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LECTURE NOTES ON OBLLIGATIONS AND CONTRACTS

FOR BSA 1102; SECTIONS BMA, BFA and BGA
College of Business Administration
University of the East – Manila

ATTY. BENJAMIN R. REONAL – PROFESSOR

MODULE 12

Extinguishment of Obligations –

Payment or Performance

1. Dacion en Pago -- the requirements are:

a) Consent of the creditor;

b) It must not be prejudicial to the other creditor;
c) The debtor must not have been declared insolvent by a judicial
decree.

Example:

X is indebted to Y in the amount of P30,000.00. Instead of payment

in money, X delivered to Y a laptop computer valued at P25,000.00. Did
the delivery of the laptop computer extinguish the obligation of X? Why?

Ans.: It depends. It is a rule that even if the thing is of lesser value than the
obligation, if the parties agree that the obligation is totally extinguished, then the
obligation is totally obliterated. Otherwise, dacion in payment may extinguish the
obligation only to the extent of the value of the thing delivered.

COMPENSATION

Compensation defined – it is the extinguishment in the concurrent amount

of the obligation of those persons who are reciprocally debtors and
creditors of each other.

Requirements of Compensation –
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a) That each one of the obligors be bound principally and that he be

at the same time a principal creditor of the other;

b) 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;

c) That the two debts are due;

d) That they be liquidated and demandable;

e) That over neither of them there be any retention or controversy,

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

The requisites enumerated above are those for LEGAL compensation;

voluntary compensation in general requires no requisite except that the
agreement be voluntarily and validly entered into.

Example: A owes B P1,000.00, and B owes A P1,000.00, but A’s credit of P1,000.00 has been
garnished by C who claims to be an unpaid creditor of A. B has been duly notified of the
controversy. There can be NO compensation here. Any possible compensation is in the
meantime suspended. If C wins his claim, there can be no compensation, if he loses, the
controversy is resolved, and compensation can take place.
Example: A owes B P5,000.00. C is the guarantor of A. B owes A P1,000.00. When B sues A,
and A cannot pay, for how much will C be liable? C will be liable for only P4,000.00, because
he can set up the P1,000.00 credit of A as the basis for partial compensation.

CONFUSION OR MERGER OF RIGHTS

Confusion or Merger defined -- It is the meeting of the qualities of
creditor and debtor with respect to the same obligation.
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Requisites for a Valid Merger

a) It should take place between the principal debtor and creditor.
(Therefore confusion of the creditor with the person of the
guarantor does not extinguish the obligation.

b) The merger must be clear and definite;

c) The very obligation involved must be the same or identical

(because if the debtor acquires certain rights from the creditor
with respect to other things, there is no merger).

Example: I borrowed P10,000.00 from my brother, and as security, I mortgaged my land

in his favor. Later, I sold the land to him. The mortgage is extinguished but I will owe him
P10,000.00.

Example: A makes a check payable to bearer, and hands the check to C, who hands it to D who
finally hands it to A. Here A owes himself, a clear case of merger, and hence the obligation of A
is extinguished.

CONDONATION OR RMISSION OF THE DEBT

Remission defined -- it is an act of liberality by virtue of which the

obligee, without receiving any price or equivalent, renounces the
enforcement of the obligation, as a result of which, it is extinguished in
its entirety or in that part or aspect of the same to which the remission
refers.

Requisites of remission – they are:

a) It must be gratuitous;
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b) It must be accepted by the obligor;

c) The obligation must be demandable.

Example: X borrowed money from Y in the amount of P100,000.00. One morning, Y went to X
and delivered to the latter the promissory note he issued to Y. What is the effect of such
delivery of the promissory note?

There is extinguishment of the obligation of X. Under the law, 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.

Example : X is indebted to Y in the amount of P100,000.00 secured by a real estate mortgage.

Y renounced his right over the mortgage. Can he still demand the payment of the obligation?
Why?

Yes, because the renunciation of the principal debt shall extinguish the accessory
obligation but the waiver of the accessory shall leave the principal. Here, what was
renounced was the accessory. Hence, the principal (amount of loan) remains.

