Meneses, Genesis A.
LAW20013
BSA 1-3 Atty. Campanilla, Perlito
Section 6. Obligation with a Penal Clause
Article 1226. In obligations with a penal clause, the penalty shall substitute the
indemnity for damages and the payment of interests in case of noncompliance, if there is
no stipulation to the contrary. Nevertheless, damages shall be paid if the obligor refuses
to pay the penalty or is guilty of fraud in the fulfillment of the obligation.
The penalty may be enforced only when it is demandable in accordance with the
provisions of this Code. (1152a)
Principal and Accessory Obligations defined
1. Principal Obligations – one which can stand alone
2. Accessory Obligations – one that is attached to the principal obligation
Example
X obliged himself to give Y a horse. The principal obligation is for X to
deliver the horse while the accessory obligation is to take care of the horse until
delivered.
Penal Clause defined
A penal clause is an attachment to the principal obligation that requires indemnification
or of greater responsibility in case of noncompliance to the obligation. This serves as an
assurance of performance to the creditor.
Situation Example
A clause in the contract of sale stipulated that in case that vendor fail to
transfer the certificate of title in the next two months, the vendee shall be
refunded of the purchase price plus 4% interest per annum. Is the clause, a
penal clause?
No. Even without the clause, the vendee under article 2209 could recover
legal interest which is 6% per annum which is greater than the 4% interest in the
clause. This means that the clause does not assure the actual recovery of the
damages incurred to the vendee.
Purposes of Penal Clause
The function of the penal clause is to strengthen the power of the obligations and
contracts between the obligor and the obligee.
1. To insure performance of the debtor. The debtor will be forced to comply with
the obligations as the consequences of penal clause is as onerous as
possible. Meaning the breach of contract will deal more damages to the
debtor than normally complying with the obligation itself.
2. To substitute for indemnity of damages and interest.
3. To punish the debtor.
Penal Clause vs. Condition
1. Penal clause constitutes an obligation white condition does not.
2. Penal clause is demandable in case of noncompliance or breaching of contract while
condition will never be demandable.
Penalty relation to Damages
In the second case (referring to purposes of penal clause) when the purpose is the
reparation or the compensation, the creditor is not obliged to prove damages because the
penalty will be anticipated equally with the damages he suffered. In the third case however, if
the purpose of the penalty is punishment, it does not relate to any of the damages incurred to
the debtor. This means that additional to the punishment, damages may be recovered.
Obligations with Penal Clause Construed
This means that the penal clause must be well settled and agreed by both parties.
Sureties are only chargeable in accordance to the strict terms of the bond. The terms in the
contract will be the one to determine the extent of their liability.
Conditional, Alternative, Facultative vs Penal Clause
Suppose that Y shall make the following premises to X.
1. Penal Clause. Y is to construct a house and he fail, Y will pay 100,000Php
2. Conditional. If Y failed to construct a house, Y will pay 100,000Php
3. Alternative. Y can build a house or pay X 100,000Php
4. Facultative. Y can build the house with a right to substitute payment of
100,000Php instead.
1. Obligations with a Penal Clause – there is a principal obligation with an accessory
obligation attached to it. There is only 1 thing due in which the creditor can demand. The
creditor can’t choose the 100,000Php instead of the house nor the debtor can’t choose
to pay 100,000Php instead of building a house except when expressly granted to him.
The penal clause is a conditional obligation which is only demandable upon
noncompliance or breaching of contract. When the condition upon the penal clause
depends on (noncompliance or breaching of contract) the two obligations (principal and
accessory) are alternatively demandable or both. He may proceed with performance of
principal or execute the penal clause or both.
2. Conditional Obligation – the existence of obligation depends upon the condition
(suspensive) being fulfilled. Unlike in the penal clause the obligation (principal) must
exist first.
3. Alternative Obligation – in obligation where there are multiple prestations due
alternatively, the obligation will be extinguished upon performance of one of them. The
debtor has the choice what prestation to render. In case that the house was destroyed
by a fortuitous event, the obligation won’t be extinguished as there are still alternative
choices. Unlike in the penal clause, if the house is destroyed by a fortuitous event, the
obligation will be extinguished.
