The Supreme Court held that imposing an unconscionable interest rate on a loan is immoral and unjust, even if the borrower knowingly agreed to it. In this case, the court reduced the stipulated interest rate from 60% per annum (5% per month) to a legal rate of 12% per annum, emphasizing that lenders cannot exploit borrowers with excessively high-interest rates. This decision safeguards borrowers from predatory lending practices and ensures fairness in financial transactions.

When Agreed Terms Lead to Unfair Burdens: Can Courts Intervene?

This case, Sps. Isagani Castro and Diosdada Castro v. Angelina De Leon Tan, et al., G.R. No. 168940, revolves around a loan agreement between Angelina de Leon Tan and the Castro spouses, secured by a mortgage on Tan’s property. The agreement stipulated an interest rate of 5% per month, compounded monthly, on a P30,000.00 loan, a rate that the lower courts later deemed unconscionable. The central legal question is whether courts can interfere with freely agreed-upon contractual terms, specifically interest rates, when they are deemed excessively high and unjust.

The factual backdrop involves respondent Angelina de Leon Tan who, along with her now deceased husband, obtained a loan of P30,000.00 from petitioners, the Castro spouses, and secured it with a Kasulatan ng Sanglaan ng Lupa at Bahay, a mortgage agreement. The agreed-upon interest rate was 5% per month, compounded monthly, with a repayment period of six months. After her husband’s death, Tan struggled to repay the loan, and when she offered to pay the principal plus some interest, the Castros demanded P359,000.00, the accumulated sum with the compounded interest. The petitioners then foreclosed on the mortgage, leading Tan and other respondents to file a complaint seeking to nullify the mortgage and foreclosure, arguing the interest rate was unconscionable.

The Regional Trial Court (RTC) found in favor of the respondents, reducing the interest rate to 12% per annum. Petitioners appealed to the Court of Appeals (CA), which affirmed the RTC’s decision, further allowing the respondents to redeem the property even after the redemption period had lapsed. The CA reasoned that the stipulated interest rate was indeed iniquitous and unconscionable, justifying the equitable reduction to the legal rate of 12% per annum. The appellate court invoked the interest of substantial justice and equity in allowing redemption beyond the statutory period. This prompted the Castros to elevate the matter to the Supreme Court.

The petitioners argued that with the removal of interest rate ceilings by the Bangko Sentral, parties are free to agree on any interest rate, and the CA erred in nullifying the stipulated interest. Respondents countered that the interest rate was excessive and contrary to morals and law, rendering it unenforceable, and that contracts must adhere to legal and moral boundaries. The Supreme Court, in its analysis, acknowledged the liberalization of interest rates but emphasized that this freedom is not absolute. While parties have the autonomy to set interest rates, these rates cannot be unconscionable or exploitative.

The Court emphasized that while Central Bank Circular No. 905 s. 1982 removed the ceiling on interest rates, it did not give lenders a blank check to impose exploitative rates. The Supreme Court cited a number of cases. For instance, the Court in Medel v. Court of Appeals, 359 Phil. 820 (1998), deemed a 5.5% monthly interest (66% per annum) as excessive. Also, in Ruiz v. Court of Appeals, 449 Phil. 419 (2003), a 3% monthly interest was deemed excessive. The Supreme Court then reasoned that the 5% monthly interest (60% per annum) in this present case, is 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, which states:

The contracting parties may 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.

The Court found no unilateral alteration of the contract, stating that stipulations contrary to law or morals are considered void from the beginning. It reiterated the Court of Appeals ruling that the legal interest of 12% per annum is fair and reasonable. However, the Supreme Court also addressed the issue of the 1% per month penalty imposed as liquidated damages. The Court noted that there was no stipulation in the Kasulatan regarding liquidated damages, rendering the award without legal basis and therefore deleted it. This highlights the importance of clearly defining all terms and conditions in a contract to avoid future disputes.

Furthermore, the Court addressed the foreclosure proceedings. The Supreme Court referenced the case of Heirs of Zoilo Espiritu v. Landrito, G.R. No. 169617, April 3, 2007, 520 SCRA 383, stating:

Since the Spouses Landrito, the debtors in this case, were not given an opportunity to settle their debt, at the correct amount and without the iniquitous interest imposed, no foreclosure proceedings may be instituted.

Because Tan was not given the opportunity to settle her debt at the correct amount, the foreclosure proceedings held on March 3, 1999, were nullified. This decision underscores the principle that foreclosure cannot be validly conducted if the outstanding loan amount is overstated due to unconscionable interest rates. Anent the allegation of petitioners that the Court of Appeals erred in extending the period of redemption, same has been rendered moot in view of the nullification of the foreclosure proceedings. As a result, the Supreme Court denied the petition and affirmed the Court of Appeals’ decision with modifications.

FAQs

What was the key issue in this case?	The key issue was whether the stipulated interest rate of 5% per month, compounded monthly (60% per annum), was unconscionable and if the courts had the right to reduce the interest rate.
What did the Supreme Court rule regarding the interest rate?	The Supreme Court ruled that the 5% monthly interest rate was indeed excessive, iniquitous, unconscionable, and contrary to morals, and therefore void ab initio. It upheld the Court of Appeals’ decision to reduce the interest rate to 12% per annum.
Can parties agree to any interest rate they want?	While the Usury Law has been suspended, allowing parties wider latitude in setting interest rates, this freedom is not absolute. Courts can still intervene if the stipulated interest rate is deemed unconscionable or oppressive.
What is an unconscionable interest rate?	An unconscionable interest rate is one that is excessively high and unjust, violating morals and equitable principles. It is a rate that no fair and honest person would demand and no sensible person would agree to.
What was the basis for nullifying the foreclosure proceedings?	The foreclosure proceedings were nullified because the amount demanded as the outstanding loan was overstated due to the imposition of an unconscionable interest rate. This meant that the borrower was not given a fair opportunity to settle her debt.
What happened to the liquidated damages in this case?	The Supreme Court deleted the award of 1% liquidated damages per month because there was no stipulation regarding liquidated damages in the original mortgage agreement (Kasulatan).
What is the significance of Article 1306 of the Civil Code in this case?	Article 1306 of the Civil Code allows parties to establish terms and conditions in contracts, provided they are not contrary to law, morals, good customs, public order, or public policy. The Supreme Court used this article to justify the nullification of the unconscionable interest rate.
What does this ruling mean for borrowers?	This ruling protects borrowers from predatory lending practices by ensuring that interest rates are fair and reasonable. It affirms that courts can intervene to prevent lenders from imposing excessively high-interest rates that exploit borrowers.

The Supreme Court’s decision serves as a crucial reminder that contractual freedom is not limitless and must be exercised within the bounds of the law and principles of equity. By protecting borrowers from unconscionable interest rates and predatory lending practices, the Court reinforces the principle of fairness and justice in financial transactions. It is a firm statement that lending, while a commercial endeavor, should not be used as a tool for exploitation.

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: SPS. ISAGANI CASTRO AND DIOSDADA CASTRO, PETITIONERS, VS. ANGELINA DE LEON TAN, SPS. CONCEPCION T. CLEMENTE AND ALEXANDER C. CLEMENTE, SPS. ELIZABETH T. CARPIO AND ALVIN CARPIO, SPS. MARIE ROSE T. SOLIMAN AND ARVIN SOLIMAN AND JULIUS AMIEL TAN, RESPONDENTS., G.R. No. 168940, November 24, 2009