Philippine National Bank v. AIC Construction Corporation [G.R. No. 228904, October 13, 2021]

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Philippine National Bank v. AIC Construction Corporation

[G.R. No. 228904, October 13, 2021]

THIRD DIVISION, LEONEN, J.

 

Mutuality of Contracts; Unilateral Imposition of Interest Rates; Unconscionable Interest; Truth in Lending Act; Equitable Reduction of Interest 

Courts may equitably reduce or strike down unconscionable interest charges, particularly where the lender unilaterally determines the interest rate through subjective and one-sided criteria, in violation of the principle of mutuality of contracts under Article 1308 of the Civil Code. While parties are generally free to stipulate interest rates, such freedom is not absolute. Interest provisions that leave the determination of the applicable rate solely to the creditor, without the borrower's meaningful consent, are void for violating public policy, the Truth in Lending Act, and the requirement of mutuality in contractual obligations. 

 

Philippine National Bank (PNB) granted AIC Construction Corporation an omnibus credit line beginning in 1989, initially amounting to ₱10 million, which was subsequently increased over the years. The loan agreement provided that interest would be computed at the rate determined by PNB as its prevailing prime rate plus the applicable spread effective on the date of each availment. As security for the loan, the spouses Rodolfo and Ma. Aurora Bacani executed real estate mortgages over several parcels of land and bound themselves solidarily with AIC Construction for all obligations under the credit line. 

By September 1998, AIC Construction's outstanding obligation had reached ₱65 million, consisting of ₱40 million principal and ₱25 million capitalized interest. Hoping to settle its obligations, AIC Construction proposed several dacion en pago arrangements involving its properties in Pampanga, Makati, Manila, and Mandaluyong. Although the properties were appraised, the parties failed to reach an agreement regarding the valuation and acceptance of the proposed dacion en pago. PNB thereafter demanded payment of ₱140,837,511.29, eventually foreclosed the mortgaged properties, and scheduled their public auction. 

AIC Construction and the Bacani spouses filed an action for annulment of interest and penalty charges, accounting, exemption of the family home from foreclosure, and damages. They alleged that PNB arbitrarily imposed excessive, exorbitant, and unconscionable interest and penalty charges, resulting in the ballooning of their loan obligation despite the absence of additional availments. They likewise claimed that PNB acted in bad faith by delaying and frustrating negotiations on their proposed dacion en pago. The Regional Trial Court dismissed the complaint, but the Court of Appeals modified the judgment by sustaining the foreclosure while declaring the interest stipulation invalid, applying instead the legal rate of interest, ordering PNB to render a detailed accounting, and excluding the penalty charges from the mortgage obligation. PNB elevated the matter to the Supreme Court. 

 

Issue No. 1: Whether the interest stipulation authorizing PNB to determine the applicable interest rate violated the principle of mutuality of contracts under Article 1308 of the Civil Code.

YES. The Supreme Court held that the interest provision was void for violating the principle of mutuality of contracts. Article 1308 of the Civil Code requires that the validity and compliance of contracts cannot be left solely to the will of one of the contracting parties. 

The loan agreement authorized PNB to determine its own prime rate plus the applicable spread, effectively allowing it to fix the interest rate unilaterally without the borrower's participation or subsequent consent. Such arrangement deprived respondents of any meaningful participation in determining one of the most essential terms of the loan agreement. The Court emphasized that any modification of the interest rate must be mutually agreed upon because the rate of interest constitutes a principal condition of every loan contract.

 

Issue No. 2: Whether the varying interest rates imposed by PNB were valid merely because they were based on prevailing market conditions.

NO. The Court rejected PNB's argument that the rates were objectively determined by prevailing market conditions. Although a variable interest rate may be valid when anchored upon an objectively determinable external standard, the agreement in this case vested upon PNB the sole authority to determine its own "prime rate" and the applicable spread. The standards employed by PNB—including profitability, cost of money, bank administrative expenses, and other internal considerations—were entirely one-sided, subjective, and beyond the borrower's participation or control. Accordingly, the supposed reference to prevailing market conditions did not cure the lack of mutual consent. 

 

Issue No. 3: Whether the parties' voluntary execution of the loan agreement barred respondents from later questioning the stipulated interest rates.

