When Fees Become Illegal in the Philippines

Loan contracts in the Philippines commonly impose interest, late-payment penalties, collection fees, service charges, and attorney’s fees. Many borrowers assume these are automatically enforceable “because it’s in the contract.” Philippine law takes a different view: freedom of contract is real, but not absolute. Courts and regulators can strike down or reduce charges that are illegal, unconscionable, iniquitous, or contrary to public policy—even if the borrower signed.

This article explains the Philippine legal framework on when loan fees and penalties become unenforceable or are reduced, how courts analyze “excessive” charges, and the practical consequences in collection cases.

1) The Basic Rule: Parties May Stipulate—But Only Within Law, Morals, and Public Policy

Philippine contract law recognizes autonomy (parties may set terms), but it is limited. A stipulation may be invalid or adjusted when it clashes with law or equity.

Key anchors:

Civil Code, Article 1306: Contracting parties may establish stipulations “provided they are not contrary to law, morals, good customs, public order, or public policy.”
Civil Code, Article 1409 (void/inexistent contracts): Contracts whose cause/object is contrary to law or public policy may be void; particular illegal stipulations may be severed depending on the case.

Practical effect: A lender cannot “contract around” mandatory rules (like the need for written interest stipulations) or impose charges so harsh that courts treat them as unconscionable.

2) Understanding the Main “Money Add-Ons” in Loan Contracts

A. Interest (the price of money)

Interest is not presumed.

Civil Code, Article 1956: No interest shall be due unless expressly stipulated in writing.

If a loan document is silent on interest (or the interest term is not properly written), the lender generally cannot collect contractual interest—though the lender may still claim damages in the form of legal interest in some situations once the debtor is in default (especially after demand or judicial action), depending on the nature of the obligation and the circumstances.

B. Penalty Clause / Late Payment Penalty (liquidated damages)

Late fees are typically framed as a penalty clause—an agreed amount payable upon breach (delay/nonpayment). Under the Civil Code:

Article 1226: A penalty clause substitutes for indemnity for damages and payment of interest unless otherwise stipulated.
- Meaning: as a default rule, penalty replaces damages/interest, but parties may validly stipulate both penalty and interest.
Article 1229: The court shall equitably reduce the penalty when:
1. the principal obligation has been partly or irregularly complied with, or
2. the penalty is iniquitous or unconscionable (even if there was no partial performance).

This is one of the most powerful borrower protections in Philippine private law: even a signed penalty clause can be reduced.

C. Liquidated damages (general rule on reduction)

Civil Code, Article 2227: Liquidated damages may be reduced if they are iniquitous or unconscionable.

Penalty clauses in loans often function as liquidated damages; courts lean on Articles 1229 and 2227 to reduce oppressive amounts.

D. Attorney’s fees and “collection fees”

Lenders often add “25% attorney’s fees,” “collection fee,” “admin fee,” and similar items.

Civil Code, Article 2208: Attorney’s fees may be recovered only in enumerated cases (including when stipulated), but courts retain discretion and require that the award be reasonable and justified by facts and law.
Courts commonly treat fixed-percentage attorney’s fees as subject to reduction when excessive or used as a penalty in disguise.

Important distinction: A lender may stipulate attorney’s fees, but courts generally resist turning it into a windfall—especially when it is automatic, high-percentage, and not tied to actual work.

3) “Usury” Is Not the Main Weapon—Unconscionability Is

Historically, the Philippines had a Usury Law with interest ceilings. In modern Philippine practice, statutory interest ceilings are generally not the controlling framework for most private loans (as ceilings were effectively relaxed), but that does not mean “anything goes.”

What replaced strict usury ceilings in real litigation is the doctrine that interest and penalties may be reduced for being unconscionable. Courts regularly apply:

equity,
Articles 1229/2227, and
the policy limits under Article 1306.

So even without a universal numeric cap, rates/fees that shock the conscience can be cut down.

4) When Exactly Do Fees Become “Illegal” or Unenforceable?

Category 1: Charges that violate an explicit rule

These are the easiest to attack.

Examples:

Interest not in writing → not collectible as contractual interest (Art. 1956).
Hidden/undisclosed finance charges in covered consumer loans → may violate disclosure laws (see Section 6).
Charges imposed without contractual basis → not collectible (basic obligations rule: you must prove the stipulation).
Double-charging that contradicts the contract’s own structure → may be disallowed depending on drafting (e.g., penalty meant to substitute for interest unless “otherwise stipulated” under Art. 1226).