NOVATION

Novation defined -- by novation is understood the substitution or

change of an obligation by another, which extinguishes or modifies the
first, either changing its object or principal conditions, or substituting
another in place of the debtor, or subrogating a third person in the
rights of the creditor.

Basic principles in Novation

(1) 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.
(Art. 1296, NCC);
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(2) 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. (Art. 1297, NCC);

(3) 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. (Art. 1298, NCC);

(4) 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. (Art. 1299,
NCC).\

Kinds of subrogation:

Subrogation may be legal or conventional. Conventional

subrogation of a third person requires the consent of the original
parties and of the third person.

Presumption of legal subrogation --- it is presumed that there is legal

subrogation:

a) When a creditor pays another creditor who is preferred, even

without the debtor’s knowledge;
b) When a third person, not interested in the obligation, pays with
the express or tacit approval of the debtor;
c) 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.
(Art. 1302, NCC).
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Requisites in order that there may be a valid novation:

In order that an obligation may be extinguished by another which

substitutes 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. In order that there may be
extinctive novation the following must be present: (1) existence of a
previous valid contract; (2) agreement of the parties to the new
contract; (3) the extinguishment of the old obligation; and (4) validity
of the new one.

Example: ABC Corporation entered into a contract of loan with PBTC secured by a chattel
mortgage. When ABC Corporation failed to pay, the bank foreclosed the mortgage; but it was
objected to by the debtor contending that there was a novation of the contract when it
executed a real estate mortgage when an extension of the loan was granted by the bank. Is
the contention of ABC Corporation correct?

No. Novation takes place where the object or principal condition of an obligation is
changed or altered. Novation is never presumed; it must be explicitly stated or there must be
manifest incompatibility between the old and the new obligations in every aspect. There is no
incompatibility between the two contracts especially so that the new contract was executed as
an additional security to the chattel mortgage. (People’s Bank and Trust Co. vs. Syvel’s Inc.,
August 121, 1989).

Example: X owes Y the amount of P10,000.00. Without X’s knowledge and consent, Y and
Z entered into an agreement whereby Z assumed X’s obligation. Z, however, turned out to be
insolvent. What is the effect of Z’s insolvency in relation to X’s obligation?

The obligation of X is extinguished and Z’s insolvency does not revive his obligation.
(Art 1294, NCC).

Example: If there is a change in the signatory of a contract of lease, the property of which is
co-owned by ABC, is there a novation?

None, because the mere change of signatory is merely an incidental and collateral
change. (Young vs. Ca, May 8, 1991).

Two Ways that indicate Novation :

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There are two ways which could indicate the presence of novation and thereby produce
the effect of extinguishing an obligation by another which substitutes the same. The first is
when novation has been explicitly stated and declared in unequivocal terms The second is
when the old and the new obligations are incompatible in every point. The test of
incompatibility is whether or not the obligations can stand together, each one having its
independent existence. If they cannot, they are incompatible and the latter obligation novates
the first. (Vda. De Mondragon vs. IAC, 184 SCRA 348, Caneda vs. CA., 181 SCRA 762).
Corollarily, changes that breed incompatibility must be essential in nature and not merely
accidental. The incompatibility must take place in any of the essential elements of the
obligation, such as its object, cause or principal conditions thereof; otherwise, the change
would be merely modificatory in nature and insufficient to extinguish the original obligation.

Whether novation may be presumed:

Novation is never presumed, (Rillo vs CA, 274 SCRA 461) and the animus novandi,
whether totally or partially, must appear by express agreement of the parties, or by their acts
that are too clear and unequivocal to be mistaken. (Fortune Motors [Phils] Corp. vs. CA, 267
SCRA 653).