NO. The Court ruled that voluntariness alone does not validate an illegal or unconscionable interest stipulation. Freedom of contract presupposes equality of bargaining power. In loan transactions, however, lenders ordinarily occupy a superior bargaining position, especially where borrowers urgently require financing. Consequently, courts may intervene when the resulting stipulations become oppressive or unconscionable. Even where borrowers knowingly sign the agreement, courts retain the equitable authority to reduce or invalidate interest rates that offend public policy and good morals. 

 

Issue No. 4: Whether the interest provision violated the Truth in Lending Act (Republic Act No. 3765).

YES. The Court held that the arrangement violated the Truth in Lending Act, which requires creditors to fully disclose, prior to the consummation of the transaction, the true cost of credit, including interest and all finance charges. Since the actual interest rates would later be fixed solely by PNB after execution of the agreement, respondents were deprived of complete information regarding the actual cost of borrowing at the time they entered into the credit arrangement. Such lack of prior disclosure defeated the very policy of Republic Act No. 3765, which seeks to protect borrowers from uninformed use of credit. 

 

Issue No. 5: Whether respondents were estopped from questioning the interest rates after repeatedly availing themselves of the credit line.

NO. The Court ruled that estoppel cannot validate an illegal contractual provision. A party cannot invoke estoppel to give effect to stipulations that violate law or public policy. The continued availment of the credit facility did not amount to consent to future unilateral modifications of interest rates, particularly where the borrowers had no real opportunity to negotiate or reject the rates subsequently imposed by the bank. 

 

Issue No. 6: Whether courts may equitably reduce unconscionable interest rates notwithstanding the suspension of the Usury Law.

YES. The Court reiterated that although the Usury Law ceilings have been suspended, courts continue to possess the equitable authority to reduce or strike down iniquitous or unconscionable interest rates.

The suspension of statutory ceilings did not grant lenders unrestricted authority to impose excessive interest. Courts remain duty-bound to prevent oppressive loan arrangements that produce unjust enrichment at the expense of borrowers and offend public morals and public policy. 

 

Issue No. 7: Whether the Court of Appeals correctly substituted the legal rate of interest for the invalid contractual interest.

YES. Having declared the contractual interest stipulation void, the Court sustained the Court of Appeals' application of the legal rate of 12% per annum, consistent with the prevailing jurisprudence and the applicable legal interest rates governing the period involved. The legal rate appropriately replaced the void contractual stipulation while preserving the parties' principal loan obligation. 

 

Issue No. 8: Whether the penalty charges formed part of the obligation secured by the real estate mortgage.

NO. The Court affirmed the exclusion of the penalty charges from the amount secured by the mortgage. The parties did not expressly stipulate that penalty charges would form part of the mortgage-secured obligation. Consequently, the penalties could not be enforced through foreclosure of the mortgaged properties. 

 

Issue No. 9: Whether PNB was obligated to accept respondents' proposal of dacion en pago.

NO. The Court agreed with the lower courts that dacion en pago is never compulsory upon the creditor. A dacion en pago requires the mutual consent of both debtor and creditor. Since PNB never accepted respondents’ proposals, no perfected dacion en pago agreement arose. The bank therefore retained the right to demand payment in accordance with the loan agreement and to foreclose the mortgages upon default. 

 

Issue No. 10: Whether PNB acted in bad faith during the negotiations for dacion en pago.

NO. The Court sustained the finding that respondents failed to establish bad faith. The evidence showed that PNB continuously communicated with respondents during the negotiations and merely exercised its contractual right to reject the proposed dacion en pago after failing to agree on the valuation of the offered properties. Such conduct did not amount to arbitrariness or bad faith. 

 

DISPOSITION

The Supreme Court DENIED the Petition for Review on Certiorari and AFFIRMED the Decision and Resolution of the Court of Appeals.

Accordingly:

1. PNB was directed to furnish respondents with a detailed accounting of their outstanding obligation.
2. The principal loan obligation was ordered to earn the legal interest of 12% per annum for the applicable period.
3. Interest on the conventional interest was likewise fixed at 12% per annum from the date of judicial demand until the issuance of the certificate of sale.
4. The penalty charges were excluded from the obligation secured by the real estate mortgage

 

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