Are You Stuck with Unfair Contract Terms? Understanding Contracts of Adhesion and Penalty Clauses in the Philippines

TLDR: Philippine courts recognize contracts of adhesion, where one party has significantly more bargaining power, but will protect the weaker party from unconscionable penalty clauses. This case demonstrates that while you’re generally bound by contract terms you sign, even in standard forms, grossly unfair penalties, like exorbitant attorney’s fees, can be reduced by the courts.

G.R. NO. 153874, March 01, 2007

INTRODUCTION

Imagine you urgently need construction materials for your project. You go to a supplier, and they hand you a sales invoice with pre-printed terms and conditions in fine print. You’re in a hurry, the project is time-sensitive, so you sign without scrutinizing every clause. Later, a dispute arises, and you discover those ‘standard’ terms include hefty penalties and attorney’s fees that seem disproportionate. Are you bound by these terms simply because you signed the document? This is the predicament Titan Construction Corporation faced in its dealings with Uni-Field Enterprises, Inc., a case that reached the Philippine Supreme Court and offers crucial insights into contracts of adhesion and the limits of penalty clauses.

This case revolves around unpaid construction materials and the enforceability of penalty clauses stipulated in sales invoices – documents often signed without detailed negotiation. The central legal question is: Can Philippine courts intervene to reduce excessively high penalty clauses, even when they are part of a contract of adhesion? The Supreme Court’s decision provides a clear answer, balancing the principle of freedom of contract with the need to protect parties from oppressive terms.

LEGAL CONTEXT: CONTRACTS OF ADHESION AND THE PRINCIPLE OF FREEDOM TO CONTRACT

Philippine contract law is primarily governed by the Civil Code. At its heart lies the principle of freedom to contract, enshrined in Article 1306, 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.” This principle underscores that parties are generally free to agree on the terms of their contracts, and courts will uphold these agreements as the law between them.

However, this freedom is not absolute. Philippine jurisprudence recognizes that not all contracts are born of equal bargaining power. Contracts of adhesion, like the sales invoices in this case, are a common reality. A contract of adhesion is defined as one where one party, usually a large corporation or entity, prepares the contract, and the other party merely affixes their signature, indicating adherence to the contract without having the opportunity to bargain. Common examples include insurance policies, loan agreements, and, as seen in this case, standard sales invoices.

While contracts of adhesion are generally valid and binding in the Philippines, courts are mindful of the potential for abuse, especially concerning onerous or unconscionable terms. The Supreme Court has consistently held that contracts of adhesion are as binding as ordinary contracts. As the Supreme Court itself reiterated, “Those who adhere to the contract are in reality free to reject it entirely and if they adhere, they give their consent.” This means that simply being a contract of adhesion doesn’t automatically invalidate its terms.

However, Philippine law provides safeguards against abusive penalty clauses. Articles 1229 and 2227 of the Civil Code are crucial here. Article 1229 states, “The judge shall equitably reduce the penalty when the principal obligation has been partly or irregularly complied with by the debtor. Even if there has been no performance, the penalty may also be reduced by the courts if it is iniquitous or unconscionable.” Article 2227 further emphasizes this, stating, “Liquidated damages, whether intended as an indemnity or a penalty, shall be equitably reduced if they are iniquitous or unconscionable.” These provisions empower courts to moderate penalties that are deemed excessive or unfair, even if stipulated in a contract.

CASE BREAKDOWN: TITAN CONSTRUCTION CORP. VS. UNI-FIELD ENTERPRISES, INC.

Titan Construction Corporation, a construction company, regularly purchased construction materials on credit from Uni-Field Enterprises, Inc., a supplier. Over several years (1990-1993), Titan accumulated a debt of over P7.6 million, paying back most but leaving a balance of P1.4 million. Uni-Field sent a demand letter in 1994, but the balance remained unpaid. In 1995, Uni-Field filed a collection suit in the Regional Trial Court (RTC) of Quezon City.

The sales invoices and delivery receipts, the documents signed for each purchase, contained pre-printed terms including:

• 24% per annum interest on overdue accounts, compounded yearly.
• 25% liquidated damages based on the total outstanding obligation.
• 25% attorney’s fees based on the total claim, including liquidated damages.

The RTC ruled in favor of Uni-Field, ordering Titan to pay not only the principal debt but also substantial interest, liquidated damages, attorney’s fees, and costs of the suit. The Court of Appeals (CA) affirmed the RTC decision, emphasizing that Titan had admitted the transactions and had not specifically denied the terms in the invoices. The CA highlighted the principle that contract stipulations are the law between the parties.

Dissatisfied, Titan elevated the case to the Supreme Court, arguing that:

1. The lower courts erred in awarding liquidated damages, attorney’s fees, and interest without legal basis.
2. The Court of Appeals overlooked crucial facts that would have altered the outcome.

Titan contended that the invoices, the basis for the penalties, were not formally offered as evidence by Uni-Field. However, the Supreme Court pointed out a critical procedural detail: Titan itself had actually presented these invoices as part of its own evidence. This procedural misstep weakened Titan’s argument about the invoices not being properly before the court.

