Are Verbal Interest Agreements Enforceable? Legal Interest on Loans Without Written Contracts in the Philippines

Introduction

In the Philippine legal system, loans and interest agreements are governed primarily by the Civil Code of the Philippines (Republic Act No. 386), as amended, along with relevant jurisprudence from the Supreme Court and regulatory issuances from bodies like the Bangko Sentral ng Pilipinas (BSP). A common question arises in lending transactions: Can a verbal agreement on interest rates be enforced in court? And what happens to interest on loans where there is no written contract at all? This article explores these issues in depth, examining the enforceability of verbal interest stipulations, the application of legal interest rates, exceptions, remedies, and practical implications for lenders and borrowers. Understanding these principles is crucial for individuals and businesses engaging in informal lending, as they highlight the importance of documentation in protecting financial interests.

Enforceability of Verbal Agreements in Loan Contracts

Under Philippine law, contracts, including loan agreements (mutuum), are generally valid and enforceable even if they are verbal. Article 1305 of the Civil Code defines a contract as a meeting of minds between two persons whereby one binds himself, with respect to the other, to give something or to render some service. Article 1318 further states that contracts are perfected by mere consent, provided there is an object certain and a cause or consideration.

For simple loans involving money, there is no general requirement for a written document to make the principal obligation enforceable. This is because loans do not fall under the Statute of Frauds outlined in Article 1403 of the Civil Code, which mandates writing for specific types of agreements, such as those not to be performed within a year, sales of real property, or guarantees. A verbal loan agreement can thus be proven through parol evidence (oral testimony or other extrinsic evidence) in court, as long as the elements of a contract are present: consent, object (the money lent), and cause (the obligation to repay).

However, this flexibility applies primarily to the principal amount borrowed. When it comes to interest—the compensation for the use of money—the rules become stricter.

Specific Rule on Interest: The Requirement of Writing

The Civil Code imposes a clear limitation on interest agreements. Article 1956 explicitly provides: "No interest shall be due unless it has been expressly stipulated in writing." This provision is a cornerstone of Philippine lending law and directly addresses the enforceability of verbal interest agreements.

Why the Writing Requirement?

The rationale behind Article 1956 is to prevent usury and protect borrowers from arbitrary or excessive interest claims that could arise from informal understandings. Without a written stipulation, courts will not enforce any agreed-upon interest rate, regardless of whether it was discussed verbally or implied through conduct. This means that even if both parties orally agree to a specific interest rate—say, 5% per month—that agreement is unenforceable if not reduced to writing.

Jurisprudence reinforces this. In landmark cases like Spouses Tan v. Court of Appeals (G.R. No. 116285, October 19, 2001), the Supreme Court emphasized that interest must be expressly stipulated in writing to be recoverable. Absent such writing, no interest accrues on the loan. Similarly, in Banco Filipino Savings and Mortgage Bank v. Court of Appeals (G.R. No. 129227, May 30, 2000), the Court held that verbal agreements on interest are void insofar as the interest is concerned, though the principal remains due.

What Constitutes a "Written Stipulation"?

To satisfy Article 1956, the stipulation must be:

Express: It cannot be implied; the interest rate or amount must be clearly stated.
In Writing: This can be in a promissory note, loan agreement, receipt, or even an email or text message if it sufficiently evidences the agreement. However, informal notes like IOUs may not qualify if they do not explicitly mention interest.
Signed or Acknowledged: While not always required, signatures from both parties strengthen enforceability.

If the writing is ambiguous or incomplete, courts may interpret it strictly against the lender, applying principles of contract interpretation under Articles 1370-1379 of the Civil Code.

Loans Without Any Written Contract: Implications for Interest

In scenarios where there is no written contract at all—not even for the principal—the loan itself may still be enforceable based on verbal agreement and evidence of delivery (e.g., bank transfers or witnesses). However, interest falls under the strict rule of Article 1956.

