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Application of payment

Problem — The debtor owes his creditor several debts, all of them due, to wit: (1) an unsecured debt; (2) a debt secured with a mortgage of the debtor’s property; (3) a debt bearing interest; (4) a debt in which the debtor is solidarily liable with another.

Partial payment was made by the debtor. Assuming that the debtor had not specified the debts to which the payment should be applied and, on the other hand, the creditor had not specified in the receipt he issued the application of payment, state the order in which the payment should be applied and your reasons therefore. (1982 Bar Problem)

Answer — In this case, according to the Civil Code, the debt, which is most onerous to the debtor, among those due, shall be deemed satisfi ed. Analyzing the four debts stated in the problem, the most onerous is No. 4, the second most onerous is No. 2, the third most onerous is No. 3, and the least onerous is No. 1. Consequently, the payment should be applied in that order. (Note: The above answer is based on Art. 1254 of the Civil Code, and on decided cases and commentaries of recognized commentators.)

Compensation

Problem — “B’’ borrowed from “C’’ P1,000.00 payable in one year. When “C’’ was in the province, “C’s’’ 17-year-old son borrowed P500.00 from “B’’ for his school tuition. However, the son spent it instead nightclubing. When

the debt to “C’’ fell due, “B’’ tendered only P500.00, claiming compensation on the P500.00 borrowed by “C’s’’ son. Question No. 1 — Is there legal compensation? Why? (1981 Bar Problem)

Answer — There is no legal compensation. Under the Civil Code, in order that there will be a valid and effective compensation, it is essential that there must be two parties, who in their own right, are principal creditors and principal debtors of each other. In the instant case, “C’’ cannot be considered as a party to the act of his 17-year-old son in borrowing P500.00 from “B.’’ Consequently, he did not become a principal debtor of “B’’; neither did “B’’ become a principal creditor of “C.’’ Therefore, there can be no partial compensation of the P1,000.00 borrowed by “B’’ from “C.’

Question No. 2 — Suppose the minor son actually used the money for school tuition, would the answer be different? Reasons. (1981 Bar Problem)

Answer — There would be no difference in my answer. There will still be no legal compensation. The fact that “C’s’’ son actually used the P500.00 for his school tuition did not make “C’’ a party to the contract between his son and “B.’’ Therefore, “C’’ is not the principal debtor of “B’’ with respect to said amount.

Novation

Problem — Suppose that under the judgment obligation, the liability of the judgment debtor is for the amount of P6,000, but both judgment debtor and judgment creditor subsequently entered into a contract reducing the liability of the former toonly P4,000, is there an implied novation which will have the effect of extinguishing the judgment obligation and creating a modifi ed obligatory relation? Reasons.

Answer — There is no implied novation in this case. We see no valid objection to the judgment debtor and the judgment creditor in entering into an agreement regarding the monetary obligation of the former under the judgment referred to. The payment by the judgment debtor of the lesser amount of P4,000, accepted by the creditor without any protest or objection and acknowledged by the latter as in full satisfaction of the money

judgment, completely extinguished the judgment debt and released the debtor from his pecuniary liability.

Novation results in two stipulations — one to extinguish an existing obligation, the other to substitute a new one in its place. Fundamentally, it is that novation effects a substitution or modification of an obligation by another or an extinguishment of one obligation by the creation of another. In the case at hand, we fail to see what new or modified obligation arose out of the payment by the judgment debtor of the reduced amount of P4,000 to the creditor. Additionally, to sustain novation necessitates that the same be so declared in unequivocal terms clearly and unmistakably shown by the express agreement of the parties or by acts of equivalent import — or that there is complete and substantial incompatibility between the two obligations. (Sandico vs. Piguing, 42 SCRA 322.)

Problem — ABC Trading Co., a domestic corporation engaged in the sale of automobile spare parts, opened with “X’’ Bank a letter of credit up to the extent of $450,000.00 for a period of one year. To secure payment thereof, it executed a chattel mortgage over its stock-in-trade valued at P500,000.00. On May 15 and June 15, 1981, “Y,” president and general manager of ABC Trading, drew against this letter of credit by means of promissory notes in the total amount of P430,000.00, payable within 30 days from the respective dates of the promissory notes with interest of 10%. Upon maturity of said notes, ABC Trading failed to pay, but was able to negotiate for an extension of six (6) months within which to pay said amount, in return for the additional security posted by Mr. “Y’’ consisting of a real estate mortgage over his land in Manila. At the end of 6 months, ABC Trading Co. failed to pay the amount due despite repeated demands by “X’’ Bank. “Y’’ Bank fi led an action for foreclosure of the chattel mortgage executed by ABC. Trading ABC Trading opposed said action contending that the chattel mortgage has been novated by the real estate mortgage executed by “X’’ Bank. Is the contention of ABC Trading Co. tenable? Reasons.

