Section 5 - Compensation

- Extinguishment of obligation of persons who are reciprocally debtors

and creditors of each other.
Requisites:
1. Each one of the obligors is bound principally
2. Debts must consist of sum of money due or things due or
consumables which are of the same kind and quality
3. The two debts are due with the exception that the parties agreeing
upon debts which are not yet due (voluntary compensation under
Art. 1282)
4. The two debts are liquidated and demandable
5. That over neither of them there be any retention or controversy,
commenced by third persons and communicated in due time to the
debtor
6. Compensation is not prohibited by law
7. Compensation is not waived
- Rules with regard to the effect of assignment of rights made by the
creditor in favor of a third person: (Art. 1285)
1. If the assignment is consented to by the debtor, compensation does
not take place
2. If the debtor does not consent to the assignment, the debtor may set
up compensation of debts previous to cession
3. If the assignment is without the knowledge of the debtor, the debtor
may set up compensation until he had knowledge of assignment
- take note that in compensation there are two persons while in merger
there is only one person where the characteristic of debtor and creditor
is merged. In compensation there are two debts while in merger there
is only one debt.
There are four kinds as to Origin
1. Conventional – by agreement of parties
2. Legal – by operation of law
3. Judicial- when decreed by court
4. Facultative- when claimed by one of the parties who has a right to
object to it but waives his objection thereto. Eg. One is given the
benefit of a period who waives it.

Distinctions between compensation and payment

 Compensation Payment
- capacity of parties is not - debtor must have the
necessary since it takes place by capacity to dispose of the
operation of law thing paid and creditor must
have the capacity to receive
payment
- there can be partial - must be full
extinguishment

- Articles 1287 and 1288 simply state those which may and may not
be subject of compensation
- Article 1289 – Rule on application of payment governs in case of
several debts susceptible of compensation
- Article 1290 enumerates the effects of compensation

1. Both debts are extinguished to the concurrent amount

2. Interests stop running
3. With regard to the obligation or the part of the obligation
extinguished, the period for prescription is ended
4. All accessory obligations attendant to the principal obligation

- In the case of Francia vs IAC - Government and taxpayers are not

mutually debtors and creditors of each other under Art. 1278
Section 6 – Novation
- Under Article 1291. Obligation is modified by:
1. Changing their object
2. Substituting the person of the debtor
3. Subrogating a third person in the rights of the creditor
Requisites
1. There must be previous valid obligation
2. There must be an agreement between the parties to extinguish or
modify the old obligation
3. The validity of a new obligation
According to Castan, the extinguishment of the old obligation is
only the effect not a requisite
Castan’s Requisites
1. Old valid obligation – this can be a voidable obligation
 2. New valid obligation – hence, if it is subject to a condition that
the new contract will be signed first, it is a mere executory
agreement
3. Substantial difference (Aliquid novum) between the old and
new obligation otherwise the new will only be a replicate of the
old
4. Capacity of the parties. For what purpose? New obligation
must be valid
5. Animus Novendi – intention to extinguish or modify the old
obligation
Maybe – express or
Implied- (incompatibility of the old and new)
- Article 1292 speaks of express or implied Real Novation as when
the cause, object or principal condition is changed
- Real Novation must be proved
Possible changes
1. Cause of the obligation – eg. Sale or deposit is converted to loan
2. Object of the obligation – eg. Thing owed like a car is substituted by
a racing horse.
- If increase only in the amount of payment it is a mere modification.
No novation.
3. Change in the principal condition – eg. Conditional obligation
converted to pure obligation and vice versa
What if there is an extension of period of payment? No novation as
period merely affects the execution and not the constitution of the
obligation.

