32.3 Extinguishment of Obligations

Extinguishment of Obligations

Article 1231 lists the modes of extinguishing obligations. This section covers payment or performance and its special forms (dation in payment, cession, tender and consignation, and application of payments), legal tender and mercantile documents, loss of the thing due, condonation, confusion, compensation, and novation.

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1. Extinguishment of Obligations (Article 1231)

Under Article 1231, obligations are extinguished by:

1. Payment or performance
2. Loss of the thing due
3. Condonation or remission of the debt
4. Confusion or merger of the rights of creditor and debtor
5. Compensation
6. Novation

Other causes include annulment, rescission, fulfillment of a resolutory condition, and prescription.

1. Payment or Performance (Articles 1232 to 1261)

Payment means not only the delivery of money but also the performance, in any other manner, of an obligation.

• Integrity of Payment (Article 1233): A debt shall not be understood to have been paid unless the thing or service in which the obligation consists has been completely delivered or rendered.
• Identity of Payment (Article 1244): The debtor of a thing cannot compel the creditor to receive a different one, although the latter may be of the same value as, or more valuable than that which is due.
• Payment in Legal Tender: Under the Bangko Sentral ng Pilipinas (BSP) Monetary Board regulations (including BSP Circular No. 1191), Philippine Peso banknotes and coins constitute legal tender. Banknotes are legal tender for any amount. For coins: 1-Piso, 5-Piso, 10-Piso, and 20-Piso coins are legal tender up to PHP 2,000; 1-sentimo, 5-sentimo, 10-sentimo, and 25-sentimo coins are legal tender up to PHP 200. Negotiable instruments (checks, promissory notes) do not constitute legal tender and produce the effect of payment only when cashed, or when through the fault of the creditor they have been impaired (Article 1249).

Special Forms of Payment

• Dacion en Pago (Dation in Payment, Article 1245): Alienation of property to the creditor in satisfaction of a monetary debt. It is governed by the Law on Sales. It transfers ownership of the property to the creditor and extinguishes the monetary obligation up to the agreed value.
• Cession (Payment by Cession, Article 1255): Assignment or abandonment of all the debtor's properties to their creditors so that the latter may sell them and apply the proceeds to their claims. It does not transfer ownership (creditors only acquire authority to sell), and extinguishes the debts only up to the net proceeds of the sale, unless agreed otherwise.
• Tender of Payment and Consignation (Articles 1256 to 1261): Tender of payment is the antecedent extrajudicial offer of the debtor to pay. Consignation is the judicial deposit of the thing or amount due with the proper judicial authority. Consignation alone, without prior tender of payment, produces legal payment in five specific cases (Article 1256):
  1. When the creditor is absent or unknown, or does not appear at the place of payment;
  2. When the creditor is incapacitated to receive the payment at the time it is due;
  3. When, without just cause, the creditor refuses to give a receipt;
  4. When two or more persons claim the same right to collect; or
  5. When the title of the obligation has been lost.

2. Loss of the Thing Due (Articles 1262 to 1269)

An obligation to deliver a determinate thing is extinguished if it is lost or destroyed without the fault of the debtor and before he has incurred delay. For generic things, loss does not extinguish the obligation (genus nunquam perit).

3. Condonation or Remission of Debt (Articles 1270 to 1274)

Condonation is the gratuitous abandonment by the creditor of their right against the debtor. Being essentially a donation, it requires the acceptance of the debtor. Formalities of donation apply: if remission involves movable property exceeding PHP 5,000, both remission and acceptance must be in writing; if it involves immovable property, both must be in a public instrument.

4. Confusion or Merger of Rights (Articles 1275 to 1277)

Occurs when the qualities of creditor and debtor become united in the same person (e.g., when a negotiable promissory note is negotiated back to the maker as holder in due course). Merger takes place only in the person of the principal debtor or creditor, extinguishing the obligation and freeing guarantors.

5. Compensation (Articles 1278 to 1290)

Compensation is the extinguishment to the concurrent amount of the debts of two persons who, in their own right, are debtors and creditors of each other. Under Article 1279, Legal Compensation operates automatically by operation of law when five requisites concur:

1. Each one of the obligors be bound principally, and that he be at the same time a principal creditor of the other;
2. Both debts consist in a sum of money, or if the things due are consumable, they be of the same kind, and also of the same quality if the latter has been stated;
3. Both debts be due;
4. Both debts be liquidated and demandable; and
5. Over neither of them there be any retention or controversy, commenced by third persons and communicated in due time to the debtor.

6. Novation (Articles 1291 to 1304)

Novation is the total or partial extinguishment of an obligation through the creation of a new one which substitutes it. It requires: (a) a previous valid obligation; (b) agreement of all parties to the new contract; (c) extinguishment of the old contract; and (d) validity of the new contract.

                                    Subjective Novation
                              (Substitution of the Debtor)
                                           │
         ┌─────────────────────────────────┴─────────────────────────────────┐
         ▼                                                                   ▼
    Expromision                                                         Delegacion
• Initiative of THIRD PERSON                                        • Initiative of DEBTOR (delegante)
• Without knowledge or against will of debtor                       • Debtor proposes, creditor accepts, substitute consents
• Requires creditor's consent                                       • Requires creditor's consent
• If new debtor is INSOLVENT:                                       • If new debtor is INSOLVENT:
  Original debtor is NEVER revived or liable!                         Original debtor is NOT liable UNLESS insolvency was
                                                                      already existing & public, or known to debtor (Art. 1295)

7. Application of Payments (Articles 1252 to 1254)

When a debtor owes several debts of the same kind to one creditor and pays an amount not enough to cover all of them:

1. The debtor may designate which debt the payment covers, at the time of payment.
2. If the debtor does not, and accepts a receipt in which the creditor applies the payment, the debtor cannot complain unless there was a cause invalidating the contract.
3. If neither party designates, the payment is applied to the debt that is most onerous to the debtor. If the debts are of the same nature and burden, the payment is applied to all of them proportionately (Article 1254).
4. If a debt bears interest, payment of the principal is not deemed made until the interest has been covered (Article 1253).

Example: A debtor owes the same creditor PHP 50,000 unsecured and PHP 50,000 secured by a mortgage, both due, with no designation. A PHP 50,000 payment is applied to the secured debt, because it is more onerous to the debtor (the mortgaged property is at risk).

8. Other Payment Rules

• Extraordinary inflation or deflation (Article 1250): The value of the currency at the time the obligation was established is the basis of payment, unless there is an agreement to the contrary. This applies only to extraordinary changes declared by competent authority.
• Place of payment (Article 1251): The place designated in the obligation; otherwise, for a determinate thing, where it was when the obligation was constituted; in other cases, the debtor's domicile.
• Payment to an unauthorized person is valid only insofar as it redounded to the creditor's benefit, or in the other cases in Article 1241.
• Partial legal compensation: If A owes B PHP 80,000 and B owes A PHP 50,000, both due, liquidated, and demandable, compensation extinguishes both debts up to PHP 50,000 by operation of law, and A still owes PHP 30,000.