G.R. No. L-17870 - Mindanao Bus Co. vs. City Assessor and Treasurer

On November 22, 1978, the Salazar spouses (defendants-appellees) obtained a loan from the Insular Bank of Asia and America (plaintiff-appellant) in the amount of Forty-Two Thousand and Fifty Pesos (P42,050.00).
The loan was evidenced by a promissory note in which the Salazars bound themselves jointly and severally to pay the principal along with interest at 19% per annum.
The promissory note contained several key provisions:

An escalation clause authorizing the bank to increase the interest rate without notice to any rate allowed by law.
A penalty clause imposing a charge equivalent to 2% per month for any unpaid amounts upon default (i.e., liquidated damages).
A stipulation that, upon referral to an attorney for collection, the defendants were also liable for attorney’s fees amounting to 25% of the due amount plus litigation expenses.

The escalation clause permitted the plaintiff-appellant to adjust the interest rate to compensate for changes in Central Bank policies.
In accordance with this clause, the bank increased the interest rate to 21% per annum effective December 1, 1979, pursuant to Central Bank Circular No. 705 dated December 1, 1979.
The validity of this increase was later questioned on the ground that certain conditions governing the enforceability of escalation clauses had not been fully met, particularly regarding the remaining maturity of the loan.

The promissory note matured on or before December 12, 1980, but the defendants-appellees failed to fully discharge their obligation on maturity.
Despite several demands, the defendants eventually made partial payments. As of November 25, 1983, a total of P68,676.75 was paid, which was applied primarily to satisfy the additional penalty and interest charges.

On September 12, 1984, the plaintiff-appellant filed a complaint with the Regional Trial Court for the collection of the outstanding indebtedness, which was claimed to be P87,647.19 as of September 15, 1984, inclusive of interest at 21% per annum, penalty charges, and attorney’s fees.
During the pre-trial conference on October 31, 1984, the defendants admitted the execution of the promissory note in consideration of the loan amount.
The trial court rendered a summary judgment ordering the defendants to pay a lower amount of P11,253.25 with interest at 19% per annum from the filing of the complaint, along with P1,000.00 for attorney’s fees and costs.

The plaintiff-appellant challenged the trial court’s decision on several grounds, arguing errors in:

The non-award of penalty charges or liquidated damages at 2% per month on all unpaid amounts.
The non-award of interest at 21% per annum as stipulated in the escalated rate.
The computation of the total amount due from the defendants.
The award of attorney’s fees, which under the contract were to be 25% of the amount due, along with litigation expenses.
The failure to order the defendants to pay jointly and severally.

The Plaintiff-Appellant defended its action by emphasizing that the promissory note constituted a binding contract, thereby giving force to the stipulated escalation clause.
The defendants’ argument, supported by reference to the Banco Filipino case, questioned whether the conditions for increasing the interest rate (in particular, the requirement of remaining maturities of more than 730 days) were met, since the loan’s remaining term was less than 730 days as of December 1, 1979.
Concerning the penalty clause, previous jurisprudence (e.g., Government Service Insurance System v. Court of Appeals and Equitable Banking Corporation cases) was cited to validate the imposition of penalties; however, the proportionality and reasonableness of such penalties, given the defendant’s partial payments and the bank’s profiting, became a critical issue.

Whether the escalation clause in the promissory note, which permitted the bank to increase the interest rate from 19% to 21% per annum, was enforceable under the conditions set out in Central Bank Circular No. 705.
Whether the conditions necessary to implement an escalation of interest rate were met, particularly in light of the remaining maturity of the loan being less than 730 days as of the effectivity of the circular.
Whether the imposition of penalty charges amounting to 2% per month on unpaid amounts is valid and enforceable, especially given the defendant’s partial payments and the actual damages incurred by the bank.
Whether the computation of the total obligation of the defendants-appellees by the trial court was erroneous in light of additional charges for interest, penalty, and the manner in which partial payments were applied.
Whether the dismissal or reduction of the claim for attorney’s fees (25% of the amount due plus litigation expenses) was proper and supported by the established principles concerning reasonableness and unconscionability.