Case Summary (G.R. No. 168940)
Factual Background
The Tans (Angelina and Ruben) executed the Kasulatan to secure a P30,000 loan with a six-month maturity and a contractual compound interest rate of 5% per month. After Ruben’s death, Angelina failed to pay on maturity. Petitioners demanded an accumulated total of P359,000. Petitioners then extrajudicially foreclosed the mortgage on February 5, 1999, became the sole bidder at auction, obtained consolidation of title after the redemption period lapsed, and were given possession through a writ of possession and sheriff’s ejectment.
Initial Court Action (RTC)
On September 26, 2000, respondents filed a Complaint for Nullification of Mortgage and Foreclosure and/or Partial Rescission of Documents and Damages in the Regional Trial Court (RTC) of Malolos, alleging the interest rate was unconscionable. On June 11, 2002, the RTC held the Kasulatan could not be wholly declared void but partially rescinded the iniquitous interest provision, reducing interest to 12% per annum and awarding an additional 1% per month as liquidated damages from February 17, 1994 to June 21, 2000; it also mentioned an offer by respondents to redeem for P200,000 but denied moral damages and attorney’s fees.
Court of Appeals Decision
The Court of Appeals affirmed the RTC’s finding that the stipulated 5% monthly compounded interest was iniquitous and equitably reduced it to the legal rate of 12% per annum. The appellate court further held that, in the interest of equity and substantial justice, respondents could redeem the mortgaged property notwithstanding the statutory redemption period’s expiration.
Issues Raised Before the Supreme Court
Petitioners advanced three principal contentions: (1) the Court of Appeals improperly nullified an interest rate agreed to voluntarily by the parties; (2) the appellate court unlawfully modified the contract, effectively making a new contract between parties; and (3) the extension of the redemption period violated Act No. 3135’s one-year rule.
Petitioners’ Argument on Freedom of Contract and Interest Ceilings
Petitioners relied on Central Bank Circular No. 905 (s. 1982), which suspended the statutory usury ceiling effective January 1, 1983, arguing lenders and borrowers may validly agree to any interest rate and that the courts lacked authority to nullify an expressly stipulated compounded interest term.
Respondents’ Argument on Unconscionability and Public Policy
Respondents countered that contractual terms are binding only to the extent they are not contrary to law, morals, good customs, public order, or public policy, and asserted that the 5% monthly compounded interest is excessive, immoral, and therefore void under Article 1306 of the Civil Code.
Supreme Court’s Governing Legal Principles
The Court reiterated that while freedom of contract is recognized, it is not absolute and is subject to Article 1306’s limitation that stipulations contrary to law, morals, good customs, public order, or public policy are invalid. The Central Bank Circular did not confer license to impose unconscionable rates that would enslave borrowers or strip them of assets. Precedent was cited where iniquitous rates were struck down (Medel, Ruiz, Solangon) and where more moderate rates were upheld (Bautista, Garcia).
On Unconscionability of the Stipulated Rate
Applying the foregoing principles and controlling precedents, the Court held the contractual 5% monthly compounded interest (60% per annum) to be excessive, iniquitous, unconscionable, and contrary to morals and Article 1306, and therefore void ab initio. The void stipulation is treated as never having existed; the underlying debt must be considered without that iniquitous interest provision.
Substitution by the Legal Interest Rate and Effect on the Contract
Because the iniquitous term was void, the Court imposed the legal interest rate of 12% per annum in substitution, consistent with prior decisions (e.g., Medel, Ruiz). The Court emphasized this is not a unilateral rewriting of the contract but an application of legal principle that void contractual terms must yield and be replaced by lawful standards where necessary to determine the proper debt.
Liquidated Damages Award
The Court addressed the additional 1% per month liquidated damages previously awarded by the RTC. Article 2226 requires an agreement between parties to establish liquidated damages. The Kasulatan contained no stipulation for liquidated damages, and none was proven. Therefore, the award for 1% per month as liquidated damages had no legal basis and was deleted.
Foreclosure, Redemption, and Equity
Because the foreclosure sale rested on an overstated outstanding balance inflated by the void iniquitous interest, the Court found the foreclosure proceedings conducted on March 3, 1999 could not stand. Citing Heirs of Zoilo Espiritu v. Landrito, the Court held that where debtors were not given a reasonable opportunity to pay the correct amount (i.e., principal plus lawful interest), foreclosure cannot properly be maintained and the resulting registration cannot transfer valid title. Accordingly, the foreclosure was nullified; the registration of the sale could not vest title in petitioners.
