payment of the principal shall not be deemed to have been made until the interests have been covered.

Interest first before principal

Article 1254 - When the payment cannot be applied in accordance with the preceding rules, or if application cannot be inferred from other circumstances, the debt which is most onerous to the debtor, among those due, shall be deemed to have been satisfied.

If the debts due are of the same nature and burden, the payment shall be applied to all of them proportionately.

Most onerous - most burdensome

When a debt more onerous than one another

• Interest-bearing debt is more onerous than a non-interest-bearing debt
• Debt as a sole debtor is more onerous than as a solidary debtor
• Debts secured by mortgage or by pledge are more onerous than unsecured debts
• Of 2 interest-bearing debts, one with a higher rate is more onerous
• Obligation with a penalty clause is more burdensome than one without penalty.

Debts are subject to different burdens - payment shall be applied to them proportionately

SUBSECTION 2 - PAYMENT BY CESSION

Article 1255 - The debtor may cede or assign his property to his creditors in payment of his debts. This cession, unless there is stipulation to the contrary, shall only release the debtor from responsibility for the net proceeds of the thing assigned. The agreements which, on the effect of the cession, are made between the debtor and his creditors shall be governed by special laws.

Payment by cession - another special form of payment - assignment or abandonment of all properties of the debtor for the benefit of his creditors in order that the latter may sell the same and apply the proceeds thereof to satisfaction of their credits

Requisites:

• 2 or more creditors
• Debtor must be (partially) insolvent
• Assignment must involve all the properties of the debtor
• Cession must be accepted by the creditors

Dation in payment and cession distinguished:

• Dation - one creditor; Cession - several creditors
• Dation - doesn’t presuppose the insolvency of the debtor; Cession - debtor is insolvent at the time of the assignment
• Dation - doesn’t involve all property; Cession - extends to all property of the debtor
• Dation - creditor becomes the owner; Cession - creditors only acquire rights to sell the thing
• Dation - really an act of novation; Cession - not an act of novation

SUBSECTION 3 - TENDER OF PAYMENT AND CONSIGNATION

Article 1256 - If the creditor to whom tender of payment has been made refuses without just cause to accept it, the debtor shall be released from responsibility by the consignation of the thing or sum due.

Consignation alone shall produce the same effect in the following cases:

(1) When the creditor is absent or unknown, or does

not appear at the place of payment;

(2) When he is incapacitated to receive the payment at the time it is due;

(3) When, without just cause, he refuses to give a receipt;

(4) When two or more persons claim the same right to collect;

(5) When the title of the obligation has been lost.

Tender of payment - act of debtor of offering to the creditor the thing or amount due

Consignation - act of depositing the thing or amount due with the proper court when the creditor does not desire or cannot receive it, after complying with the formalities required by law

Requisites of valid consignation:

• Existence of a valid debt which is due
• Tender of payment by the debtor and refusal without justifiable reason by the creditor to accept it
• Previous notice of consignation to persons interested in the fulfillment of obligation
• Subsequent notice of consignation

Article 1257 - In order that the consignation of the thing due may release the obligor, it must first be announced to the persons interested in the fulfillment of the obligation.

The consignation shall be ineffectual if it is not made strictly in consonance with the provisions which regulate payment.

Absence of prior notice to the persons interested in the fulfillment of the obligation, the consignation, as payment, shall be void

Article 1258 - Consignation shall be made by depositing the things due at the disposal of judicial authority, before whom the tender of payment shall be proved, in a proper case, and the announcement of the consignation in other cases.

The consignation having been made, the interested parties shall also be notified thereof.

Article 1259 - The expenses of consignation, when properly made, shall be charged against the creditor.

When Consignation deemed properly made

• When creditor accepts the thing or sum deposited without objection as payment
• When creditor questions the vailidity of the consignation, and the court, after hearing declares that it has been properly made
• When the creditor neither accepts nor questions the validity of the consignation, and the court after hearing, orders cancellation of the obligation

Article 1260 - Once the consignation has been duly made, the debtor may ask the judge to order the cancellation of the obligation.

Before the creditor has accepted the consignation, or before a judicial declaration that the consignation has been properly made, the debtor may withdraw the thing or the sum deposited, allowing the obligation to remain in force.

Debtor may withdraw before:

• Creditor has accepted the consignation or;
• A judicial declaration that the consignation has been properly made

Article 1261 - If, the consignation having been made, the creditor should authorize the debtor to withdraw the same, he shall lose every preference which he may have over the thing. The co-debtors, guarantors and sureties shall be released.

