Mutuality of contracts and higher interest rates

The Supreme Court has historically used the principle of mutuality of contracts as lens to scrutinize interest-imposing clauses. This principle, found in Article 1308 of the Civil Code, provides that contracts “must bind both contracting parties; its validity or compliance cannot be left to the will of one of them.” The rule “dictates that a contract must be rendered void when the execution of its terms is skewed in favor of one party” (Vasquez v. Philippine National Bank, G.R. Nos. 228355 & 228397, August 28, 2019). With that said, what are these specific nuances in interest-imposing clauses, expounded upon by the Supreme Court through the principle of mutuality, that are relevant in contract review?

Appreciation of Escalation Clauses

Escalation clauses allow an increase in the interest rate/s agreed upon by the contracting parties (Juico v. China Banking Corporation, G.R. No. 187678, April 10, 2013). This must, however, be accompanied by a corresponding de-escalation clause, otherwise the escalation clause is void (Llorin Jr. vs. Court of Appeals, G.R. No. 103592, February 4, 1993). Additionally, when one party has the sole discretion to increase rates—“completely depriving the debtor of the right to assent”—the escalation clause is also void (Vasquez v. Philippine National Bank, G.R. Nos. 228355 & 228397, August 28, 2019).

This seems straightforward to apply given the vast jurisprudence on the topic, but in legal practice, no contract will expressly state that a debtor has no right to dissent in the escalation of interest rates. Complicated and voluminous contracts also need closer inspection. For example, some interest clauses on its face may seem to grant debtors the right to assent, but once read with the entire contract, the debtors have in fact no choice but to assent. Applying the principle of mutuality, such escalation clause will likely be deemed null and void.

Notice or Acknowledgment by the Debtor

In one case decided by the Supreme Court, even if prior notice was given to the debtors with acknowledgment by the debtors of the notice, the escalation clause was still considered void because the debtor could not dissent to the escalation (Spouses Limson v. PNB, G.R. No. 158622, January 27, 2016.).

Thus, preliminarily speaking, notice and/or acknowledgment does not cure a unilateral escalation clause. However, consider a situation where a creditor can unilaterally increase interest rates beyond a certain period, provided that (1) notice is given to the debtor, and (2) the debtor expressly waives the right to dissent from that point onwards. In this instance, the “notice” might be “curative” per se because the right to dissent was available, enforceable, and known to the debtor—the debtor simply chose to waive it. Arguably, there is no violation of mutuality.

Unreasonable Rates

Even if parties can freely stipulate interest rates, certain rates have been deemed “unreasonable” or “unconscionable” such as those providing a 3% monthly rate (Caparuso v. Oliveron, G.R. No. 255179 [Notice], April 26, 2021), or 60% annual rate (Rivera v. Spouses Chua, G.R. Nos. 184458 & 184472, January 14, 2015.). Given varying jurisprudence, the treatment of specific interest rates should be on a case to case basis, with the entire contract as context.

But in terms of assessing liability, note that when escalation clauses with unreasonable rates are declared void, they are only deemed unwritten. This does not mean that there will be no interest anymore; it is still possible that a lower or the legal rate will be substituted, as done before by the Supreme Court (see Mallari v. Prudential Bank (now Bank of the Philippine Islands), G.R. No. 197861, June 5, 2013). The principal obligation likewise remains.

Floating Interest Rates

Floating rates are those where “the rate is not fixed as it is dependent on a market-based reference…agreed upon by the parties.” (Vasquez v. Philippine National Bank, G.R. Nos. 228355 & 228397, August 28, 2019). In the banking sector, the Bangko Sentral has allowed banks and borrowers to agree on a floating rate of interest, provided that it is based on market-based reference rates (Security Bank Corp. v. Spouses Mercado, G.R. Nos. 192934 & 197010, June 27, 2018). However, it is not automatic that with a market rate reference, floating rates are valid with no further scrutiny needed. Reviewing floating rates must still be grounded on the principle of mutuality (e.g. is the market rate preferred by both parties, is the market rate unconscionable, etc.).

A Final Note

The general phrasing of Article 1308 makes the principle of mutuality a flexible concept in reviewing interest clauses and assessing its benefits and risks to clients. Ultimately, the litmus test is whether both parties stand on equal footing in agreeing and enforcing interest-imposing clauses.

This article is for general informational and educational purposes only and not offered as and does not constitute legal advice or legal opinion.

Roilan Rigil Kent A. Alonzo is an Associate of the Corporate & Special Projects Department of the Angara Abello Concepcion Regala & Cruz Law Offices (ACCRALAW).

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