33.1 Law on Contracts: Essential Requisites & Performance

Law on Contracts: Essential Requisites & Performance

Contracts represent the primary commercial instrument through which obligations are voluntarily created, structured, and executed in civil society. In Philippine law, the Law on Contracts is governed by Book IV, Title II (Articles 1305 to 1422) of the Civil Code of the Philippines. For CPALE candidates, mastering contract law requires a thorough understanding of the governing principles, the three indispensable requisites of a valid contract, the cognition theory of acceptance, formal and solemn execution requirements, reformation of instruments, and rules of interpretation.

---

1. Statutory Definition and Cornerstone Principles of Contract Law

Definition under Article 1305

Article 1305 defines a contract as: "A contract is a meeting of minds between two persons whereby one binds himself, with respect to the other, to give something or to render some service."

                               Four Cornerstone Principles of Contract Law
                                                    │
         ┌──────────────────────────┬───────────────┴───────────────┬──────────────────────────┐
         ▼                          ▼                               ▼                          ▼
  Autonomy of Will              Mutuality                       Relativity               Obligatoriness
    (Art. 1306)                (Art. 1308)                     (Art. 1311)                (Art. 1315)
Liberty to stipulate       Binds both parties;             Takes effect only          Consensual perfection;
terms, provided not        cannot leave validity           between parties,           binds to all consequences
contrary to law, morals,   or compliance to sole           assigns, and heirs         in good faith, usage,
public policy/order        will of one party               (with exceptions)          and positive law

1. Principle of Autonomy of Will (Liberty of Terms, Article 1306)

Contracting parties are free to establish such stipulations, clauses, terms, and conditions as they may deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy. Contracts violating these statutory boundaries are void ab initio under Article 1409.

2. Principle of Mutuality of Contracts (Article 1308)

A contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them. An agreement giving one party unbridled discretion to determine whether a contract shall be fulfilled is completely void. However, under Article 1309, the determination of the performance may be left to a third person, whose decision becomes binding once made known to both parties, unless it is evidently inequitable (Article 1310).

3. Principle of Relativity of Contracts (Article 1311)

As a general rule, contracts take effect only between the parties, their assigns, and heirs. Third persons have no standing to enforce contractual rights or incur liabilities thereunder.

• Heirs' Limitation: Heirs are bound only to the extent of the value of the inheritance received from the decedent.
• Non-Transmissible Rights: Rights and obligations are not transmissible when they are purely personal by nature (e.g., painting a portrait), by express stipulation, or by provision of law.

The Four Statutory Exceptions to Relativity

1. Stipulation Pour Autrui (Article 1311 par. 2): A stipulation in favor of a third person. To be legally demandable, five requisites must concur:
   • There must be a clear and deliberate conferment of a favor upon a third person;
   • The stipulation in favor of the third person is only a part, not the whole, of the contract;
   • The favorable stipulation is not conditioned upon any obligation to be performed by the third person;
   • Neither of the contracting parties represents or is authorized by the third person; and
   • The third person communicated their acceptance to the obligor before its revocation by the original parties.
2. Contracts Creating Real Rights (Article 1312): In contracts creating real rights (such as real estate mortgages or easements), third persons who come into possession of the object of the contract are bound thereby, subject to mortgage and registration laws.
3. Contracts in Fraud of Creditors (Article 1313): Creditors are protected against contracts intended to defraud them through the remedy of Accion Pauliana (Article 1381 No. 3).
4. Tortious Interference by a Third Person (Article 1314): Any third person who induces another to violate his contract shall be liable for damages to the other contracting party. The requisites are: (a) existence of a valid contract; (b) knowledge of the contract by the third person; and (c) interference without legal justification or with malice.

4. Principle of Obligatoriness and Consensual Nature (Article 1315)

Contracts are perfected by mere consent (the consensual rule), and from that moment the parties are bound not only to the fulfillment of what has been expressly stipulated but also to all the consequences which, according to their nature, may be in keeping with good faith, usage, and law.

• Exceptions to Consensual Rule:
  • Real Contracts (Article 1316): Perfected not by mere consent, but only upon actual delivery of the object (e.g., deposit, pledge, commodatum).
  • Formal / Solemn Contracts: Perfected only upon execution of the statutory formalities prescribed by law.

