G.R. No. 138703; June 30, 2006
DEVELOPMENT BANK OF THE PHILIPPINES and PRIVATIZATION AND MANAGEMENT OFFICE, Petitioners, vs. HON. COURT OF APPEALS, PHILIPPINE UNITED FOUNDRY AND MACHINERY CORP. and PHILIPPINE IRON MANUFACTURING CO., INC., Respondents.

FACTS

Respondent corporations obtained loans from petitioner DBP, secured by mortgages on their properties. Due to payment difficulties, the loans were restructured in 1975, consolidating the principal and accrued interest into separate promissory notes. Respondents again defaulted, leading DBP to grant three foreign currency-denominated loans between 1980 and 1981 to refinance the obligation. These new loans were also secured by mortgages and contained stipulations for interest, service fees, and penalty charges. Respondents failed to pay, prompting DBP to initiate extrajudicial foreclosure. Respondents then filed an action for annulment of mortgage and loan contracts, alleging the stipulated interest and penalty rates were unconscionable and constituted pactum commissorium.
The Regional Trial Court declared the stipulated interest and penalty charges in the 1980 and 1981 promissory notes void for being excessive and unconscionable. It ordered the recomputation of the obligation using a 12% annual interest rate. The Court of Appeals affirmed this decision. Petitioners elevated the case, arguing the stipulations were valid and that the courts below erred in invalidating them.

ISSUE

Whether the stipulated interest, service fees, and penalty charges in the foreign currency promissory notes are void for being excessive, iniquitous, and unconscionable.

RULING

The Supreme Court affirmed the lower courts’ rulings, declaring the stipulated charges void. The legal logic rests on the principle of equity and the court’s supervisory authority over contractual stipulations. While parties are free to stipulate on loan terms under Article 1306 of the Civil Code, this freedom is not absolute. Stipulations that are contrary to law, morals, good customs, public order, or public policy are void. The Court emphasized that interest rates, service fees, and penalties, even if voluntarily agreed upon, are subject to judicial review for reasonableness.
The combined effect of the charges in the 1980 and 1981 notes—comprising a basic interest rate (DBP’s borrowing rate plus 3% or 4%), a 2% annual service fee, additional interest on arrears, and penalty charges of 8% or 16% per annum—was deemed excessive and unconscionable. Such a structure would produce a compounded obligation far exceeding the principal, effectively oppressing the borrowers and violating the essence of mutuality in contracts. The Court found the stipulations to be a clever scheme to impose hidden charges, amounting to a disguised pactum commissorium by ensuring the debt would balloon beyond the value of the mortgaged property, guaranteeing its forfeiture. Consequently, the Court upheld the imposition of a straight 12% annual interest on the restructured principal obligation as fair and equitable.