The Law on Obligations and Contracts

Chapter 4: Extinguishment of Obligations

Section 4 – Confusion or Merger of Rights

Article 1275. The obligation is extinguished from the time the characters of creditor and debtor are merged in the same person.

Confusion/Merger

- Meeting in one (1) person of the characters of creditor and debtor with respect to the same obligation.

Reason/Basis for confusion:

1. The law treats it as a mode of extinguishing obligations.

 If his debtor is his won creditor, enforcement of obligation becomes absurd since a person cannot claim
payment from himself.
2. The purposes for which the obligation may have been created are deemed realized.

Requisites of confusion:

1. Must take place between the principal debtor and creditor

2. It must be complete

Article 1276. Merger which takes place in the person of the principal debtor or creditor benefits the guarantors. Confusion which
takes place in the person of any of the latter does not extinguish the obligation.

Effect of merger in the person of principal debtor or creditor

 When the principal extinguishes, the accessory obligation of guaranty is also extinguished in accordance with the principle
that the accessory follows principal.

Effect of merger in the person of guarantor

 The accessory extinguishes does not carry with it that of the principal obligation.
 Merger in between the guarantor and the principal creditor does not extinguish the principal obligation.

Article 1277. Confusion does not extinguish a joint obligation except as regards the share corresponding to the creditor or debtor in
whom the two characters concur. (1194)

Confusion in a joint obligation

- There are as many debts as there are debtors and as many credits as there are creditors, the debts and/or credits being
considered distinct and separate from one another.
- Each debtor has his own creditor to whom he is liable and confusion taking place in the person of any debtor or creditor
does not affect the others.
- The confusion will extinguish only the share corresponding to the creditor or debtor in whom the two character concur.

Confusion in solidary obligation

- It shall extinguish the entire obligation because it is also a merger in the other solidary debtors.
- He who makes payment may claim reimbursement from his co-debtors for the shares which correspond to them.

denairasr Page 1 of 8
 Section 5. – Compensation

Article 1278. Compensation shall take place when two persons, in their own right, are creditors and debtors of each other.

Compensation1.

- 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.
- Involves the simultaneous balancing of two obligations in order to extinguish them to the extent in which the amount is
covered b y that of the other.

Object of compensation

- This is accomplished through the mutual extinguishment by operation of law of concurring debts of two (2) persons.
- Is often called simplified payment, as it provides a more convenient and less expensive effectuation of payments between
two (2) persons who are reciprocally creditors and debtors.

Confusion VS Compensation

Confusion Compensation
- Only one person who is a creditor and debtor of - There are two (2) persons involved, each whom is a
himself debtor and a creditor of the other
- There is but one obligation. - There are two (2) obligation.
- There is impossibility of payment. - There is indirect payment.
- - There many be a compensation in joint and solidary
obligation.

Kinds of compensation:

1. By its effect or extent:

a. Total – when both obligations are of the same amount and are entirely extinguished.
b. Partial – when the two (2) obligations are of different amounts and a balance remains. The extinctive effect of
compensation will be partial only as regards the larger debt.

2. By its cause or origin:

a. Legal – operation of law even without the knowledge of the parties
b. Voluntary – agreement of the parties
c. Judicial – order from a court in a litigation.
 Merely a form of legal or voluntary compensation when declared by the courts by virtue of an action by one of
the parities, who refuses to admit it, and by the defense of the other who invokes it.
d. Facultative – it can be set up only by one of the parties.

Article 1279. In order that compensation may be proper, it is necessary:

(1) That each one of the obligors be bound principally, and that he be at the same time a principal creditor of the other;

(2) That 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) That the two debts be due;

(4) That they be liquidated and demandable;

(5) That over neither of them there be any retention or controversy, commenced by third persons and communicated in due time to
the debtor. (1196)

Requisites of legal compensation

1. The parties are principal creditors and debtors of each other.

2. Both debts consist in a sum of money, or of consumable things of the same kind and quality.
3. The two debts are due or demandable.
4. The two debts are liquidated.
5. No retention or controversy commenced by a third person.

denairasr Page 2 of 8
 Article 1280. Notwithstanding the provisions of the preceding article, the guarantor may set up compensation as regards what the
creditor may owe the principal debtor. (1197)

Compensation benefits guarantor

- Exception to the general rule of legal compensation.

- Although the guarantor is only subsidiarily and not principally bound, he is given the right to set up compensation
- Reason: The extinguishment of the principal obligation as a consequence of compensation carries with it the accessory
obligations such as guaranty.

Article 1281. Compensation may be total or partial. When the two debts are of the same amount, there is a total compensation.

Total VS Partial Compensation

Total Partial
- When two (2) debts are of the same amount - only with respect to the larger debt.
- If different amounts, total as regards the smaller debt
- Both applies to all the different kinds of compensation.