SECTION 2 - LOSS OF THE THING DUE

Article 1262 - An obligation which consists in the delivery of a determinate thing shall be extinguished if it should be lost or destroyed without the fault of the debtor, and before he has incurred in delay.

When by law or stipulation, the obligor is liable even for fortuitous events, the loss of the thing does not extinguish the obligation, and he shall be responsible for damages. The same rule applies when the nature of the obligation requires the assumption of risk.

Thing is lost - when it perishes, or goes out of commerce, or disappears in such a way that its existence is unknown or cannot be recovered.

When loss of thing will extinguish an obligation to give:

• Obligation is to deliver a specific or determinate thing;
• Loss of thing occurs without the fault of the debtor;
• Debtor is not guilty of delay

When loss of thing will not extinguish liability:

• The law so provides; 
• Stipulation so provides;
• Nature of the obligation requires the assumption of risk (insurance);
• Obligation to deliver a specific thing arises from a crime

Article 1263 - In an obligation to deliver a generic thing, the loss or destruction of anything of the same kind does not extinguish the obligation.

Generic thing never perishes - genus nunquamperit)

Article 1264 - The courts shall determine whether, under the circumstances, the partial loss of the object of the obligation is so important as to extinguish the obligation.

Partial loss - when only a portion of the thing is lost or destroyed or when it suffers depreciation or deterioration

Article 1265 - Whenever the thing is lost in the possession of the debtor, it shall be presumed that the loss was due to his fault, unless there is proof to the contrary, and without prejudice to the provisions of article 1165. This presumption does not apply in case of earthquake, flood, storm, or other natural calamity.

Article 1266 - The debtor in obligations to do shall also be released when the prestation becomes legally or physically impossible without the fault of the obligor.

Example ni sir - to deliver condoms on Feb 10, but before Feb 10, a law was passed that prohibits selling of condoms

Kinds of impossibility:

• Physical impossibility - in personal obligations, when personal qualifications of the obligor are involved. (ex. When obligor dies or becomes insolvent)
• Legal impossibility - obligation is rendered impossible by provisions of law

Article 1267 - When the service has become so difficult as to be manifestly beyond the contemplation of the parties, the obligor may also be released therefrom, in whole or in part.

Article 1268 - When the debt of a thing certain and determinate proceeds from a criminal offense, the debtor shall not be exempted from the payment of its price, whatever may be the cause for the loss, unless the thing having been offered by him to the person who should receive it, the latter refused without justification to accept it.

Article 1269 - The obligation having been extinguished by the loss of the thing, the creditor shall have all the rights of action which the debtor may have against third persons by reason of the loss.

SECTION 3 - CONDONATION OR REMISSION OF DEBT

Article 1270 - Condonation or remission is essentially gratuitous, and requires the acceptance by the obligor. It may be made expressly or impliedly.

One and the other kind shall be subject to the rules which govern inofficious donations. Express condonation shall, furthermore, comply with the forms of donation.

Condonation or remission - gratuitous abandonement by the creditor of his right against the debtor

Requisites of condonation:

• Must be gratuitous (act of liberality or generosity)
• Must be accepted by the obligor
• Parties must have capacity (to remit something
• Must not be inofficious (debt must not affect inheritance)
• Made expressly, it must be comply with the forms

Kinds of remission:

• As to its extent:
• Complete - when it covers entire obligation
• Partial - does not cover entire obligation
• As to its form:
• Express - when it is made either verbally or writing
• Implied - when it can only be inferred from conduct
• As to its date effectivity:
• Inter vivos - when it will take effect during the lifetime of donor
• Mortis causa - when it will become effective upon death of the donor

Article 1271 - The delivery of a private document evidencing a credit, made voluntarily by the creditor to the debtor, implies the renunciation of the action which the former had against the latter.

If in order to nullify this waiver it should be claimed to be inofficious, the debtor and his heirs may uphold it by proving that the delivery of the document was made in virtue of payment of the debt.

Presumption in case of voluntary delivery of document of indebtedness by creditor:

• Presumption of implied remission - if debt is not yet paid, creditor would need the document to enforce payment
• Contrary evidence - presumption is prima facie or rebuttable by contrary evidence
• Extent of remission - if obligation is joint, presumption of remission pertains only to the share of the debtor who is in possession of the document; if solidary, to the total obligation.
• Presumption applicable only to private document - legal presumption of remission does not apple in the case of a public document because it is easy to obtain a copy of the same

Article 1272 - Whenever the private document in which the debt appears is found in the possession of the debtor, it shall be presumed that the creditor delivered it voluntarily, unless the contrary is proved.