In the case of Kabankalan Sugar Co. vs. Pacheco, 55 Phil. 555 – If the
duration of the period is reduced, there is incompatibility and there
is extinctive novation
4. Accidental changes or accidental modification, generally there is no
novation such as change in the place of payment or manner of
fulfilment –eg. Change in place of payment

- Article 1293 speaks of Personal Novation

1. Substitution of Debtor
a. Expromision – third person assumed obligation of the
debtor (upon initiative or proposal of third person) with
acceptance of the creditor without intervention of debtor
b. Delegacion – with knowledge of old debtor (initiated by the
old debtor himself) and creditor
o – note that in case of expromision and delegacion the consent
of the creditor is necessary
 o – in expromision there must be an agreement that the first
debtor be released from the obligation otherwise the third
person can be treated as additional debtor
o – the insolvency of third person does not revive the liability
of the original debtor be it without the knowledge of the
debtor under Art. 1294 or with knowledge under Art. 1295
Unless in Art. 1295
– insolvency is existing and of public knowledge
or
- known to the debtor when he delegated the debt
- Circumstances which do not give rise to novation by delegacion
- third person acting merely as surety or guarantor of
original debtor
- third person is merely an agent of debtor
- new debtor merely agreed to assume joint responsibility
for the obligation
2. Subrogation of Creditor

- Art. 1296 - Principal obligation is extinguished as a consequence of

novation. Accessory obligation may subsist only insofar as they
may benefit third persons who did not give their consent. Eg. Is
stipulation pour autri (Art. 1311)
Parties in stipulation pour autri
 Promissor
 Promisee
 3rd person or beneficiary
Requisites:
1. Contracting parties clearly conferred favour upon third
person
2. No compensation for stipulation in favour of third
person
3. Stipulation in favour of third person should not be the
entire contract
4. Neither of the contracting parties bear the legal
representation of the third person
5. Third person communicates his acceptance to the
obligor before its revocation by the original parties

- Art 1297 merely states that the original obligation subsists if the
new obligation is void unless otherwise intended by the parties
 - Art. 1298 speaks of the new obligation being subjected to the same
suspensive or resolutory condition attached to the original
obligation
Subrogation – transfer of all the rights of creditor to a third person
who thereby acquires all his rights against the debtor or against third
persons.
- Article 1302 refers to presumed legal subrogation
1. Creditor pays another creditor who is preferred even without
the knowledge of the debtor governed under Title XIX of the
Civil Code, Concurrence and Preference of Credit
2. Third person not interested in the obligation pays with express
or tacit approval of the debtor – should be read in consonance
with Art. 1237, third person can compel the creditor to
subrogate him in his rights
3. Without knowledge of the debtor, the person interested in the
fulfilment of the obligation pays without prejudice to the effects
of confusion as to the latter’s share eg. a co-debtor is not
subrogated to the rights of the creditor
- Article 1304 - between the old and new creditor the former is
preferred.

ASSIGNMENT
Read
Title II – Contracts
Chapter I- General Provisions 1305-1317
1305 ABS CBN vs. C.A. 301 SCRA 592
1306 Autonomy of Contracts
Allied Banking Corp. vs C.A. 284 SCRA 357
1307 Innominate Contracts
Corpus vs C.A. 98 SCRA 424
1311 Principle of Relativity or Principle of Limited Effectivity
Everest Steamship Corp. vs C.A. 297 SCRA 496
Kauffman vs. PNB, 43 Phil. 182
Associated Bank vs C.A. 291 SCRA 513

Chapter II – Essential Requisites of Contracts

 1318 - General Provisions
Section 1 – Consent 1319 -1346
1319 Rosenstock vs. Burke, 46 Phil. 217
Batangas. vs. Cojuangco, 78 Phil. 481
Laudico vs. Arias, 43, Phil. 270
1324 Sanchez vs. Rigos, 45 SCRA 368
1338 Woodhouse vs Halili, 93 Phil 526
1340 Exaggerations in Trade
Azarraga vs Gay, 52 Phil. 599
Section 2 – Object of Contracts 1347 – 1349
Section 3 – Cause of Contracts 1350 - 1355