Iniquitous and unconscionable interest rate (again)

In September 2009, the Supreme Court promulgated its decision in Ileana Dr. Macalino vs. Bank of the Philippines Islands, G.R. No. 175490, September 17, 2009, and held that the interest rate of 1.5% per month on credit card payments should be reduced to 1% per month.

In Sps. Isagani & Diosdada Castro vs. Angelina de Leon Tan, G.R. No. 168940. November 24, 2009, the Supreme Court again faced the issue of whether the interest rate imposed (this time under a loan agreement) is excessive.  Here, the loan agreement (denominated as Kasulatan ng Sanglaan ng Lupa at Bahay) provided for an interest rate of 5% per month, compounded monthly.  The principal amount of the loan was PhP30,000.

The borrowers (spouses Tan) failed to pay the loan and the lenders (spouses Castro) instituted an extra-judicial foreclosure of mortgage. The lenders emerged as the only bidder and the redemption period expired without the property being redeemed.

A Complaint for Nullification of Mortgage and Foreclosure and/or Partial Rescission of Documents and Damages was subsequently filed before the Regional Trial Court of Malolos, Bulacan. The complainants alleged, inter alia, that the interest rate imposed on the principal amount of P30,000.00 is unconscionable.

The Regional Trial Court reduced the interest rate to 12% per annum and the Court of Appeals affirmed.

In proceedings before the Supreme Court, the petitioners contend that with the removal by the Bangko Sentral of the ceiling on the rate of interest that may be stipulated in a contract of loan, the lender and the borrower could validly agree on any interest rate on loans. Thus, they argue that the Court of Appeals gravely erred when it declared the stipulated interest in the Kasulatan as null as if there was no express stipulation on the compounded interest.

On the other hand, respondents assert that the appellate court correctly struck down the said stipulated interest for being excessive and contrary to morals, if not against the law. They also point out that a contract has the force of law between the parties, but only when the terms, clauses and conditions thereof are not contrary to law, morals, public order or public policy.

The Supreme Court agreed with Court of Appeals and the Regional Trial Court. It ruled:

While we agree with petitioners that parties to a loan agreement have wide latitude to stipulate on any interest rate in view of the Central Bank Circular No. 905 s. 1982 which suspended the Usury Law ceiling on interest effective January 1, 1983, it is also worth stressing that interest rates whenever unconscionable may still be declared illegal. There is certainly nothing in said circular which 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.

In several cases, we have ruled that stipulations authorizing iniquitous or unconscionable interests are contrary to morals, if not against the law. In Medel v. Court of Appeals, we annulled a stipulated 5.5% per month or 66% per annum interest on a P500,000.00 loan and a 6% per month or 72% per annum interest on a P60,000.00 loan, respectively, for being excessive, iniquitous, unconscionable and exorbitant. In Ruiz v. Court of Appeals, we declared a 3% monthly interest imposed on four separate loans to be excessive. In both cases, the interest rates were reduced to 12% per annum.

In this case, the 5% monthly interest rate, or 60% per annum, compounded monthly, stipulated in the Kasulatan is even higher than the 3% monthly interest rate imposed in the Ruiz case. Thus, we similarly hold the 5% monthly interest to be excessive, iniquitous, unconscionable and exorbitant, contrary to morals, and the law. It is therefore void ab initio for being violative of Article 1306 of the Civil Code. With this, and in accord with the Medel and Ruiz cases, we hold that the Court of Appeals correctly imposed the legal interest of 12% per annum in place of the excessive interest stipulated in the Kasulatan.

The Supreme Court also ruled that the imposition of a 12% rate per annum does not violate the freedom of contract:

Petitioners allege that the Kasulatan was entered into by the parties freely and voluntarily. They maintain that there was already a meeting of the minds between the parties as regards the principal amount of the loan, the interest thereon and the property given as security for the payment of the loan, which must be complied with in good faith. Hence, they assert that the Court of Appeals should have given due respect to the provisions of the Kasulatan. They also stress that it is a settled principle that the law will not relieve a party from the effects of an unwise, foolish or disastrous contract, entered into with all the required formalities and with full awareness of what he was doing.

Petitioners’ contentions deserve scant consideration. In Abe v. Foster Wheeler Corporation, we held that the freedom of contract is not absolute. The same is understood to be subject to reasonable legislative regulation aimed at the promotion of public health, morals, safety and welfare. One such legislative regulation is found in Article 1306 of the Civil Code which allows the contracting parties 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.”

To reiterate, we fully agree with the Court of Appeals in holding that the compounded interest rate of 5% per month, is iniquitous and unconscionable. Being a void stipulation, it is deemed inexistent from the beginning. The debt is to be considered without the stipulation of the iniquitous and unconscionable interest rate. Accordingly, the legal interest of 12% per annum must be imposed in lieu of the excessive interest stipulated in the agreement. . .

From the foregoing, it is clear that there is no unilateral alteration of the terms and conditions of the Kasulatan entered into by the parties. Surely, it is more consonant with justice that the subject interest rate be equitably reduced and the legal interest of 12% per annum is deemed fair and reasonable.