Redemption Period and Act No. 3135
Although Act No. 3135 provides a one-year statutory redemption period, the Court determined the extension or allowance of redemption was unnecessary to analyze separately because nullification of the foreclosure rendered the statutory redemption issue
Case Syllabus (G.R. No. 168940)
Caption, Decision and Bench
- G.R. No. 168940, November 24, 2009; Second Division.
- Decision penned by Justice Del Castillo.
- Concurring Justices: Carpio (Chairperson), Leonardo-De Castro, Brion, and Abad.
- Special Orders naming Carpio and Leonardo-De Castro as members: Carpio per Special Order No. 775 dated November 3, 2009; Leonardo-De Castro per Special Order No. 776 dated November 3, 2009.
Core Holding (Supreme Court)
- The imposition of an unconscionable rate of interest on a money debt, even if knowingly and voluntarily assumed, is immoral and unjust, tantamount to iniquitous deprivation of property and contrary to law, morals, and public policy.
- The Court affirmed the Court of Appeals’ reduction of the stipulated 5% per month (60% per annum), compounded monthly, to the legal rate of 12% per annum.
- The award of 1% per month as liquidated damages was deleted for lack of legal basis.
- The foreclosure proceedings held on March 3, 1999, and the subsequent registration thereof were nullified; the registration cannot vest title over the mortgaged property.
- Petition for review was DENIED; the Court of Appeals Decision (Oct. 29, 2004) and Resolution (July 18, 2005) were AFFIRMED with modification: deletion of 1% liquidated damages per month and ordering reconveyance of the subject property to respondents conditioned upon payment of the loan with interest fixed by the Court.
Factual Antecedents
- Respondents Angelina de Leon Tan and husband Ruben Tan were registered owners of a 240-square meter residential lot in Barrio Canalate, Malolos, Bulacan, covered by TCT No. T-8540.
- On February 17, 1994, the Tans entered into a Kasulatan ng Sanglaan ng Lupa at Bahay with petitioners Spouses Isagani and Diosdada Castro to secure a loan of P30,000.00.
- The Kasulatan stipulated payment within six months (until August 17, 1994) with interest at 5% per month, compounded monthly.
- Ruben Tan died on September 2, 1994; Angelina Tan failed to pay the loan upon maturity.
- She offered to pay the principal P30,000.00 plus a portion of interest; petitioners refused and demanded P359,000.00.
- On February 5, 1999 petitioners caused extrajudicial foreclosure of the real estate mortgage and became sole bidder at the auction sale.
- Redemption period elapsed without redemption; title consolidated in favor of petitioners; writ of possession issued and Sheriff delivered possession to petitioners, ejecting respondents.
Trial Court Proceedings and Judgment
- On September 26, 2000 respondents (Angelina Tan and other named parties) filed before the Regional Trial Court, Malolos, Bulacan: Complaint for Nullification of Mortgage and Foreclosure and/or Partial Rescission of Documents and Damages.
- Allegation: the interest rate imposed (5% per month) was unconscionable.
- June 11, 2002 Decision (RT Court) ruled that the Kasulatan could not be declared null and void in entirety but:
- The Kasulatan was partially rescinded to only 12% interest per annum with additional 1% per month penalty charges as liquidated damages from February 17, 1994 up to June 21, 2000 (date of Delivery of Possession).
- Ordered defendants to accept plaintiffs’ offer of P200,000.00 to redeem the property (as alternative remedy mentioned).
- No moral damages awarded due to lack of proof.
- No attorney’s fees awarded.
- Counterclaim dismissed; costs against defendants.
Court of Appeals Proceedings and Ruling
- Petitioners appealed to the Court of Appeals (CA-G.R. CV No. 76842).
- The Court of Appeals affirmed the trial court’s finding that the 5% monthly compounded interest was iniquitous/unconscionable and warranted equitable reduction to the legal rate of 12% per annum.
- The CA, however, modified relief: plaintiffs-appellees (respondents here) may redeem the mortgaged property by paying petitioners the amount of P30,000.00 with interest at 12% per annum from February 17, 1994 until fully paid, plus penalty charges at the same rate from February 17, 1994 to June 21, 2000.
- Petitioners’ Motion for Reconsideration before the CA was denied in a Resolution dated July 18, 2005.
Issues Raised in the Petition for Review
- Whether the Court of Appeals erred in nullifying the interest rate expressly stipulated in the contract of mortgage.
- Whether the Court of Appeals erred by unilaterally changing the contract terms and conditions.
- Whether the Court of Appeals erred in extending the period of redemption in violation of Act No. 3135 which provides a one-year period for redemption of a foreclosed real property.
Petitioners’ Arguments (as presented)
- With the removal by the Bangko Sentral of the ceiling on interest (Central Bank Circular No. 905 s. 1982 effective Jan. 1, 1983), parties could validly agree on any interest rate; thus CA erred in decl