No Stipulated Interest: Application of Legal Interest

If interest is not stipulated in writing, or if the stipulation is invalid (e.g., verbal), the loan does not become interest-free in all cases. Instead, legal interest may apply under certain circumstances, as provided by Article 2209 of the Civil Code: "If the obligation consists in the payment of a sum of money, and the debtor incurs in delay, the indemnity for damages, there being no stipulation to the contrary, shall be the payment of the interest agreed upon, and in the absence of stipulation, the legal interest, which is six percent per annum."

Key points:

When Legal Interest Applies: Legal interest accrues only from the time of judicial or extrajudicial demand (e.g., a formal demand letter or filing of a lawsuit), not from the loan's inception. This is due to the concept of "delay" or mora under Article 1169.
Rate of Legal Interest: Historically 12% per annum, but reduced to 6% per annum by BSP Monetary Board Resolution No. 796 dated May 16, 2013, for loans or forbearances of money without stipulated interest. This rate applies to the principal amount from the date of demand until full payment.
Distinction from Monetary Interest: Legal interest under Article 2209 is compensatory for delay, not the same as "monetary interest" for the use of money, which requires written stipulation.

In cases involving judgments, Supreme Court Administrative Circular No. 83-15 (as amended) and subsequent rulings like Nacar v. Gallery Frames (G.R. No. 189871, August 13, 2013) adjust legal interest on monetary judgments to 6% per annum from finality until satisfaction, aligning with BSP rates.

Exceptions and Special Cases

While the general rule is stringent, there are nuances and exceptions:

1. Usurious Interest

Even if in writing, interest rates deemed usurious (excessive) may be voided. The Usury Law (Act No. 2655) was suspended in 1974 by Central Bank Circular No. 416, allowing market-driven rates. However, courts can still strike down unconscionable rates under Article 1306 (contracts must not be contrary to law, morals, etc.). For instance, in Medel v. Court of Appeals (G.R. No. 131622, November 27, 1998), a 5.5% monthly rate was declared void for being iniquitous.

2. Compensatory vs. Penalty Interest

Penalty interest for default may be enforceable if stipulated in writing, but it is subject to reduction if excessive (Article 1229).

3. Loans Between Family or Friends

Informal loans often rely on trust, but verbal interest remains unenforceable. Courts may award legal interest if delay is proven.

4. Commercial Loans and Banking Regulations

For banks and financial institutions, additional rules under the New Central Bank Act (Republic Act No. 7653) and BSP regulations apply. Interest must still be in writing, but disclosure requirements are stricter.

5. COVID-19 and Moratoriums

During the pandemic, Bayanihan Acts (Republic Acts Nos. 11469 and 11494) imposed grace periods on loans, suspending interest accrual temporarily, but this did not alter the writing requirement.

Remedies and Enforcement

For Lenders

To recover principal: File a collection suit with evidence of the loan (e.g., witnesses, receipts).
For interest: Ensure written stipulation; otherwise, claim only legal interest from demand.
Prescription: Actions on verbal contracts prescribe in 6 years (Article 1145); written in 10 years (Article 1144).

For Borrowers

Defend against verbal interest claims by invoking Article 1956.
Seek annulment of usurious written interest.

Evidence in Court

Parol evidence is admissible for verbal loans, but the burden of proof lies on the claimant (Article 1316). Digital evidence, like chat logs, may serve as writing if explicit.

Practical Implications and Recommendations

Verbal interest agreements expose lenders to risk, as they cannot enforce custom rates and may only recover legal interest post-demand. Borrowers benefit from this protection but should document repayments to avoid disputes. To mitigate issues:

Always execute written loan agreements with clear interest terms.
Use standard forms or consult lawyers for complex transactions.
For small loans, consider alternatives like pawnshops, which have regulated rates.

In summary, while verbal loan agreements are generally enforceable for the principal, interest requires express written stipulation under Philippine law. Absent this, legal interest at 6% applies only in cases of delay, underscoring the Civil Code's emphasis on formality for financial protections. Parties should prioritize documentation to avoid litigation and ensure equitable outcomes.