Answer — The contention of ABC Trading Co. that the chattel mortgage has been novated by the real estate mortgage executed by Mr. “R” in favor of “X’’ Bank is untenable. Well- settled is the rule that in order that there will be a novation there must be complete incompatibility between the two obligations. And the test of incompatibility is simple. The test is whether the

two obligations can stand together. If they can stand together, then there is no incompatibility. If there is incompatibility, then there is novation. Applying the test to the instant case, it is clear that the two obligations can stand together. Therefore, there is no novation.

Problem — A obtained a favorable judgment against B from the Court of First Instance of Manila for the sum of P2,000. Subsequently, a writ of execution was issued and a jeep belonging to the latter was seized by the sheriff. However, the two (A and B) arrived at an arrangement by virtue of which B executed a chattel mortgage on the jeep stipulating, inter alia that B shall satisfy the judgment in two equal installments pay- able at designated periods. B failed to pay the fi rst installment, and as a result, A obtained an alias writ of execution and levied upon certain personal properties of B. The latter fi led an urgent motion for suspension of the execution sale on the ground of pay- ment of the judgment obligation. He maintains that the execu- tion of the deed of chattel mortgage has extinguished the judg- ment debt because of implied novation. Is this correct? Reasons.

Answer — The contention of B that the mortgage obligation has extinguished the judgment obligation because of implied novation is not correct. The defense of implied novation requires clear and convincing proof of complete incompatibility between the two obligations. The law requires no specific form for an effective novation by implication. The test is whether the two obligations can stand together. If they cannot, incompatibility arises, and the second obligation novates the first. If they can stand together, no incompatibility results and novation does not take place.

Applying this test, we see no substantial incompatibility between the mortgage obligation and the judgment obligation sufficient to justify a conclusion of implied novation. The stipulation for the payment of the obligation under the terms of the deed of chattel mortgage serves only to provide an express and specific method for its extinguishment — payment in two equal installments. The chattel mortgage simply gave the judgment debtor a method and more time to enable him to fully satisfy the judgment indebtedness. (Millar vs. Court of Appeals, 38 SCRA 642.)

Problem No. 1 — “A’’ owed “B’’ a certain sum of money. “C’’ wrote “B’’ a letter stating that he would be the one to take care of “A’s’’ debt as soon as

“A’’ had made a shipment of logs to Japan. “A’’ never made such shipment. “C’’ did not pay “B.’’ Is “C’’ liable to “B’’? Explain. (1975 Bar Problem)

Answer — “C’’ is not liable to “B.’’ In the fi rst place, in order that “C’’ may be held liable to “B,’’ there should have been a substitution of debtor through expromision within the meaning of Art. 1291, No. 2, and Art. 1293 of the Civil Code resulting in novation of the obligation. Here, there was none. “C’’ merely wrote a letter to the creditor “B” stating that he would take care of “A’s” debt. The problem does not even say that “B” gave his assent or consent to “C’s’’ statement. In the second place, even assuming that there was a substitution of debtor, “C’s’’ liability depends upon a suspensive condition, that he would take care of “A’s’’ debt as soon as “A’’ had made a shipment of logs to Japan. “A” never made such shipment. Therefore, “C’s’’ liability never became effective. (Villanueva vs. Girged, 110 Phil. 478.)

Problem No. 2 — “A’’ borrowed from “B” the sum of P3,000.00. Three days after, “A’’ in a letter authorized the Philippine National Bank to pay his debt to “B” out of whatever crop loan might be granted to him by said Bank. On the same day, the Bank agreed but the Bank paid “B’’ only P2,000.00. On the date of maturity, “B’’ sued the Bank and “A’’ for the remaining P1,000.00. Is the Bank liable to “B’’? (1975 Bar Problem.)

Answer — The Bank is not liable to “B’’ for the remaining P1,000.00. Even assuming that “B’’ gave his consent to “A’s’’ proposal that the Bank shall pay his indebtedness of P3,000.00, in reality, there was no substitution of debtor by delegacion within the meaning of Arts. 1291, No. 2, and 1293 of the Civil Code resulting in a novation of the obligation. The Bank never assumed payment of the obligation. There was merely an authorization, which was accepted by the Bank, that the latter shall pay “A’s’’ debt out of whatever crop loan would be granted to him by the Bank. As it turned out, the Bank agreed to lend “A’’ only P2,000.00, and said amount was paid directly to “B’’ in accordance with the Bank’s promise. Beyond that amount, the Bank cannot be held liable. (Hodges vs. Rey, 111 Phil. 219.)