Necessary Element of Novation:

The extinguishment of the old obligation by the new one is a necessary element of
novation which may be effected either expressly or impliedly. (Uraca vs. CA, 278 SCRA 702).
The term “expressly” means that the contracting parties incontrovertibly disclose that their
object in executing the new contract is to extinguish the old one (PNB vs Grande, [CA], G. R. No
13919-R, July 20, 1955). Upon the other hand, no specific form is required for an implied
novation and all that is prescribed by law would be an incompatibility between the two
contracts. While there is really no hard and fast rule to determine what might constitute to be
a sufficient change that can bring about novation, the touchstone for contrariety, however,
would be an irreconcilable incompatibility between the old and the new obligations (Gaw vs.
IAC, 220 SCRA 405).

Whether consent of the creditor to Novation should be given expressly:

The consent of the creditor should be given expressly because novation can never be
presumed. In order to give novation its legal effect, the law requires that the creditor should
consent to the substitution of a new debtor. This consent must be given expressly for the
reason that, since novation extinguishes the personality of the first debtor who is to be
substituted by a new one, it implies on the part of the creditor a waiver of the right that he had
before the novation, which waiver must be express under the principle of renuntiatio non
praesumitur, recognized by the law in declaring that a waiver of right may not be presumed
unless the will to waive is indisputably shown by him who holds the right.
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Kinds of Novation:

1. Objective novation, which is a novation of existing terms and conditions

of the contract;
2. Subjective novation, which is a novation by the change of debtor or
creditor;
3. Mixed novation, which is both objective and subjective. (Cochingyan, Jr.
vs. R and B Surety and Ins. Co., June 30, 1987).

Effect of novation, compensation, confusion, or remission that may be obtained by

one of the debtors:

As a rule, it extinguishes the obligation. Under the law, novation, compensation,

confusion, or remission of the debt, made by any of the solidary creditors or with any of the
solidary debtors, shall extinguish the obligation without prejudice to the rule that the remission
made by the creditor of the share which affects one of the solidary debtors does not release the
latter from his responsibility towards the co-debtors, in case the debt had been totally paid by
anyone of them before the remission was effected. (Arts. 1215 and 1219, NCC).

CONTRACTS

What is a contract?

A contract is a meeting of minds between two persons whereby one binds himself, with
respect to the other, to give something or to render some service. (Art. 1305, NCC). It is
juridical convention in legal form, by virtue of which one or more persons bind themselves in
favor of another, or others, or reciprocally, to the fulfillment of a prestation to do, to give or not
to do. (Sanchez vs. Mapalad Realty Corp. G.R. No. 148516, December 27, 2007).

What is the so-called “liberty of contracts”:

The liberty of contracts simply means the right of the parties to enter into such
stipulations or terms and conditions in their contracts.

The liberty of contracts is not absolute. It is subject to certain limitations imposed by

law and that the contracting parties may establish such stipulations, clauses, terms, and
conditions as they may deem convenient, provided they are not contrary to law, morals, good
customs, public order, or public policy. (Art. 1306, NCC).
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What is the principle of mutuality of contracts;

It means that the contracts are binding between the parties; its validity or compliance
cannot be left to the will of one of them. (Art. 1308, NCC). For a contract is a contract. Once
agreed upon and the essential elements are present, it is valid and binding between the parties.
(Mate vs. CA, et., G.R. No 120724-25, May 21, 1998, 94 SCAD 615; Blas vs. Linda Angeles-
Hutalla, G.R. No. 155594, September 27, 2004; Sps. Dumlao vs. Marion Realty Corp., G.R. No.
131491, August 17, 2007).

General Rule with respect to effectivity of contracts and the exceptions:

Contracts take effect only between the parties, their assigns and heirs, except in case
where the rights and obligations arising from the contract are not transmissible by their nature,
or by stipulation or by provision of law. The heir is not liable beyond the value of the property
he received from the decedent.

If a contract should contain some stipulation in favor of a third person, he may demand
its fulfillment provided he communicated his acceptance to the obligor before its revocation. A
mere incidental benefit or interest of a person is not sufficient. The contracting parties must
have clearly and deliberately conferred a favor upon a third person.