Article 1282. The parties may agree upon the compensation of debts which are not yet due.

Voluntary Compensation

- Includes any compensation which takes place by agreement of the parties even if all the requisites for legal compensation
are not present.
- Has no special requisites.
- It is sufficient that the contract of the parties, which declares the compensation is valid.

Article 1283. If one of the parties to a suit over an obligation has a claim for damages against the other, the former may set it off
by proving his right to said damages and the amount thereof.

Judicial Compensation

- Take place when so declared by a final judgement of a court in a suit.

- May set off his claim for damages against his obligation to the other party by proving his right to said damages and the
amount thereof.

Article 1284. When one or both debts are rescissible or voidable, they may be compensated against each other before they are
judicially rescinded or avoided.

Compensation of rescissible or voidable debts.

- Valid until they are judicially rescinded or avoided.

- Prior to rescission or annulment, the debts may be compensated against each other.

Article 1285. The debtor who has consented to the assignment of rights made by a creditor in favour of a third person, cannot set
up against the assignee the compensation which would pertain to him against the assignor, unless the assignor was notified by the
debtor at the time he gave his consent, that he reserved his right to the compensation.

If the creditor communicated the cession to him but the debtor did not consent thereto, the latter may set up the compensation of
debts previous to the cession, but not of subsequent ones.

If the assignment is made without the knowledge of the debtor, he may set up the compensation of all credits prior to the same and
also later ones until he had knowledge of the assignment. (1198a)

Where compensation has taken place before assignment

- Takes effect by operation of law or automatically, the debts are extinguished to the concurrent amount.
- If subsequently, the extinguished debt assigned by the creditor to a third person, the debtor can raise the defense of
compensation with respect to the debt.
 The remedy of the assignee is against the assignor

denairasr Page 3 of 8
  Right to the compensation may be waived by the debtor before or after the assignment.

Where compensation has taken place after assignment

1. Assignment with the consent of debtor.

2. Assignment with the knowledge but without the consent of debtor.
3. Assignment without the knowledge of the debtor.

Article 1286. Compensation takes place by operation of law, even though the debts may be payable at different places, but there
shall be an indemnity for expenses of exchange or transportation to the place of payment. (1199a)

Compensation where debts payable at different places

- The indemnity contemplated above refers to the  Foreign exchange

expenses of monetary exchanges (in case of money  Conversion of an amount of money or
debts) and expenses of transportation (in case of the currency of one country into an
thing to be delivered). equivalent amount of money or
- Once these expenses are liquidated, the debts also currency of another.
become compensable. The indemnity shall be paid by  Exchange rate
the person who raises the defense of compensation  Price of one currency expressed or
quoted in relation to another currency.

Article 1287. Compensation shall not be proper when one of the debts arises from a depositum or from the obligations of a
depositary or of a bailee in commodatum.

Neither can compensation be set up against a creditor who has a claim for support due by gratuitous title, without prejudice to the
provisions of paragraph 2 of Article 301. (1200a)

Article 1288. Neither shall there be compensation if one of the debts consists in civil liability arising from the penal clause (n)

Instances when legal compensation is not allowed by law

1. When one of the debts arises from a depositum

- Safely keeping a thing and of returning the same.
 “depositum” is not a bank deposit; it is really a loan which creates the relationship of debtor and creditor.
 A bank’s failure to honor a deposit of money is failure to pay its obligation as debtor and not a breach of trust
arising from a depositary’s failure to return the thing deposited.
 General rule: A bank has a right to set-off of the deposits in its hands for the payment of any indebtedness to
it on the part of a depositor. Similarly, a depositor has every right toset-off his money deposit with a bank
against the loans he had obtained from said bank.

2. Where one of the debts arises from a commodatum.

 “commodatum” is a gratuitous contract whereby one of the parties delivers to another something not
consumable so that the latter may use the same for a certain time and return it
 Purpose: To prevent a breach of trust and confidence on the part of the borrower (or depositary in a
depositum).

3. Where one of the debts arises from a claim for support due by gratuitous title.
 “support” comprises everything that is indispensable for sustenance, dwelling, clothing, medical attendance,
education and transportation, in keeping with the financial capacity of the family. (Family Code)
4. Where one of the debts consists in civil liability arising from a penal offense
- Compensation would be improper abd inadvisable because the satisfaction of such obligation is imperative.

Article 1289. If a person should have against him several debts which are susceptible of (sic) compensation, the rules on the
application of payments shall apply to the order of the compensation. (1201)

Rules on application of payments apply to order of compensation

- Compensation is similar to payment.

- If a debtor has various debs which are susceptible of compensation, he must inform the creditor which of them shall be the
object of compensation.
- In case he fails to do so, then the compensation shall be applied to the most onerous obligation.

denairasr Page 4 of 8
 Article 1290. When all the requisites mentioned in Art. 1279 are present, compensation takes effect by operation of law, and
extinguishes both debts to the concurrent amount, even though the creditors and debtors are not aware of the compensation.

