A contract is a meeting of minds between two parties [Article 1305, Civil Code], who are free to make any terms and conditions provided they are not contrary to law, morals, good customs, public order or public policy [Article 1306, Civil Code]. A contract to be valid must be entered freely based on equality and mutuality.
Under Article 1308 of the Civil Code, contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them. Our Supreme Court has often used this principle of mutuality in striking down contracts which make the fulfillment of an obligation dependent upon the sole will of only one of the contracting parties.
In a contract of loan, the banks have a ready prepared contract for the signature of a debtor. It is normal for banks to require a security in the form of real estate mortgage. Once the debtor defaults [fails to pay], the banks will first send a demand letter, foreclose the mortgage, consolidate the title in its name after the expiration of redemption period and file a petition for issuance of a writ of possession. Notwithstanding the foreclosure, transfer of title and loss of possession, debtors may still question all the bank’s action, like the computation of interests in violation of mutuality of contract.
The principle of mutuality of contracts was raised in the consolidated case of Vasquez v. PNB, G.R. No. 228355 and PNB v. Vasquez, G.R. No. 228397, dated 28th August 2019. In this case, PNB lent Vasquez two [2] loans of P600,000 and P800,000, secured by real mortgage over four parcels of lands. The Credit Agreement stated: “the Borrower agrees to pay interest on the Loan at the yearly rate of Prime Rate plus Spread interest rate. The Promissory Note provides applicable interest rate. The first did not explain how the rate is fixed while the second did not indicate what exactly is the applicable rate of interest. Section 6.02 [c] of the same document provides the bank’s determination of the interest shall be conclusive and binding on the borrower.
PNB increased the interest rates from 17% to 33%. Vasquez defaulted. PNB foreclosed the realties. Vasquez filed a suit questioning the interest rate and praying to annul the foreclosure. PNB filed a counterclaim for damages. After trial, the RTC dismissed both the complaint and counterclaim. On appeal, the CA did not annul the foreclosure, but found that the loan involved the unilateral imposition of increased interest rate, which is a violation of the principle of mutuality of contracts. Both parties assailed the decision. The issues were summarized into two: whether the interest rate scheme imposed by PNB is valid and if PNB’s imposition of interest rate is found to be void, what are the implications on the foreclosure and principal obligation of Vasquez?
Our Supreme Court voided the imposition of interest as it found that method of fixing interest rates based on the “prime rate plus” is one-sided, indeterminate and subjective criteria that is arbitrary for there is no fixed standard. When banks impose “prevailing lending rates,” such imposition is deemed one-sided, arbitrary and potestative since the bank is still the one who determines its own prevailing lending rate. The unilateral modification by PNB of the interest rate fixed in the loan contract is, in reality, never really fixed. The interest rates are beholdened to the sole will of PNB. Now that the interest rates imposed are void for being unilateral impositions violative of the principle of mutuality of contracts, what is its effect on the foreclosure?
Jurisprudence has held that in a situation wherein a debtor was not given an opportunity to settle his debt at the correct amount due to the imposition of a null and void interest rate scheme, no foreclosure may be filed. The registration of such foreclosure sale has been held to be invalid and cannot vest title over the mortgaged realty. Where a null and void interest rates are imposed under a contract of loan, the non-payment of the principal loan obligation does not place the debtor in a state of default, considering that under Article 1252 of the Civil Code, if a debt produces interest, payment of the principal shall not be deemed to have been made until the interests have been covered. Since the contract of making interest payments in this case is illegal and thus non-demandable, the payment of the principal loan was likewise not yet demandable on the part of PNB. With Vasquez not being in a state of default, the foreclosure of the subject properties should not have proceeded. Thus, the extrajudicial foreclosure made by PNB is also void and the consolidated title in its name is cancelled.