If document is later found in the hands of the debtor and it is not known how he came into possession of the same, the presumption is that it was voluntarily delivered by the creditor

Article 1273 - The renunciation of the principal debt shall extinguish the accessory obligations; but the waiver of the latter shall leave the former in force.

Follows the rule that accessory follows the principal

Artilce 1274 - It is presumed that the accessory obligation of pledge has been remitted when the thing pledged, after its delivery to the creditor, is found in the possession of the debtor, or of a third person who owns the thing.

Contract of pledge - necessary that the thing pledged be placed in the possession of the creditor, or of a third person by common agreement

SECTION 4 - CONFUSION OR MERGER OF RIGHTS

Article 1275- The obligation is extinguished from the time the characters of creditor and debtor are merged in the same person.

Confusion or merger - 1 person of the qualities of creditor and debtor with respect to the same obligation

Reason or basis for confusion

• Law treats confusion or merger as a mode of extinguishing obligation because if a debtor is his own creditor, enforcement of the obligation becomes absurd since a person cannot claim payment from himself
• When there is confusion of rights, the purposes for which the obligation may have been created are deemed realized.

Requisites of confusion

• Must take place between the principal debt and creditor
• Must be complete

Article 1276 - Merger which takes place in the person of the principal debtor or creditor benefits the guarantors. Confusion which takes place in the person of any of the latter does not extinguish the obligation.

Effect of merger in the person of principal debtor or creditor - extinguishes the obligation. Hence accessory obligation of guaranty is also extinguished

Effect of merger in the person of guarantor - extinguishes the guaranty, however it leaves the principal obligation in force

Article 1277 - Confusion does not extinguish a joint obligation except as regards the share corresponding to the creditor or debtor in whom the two characters concur.

Confusion in a joint obligation - confusion will extinguish only the share corresponding to the creditor or debtor in whom the two characters concur

Confusion in a solidary obligation - extinguish the entire obligation

SECTION 5 - COMPENSATION

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

Compensation (simplified payment) - extinguishment to the concurrent amount of the debts of two persons who, in their own right, are debtors and creditors of each other.

Object of compensation - prevention of unnecessary litigation and payments

Compensation and confusion distinguished:

• Confusion - only one person who is a creditor and debtor himself; Compensation - two person involved, each of whom is a debtor and a creditor of the other
• Confusion - one obligation; Compensation - two obligations
• Confusion - there is impossibility of payment; Compensation - indirect payment

Kinds of compensation

• By its effect or extent
• Total - when both obligations are of the same amount and are entirely extinguished
• Partial - 2 obligations are different amounts and a balance remains
• By its cause or origin 
• Legal - when it takes place by operation of law even without the knowledge of the parties
• Voluntary - when it takes place by agreement of parties
• Judicial - takes place by order from a court in a litigation
• Facultative - it can be set up only by one of the parties

Article 1279 - In order that compensation may be proper, it is necessary:

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

(3) That the two debts be due;

(4) That they be liquidated (quantified) and demandable;

(5) That over neither of them there be any retention or controversy, commenced by third persons and communicated in due time to the debtor (if third person became involve then there’s a controversy therefore no compensation).

Requisites of legal compensation:

• Parties are principal creditors and principal debtors of each other
• Both debts consist in a sum of money, or of consumable things of the same kind and quality
• Two debts are due or demandable
• Two debts are liquidated
• No retention or controversy commenced by a third person (Retention - when credit of one of the parties is subject to the satisfaction of the claims of a third person; Controversy - when a third person claims he is the creditor of one of the parties)

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.

Guarantor is given the right to set up compensation

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

Total or partial compensation applies to all different kinds of compensation

Article 1282 - The parties may agree upon the compensation of debts which are not yet due.

Voluntary or conventional compensation - any compensation which takes place by agreement of the parties even if all the requisites for legal compensation are not present

Article 1283 - If one of the parties to a suit over an obligation has a claim for damages against the other, the former may set it off by proving his right to said damages and the amount thereof.

Judicial compensation - compensation may also take place when so declared by a final judgment of a court or suit.

Article 1284 - When one or both debts are rescissible or voidable, they may be compensated against each other before they are judicially rescinded or avoided.