Consent of parties not required in legal compensation

1. Compensation takes place automatically by mere operation of law.

2. Full legal capacity of parties not required.
 As it takes place by operation of law and without any act of the parties, it is mnot required that the parties
have full legal capacity to give or to receive, as the case may be.

Section 6. – Novation

Article 1291. Obligations may be modified by:

(1) Changing their object or principal conditions;

(2) Substituting the person of the debtor;
(3) Subrogating a third person in the rights of the creditor.

Novation

- Total or partial extinction of an obligation through the creation of a new one which substitutes it.
- It is the substitution or change of an obligation by another, which extinguishes or modifies the first, either by changing its
object or principal conditions, or by substituting another in place of the debtor, or by subrogating a third person in the rights
of the creditor.

Dual function of novation

- Novation is a contract containing two (2) stipulations: one to extinguish or modify an existing obligation, the other to
substitute a new one in its place.
- It does not operate as an absolute but only as a relative extinction of an obligation which is only “modified”
- Actually a new obligation (or contract) based upon a former one, but containing one (1) or more material changes.

Kinds of novation:
3. According to extent or effect
1. According to origin: a. Total or extinctive
a. Legal b. Partial or modificatory
b. Conventional 4. According to the subject
2. According to how it is constituted: a. Real or objective
a. Express b. Personal or subject
b. Implied c. Mixed

Article 1292. In order that an obligation may be extinguished by another which substitute the same, it is imperative that it be so
declared in unequivocal terms, or that the old and the new obligations be on every point incompatible with each other.

Requisites of novation:

1. A previous valid obligation

2. Capacity and intention of the parties to modify or extinguish the obligation
3. The modification or extinguishment of the obligation
4. The creation of a new valid obligation.

Novation is NOT presumed.

- Must be express agreement of the parties or acts of equivalent import or by the incompatibility of the two (2) opbligations
with each other in every material aspect.
- The burden of showing novation is on the party who claims its existence.

Test of incompatibility between two obligations or contracts

- Test whether they can stand together, each one having an independent existence.
- If they cannot, they are incompatible, and the subsequent obligation novates the first.
- Upon such novation, the former obligation loses all its force and effect and only the new obligation can be enforced.

denairasr Page 5 of 8
 Article 1293. Novation which consists in substituting a new debtor in the place of the original one, may be made even without the
knowledge or against the will of the latter, but not without the consent of the creditor. Payment by the new debtor gives him the
rights mentioned in Articles 1236 and 1237.

Kinds of personal novation

1. Substitution – debtor substituted

Kinds:
a. Expromision – when a third person of his own initiative and without the knowledge or against the will of the original
debtor assumes the latter’s obligation with the consent of the creditor. It logically requires the consent of the third
person and the creditor.
 The old debtor be released from its obligation; otherwise, there is no expromision or delegacion.
b. Delegacion – when the creditor accepts a third person to take the place of the debtor at the instance of the latter. The
creditor may withhold approval.
 All the parties, the old debtor, the new debtor, and the creditor must agree.
2. Subrogation – third person is subrogated

Consent of creditor necessary

- In either the two modes of substitution, the consent of the creditor is an indispensable requirement.
- Reason: The substitution implies a waiver by the creditor of his credit and it may be prejudicial to him.
 The prejudice may take the form of delay in the fulfillment of the obligation or contravention of its tenor, or
non-performance thereof by the new debtor, by reason of his financial inability or insolvency.

Right of new debtor who pays

1. In expromision- gives him the right to beneficial reimbursement

2. If the payment was made with the consent of the original debtor or on his own initiative (delegacion), the new debtor is
entitled to reimbursement and subrogation.

Article 1294. If the substitution is without the knowledge or against the will of the debtor, the new debtor’s insolvency or non-
fulfillment of the obligations shall not give rise to any liability on the part of the original debtor. (n)

Effect of new debtor’s insolvency or non-fulfillment of the obligation in expromission

- Will not revive the action of the creditor against the old debtor whose obligation is extinguished by the assumption of the
debt by the new debtor.
- Debtor will no longer be liable to creditor in case of insolvency of third person or non-fulfillment by third person of his
obligation.
 Remember that in expromission, the replacement of the old debtor is not made at his own initiative.

Article 1295. The insolvency of the new debtor, who has been proposed by the original debtor and accepted by the creditor, shall
not revive the action of the latter against the original obligor, except when said insolvency was already existing and of public
knowledge, or known to the debtor, when the delegated his debt. (1206a)

Effect of new debtor’s insolvency or non-fulfillment of the obligation in delegation

- if the non-fulfillment of the obligation is due to other causes, other than exception from the insolvency of new debtor, the
old debtor is not liable.
1. The said insolvency was already existing and of public knowledge (although not known to the old debtor) at the time of
delegacion; or
2. The insolvency was already existing and known to the debtor (although it was not of public knowledge) at the thime of the
delegacion.
 Reason: To present fraud on the part of the old debtor.