4. Facultative Obligation – there is only one thing due. This means that he can construct a
house or substitute it by paying 100,000Php instead. Unlike in the penal clause,
100,000Php is only available upon noncompliance or breaching of contract.
Kinds of Penal Clause
1. As to origin
a. Legal penal clause – provided by the law
b. Conventional penal clause – provided by the parties
2. As to purpose
a. Compensatory penal clause – penalty takes place of damages
b. Punitive penal clause – penalty is punishment
3. As to dependability
a. Subsidiary/alternative penal clause – only the penalty is demandable
b. Joint/cumulative penal clause – both principal and penalty is demandable
Liability for Penalty, Damages and Interest
1. Penalty as a substitute for damages and interest – as the general rule the penalty takes
place for the damages and interest in case of noncompliance with the obligation. Proof
of actual damages does not need to be proved by the creditor for penalty to be
demandable.
2. Penalty and interest demandable – the law permits stipulations making penalty distinct
from the interest making them both demandable separately. An example is that in the
nature of liquidated damages, the attorney’s fees are given not by his counsel but the
opposition.
3. Penalty damages and interest demandable – the creditor may demand all of these in
such cases as:
a. When stipulated by the parties
b. When the debtor refuses to pay penalty
c. When the debtor is guilty of fraud in the fulfillment of the obligation
Example
X obliged himself to give a truck to Y. The obligation came with a
penal clause that in case of noncompliance, X would have to pay a
penalty of 20,000Php. In the end X did not delivered the truck thus, Y
suffered damages of 15,000Php. The penalty of 20,000Php substitutes
for the 15,000Php damages suffered by Y. Y can’t recover more than
20,000Php even if the damages surpassed the amount of the penal
clause unless:
a. If there is a stipulation in which Y may also recover
damages proved by him.
b. If X refuses to pay the penalty. In this case, Y may recover
legal interest representing new damages upon the
noncompliance with the penalty.
c. If X is guilty of fraud. According to Article 1171, he will be
liable for the damages caused. In this case, Y has the
burden to prove the damages caused by the fraud of X but
he does not need to prove fraud to get the penalty of
20,000Php.
4. Requirement to make penalty demandable – the penalty is only demandable in case of
noncompliance of breaching of contract and if it does not contradict in any way the law,
morals, good customs, public order and public policy. Article 1229 provided that in case
of partial fulfillment, penalty may be reduced.
Article 1227. The debtor cannot exempt himself from the performance of the
obligation by paying the penalty, save in the case where this right has been expressly
reserved for him. Neither can the creditor demand the fulfillment of the obligation and the
satisfaction of the penalty at the same time, unless this right has been clearly granted
him. However, if after the creditor has decided to require the fulfillment of the obligation,
the performance thereof should become impossible without his fault, the penalty may be
enforced. (1153a)
Penalty not Substitute for Performance
The general rule is that the debtor can’t pay the penalty instead of doing the
performance. If the debtor may pay penalty instead, it will be an alternative obligation instead of
obligation with a penal clause.
Situational Example
Suppose that E is a lessee to lessor R not to construct anything to the
land of R and in case that he shall construct, it shall be for the benefit of the land
without any reimbursement from R. E violated the clause and construct additions
to the property. Can R rescind the contract even if E is willing to take down what
he built?
Yes. The penal clause can’t serve as a defense for the purpose of leaving
the principal obligation unfulfilled.
Penal Clause not presumed Subsidiary
The creditor can’t demand the obligation and the penalty at the same time because the
obligation penal clause is to urge the debtor to fulfill the obligation.
1. Where there is performance – if the obligation was performed without
contravention to the contract, there is no need for demanding penalty. Except
when there is a stipulation that granted to creditor to do so.
2. Where there is no performance – in case of noncompliance with the
obligation, the creditor may alternatively demand fulfilment or the penalty. If
the creditor required fulfillment and the obligation has now become
impossible to render without the fault the debtor then penalty will be collected
instead.