---

2. Essential Requisites of a Valid Contract (Article 1318)

Under Article 1318, there is no contract unless the following three requisites concur:

1. Consent of the contracting parties;
2. Object certain which is the subject matter of the contract; and
3. Cause of the obligation which is established.

                          Article 1318 Essential Requisites
                                          │
     ┌────────────────────────────────────┼────────────────────────────────────┐
     ▼                                    ▼                                    ▼
  Consent                               Object                               Cause
(Arts. 1319-1346)                 (Arts. 1347-1349)                    (Arts. 1350-1355)
Concurrence of offer &            Within commerce of man,              The essential 'why';
acceptance; free from vices;      licit, possible, and                 onerous, remuneratory, or
cognition theory applies          determinate/determinable             gratuitous (presumed lawful)

Requisite 1: Consent (Articles 1319 to 1346)

Consent is the conformity of wills (concurrence of offer and acceptance) upon the object and the cause.

The Cognition Theory of Acceptance (Article 1319)

Under Article 1319, paragraph 2: "Acceptance made by letter or telegram does not bind the offerer except from the time it came to his knowledge."

CPALE Rule: Under the Cognition Theory, even if the offeree mailed a written acceptance, the offeror may validly revoke or withdraw the offer at any time before the letter of acceptance is actually received and read by the offeror!

Option Contracts vs. Option Money vs. Earnest Money

• Option Contract (Article 1324): A preparatory contract granting a person a fixed period within which to accept an offer.
  • If supported by a separate, independent consideration (Option Money): The offeror cannot withdraw the offer before the expiration of the agreed option period.
  • If NOT supported by independent consideration: The offeror may withdraw the offer at any time prior to acceptance by communicating the withdrawal to the offeree.
• Earnest Money (Arras, Article 1482): Forms part of the purchase price and serves as conclusive proof of the perfection of a contract of sale.

Legal Incapacity to Give Consent (Article 1327)

The following persons cannot give legal consent to a contract:

1. Unemancipated minors;
2. Insane or demented persons;
3. Deaf-mutes who do not know how to write.

Contracts entered into by these persons are voidable (if one party is incapacitated) or unenforceable (if both parties are incapacitated under Article 1403 No. 3).

Vices of Consent (Article 1330)

A contract where consent is given through mistake, violence, intimidation, undue influence, or fraud is VOIDABLE:

• Mistake / Error (Article 1331): Must refer to the substance of the thing which is the object of the contract, or to those conditions which principally moved one or both parties. Ignorance of the law does not excuse, except mutual error as to the legal effect of an agreement when the real purpose is frustrated (Article 1334).
• Violence (Vis Absoluta, Article 1335 par. 1): When in order to wrest consent, serious or irresistible physical force is employed.
• Intimidation (Vis Compulsiva, Article 1335 par. 2): When one party is compelled by a reasonable and well-grounded fear of an imminent and grave evil upon their person or property, or upon the person or property of their spouse, descendants, or ascendants. A threat to enforce a just claim through competent authority does not vitiate consent.
• Undue Influence (Article 1337): When a person takes improper advantage of their power over the will of another, depriving the latter of reasonable freedom of choice (e.g., confidential, family, or spiritual relations).
• Fraud (Dolo Causante, Article 1338): Insidious words or machinations employed by one party to induce the other to enter into a contract which, without them, they would not have agreed to. Failure to disclose facts when there is a duty to reveal constitutes fraud (Article 1339). Usual exaggerations in trade (dealer's talk) do not constitute fraud if the other party had an opportunity to know the facts (Article 1340).

Simulated Contracts (Articles 1345 and 1346)

• Absolute Simulation: The parties do not intend to be bound at all. The contract is fictitious and completely VOID.
• Relative Simulation: The parties conceal their true agreement under the guise of another contract. The parties are bound to their real agreement, provided it does not prejudice a third person and is not contrary to law, morals, good customs, public order, or public policy.

