The Supreme Court affirmed that contracts cannot circumvent usury laws by disguising interest as fees in separate agreements. This case underscores that courts will examine the true nature of financial transactions, protecting borrowers from excessively high interest rates. Parties entering loan agreements should be aware that related contracts may be scrutinized to determine if they are designed to conceal usurious interest, ensuring fairness and compliance with legal limits.

Beyond the Loan: Did ‘Consultancy’ Fees Mask Illegal Interest?

In First Metro Investment Corporation v. Este del Sol Mountain Reserve, Inc., the central question revolved around whether underwriting and consultancy agreements, executed alongside a loan agreement, were actually a facade to hide usurious interest rates. Este del Sol obtained a loan from First Metro Investment Corporation (FMIC) to finance a resort complex. Simultaneously, they entered into underwriting and consultancy agreements with FMIC, which included fees for underwriting, supervision, and consultancy services. When Este del Sol defaulted, FMIC foreclosed on the property and sought to recover a deficiency balance from Este del Sol and its individual sureties. The respondents argued that the underwriting and consultancy fees were a subterfuge to camouflage usurious interest charged by FMIC.

The trial court sided with FMIC, but the Court of Appeals reversed, finding the fees to be a disguise for usurious interest. The Supreme Court agreed with the Court of Appeals, emphasizing that laws in force at the time of the contract govern it, and Central Bank Circular No. 905, which removed interest rate ceilings, did not have retroactive effect. Additionally, the Court highlighted that while written contracts are the best evidence of their terms, parol evidence is admissible to show that a contract, though legal in form, was a device to cover usury.

Several factors led the Court to conclude that the agreements were indeed a cover for usury. First, the loan, underwriting, and consultancy agreements were all dated January 31, 1978, with the supervision and consultancy fees set to coincide with the loan term. Second, the Loan Agreement specifically required the execution of an underwriting agreement as a condition for extending the loan, indicating it was an integral part of the Loan Agreement. Third, Este del Sol was billed for consultancy fees in a manner inconsistent with the terms of the Consultancy Agreement. Fourth, the underwriting, supervision, and consultancy fees were deducted from the first loan release, effectively returning a significant portion of the loan amount to FMIC.

Furthermore, FMIC failed to fulfill its obligations under both the Underwriting and Consultancy Agreements. They did not organize an underwriting syndicate, and Este del Sol had its own marketing arm for selling shares. Additionally, there was no real need for consultancy services, as Este del Sol’s officers were competent in developing the resort complex. As a result, the Court found that the agreements were exacted by FMIC as essential conditions for the loan, thus disguising additional compensation for the loan through ostensibly unrelated contracts. The New Civil Code, Article 1957, provides that:

“Art. 1957. Contracts and stipulations, under any cloak or device whatever, intended to circumvent the laws against usury shall be void. The borrower may recover in accordance with the laws on usury.”

In simple loan with stipulation of usurious interest, the prestation of the debtor to pay the principal debt, which is the cause of the contract (Article 1350, Civil Code), is not illegal. The illegality lies only as to the prestation to pay the stipulated interest; hence, being separable, the latter only should be deemed void, since it is the only one that is illegal.

The Court reaffirmed that in usurious loans, the principal debt remains valid, but the stipulation for usurious interest is void. The debtor can recover amounts paid as interest under a usurious agreement, as such payments are deemed made under restraint rather than voluntarily. On the matter of attorney’s fees, the Court agreed with the appellate court that the originally stipulated amount was exorbitant and unconscionable. While attorney’s fees in penal clauses are considered liquidated damages and are binding if they don’t contravene any law, morals, or public order, courts can reduce the amount if it is iniquitous or unconscionable. Articles 1229 and 2227 of the New Civil Code give the court the power to equitably reduce the penalty when the principal obligation has been partly or irregularly complied with by the debtor, or even if there has been no performance, if it is iniquitous or unconscionable.

In conclusion, the Supreme Court upheld the appellate court’s decision, finding that the additional agreements were schemes to conceal usurious interest, and thus, the debtor was entitled to relief. This ruling serves as a significant reminder of the court’s vigilance against any scheme, regardless of how ingeniously crafted, designed to circumvent the usury laws.

FAQs

What was the key issue in this case?	The key issue was whether the underwriting and consultancy agreements were a disguise for usurious interest rates on a loan. The court examined whether these agreements were a condition for the loan and whether the fees charged were justified by actual services rendered.
What is usury?	Usury is the practice of lending money at an excessively high interest rate. Usury laws set legal limits on interest rates to protect borrowers from exploitation by lenders.
Can a lender charge fees in addition to interest?	Yes, a lender can charge fees, but courts will scrutinize these fees to ensure they are not a way to hide excessive interest. If the fees are found to be a mere subterfuge to increase the effective interest rate, they can be deemed usurious.
What happens if a loan is found to be usurious?	If a loan is found to be usurious, the stipulation for usurious interest is void, and the borrower can recover any amounts paid as interest. The principal debt, however, remains valid and must be repaid.
What is parol evidence?	Parol evidence is evidence of an agreement that is not found in the written contract itself. It can include oral agreements or other documents, and it is admissible to show that a written contract was intended to cover up usury.
How did the court determine that the agreements were a cover for usury?	The court considered several factors, including the timing of the agreements, the requirement of the underwriting agreement as a condition for the loan, inconsistent billing practices, and the failure of FMIC to perform its obligations under the agreements. These factors, taken together, indicated that the agreements were not legitimate separate transactions.
What is the significance of Central Bank Circular No. 905 in this case?	Central Bank Circular No. 905 removed the ceiling on interest rates, but the Court held that it did not apply retroactively to contracts entered into before its effectivity. Therefore, the usury laws in effect at the time the loan agreement was made still applied.
Can attorney’s fees be reduced by the court?	Yes, attorney’s fees stipulated in a contract can be reduced by the court if they are found to be iniquitous or unconscionable. The court has the power to equitably reduce penalties and liquidated damages to ensure fairness.
What is the effect of Article 1957 of the New Civil Code?	Article 1957 declares that any contract or stipulation intended to circumvent usury laws is void. This provision allows borrowers to recover payments made under usurious agreements, reinforcing the protection against excessive interest rates.

This case serves as a reminder to lenders that the courts will look beyond the form of a contract to its substance, ensuring that borrowers are protected from usurious interest rates. The ruling reinforces the principle that parties cannot circumvent usury laws through cleverly disguised agreements.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: First Metro Investment Corporation v. Este del Sol Mountain Reserve, Inc., G.R. No. 141811, November 15, 2001