Joint Penal Clause
The general rule is that the principal obligations and the penalty are not alternative, the
penalty is simply a subsidiary to the principal. This means that the debtor may not choose the
penalty instead of the performance of the obligation and same to the creditor but exemptions
arise when there is a clear stipulation where the right to demand the principal and the penalty at
the same time has been given to the creditor. If the obligation was to pay a sum of money, then
the creditor may demand the principal plus the interest from the date of demand where the
debtor has refused to pay the penalty.
Article 1228. Proof of actual damages suffered by the creditor is not necessary in
order that the penalty may be demanded. (n)
Penalty Demandable even without Proof of Damages
The creditor only needs to prove the violation of obligation to demand the penalty. He
does not need to prove the actual damages suffered by him for the penalty to be demandable.
The fixation of penalty is to avoid confusion and other difficulties involved in liquidating the
damage. The creditor may enforce the penalty whether he suffered damages or not but he can’t
demand more than the stipulated penalty even if he proved that the damages exceeded the
stipulated penalty.
Damages Recoverable must be Proved
These are three exceptions where creditor may demand the penalty plus the damages
even though the penalty is a substitute for indemnifying the damages. Damages must be
proved.
a. When stipulated by the parties
b. When the debtor refuses to pay penalty
c. When the debtor is guilty of fraud in the fulfillment of the obligation
Penalty vs Liquidation of Damages
One of the purposes of the fixating a penalty is to avoid confusion and save both parties
from the hassle of litigations where they will take legal steps to liquidate the said damages. In
the liquidation of damages, you’ll have to prove the damage then convert it monetarily whereas
in penalty, the value is fixated. Liquidation of damages is a penal clause where the debtor
assumed greater liability in case of noncompliance. For example, the liquidated damages are
5,000Php but the fixated penalty is 7,000Php. The debtor wants to avoid that. According to the
Code of Commission, liquidated damages are agreed damages where penalty is a punishment
but we must keep in mind that the main purpose of the penalty is reparation not punishment
Article 1229. The judge shall equitably reduce the penalty when the principal
obligation has been partly or irregularly complied with by the debtor. Even if there has
been no performance, the penalty may also be reduced by the courts if it is iniquitous or
unconscionable. (1154a)
Penalty can be reduced by Courts
Article 1229 refers to “iniquitous and unconscionable stipulations on interest rates,
penalties, attorney’s fees that contradicts moral.” The penalty may be reduced by the court in
cases such as”
1. When there is an irregular or partial performance – the penalty should be
proportionate to the actual damages suffered by the creditor. It is a general
rule that the obligation is not deemed performed unless the thing or the
service has been completely done and rendered.
2. When the agreed penalty is iniquitous or unconscionable – the penalty may
be reduced even if there were no performance at all. Even if the penalty is
iniquitous or unconscionable it does not mean that the penalty is void but
subject to reduction. This means that the penalty must be reasonable. The
factors courts look at includes: the type of obligation, the extent of obligation,
the purpose of the penalty, the nature of obligation, how the debtor breached
and the consequence, the relationship between the parties, the extent of
prejudice of the plaintiff and etc. Thus, it may be reduced partly subjective
and partly objective
a. The penalty will be held iniquitous to have the amount of 101,550Php
when the debtor has already complied with the 76,000Php in full
payment of the obligation. But if the debtor only paid 8% or below the
stipulated price, then the penalty in the amount of 101,550Php is not
held iniquitous or unconscionable.
b. In a case where Supreme Court ruled that attorney’s fees will be
equivalent to the 25% of the principal debts plus the interest. Facts:
the interest alone of 4.5 million exceeded the principal itself of 4
million. The 25% will be roughly amount to 2 million. The courts then
reduced it to 10%.
c. Private respondent made regular pay to comply with their obligation to
DBP (Development Bank of the Philippines) They failed to pay to the
stipulated date. This means that the private respondent does not act
on bad faith as he was willing to comply but was late. Also, the
responded already have paid 290,000Php of the 207,000Php (already
exceeded the principal). The courts reduced the additional interest
from 18% to 8%. This is already enough to cover for the other
damages incurred like litigation expenses, attorney’s fees, the delay
and etc.
d. An interest of 4% monthly or 48% per annum on the remaining
balance of the rural banks are held highly unconscionable.
e. As provided in the contract of lease, the private respondent shall pay
30,000Php per month and in case that he shall be delayed in
payment, 5,000Php will be added as a penalty per day or 150,000Php
per month. The penalty is highly exorbitant and unconscionable,
taking into account that the private respondent is an agricultural
cooperative, meaning that he is cooperating with farmers with little
resources. A simple delay in the payment will deprive farmers their
income and will lead them to bankruptcy.
f. Note that even though interest rates were lifted by C.B. Circular No.