Furthermore, Titan argued that the invoices were contracts of adhesion, implying they were inherently unfair. The Supreme Court acknowledged this but reiterated that contracts of adhesion are generally valid. The Court stated:

“Considering that petitioner and respondent have been doing business from 1990 to 1993 and that petitioner is not a small time construction company, petitioner is ‘presumed to have full knowledge and to have acted with due care or, at the very least, to have been aware of the terms and conditions of the contract.’ Petitioner was free to contract the services of another supplier if respondent’s terms were not acceptable.”

Despite upholding the validity of the contract and the penalty clauses in principle, the Supreme Court exercised its power to reduce the attorney’s fees. The Court reasoned:

“The Court notes that respondent had more than adequately protected itself from a possible breach of contract because of the stipulations on the payment of interest, liquidated damages, and attorney’s fees. The Court finds the award of attorney’s fees ‘equivalent to 25% of whatever amount is due and payable’ to be exorbitant… Moreover, the liquidated damages and the attorney’s fees serve the same purpose, that is, as penalty for breach of the contract. Therefore, we reduce the award of attorney’s fees to 25% of the principal obligation…”

The Supreme Court affirmed the CA decision with a modification, reducing the attorney’s fees to 25% of the principal debt only, excluding the accumulated interest and liquidated damages from the computation.

PRACTICAL IMPLICATIONS: WHAT THIS CASE MEANS FOR BUSINESSES AND INDIVIDUALS

This case provides several key takeaways for businesses and individuals in the Philippines:

• Contracts of Adhesion are Generally Enforceable: Don’t assume that just because a contract is presented as a ‘take-it-or-leave-it’ agreement, it is automatically invalid. Philippine courts generally uphold contracts of adhesion.
• Read the Fine Print, Even in Standard Forms: This case underscores the importance of carefully reviewing all contract terms, even in seemingly routine documents like sales invoices or delivery receipts. Terms and conditions printed on these documents can be legally binding.
• Unconscionable Penalties Can Be Reduced: Philippine courts have the power to reduce penalties, including liquidated damages and attorney’s fees, if they are deemed iniquitous or unconscionable. This is a crucial protection against overly oppressive contract terms.
• Context Matters: The Supreme Court considered Titan Construction Corporation’s status as a non-“small time” company and its history of business dealings with Uni-Field. This suggests that the court assesses the parties’ relative bargaining power and sophistication when evaluating contracts of adhesion.
• Procedural Issues are Important: Titan’s own submission of the invoices as evidence weakened its argument against their consideration by the court. Properly presenting and objecting to evidence is crucial in litigation.

Key Lessons:

• For Businesses: Ensure your standard contracts are fair and reasonable. While you can include penalty clauses to protect your interests, avoid excessively high penalties that could be deemed unconscionable by the courts. Consider offering opportunities for negotiation, even in standard contracts, where feasible.
• For Individuals and Businesses Signing Standard Contracts: Always take the time to read and understand contract terms, even in standard forms. If you find clauses that seem unfair or unclear, seek clarification or legal advice before signing. If a dispute arises over potentially unconscionable penalties, be aware of your right to argue for their reduction in court.

FREQUENTLY ASKED QUESTIONS (FAQs)

Q: What is a contract of adhesion?

A: A contract of adhesion is a contract drafted by one party (usually with stronger bargaining power) and offered to another party on a “take it or leave it” basis. The second party has little to no opportunity to negotiate the terms.

Q: Are contracts of adhesion legal in the Philippines?

A: Yes, contracts of adhesion are generally legal and binding in the Philippines. However, courts will scrutinize them more closely, especially concerning potentially unconscionable terms.

Q: What makes a penalty clause “unconscionable”?

A: A penalty clause is considered unconscionable when it is excessively disproportionate to the actual damages suffered or is contrary to morals, good customs, or public policy. Courts assess this on a case-by-case basis, considering factors like the nature of the obligation, the extent of the breach, and the relative positions of the parties.

Q: Can I get out of a contract of adhesion if I don’t like the terms later?

A: It’s difficult to unilaterally get out of a contract just because it’s a contract of adhesion. However, if the contract contains unconscionable terms, particularly penalty clauses, you can argue in court for the reduction or unenforceability of those specific terms.

Q: What should I do if I think a contract I signed has unfair penalty clauses?

A: Seek legal advice immediately. A lawyer can review your contract, assess the fairness of the penalty clauses under Philippine law, and advise you on the best course of action, whether it’s negotiation, mediation, or litigation.

Q: Does the Supreme Court always reduce attorney’s fees in contracts of adhesion?

A: No, the Supreme Court doesn’t automatically reduce attorney’s fees. Reduction happens when the stipulated fees, especially when combined with other penalties, are deemed excessive or unconscionable in the specific context of the case. The court exercises its discretion based on the facts presented.

Q: If delivery receipts and invoices are contracts of adhesion, should I refuse to sign them?

A: Refusing to sign might hinder your business transactions. Instead, carefully review the terms before signing. If possible, try to negotiate unfair terms. If negotiation fails and the terms are still problematic, document your objections in writing. If you proceed with the transaction, be aware of the terms you are agreeing to and seek legal advice if needed.

ASG Law specializes in Contract Law and Civil Litigation. Contact us or email hello@asglawpartners.com to schedule a consultation.