G.R. No. 177484 July 18, 2014
SPOUSES ALEJANDRO MANZANILLA AND REMEDIOS VELASCO, Petitioners, vs. WATERFIELDS INDUSTRIES CORPORATION, represented by its President, ALIZA MA, Respondent.

FACTS

Petitioners Spouses Alejandro Manzanilla and Remedios Velasco (spouses Manzanilla) are the owners of a parcel of land in Batangas. On May 24, 1994, they leased a portion to respondent Waterfields Industries Corporation (Waterfields) for 25 years, with a monthly rental of ₱18,000.00 and a rental deposit of ₱216,000.00. The contract stated the deposit would “answer for any unpaid rentals, damages, penalties and unpaid utility charges.” The parties executed an Amendment on June 6, 1994. Beginning April 1997, Waterfields failed to pay rentals. On July 9, 1997, Waterfields’ President, Aliza Ma, sent a letter to the spouses Manzanilla promising to pay arrears and stating: “The deposit stipulated in our lease contract shall be used exclusively for the payment of unpaid utilities, if any, and other incidental expenses only and applied at the termination of the lease.” Waterfields again failed to pay rentals from December 1997 to May 1998. The spouses Manzanilla filed a Complaint for Ejectment (Unlawful Detainer) before the Metropolitan Trial Court (MTC), alleging violation of the lease due to non-payment and seeking eviction and payment of accrued rentals. Waterfields, in its Answer, admitted the lease and its amendments but claimed it did not fail to pay as it was utilizing the rental deposit for rental payments per the original contract. The MTC ruled in favor of the spouses Manzanilla, ordering Waterfields to vacate and pay arrears, and held that the July 9, 1997 letter amended the contract, limiting the deposit’s use to unpaid utilities and incidental expenses only at termination, not for unpaid rentals. The Regional Trial Court (RTC) affirmed. The Court of Appeals (CA) reversed, holding that upon the termination of the lease as alleged by the spouses, the deposit should be applied exclusively to unpaid utilities/incidental expenses per the July 9 letter. Since no such unpaid expenses were alleged, the entire deposit should be returned to Waterfields, creating a debt from the spouses to Waterfields. Applying compensation, the CA offset the unpaid rentals (₱144,000 as of filing) against the deposit (₱216,000), finding Waterfields was even overpaid by ₱72,000, and thus dismissed the unlawful detainer case for lack of cause of action.

ISSUE

Whether the Court of Appeals erred in applying legal compensation to offset the unpaid rentals against the rental deposit, thereby dismissing the unlawful detainer complaint.

RULING

Yes. The Supreme Court REVERSED the Court of Appeals and REINSTATED the MTC Decision. The Court held that legal compensation under Article 1278 of the Civil Code could not apply in this case. For compensation to take place, among other requisites, the debts must be due and liquidated. The rental deposit was not a debt due from the spouses Manzanilla to Waterfields at the time the action was filed. The July 9, 1997 letter provided that the deposit “shall be used exclusively for the payment of unpaid utilities, if any, and other incidental expenses only and applied at the termination of the lease.” The lease contract had not been terminated with finality at the time of filing; the action for ejectment was precisely to seek termination. Therefore, the obligation to return any balance of the deposit would only arise after termination and after deducting any unpaid utilities/expenses. Since the contract was not yet terminated, the deposit could not be considered a liquidated amount due to Waterfields. Furthermore, the spouses Manzanilla, in their Complaint, did not pray for the return of the deposit or acknowledge it as a debt; they sought its application to rental arrearages. Waterfields, in its Answer, also did not assert a counterclaim for the deposit’s return but argued for its application to unpaid rentals under the original contract. Thus, there was no concurrence of debts between the parties to allow compensation. The MTC and RTC correctly ordered the deposit to be applied to the rental arrears. The spouses Manzanilla sufficiently established Waterfields’ violation of the lease agreement through non-payment of rentals, warranting ejectment.