In a landmark decision, the Supreme Court of the Philippines affirmed that banks cannot unilaterally increase interest rates, penalties, and other charges on loans without the explicit consent of the borrower. The Court emphasized that such unilateral authority violates the principle of mutuality of contracts, which requires that the terms of a contract be binding on both parties equally. Even with the repeal of the Usury Law, courts retain the power to reduce iniquitous or unconscionable rates charged for the use of money. Furthermore, the Truth in Lending Act requires that all fees and charges be transparently disclosed, and any undisclosed or excessive charges will not be enforced. This decision protects borrowers from predatory lending practices and ensures fairness in financial transactions.

Loan Sharks in Pinstripes: Can Banks Freely Hike Interest Rates on Borrowers?

The case of New Sampaguita Builders Construction, Inc. (NSBCI) and Spouses Eduardo R. Dee and Arcelita M. Dee vs. Philippine National Bank revolves around a loan obtained by NSBCI from PNB, secured by real estate properties owned by the Dees. When NSBCI failed to meet its obligations, PNB foreclosed on the properties. PNB then sought to recover a deficiency, leading NSBCI and the Dees to challenge the interest rates, penalties, and attorney’s fees imposed by PNB, claiming these were unilaterally increased and therefore unconscionable. The central legal question was whether PNB could unilaterally increase these charges without prior notice and consent from NSBCI and the Dees.

The Supreme Court embarked on a meticulous review of the promissory notes, credit agreements, and disclosure statements associated with the loan. The Court highlighted a critical flaw in the promissory notes: a clause that granted PNB the power to increase interest rates at any time based on its policies, without prior notice to NSBCI. The Court deemed this “unilateral determination and imposition” a violation of Article 1308 of the Civil Code, which embodies the principle of mutuality of contracts. Contracts must bind both parties, and compliance cannot be left to the will of one party. The Court found that such one-sided impositions lack the force of law because they are not founded on the essential equality of the parties.

While acknowledging that escalation clauses are sometimes valid to maintain fiscal stability, the Court clarified that an unbridled right to adjust interest rates independently negates the borrower’s right to assent to modifications in their agreement, thus destroying mutuality. The pro forma promissory notes used by PNB were characterized as contracts of adhesion, where the weaker party’s participation is reduced to a take-it-or-leave-it alternative. The Court then stated:

“Although the Usury Law ceiling on interest rates was lifted by [Central Bank] Circular No. 905, nothing in the said Circular grants lenders carte blanche authority to raise interest rates to levels which will either enslave their borrowers or lead to a hemorrhaging of their assets.”

The Court emphasized that Circular No. 905 did not authorize either party to unilaterally raise the interest rate without the other’s consent. Borrowing, according to the Court, is meant to stimulate growth, but PNB’s policy of increasing interest rates without prior consent deviates from this purpose. While the increased rates were not necessarily usurious, the Court found them to be iniquitous, unconscionable, and exorbitant, warranting equitable reduction. Importantly, the lack of response from NSBCI to the statements of account sent by PNB could not be interpreted as implied consent to the increases. As such the interest was not a part of the binding contract between PNB and the borrowers.

Furthermore, PNB failed to follow the stipulation in the promissory notes for the automatic conversion of unpaid portions into medium-term loans with applicable interest rates. This failure added to the complexity of the bloated loan accounts. The Court found issues with the credit agreements as well. The first credit agreement was deemed unreliable due to a lack of signature from PNB’s branch manager and objections from NSBCI. While the second and third credit agreements were admitted, they lacked provisions for increasing or decreasing interest rates, meaning the stipulated prime rates plus applicable spreads should have been consistently applied.

The Court examined the Disclosure Statements furnished by PNB, noting inconsistencies. While the first Disclosure Statement showed the same interest rate as the first promissory note (19.5%), the second and third Disclosure Statements, issued after consummation of the related availments, also showed rates of 21.5%. However, none of the Disclosure Statements, nor the credit agreements, provided for any increases in these specified interest rates. The court then quoted from RA 3765, or the Truth in Lending Act stating that, it is now time to “give teeth to the often ignored forty-one-year old “Truth in Lending Act” and thus transform it from a snivelling paper tiger to a growling financial watchdog of hapless borrowers.”

Regarding the penalty charges, the Court pointed out the absence of any mention in the Disclosure Statements or in the credit agreements. Though a standard penalty of 6% per annum was imposed in the promissory notes for unpaid amounts, no stipulation justified any increase in this charge. Emphasizing the binding nature of contracts of adhesion, the Court noted that any ambiguity should be strictly construed against PNB, the party who caused the ambiguity. The liquidated damages intended as a penalty were deemed iniquitous and unconscionable due to PNB’s unilateral increase of the penalty rate to 36% without NSBCI’s consent, leading the Court to reduce this penalty to zero.

The Court also upheld the appellate court’s ruling on the debt relief package. NSBCI failed to satisfactorily establish that they were seriously and directly affected by the economic slowdown in the areas near the former US military bases. Therefore, the extrajudicial foreclosure sale and the subsequent proceedings were deemed valid, but the Court vehemently disputed the claimed deficiency. The accessory contract of real estate mortgage allowed the bid price to be lower than the fair market value, recognizing that this facilitated redemption for the owner. A low bid price does not automatically invalidate an auction.

