G.R. No. L-17247. April 28, 1962.
C. N. HODGES, petitioner, vs. ELPIDIO JAVELLANA and the HON. COURT OF APPEALS, respondents.

FACTS

Petitioner C.N. Hodges filed an action to recover sums of money from respondent Elpidio Javellana under three causes of action: a promissory note, a sale of ice machinery, and a sale of various equipment. All obligations, secured by mortgages, stipulated payment with 12% annual interest and a provision for compounding unpaid interest. The complaint, filed in 1953, sought recovery of principal balances plus accumulated interest from the 1930s and early 1940s. The Court of First Instance ruled in favor of Hodges.
On appeal, the Court of Appeals affirmed the liability but significantly modified the award. It held that requiring payment of interest for the period of Japanese occupation, during which the mortgaged properties were destroyed and Hodges, as an American, was an enemy alien, would be revolting to the conscience. The appellate court thus relieved Javellana of all interest obligations, limiting recovery to the principal amounts due as of April 16, 1942, when the properties were destroyed. Hodges appealed, arguing the Court of Appeals erred in eliminating the stipulated regular interest, contending the issue was not properly raised and that valid contracts must be enforced.

ISSUE

Whether the Court of Appeals erred in relieving the debtor from paying the stipulated regular interest on the obligations.

RULING

The Supreme Court modified the decision of the Court of Appeals. It upheld the elimination of interest for the period of the Japanese occupation but reinstated the obligation to pay regular interest from liberation onwards. The legal logic proceeds from distinct principles for the wartime and post-liberation periods. For the occupation period, the Court, invoking equity and its power to moderate liability under Article 1172 of the Civil Code, affirmed the appellate court’s disallowance of interest. This aligns with precedent (Warner Barnes & Co. vs. Yasay) where recovery of interest during war years was deemed inequitable, considering the debtor’s inability to pay an enemy alien creditor and the creditor’s indirect benefit from not receiving payment in devalued military scrip.
However, for the period after liberation, the Court found no legal authority to disregard the valid contractual stipulation for 12% annual interest. The obligation to pay this regular interest revived. Concerning compounded interest, the Court treated the compounding clause as a penal clause. Applying Article 1229 of the Civil Code, which allows courts to equitably reduce iniquitous penalties, it sustained the appellate court’s complete disallowance of compounded interest as equitable under the circumstances. Thus, the principal sums awarded shall bear simple interest at 12% per annum only from the liberation of Panay Island.