Arbitrary, Illegal, and Unconscionable INTEREST RATE

Arbitrary, Illegal, and Unconscionable INTEREST RATE

 

Parties to a contract are free to stipulate the terms and conditions of their agreement, including the payment of interest and the interest rate. Under Article 1159 of the Civil Code, their respective obligations arising from their contract have the force of law between the parties and should be complied with in good faith. Accordingly, with respect to the payment of interest, the debtor (obligor) is bound to pay the interest rate stipulated and agreed upon, EXCEPT when no interest rate was agreed upon, or when the interest rate is illegal and unconscionable, or the imposition of interest is arbitrary.

 

In cases where the interest rate was not agreed upon, or its imposition was arbitrarily made only by the creditor (obligee), or when the interest rate imposed is illegal and unconscionable, the courts will step in and impose the prevailing and legal interest. 

 

The obligation to pay interest may arise either by contract, or those fixed by the parties, and/or by the imposition of law or by the courts.

 

What then is the prevailing and legal interest? What is interest in the first place?

 

Monetary and Compensatory Interest

 

In the case of Catalina F. Isla et. al. vs. Genevira P. Estorga (G.R. No. 233974, July 02, 2018), the Supreme Court discussed the two types of interest as follows:

 

“Case law states that there are two (2) types of interest, namely, monetary interest and compensatory interest. Monetary interest is the compensation fixed by the parties for the use or forbearance of money. On the other hand, compensatory interest is that imposed by law or by the courts as penalty or indemnity for damages. Accordingly, the right to recover interest arises only either by virtue of a contract (monetary interest) or as damages for delay or failure to pay the principal loan on which the interest is demanded (compensatory interest).

 

Anent monetary interest, the parties are free to stipulate their preferred rate. However, courts are allowed to equitably temper interest rates that are found to be excessive, iniquitous, unconscionable, and/or exorbitant, such as stipulated interest rates of three percent (3%) per month or higher. In such instances, it is well to clarify that only the unconscionable interest rate is nullified and deemed not written in the contract; whereas the parties' agreement on the payment of interest on the principal loan obligation subsists. It is as if the parties failed to specify the interest rate to be imposed on the principal amount, in which case the legal rate of interest prevailing at the time the agreement was entered into is applied by the Court. This is because, according to jurisprudence, the legal rate of interest is the presumptive reasonable compensation for borrowed money.”[1]

 

In the Catalina Isla case cited above, the Supreme Court affirmed the findings of the Court of Appeals that the interest agreed upon by the parties of 10% per month was unconscionable. Thus, the Court of Appeals imposed a new monetary interest of twelve percent (12%) per annum, which was the prevailing legal rate of interest for loans and forbearances of money at the time the loan was contracted on December 6, 2004, “reckoned from the date of extrajudicial demand until the finality of this ruling” (i.e., Supreme Court’s ruling in the case).

 

The same interest rate will apply in case the parties fail to state an interest rate in their contract - the prevailing legal rate of interest for loans and forbearances of money at the time the loan was contracted reckoned from the date of extrajudicial demand until the finality of the ruling in the case.

 

Compensatory interest rate, on the other hand, shall be at the legal rate imposed on the principal amount plus the total of the monetary interest. The Supreme Court discussed the imposition of compensatory interest in the Catalina Isla case as follows:

 

“In addition, not only the principal amount but also the monetary interest due to respondent as discussed above shall itself earn compensatory interest at the legal rate, pursuant to Article 2212 of the Civil Code, which states that "[i]nterest due shall earn legal interest from 

the time it is judicially demanded, although the obligation may be silent upon this point." To be sure, Article 2212 contemplates the presence of stipulated or conventional interest, i.e., monetary interest, which has accrued when demand was judicially made. In cases where no monetary interest had been stipulated by the parties, no accrued monetary interest could further earn compensatory .interest upon judicial demand. Thus, the principal amount and monetary interest due to the respondent shall earn compensatory interest of twelve percent (12%) per annum from judicial demand, i.e., the date of the filing of the complaint on July 24, 2007,42 to June 30, 2013, and thereafter, at the rate of six percent (6%) per annum from July 1, 2013, until fully paid.” 

 

To illustrate, assume that the parties to a loan contract stipulated the payment of interest but failed to state the interest rate, the monetary and compensatory interest rate shall be as follows:

 

Monetary Interest

 

(Principal x Prevailing Legal Rate of Interest) x Period from Extrajudicial Demand to Finality of Decision in the Case

 

Compensatory Interest

 

Principal & Monetary Interest x 12% x Period from Judicial Demand to Finality of the Decision in the Case 

 

PLUS

 

6% on the total amount from the finality of the Decision in the Case until fully paid.

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[1] Citing the cases of Pen v. Santos, G.R. No. 160408 (January 11, 2016, 778 SCRA 56, 68),  Trade & Investment Development Corporation of the Philippines v. Roblett Industrial Construction Corporation(523 Phil. 360, 366 [2006]), Chua v. Timan(584 Phil. 144, 148 [2008]), Limso v. Philippine National Bank  (G.R. No. 158622, January 27, 2016, 782 SCRA 137, 229)