Article 1296. When the principal obligation is extinguished in consequence of a novation, accessory obligations may subsist only
insofar as they may benefit third persons who did not give their consent. (1207)

Effect of novation on accessory obligations

 General rule: accessory follows the principal

 Exception: in case of an accessory obligation created in favor of a third person which remains in force unless said third
person gives his consent to the novation.
 Reason: A person should not be prejudiced by the act of another without his consent.

denairasr Page 6 of 8
 Article 1297. If the new obligation is void, the original one shall subsist, unless the parties intended that the former relations should
be extinguished in any event.

Effect where the new obligation void

 General rule: Ther is no novation if the new obligation is void. The original one shall subsist for the reason that the second
obligation being inexistent, it cannot extinguish or modify the first.
 Exception: The parties intended that the old obligation should be extinguished in any event.

Effect where the new obligation voidable

- If the new obligation is only voidable, novation can take place.

- But the moment it is annulled, the novation must be considered as not having taken place, and the original one can be
enforced, unless the intention of the parties is otherwise.

Article 1298. The novation is void if the original obligation was void, except when annulment may be claimed only by the debtor, or
when ratification validates acts which are voidable.

- A void obligation cannot be novated because there is nothing to novate.

- If the original obligation is only voidable, or if the voidable obligation is validated by ratification, the novation is valid.
 Note: A voidable obligation is valid until it is annulled in court.

Article 1299. If the original obligation was subject to a suspensive or resolutory condition, the new obligation shall be under the
same condition, unless it is otherwise stipulated.

Presumption where original obligation subject to a condition.

- If the first obligation is subject to a suspensive or resolutory condition, the second obligation is deemed subject to the same
condition unless the contrary is stipulated by the parties in their contract.
Reason:
 The efficacy of the new obligation depends up-on whether the condition which affects the old obligation is
complied with or not.
 Suspensive condition + not complied with = No obligation arises
 Resolutory condition + complied with = No old obligation is extinguished
- In either case, one requisite of novation, i.e., a previous valid obligation would be wanting.

Article 1300. Subrogation of a third person in the rights of the creditor is either legal or conventional. The former is not presumed,
except in cases expressly mentioned in this Code; the latter must be clearly established in order that it may take effect.

Subrogation

- Substitution of a third person (subrogee) in the place of a creditor (subroger) with reference to a lawful claim or right to
employ all remedies to enforce payment.

Kinds of subrogation:

1. Conventional
- Must be clearly established in order that it may take place.
2. Legal
- Is not presumed except in the cases expressly provided by law.

Article 1301. Conventional subrogation of a third person requires the consent of the original parties and of the third person.

Consent of all parties required in conventional subrogation

1. Debtor – he becomes liable under the new obligation to a new creditor

2. Old creditor – his right against the debtor is extinguished
3. New creditor – he may dislike or distrust the debtor

denairasr Page 7 of 8
 Article 1302. It is presumed that there is legal subrogation:

(1) When a creditor pays another creditor who is preferred, even without the debtor’s knowledge;
(2) When a third person, not interested in the obligation, pays with the express or tacit approval of the debtor;
(3) When, even without the knowledge of the debtor, a person interested in the fulfillment of the obligation pays, without
prejudice to the effects of confusion as to the latter’s share. (1210a)

Cases of legal subrogation

1. When a creditor pays another creditor who is preferred.

2. When a third person without interest in the obligation pays with the approval of the debtor.
3. When a third person with interest in the obligation pays even without the knowledge of the debtor.

Article 1303. Subrogation transfers to the persons subrogated the credit with all the rights thereto appertaining, either against the
debtor or against third person, be they guarantors or possessors of mortgages, subject to stipulation in a conventional subrogation.
(1212a)

Effect of legal subrogation

- To transfer to the new creditor the credit and all the rights and actions that could have been exercised by the former
creditor either against the debtor or against the third person.
- Simply stated, except only for the change in the person of the creditor, the obligation subsists in all respects as before the
novation.
- May not be modified by agreement.

Article 1304. A creditor, to whom partial payment has been made, may exercise his right for the remainder, and he shall be
preferred to the person who has been subrogated in his place in virtue of the partial payment of the same credit.

Effect of partial subrogation

- The creditor to whom partial payment has been made by the new creditor remains a creditor to the extent of the balance of
the debt.
- In case of insolvency of the debtor, he is given a preferential right under above article the remainder as against the new
creditor.

denairasr Page 8 of 8