Requisite 2: Object of Contracts (Articles 1347 to 1349)

The object is the thing, right, or service which is the subject matter of the obligation. The object must be:

1. Within the commerce of men: Outside things (public plazas, streets, sunlight) cannot be objects.
2. Licit: Not contrary to law, morals, good customs, public order, or public policy.
3. Possible: Physically and legally possible. Impossibility voids the contract.
4. Determinate or Determinable: Determinate as to its kind; the quantity may be indeterminate provided it can be determined without the need of a new agreement (Article 1349).

Statutory Prohibition (Article 1347 par. 2): No contract may be entered into upon future inheritance, except in cases expressly authorized by law (such as marriage settlements under Family Code Art. 84 or partitions inter vivos under Civil Code Art. 1080). A sale of future inheritance is void ab initio.

Requisite 3: Cause of Contracts (Causa, Articles 1350 to 1355)

The cause is the essential, direct, and immediate purpose why a party enters into a contract:

• In onerous contracts, the cause is the prestation or promise of a thing or service by the other party;
• In remuneratory contracts, the cause is the past service or benefit remunerated;
• In contracts of pure beneficence (gratuitous), the cause is the mere liberality of the benefactor.

Causa vs. Motive

• Cause (Causa): The direct, objective, and proximate reason of the contract; identical for both parties in similar contracts. Absence or illegality of cause voids the contract.
• Motive: The personal, subjective, and psychological reason moving a party to contract. The illegality of a party's motive does not affect the validity of the contract, unless the motive was made the condition or predetermined the purpose of the agreement.

Legal Presumption of Cause (Article 1354)

Although the cause is not stated in the contract, it is presumed to exist and be lawful, unless the debtor proves the contrary.

---

3. Stages of Contract Formation

                                   The Three Contract Stages
                                               │
         ┌─────────────────────────────────────┼─────────────────────────────────────┐
         ▼                                     ▼                                     ▼
    Preparation                           Perfection                            Consummation
(Negotiation / Conception)             (Birth of Contract)                   (Fulfillment / Death)
Begins with initial inquiries,        Concurrence of consent,               Parties fulfill their
bargaining, and counter-offers;       object, and cause;                    prestations; obligations
no binding obligation yet             contract becomes binding              are extinguished

---

4. Formal and Solemn Contract Requirements (Articles 1356 to 1358)

The Consensual Rule (Article 1356)

As a general rule, contracts are obligatory in whatever form they may have been entered into, whether oral, written, or implied, provided all three essential requisites (consent, object, and cause) are present.

Exceptions: Formal / Solemn Contracts (Form Required for Substantive VALIDITY)

In formal or solemn contracts, statutory formalities are essential for the very existence and validity of the contract. If the prescribed form is not observed, the contract is completely VOID ab initio:

Contracts Required in Public Instrument for Convenience / Greater Efficacy (Article 1358)

Under Article 1358, certain contracts must appear in a public document (e.g., acts involving real rights over immovables, sales of real property, cession of actions). However, non-compliance with Article 1358 does not invalidate the contract. The contract remains valid and enforceable between the parties, and under Article 1357, either party may compel the other to execute the required public instrument.

---

5. Reformation of Instruments (Articles 1359 to 1369)

Concept and Grounding

Reformation is an equitable remedy by means of which a written instrument is made or construed so as to express or conform to the real intention of the parties, when such intention is not expressed due to mistake, fraud, inequitable conduct, or accident.

                               Reformation vs. Annulment
                                           │
         ┌─────────────────────────────────┴─────────────────────────────────┐
         ▼                                                                   ▼
    Reformation                                                          Annulment
• There WAS a true meeting of minds                                 • There was NO true meeting of minds
• The written instrument is erroneous                               • Consent was vitiated by fraud, mistake, etc.
• Remedy: Correct the writing                                       • Remedy: Invalidate and cancel the contract

Concurrent Requisites for Reformation

1. There must have been a true meeting of the minds of the parties;
2. The written instrument does not express the true intention of the parties; and
3. The failure of the instrument to express the true intention is due to mistake, fraud, inequitable conduct, or accident.

