Unilateral Imposition of Interest Rates Violates Mutuality of Contracts

Philippine National Bank v. AIC Construction Corporation, G.R. No. 228904, October 13, 2021

Imagine borrowing money to keep your business afloat, only to find yourself drowning in interest payments that seem to grow exponentially. This is the reality faced by many borrowers who enter into loan agreements with seemingly favorable terms, only to be blindsided by exorbitant interest rates. The Supreme Court case of Philippine National Bank v. AIC Construction Corporation sheds light on this issue, illustrating the importance of transparency and fairness in loan agreements.

In this case, AIC Construction Corporation and the Bacani Spouses found themselves in a dire financial situation due to the Philippine National Bank’s (PNB) unilateral imposition of interest rates on their loan. The central legal question was whether the interest rates imposed by PNB were unconscionable and thus void, and whether the court could equitably reduce them.

Legal Context

The principle of mutuality of contracts, enshrined in Article 1308 of the Civil Code, states that a contract must bind both parties and its validity or compliance cannot be left to the will of one party. This principle is crucial in ensuring fairness and equality between contracting parties, particularly in loan agreements where interest rates are a key component.

Interest rates in loan agreements are typically agreed upon by both parties. However, the suspension of the Usury Law ceiling on interest rates in 1983 has led to a scenario where lenders can impose rates that may be considered iniquitous or unconscionable. The Supreme Court has clarified that while parties are free to stipulate interest rates, courts can intervene to equitably reduce rates that are found to be unjust.

In the case of Vitug v. Abuda, the Court emphasized that the freedom to stipulate interest rates assumes a competitive market where borrowers have options and equal bargaining power. However, when one party has more power to set the interest rate, the state must step in to correct market imperfections. The Court noted, “Iniquitous or unconscionable interest rates are illegal and, therefore, void for being against public morals.”

Case Breakdown

AIC Construction Corporation, owned by the Bacani Spouses, opened a current account with PNB in 1988 and was granted a credit line of P10 million the following year. The interest provision in their agreement allowed PNB to determine the rate based on its prime rate plus an applicable spread, a clause that would later become the crux of the dispute.

Over the years, the credit line increased, and by September 1998, the loan had ballooned to P65 million, with P40 million as principal and P25 million as interest charges. AIC Construction proposed a dacion en pago (payment through property) to settle the loan, but negotiations failed, leading to PNB’s foreclosure of the mortgaged properties.

AIC Construction then filed a complaint against PNB, alleging bad faith and unconscionable interest rates. The Regional Trial Court dismissed the complaint, but the Court of Appeals modified the ruling, finding the interest rates unreasonable and applying the legal rate of interest instead.

The Supreme Court upheld the Court of Appeals’ decision, emphasizing that the interest rates imposed by PNB violated the principle of mutuality of contracts. The Court cited Spouses Silos v. Philippine National Bank, where similar interest provisions were invalidated due to their one-sided nature. The Court noted, “The interest rates are yet to be determined through a subjective and one-sided criterion. These rates are no longer subject to the approval of respondents.”

The Court also highlighted the importance of the Truth in Lending Act (Republic Act No. 3765), which requires full disclosure of all charges to protect borrowers from being unaware of the true cost of credit. The Court concluded that the interest rates imposed by PNB were unconscionable and ordered the application of the legal rate of interest.

Practical Implications

This ruling underscores the importance of transparency and fairness in loan agreements. Borrowers should be vigilant about the terms of their loans, particularly interest rate provisions, and seek legal advice if they suspect unfair practices. Lenders, on the other hand, must ensure that their interest rate provisions comply with legal standards and do not exploit borrowers.

The decision may encourage more borrowers to challenge unconscionable interest rates in court, potentially leading to more equitable loan agreements. Businesses and individuals entering into loan agreements should carefully review the terms and consider negotiating for fixed or more transparent interest rate structures.

Key Lessons:

• Ensure that loan agreements clearly specify the interest rates and any potential adjustments.
• Be wary of provisions that allow lenders to unilaterally determine interest rates.
• Seek legal advice before signing loan agreements to understand your rights and obligations.

Frequently Asked Questions

What is the principle of mutuality of contracts?
The principle of mutuality of contracts requires that a contract binds both parties equally and its validity or compliance cannot be left to the will of one party.

Can courts reduce interest rates in loan agreements?
Yes, courts can equitably reduce interest rates if they are found to be iniquitous or unconscionable, even if the parties initially agreed to them.

What is the Truth in Lending Act?
The Truth in Lending Act (Republic Act No. 3765) requires creditors to fully disclose to debtors all charges related to the extension of credit, including interest rates, to protect borrowers from being unaware of the true cost of credit.

How can borrowers protect themselves from unconscionable interest rates?
Borrowers should carefully review loan agreements, seek legal advice, and negotiate for clear and fair interest rate provisions.

What should lenders do to comply with legal standards?
Lenders should ensure transparency in their loan agreements, avoid unilateral interest rate provisions, and comply with the Truth in Lending Act.

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