Requisites of stipulation pour autrui:

The requisites for such stipulation are the following;

(a) The stipulation in favor of a third person, the third-party beneficiary which should
be a part, not the whole, of the contract;
(b) The contracting parties must have clearly and deliberately conferred a favor upon a
third person, not a mere incidental benefit or interest;
(c) The favorable stipulations should not be conditioned or compensated by any kind of
obligation whatsoever;
(d) The third person must have communicated his acceptance to the obligor before its
revocation;
(e) Neither of the contracting parties bear the legal representation or authorization of
the third party.

How are contracts perfected:

It depends. If the contracts are consensual, they are perfected by mere consent. If they
are real they are perfected by the delivery of the object. (Arts. 1315 and 1316, NCC).
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Elements of a valid contract:

They are a) consent of the contracting parties; b) object certain which is the subject
matter of the contract; c) cause of the obligation which is established. (Art. 1318, NCC).

How is consent manifested:

Consent is manifested by the meeting of the offer and the acceptance upon the thing
and the cause which are to constitute the contract. The offer must be certain and the
acceptance, absolute. A qualified acceptance constitutes a counter-offer. (Art. 1319, NCC).

If there is an offer and there is an acceptance with conditions, whether there is a

perfected contract?

None, because an offer must be clear and definite while an acceptance must be
unconditional and unfounded, in order that their concurrence can give rise to a perfected
contract. If there are conditions imposed, there is no meeting of the minds, as the same is a
mere counter-offer. (Maria Cristina Fertilizer Corp., et al., vs. CA, et al., G. R. No. 123905, June
9, 1997, 83 SCAD 130).

Example:

X owns a house and lot. He sent a letter to Y and offered it for sale. Two days after
receipt, Y sent X a letter accepting the offer; but when the letter of acceptance reached X’s
residence, he was already dead. Was there a meeting of the minds?

None. Acceptance made by letter does not bind the offerer except from the time it
came to his knowledge. (Art. 1319, NCC). Since X was already dead when the letter of
acceptance reached his residence, he could not have known the said acceptance.

Effect if both parties to a contract employed fraud:

The contract is valid and they cannot invoke the fraud to avoid liability as their mutual
fraud would negate each other. Under the law, in order that fraud may make a contract
voidable, it should be serious and should not have been employed by both contracting parties.
(Art. 1344, NCC).

OBJECT OF CONTRACTS

What may be the object of a contract?

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All things which are not outside the commerce of men, including future things, may be
the object of a contract. All rights which are not intransmissible may also be the object of
contracts.
No contract may be entered into upon future inheritance except in cases expressly
authorized by law.
All services which are not contrary to law, morals, good customs, public order, or public
policy may likewise be the object of a contract. (Art. 1347, NCC)

Example:

X entered into a contract of sale with right to repurchase with Y over a house and lot
belonging to him. Can he sell that right?

Yes, because that right, even if intangible, is determinate. The object of every contract
must be determinate as to its kind. The fact that the quantity is not determinate shall not be an
obstacle to the existence of the contract, provided it is possible to determine the same,
without the need of a new contract between the parties. (Art. 1349, NCC).

CAUSE OF CONTRACTS

What are the causes of contracts?

In onerous contracts the cause is understood to be, for each contracting party the
prestation or promise of a thing or service by the other: in remuneratory ones, the service or
benefit which is remunerated; and in contracts of pure beneficence the mere liberality of the
benefactor. (Art. 1350, NCC).

Example:

X and Y entered into a contract of sale over a parcel of land without any cause or
consideration. Is the contract valid?

No, because the law requires as one of the requirements for the validity of a contract
that there be a cause or consideration. (Art. 1318, NCC; Robleza vs. CA, G.R. No. 80364, June
28, 1989).

Suppose the cause or price was not paid, is the contract valid?

Yes. Non-payment of the price is not the controlling criterion to make a contract void.
Non-payment is merely a ground for specific performance or rescission of the contract.
(Robleza vs CA, supra).
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Is an oral contract of sale over a parcel of land valid and binding?

Yes, an oral contract of sale over a parcel of and is valid and binding between the
parties, but with respect to innocent third persons, it is not binding upon them.