Rescissible and voidable obligations - valid until they are judicially rescinded or avoided

Article 1285 - The debtor who has consented to the assignment of rights made by a creditor in favor of a third person, cannot set up against the assignee the compensation which would pertain to him against the assignor, unless the assignor was notified by the debtor at the time he gave his consent, that he reserved his right to the compensation.

If the creditor communicated the cession to him but the debtor did not consent thereto, the latter may set up the compensation of debts previous to the cession, but not of subsequent ones.

If the assignment is made without the knowledge of the debtor, he may set up the compensation of all credits prior to the same and also later ones until he had knowledge of the assignment.

If debtor consents but did not mention compensation then there’s no offset

If debtor has knowledge, creditor can set up before the cession or assignment

Where compensation has taken place before assignment - debtor can raise the defense of compensation with respect to the debt. The remedy of the assignee is against the assignor

Where compensation has taken place after assignment

• Assignment with the consent of the debtor 
• Assignment with knowledge but without consent of debtor
• Assignment without the knowledge of the debtor

Article 1286 - Compensation takes place by operation of law, even though the debts may be payable at different places, but there shall be an indemnity for expenses of exchange or transportation to the place of payment.

Foreign exchange - conversion of an amount of money or currency of 1 country into an equivalent amount of money or currency of another

Exchanging rate - price of one currency expressed or quoted in relation to another currency

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 to the provisions of paragraph 2 of Article 301.

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

• Where one of the debts arises from a depositum - deposit is constituted from the moment a person receives a thing belonging to another with the obligation of safely keeping it and of returning the same
• Where one of the debts arises from a commodatum - commodatum is 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
• Where one of the debts arises from a claim for support due by gratuitous title
• 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.

If debtor has various debts which are susceptible, Debtor must inform the creditor which of them shall be the object of compensation

Art. 1290. When all the requisites mentioned in Article 1279 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

• Compensation takes place automatically by mere operation of law
• Full legal capacity of parties not required

SECTION 6 - NOVATION

Article 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.

Novation 

• Total or partial extinction of an obligation through the creation of a new one which substitutes it.
• Modification
• Never presumed
• Must be clear and unmistakably established by the express agreement of the parties or acts of equivalent import or by the incompatibility of the 2 obligations with each other in every material respect

2 stipulations of Novation:

• To extinguish or modify an existing obligation
• To substitute a new one in its place

Kinds of novation

• According to origin
• Legal - which takes place by operation of law
• Conventional - takes place by agreement of the parties
• According to how it is constituted
• Express - when it is so declared in unequivocal terms
• Implied - when the old and the new obligations are essentially incompatible with each other
• According to extent or effect
• Total or extinctive - when the old obligation is completely extinguished
• Partial or modificatory - when the old obligation is merely modified. (ex. The change is merely incidental to the main obligation)
• According to the subject
• Real or objective - when the object or principal conditions of the obligation are changed
• Personal or subjective - when the person of the debtor is substituted and/or when a third person is subrogated in the rights of the creditor
• Mixed - when the object and/or principal conditions of the obligation and the debtor or the creditor or both the parties are changed. It is a combination of real and personal novation

Article 1292. In order that an obligation may be extinguished by another which substitute the same, it is imperative that it be so declared in unequivocal terms, or that the old and the new obligations be on every point incompatible with each other.

Requisites of novation

• A previous valid obligation;
• Capacity and intention of the parties to modify or extinguish the obligation;
• The modification or extinguishment of the obligation; and
• The creation of a new valid obligation

Article 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.

Kinds of personal novation

• Substitution - when the person of the debtor is substituted
• Subrogation - when the third person is subrogated in the rights of the creditor

Kinds of substitution

• Expromision
• A third person of his own initiative and without the knowledge or against the will of the original debtor assumes the latter’s obligation with the consent of the creditor.
• Third person volunteered without the knowledge or against the will of the debtor but with the consent of the creditor
• Delegacion
• The creditor accepts a third person to take place of the debtor at the instance of the latter. Creditor may withhold approval
• Debtor delegates a new debtor with the approval of the creditor. All parties (debtor, new debtor and creditor) must agree.

