There are two kinds of loan under the new Civil Code: commodatum – a loan for use where the lender allows the borrower temporary use of a non-consumable thing; and mutuum – a loan for money that must be returned in equal amount. A loan may also be oral or written. The difference is that in oral loan, any interest even if agreed upon by the borrower, is not valid and thus may be recovered by the borrower as mistake in payment [known in legal parlance as solutio indebiti]. This is because under Article 1956 of the new Civil Code, “no interest shall be due unless it has been expressly stipulated in writing.”
Is the stipulated interest of 3% per month valid? What is its effect on a promissory note, real estate mortgage, foreclosure and consolidation of title? These were answered by our Honorable Supreme Court in the case of Manila Credit Corp. v. Viroomal, G.R. 258526, January 11, 2023. In 2009, MCC loaned Vimooral P467,600 payable in 60 months at 23% annual interest secured by a real estate mortgage. To keep up with monthly payments, he asked for restructuring and he signed a new promissory note for P495,840 payable in 84 months at 24% annual interest. In 2016, MCC demanded its full payment computed at P549,029.69. Viroomal asked for a recomputation because he paid P1,175,638.12. MCC ignored it, foreclosed the mortgaged realty and consolidated the title in its name. A suit against MCC was filed for the annulment of mortgage, foreclosure, consolidation of title and loan because the annual interest and penalty were immoral. MCC filed Answer that the borrower willingly consented to loan contract, which charges an effective interest rate of 36% per annum on the principal amount plus penalties in case of delay. As such, he is estopped from assailing the validity of the promissory notes since he benefited from the loan. In 2020, the Regional Trial Court ruled for Viroomal voiding the second loan and compounded interest. It also cancelled both the foreclosure and land title issued to MCC. The latter appealed, but the Court of Appeals affirmed the RTC decision. MMC filed a last appeal.
Our Supreme Court ruled that the RTC found that MCC imposed an additional 3% monthly interest, referred to as EIR – effective interest rate on top of the stipulated 24% annual interest rate. MCC unilaterally imposed the EIR by simply inserting it in the disclosure statement, which violated the principle of autonomy of contracts. Under Article 1306, new Civil Code, the parties to a contract are free to make stipulations as they may deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy. The stipulation authorizing the imposition of iniquitous or unconscionable interest are contrary to morals, if not against the law. Under Article 1409 of the Civil Code, these contracts are inexistent and void from the beginning. They cannot be ratified and the right to set up the defense of illegality cannot be waived. The unconscionable interest rate is nullified and is deemed not written in the contract of loan. The reduction of interest and penalties to the applicable 12% per annum legal interest is more equitable.
While the parties may depart from the legal interest rate, any deviation must be reasonable and fair. If the stipulated interest for a loan is more than twice the legal rate of interest, it is unconscionable and void. The Central Bank Circular No. 905-82 removed the interest ceilings under Usury Law, but the lenders may not impose interest rates that would enslave the borrowers or hemorrhage their assets. It was ruled in the 2021 case of Megalopolis Properties, Inc., that while no numerical limit on conscionability, the annual 36% interest rate is three times more than the 12% legal interest rate, which is unconscionable and excessive. The debtor’s willingness to assume unconscionable interest rate is inconsequential to its validity. The 36% EIR charged on top of the agreed 24% annual interest and compounded monthly is unacceptable. This scheme exponentially bloated the principal loan, misled the debtor to continuously pay on the belief that their balance was increasing due to several delayed payments. That interest rate is unconscionable and deemed not written in the loan contract. The Court found overpayment of P417,859.58 on the first loan. This makes the restructured loan void for lack of consideration. An overpayment of P203,532.47 exists on the second loan. Thus, MCC was ordered to return these amounts with 6% legal interest per annum from 2016 to 2023. Since the principal loan was paid, the real estate mortgage is automatically terminated and thus the new title issued to MCC as a result of the foreclosure is also void.