However, because of the excessive interest rates and unwarranted charges in the statements of account, the Court revised the rates down to those stipulated in the original documents. Payments made by the petitioners were re-evaluated and properly credited. Charges on penalty and insurance were eliminated, and attorney’s fees were capped at 1%. Given these adjustments, the claimed deficiency vanished, revealing an overpayment by NSBCI.

Under solutio indebiti or payment by mistake, there is no deficiency receivable in favor of PNB, but rather an excess claim or surplus payable by respondent; this excess should immediately be returned to petitioner-spouses or their assigns to the end that no one may be unjustly enriched or benefited at the expense of another.”

This means the excessive interest rates in the statements of account sent to petitioners are reduced to 19.5 percent and 21.5 percent, as stipulated in the Promissory Notes; upon loan conversion, these rates are further reduced to the legal rate of 12 percent. Payments made by petitioners are pro-rated, the charges on penalty and insurance eliminated, and the resulting total unpaid principal and interest of P6,582,077.70 as of the date of public auction is then subjected to 1 percent attorney’s fees. The total outstanding obligation is compared to the bid price. On the basis of these rates and the comparison made, the deficiency claim receivable amounting to P2,172,476.43 in fact vanishes. Instead, there is an overpayment by more than P3 million. The Court thus ordered PNB to refund the overcollection plus interest.

The Court also affirmed that the Joint and Solidary Agreement (JSA) signed by the spouses made them sureties, jointly and severally liable with NSBCI, but clarified the extent of their liability. They were bound by the terms of the JSA, covering promissory notes issued after the JSA’s execution, and this liability extended to costs, charges, and expenses as defined in the credit documents. Since PNB still owed the petitioner-spouses, it should not be held individually liable for the entire onerous obligation. In conclusion, the Supreme Court found that PNB had excessively burdened NSBCI with unilateral rate increases and improper charges, and ordered a refund of the overcollected amount, thereby upholding the principles of contractual mutuality and transparency in lending.

FAQs

What was the key issue in this case?	The key issue was whether Philippine National Bank (PNB) could unilaterally increase interest rates, penalties, and other charges on a loan without the explicit consent of the borrower, New Sampaguita Builders Construction, Inc. (NSBCI). This centered on the principle of mutuality of contracts, which requires that agreements be binding on both parties equally.
What is the principle of mutuality of contracts?	The principle of mutuality of contracts, as enshrined in Article 1308 of the Civil Code, mandates that a contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them. This means that both parties must agree to any changes or modifications to the contract.
What did the Court say about unilateral increases in interest rates?	The Supreme Court held that the unilateral determination and imposition of increased interest rates by PNB was a violation of the principle of mutuality of contracts. It stated that giving PNB an unbridled right to adjust the interest independently and upwardly took away from NSBCI the right to assent to an important modification in their agreement.
What is a contract of adhesion, and how does it apply here?	A contract of adhesion is one where the parties do not bargain on equal footing, with the weaker party’s participation being reduced to the alternative to take it or leave it. The Court found that the pro forma promissory notes used by PNB had the character of a contract of adhesion, requiring any ambiguity to be construed against the party who caused the obscurity (PNB).
What is the Truth in Lending Act, and how was it applied in this case?	The Truth in Lending Act (RA 3765) requires lenders to disclose the true cost of credit to borrowers. In this case, the Court emphasized that because PNB did not clearly inform NSBCI of the interest rate in the Disclosure Statements prior to the consummation of the loan, PNB had no right to collect upon such undisclosed charges.
What did the Court say about penalty charges in the loan?	The Court found that the penalty rate had been unilaterally increased by PNB to 36% without NSBCI’s consent. As a result, such liquidated damages intended as a penalty were equitably reduced by the Court to zero for being iniquitous or unconscionable.
Was the foreclosure of the properties valid?	The Court ruled that the extrajudicial foreclosure sale and subsequent proceedings were valid because the public auction sale had been regularly and fairly conducted, there had been ample authority to effect the sale, and the Certificates of Title could be relied upon. No personal notice is even required.
Did the borrower have a deficiency balance after the foreclosure?	After recomputing the loan obligation with only the originally stipulated interest, legal interest where appropriate, and allowable charges, the Supreme Court determined that the borrower had, in fact, overpaid the bank. Consequently, PNB was ordered to refund the sum of ₱3,686,101.52 to NSBCI, representing the overcollection.

The Supreme Court’s decision serves as a stern warning to lending institutions against imposing arbitrary and excessive charges on borrowers. It reinforces the principle of fairness in lending practices and underscores the importance of transparency and mutual consent in contractual agreements. It protects borrowers from predatory lending practices and ensures fairness in financial transactions.

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: NEW SAMPAGUITA BUILDERS CONSTRUCTION, INC. (NSBCI) AND SPOUSES EDUARDO R. DEE AND ARCELITA M. DEE, PETITIONERS, VS. PHILIPPINE NATIONAL BANK, RESPONDENT., G.R. No. 148753, July 30, 2004