905, the creditor may not lift the interest as much as they want to the
level that the debtor will be enslaved. If the interest rate was held
iniquitous or unconscionable, the rate would be at 12% per annum
default.
i. Situational Example
It appears that X, an official failed to return 20 guns
that was entrusted to him. The failure to comply with the
bond came with a penalty. However, third party with the aid
of X has recovered 5 out of 20 guns. Should X be liable for
the whole amount?
No. The judgement of the court of 2,000Php has
been reduced to 1,500Php instead.
ii. Situational Example
It appears that A and B bought a parcel of land
from C for 700,000Php with the unpaid balance of
560,000Php. B is the one who paid 140,000Php with the
intention that A would reimburse him half (70,000Php) but
A only gave 20,000Php. Now, A forfeited his interest to the
land and sold it to be for 22,000Php with a penal clause
that in case of noncompliance, he shall pay A 6,000Php
annually for the next 3 years. B failed to comply not only
with his obligation to C but also to A. is A entitled to the
stipulations granted?
No. The court has declared it iniquitous. First his
20,000Php interest was sold by 22,000Php then plus the
6,000 each year for the next three years would make result
him for 8,000Php which is 40% of his original interest.
Penal Clause where Performance is Irregular and Partial
1. When the penal clause is punitive – in case where the performance of the obligation is
either partial or irregular, courts has the power where the whole amount of penalty will
be subject to reduction. The fixated penalty has no regards to the probable damages
incurred but a mere encouragement for the debtor to comply with his obligation.
Situation Example
B is obliged to build a house for S. There is a stipulation that the
construction must be complete 50% in the period of 2 years starting on March 1,
1959 with a penal clause that B will pay S 12,000Php. B did not build the house
but instead sold it to C. S made a demand for the 12,000Php as neither B nor C
built a house within the 2 years period. It has appeared that before March 1,
1961, the lot has already been fenced and building materials were also stocked
in the premises and at the end of April, C had already finished the required 50%.
Should B be held accountable for the whole 12,000Php?
No. There was a partial performance where he already fenced the lot and
brought materials to be used. Also, the penal clause was not to replace the
damages incurred but only to encourage the debtor to comply with his obligation.
If in case the house was built was late, the penal clause from 12,000Php shall be
reduced to 1,500Php plus interest and plus the attorney’s fees.
2. When the penal clause is compensatory – the penalty has the intention to substitute the
anticipated liquidated damages suffered and not a mere punishment or encouragement.
As per article 1229, the court may reduce penalty if it is iniquitous or unconscionable
even if there were no performance at all. The second paragraph of the article is new.
Article 1230. The nullity of the penal clause does not carry with it that of the principal
obligation.
The nullity of the principal obligation carries with it that of the penal clause. (1155)
Effect of nullity of Penal Clause
The article above states that the noncompliance of principal automatically gave birth to
penalty but if the penal clause is void or invalid, it does not affect the principal obligation. In
other words, only the penal clause is void and the principal obligation is valid and demandable.
Thus, when penal clause is invalid, in case of noncompliance, the creditor may recover
indemnity damages.
Effect of nullity of Principal Obligation
If the principal obligation is void then automatically, the penal clause will also be void.
The reason is that the penal clause is subsidiary to the principal, thus it can’t stand alone.
However, if the nullity of the obligation is caused by the fault of the debtor, the penalty may be
enforced.
Reference:
De Leon, H. S., & De Leon, J. H. (2014). The Law on Obligations and Contracts. Manila: REX
Book Store.