When Reformation is Expressly Barred (Article 1366 and 1367)

Under Article 1366, there shall be no reformation in the following cases:

1. Simple donations inter vivos wherein no condition is imposed;
2. Wills;
3. When the real agreement is void.

Estoppel Bar (Article 1367): When one of the parties has brought an action to enforce the instrument, he cannot subsequently ask for its reformation. By filing an enforcement suit, he affirms the validity and accuracy of the written document.

---

6. Interpretation of Contracts (Articles 1370 to 1379)

When contractual terms are obscure or disputed, courts apply statutory rules of interpretation:

• Plain Meaning Rule (Article 1370 par. 1): If the terms of a contract are clear and leave no doubt upon the intention of the contracting parties, the literal meaning of its stipulations shall control.
• Intention Prevails over Words (Article 1370 par. 2): If the words appear contrary to the evident intention of the parties, the intention shall prevail over the words.
• Contemporaneous and Subsequent Acts (Article 1371): In order to judge the intention of the contracting parties, their contemporaneous and subsequent acts shall be principally considered.
• Harmonization of Clauses (Article 1374): The various stipulations of a contract shall be interpreted together, attributing to the doubtful ones that sense which may result from all of them taken jointly.
• Contra Proferentem Rule (Article 1377): The interpretation of obscure words or stipulations in a contract shall not favor the party who caused the obscurity. This rule is vigorously applied against the drafter in standard-form contracts of adhesion (e.g., insurance policies, bank loan contracts).

---

7. Comprehensive Worked Problem Scenarios

Problem 1: The Cognition Theory and Option Contract

Scenario: On March 1, 2026, Samuel sent a signed letter to Patrick offering to sell his commercial lot in Taguig City for PHP 10,000,000. Samuel gave Patrick until March 31, 2026 to accept the offer. Patrick paid no option money to Samuel. On March 15, Patrick mailed a registered letter containing his absolute, unqualified acceptance. On March 18, before Patrick's letter arrived at Samuel's office, Samuel sent a telegram to Patrick stating: "Offer to sell Taguig commercial lot is hereby withdrawn." Patrick received Samuel's telegram on March 19. On March 20, Samuel received and opened Patrick's registered letter of acceptance. Patrick claims a perfected contract of sale exists. Is Patrick correct?

Analysis:

1. Nature of Option: Because Patrick did not give any separate consideration (option money) for the 30-day option period, the option was not binding on Samuel. Under Article 1324, Samuel had the right to withdraw the offer at any time prior to acceptance.
2. Application of Cognition Theory (Article 1319): Philippine civil law rejects the mailbox/expedition rule. An acceptance binds the offeror only from the time it comes to their actual knowledge.
3. Timeline of Withdrawal vs. Knowledge:
   • March 19: Patrick received Samuel's telegram of withdrawal (offer terminated).
   • March 20: Samuel received Patrick's letter of acceptance.
4. Conclusion: Samuel learned of Patrick's acceptance on March 20, after the offer had already been validly withdrawn and communicated on March 19. Therefore, no meeting of minds occurred, and no contract of sale was perfected.

Problem 2: Formal Contract Requirements: Agent's Sale of Land

Scenario: Leonardo, the registered owner of a parcel of land in Cebu City, orally instructed and authorized Gabriel to sell the land for not less than PHP 5,000,000. Gabriel entered into a formal, notarized Deed of Absolute Sale selling the land to Miranda for PHP 5,500,000. Miranda paid the full purchase price to Gabriel, who absconded with the money. Leonardo refuses to deliver the land to Miranda, claiming the sale is void. Miranda argues that because the contract of sale was executed in a public instrument, it is fully valid and binding. Who is correct?

Analysis:

1. Statutory Requirement under Article 1874: Under Article 1874 of the Civil Code: "When a sale of a piece of land or any interest therein is through an agent, the authority of the latter shall be in writing; otherwise, the sale shall be void."
2. Defect: Gabriel's authority from Leonardo was purely oral.
3. Effect: The failure to reduce the agent's authority to writing renders the sale completely VOID ab initio, not merely unenforceable or voidable. The fact that the agent executed the deed of sale in a public instrument cannot cure the absolute nullity arising from the lack of written agency authority.
4. Conclusion: Leonardo is correct. The sale is void, and Miranda did not acquire title to the land.