Consent of creditor - with the 2 modes of substitution, the consent of the creditor is an indispensable requirement

Right of the new debtor who pays:

• In expromision - payment of new debtor gives him a right for beneficial reimbursement (reimbursement of up to the exact amount of the debt even if his payment exceeds to that amount)
• Delegacion - the new debtor is entitled for reimbursement and as well as subrogation

Article 1294 - If the substitution is without the knowledge or against the will of the debtor, the new debtor's insolvency or non-fulfillment of the obligations shall not give rise to any liability on the part of the original debtor.

Effect of new debtor’s insolvency or non-fulfillment of the obligation in expromision

·         Insolvency or nonfulfillment of the obligation will not revive the action of the creditor against the old debtor whose obligation is extinguished by the assumption of the debt of the new debtor

Article 1295 - The insolvency of the new debtor, who has been proposed by the original debtor and accepted by the creditor, shall not revive the action of the latter against the original obligor, except when said insolvency was already existing and of public knowledge, or known to the debtor, when the delegated his debt.

Effect of new debtor’s insolvency or non- fulfillment of the obligation in delegacion:

General rule is that old debtor will not be liable to the creditor if the new debtor is insolvent or did not fulfill the obligation. The exceptions are:

• If insolvency was already existing and of public knowledge (although it was not known to the old debtor) at the time of the delegacion; or
• Insolvency was already existing and known to the debtor (but not of public knowledge) at the time of the delegacion

Article 1296 - 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.

Extinguishment of the principal obligation carries with it that of the accessory obligation. The exception is:

• If in the case of an accessory obligation created in favor of a third person which remains in force unless said third person gives his consent to the novation

Article 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.

Effect where the new obligation is void

• New obligation must be valid. As a general rule, there will be no novation if the new obligation is void. 
• Therefore, the original one shall subsist for the reason that the 2nd obligation being inexistent, cannot extinguish or modify the 1st.
• Unless the case where parties intended that the old obligation should be extinguished in any event

Effect where the new obligation is voidable

• If new obligation is only voidable, novation can take place
• But the moment it is annulled, novation must be considered as not having taken place
• And the original one can be enforced unless the intention of the parties is otherwise,

Article 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.

Effect where old obligation is void or voidable:

• Void obligation cannot be novated because there is nothing to novate.
• If obligation is only voidable or if obligation is validated by ratification, the novation is valid

Article 1299 - If the original obligation was subject to a suspensive or resolutory condition, the new obligation shall be under the same condition, unless it is otherwise stipulated.

• If first obligation is subject to a suspensive or resolutory condition, the 2nd obligation is deemed subject to the same condition unless otherwise stipulated
• The reason for the rule is that the efficacy of the new obligation depends whether the condition which affects the old obligation is complied with or not. 
• If condition is suspensive and it is not complied with, no obligation arises
• If it is resolutory, and it is complied with, old obligation is extinguished

Article 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 - substitution of 1 person(subrogee) in the place of a creditor (subroger) with reference to a lawful claim or right, giving the former all the rights of the latter

Kinds of subrogation:

• Conventional - takes place by express agreement of the original parties (debtor and creditor) and the third person.
• Legal - takes place without agreement but by operation of law

Article 1301 - Conventional subrogation of a third person requires the consent of the original parties and of the third person.

Consent of all the parties is an essential requirement:

• Debtor - because he becomes liable under the new obligation to a new creditor
• Old creditor - because his right against the debtor is extinguished
• New creditor - because he may dislike or distrust the debtor

Article 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;

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

(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.

Cases of legal subrogation (cases where subrogation takes place by operation of law even without the consent of the parties):

• When a creditor pays another creditor who is preferred (secured)
• When a third person without interest in the obligation pays with the approval of the debtor.
• When a third person with interest in the obligation pays even without the knowledge of the debtor

Article 1303 - Subrogation transfers to the persons subrogated the credit with all the rights thereto appertaining, either against the debtor or against third person, be they guarantors or possessors of mortgages, subject to stipulation in a conventional subrogation.

Effect of legal subrogation:

• Transfer to the new creditor the credit and all rights and actions that could have been exercised by the former creditor either against the debtor or third persons, be they guarantors or mortgagers.
• Except only for the change in the person of the creditor, the obligation subsists in all respects as before the novation

Article 1304 - A creditor, to whom partial payment has been made, may exercise his right for the remainder, and he shall be preferred to the person who has been subrogated in his place in virtue of the partial payment of the same credit.

Effects of partial subrogation

• Creditor to whom partial payment has been made by the new creditor remains a creditor to the extent of the balance of the debt
• In case of insolvency of the debtor, he is given a preferential right under the above article to recover the remainder as against the new creditor