Category 2: Charges that are valid in concept but excessive in amount (unconscionable/iniquitous)

This is the most common battlefield in court.

A charge becomes unenforceable to the extent of excess when:

it is iniquitous or unconscionable (Art. 1229; Art. 2227), or
it violates public policy limits (Art. 1306).

Key point: Many loan stipulations are not void from the start; rather, they are enforceable only after judicial “equitable reduction.”

Category 3: Charges that function as a penalty in disguise

Courts look at substance over labels. A lender might call something:

“processing fee,” “admin fee,” “collection support fee,” “service fee,” “field visit fee,” etc.

If the fee:

triggers only upon default,
is computed as a percentage of the unpaid balance,
piles on monthly,
and primarily punishes nonpayment rather than compensate actual cost,

courts may treat it as a penalty/liquidated damages, making it reducible under Articles 1229/2227.

Category 4: Charges imposed through unfair, deceptive, or oppressive conduct

Even if a fee is written, enforcement can be affected if:

consent was vitiated (fraud, mistake, intimidation),
terms were not properly disclosed/explained,
collection practices violate consumer protection norms, or
the transaction is structured to evade protective laws.

5) How Courts Decide “Unconscionable”: The Practical Tests

Philippine decisions evaluate unconscionability case-by-case; there is no single universal percentage threshold in the Civil Code. Common factors include:

Total effective burden (interest + penalties + recurring fees): Courts often look at the combined effect. A “reasonable” interest can become oppressive once stacked with heavy penalties and monthly “fees.”
Speed of ballooning: Terms that make debt grow explosively—e.g., high monthly penalty plus high monthly interest plus compounding—are prime targets for reduction.
Comparative norms and risk: Courts consider whether the rate is grossly disproportionate to ordinary commercial practice and the lender’s actual risk.
Borrower’s situation and bargaining power: Adhesion contracts (take-it-or-leave-it) and distressed borrowers strengthen the case for equitable intervention.
Partial performance: If the borrower paid substantial amounts or partially complied, Article 1229 explicitly supports reduction of the penalty.
Purpose of the clause: If the fee is primarily punitive rather than compensatory, courts are more willing to cut it.

6) Statutes and Regulators That Matter (Philippine Context)

Beyond the Civil Code, several laws and regulators shape what lenders may charge and how they must disclose it:

A. Truth in Lending Act (Republic Act No. 3765)

This law focuses on meaningful disclosure of credit terms to borrowers. In covered transactions, lenders are expected to disclose finance charges and key credit terms so borrowers can understand the true cost of credit. Failure to comply can expose lenders to legal consequences (civil and/or administrative, depending on circumstances and implementing rules).

Practical use in disputes: Borrowers challenge “surprise” add-ons and undisclosed charges, especially when the documentation is unclear or misleading.

B. Financial Products and Services Consumer Protection Act (Republic Act No. 11765)

This law strengthens consumer protection in financial products and services, including expectations around:

fair treatment,
transparency and disclosure,
protection from abusive practices,
and regulatory oversight (particularly relevant to BSP-supervised institutions and broader financial consumer protection frameworks).

C. Lending Company Regulation Act (Republic Act No. 9474) and Financing Company Act (Republic Act No. 8556)

These govern lending companies and financing companies, typically under SEC regulation. Issues often arising here include:

compliance/registration status,
disclosure and documentation,
and unfair or abusive charges/collection practices.

D. Consumer Act of the Philippines (Republic Act No. 7394)

While not a loan-specific code, it underpins broad policies against deceptive or unfair practices affecting consumers, sometimes invoked alongside disclosure laws and civil law doctrines.

E. BSP and SEC supervisory frameworks (industry-dependent)

Banks and BSP-supervised financial institutions: subject to BSP consumer protection expectations and related regulations on disclosure and fair dealing.
SEC-registered lending/financing companies: subject to SEC rules and enforcement actions (often relevant to online/consumer lending environments).

Important: Even when regulators don’t set a single “cap,” they often enforce fair disclosure and prohibit unfair practices, which can make certain fees effectively unenforceable or sanctionable.

7) Common Loan Charges and When They Cross the Line

1) Late payment penalties (e.g., “5% per month penalty”)

Risk points:

penalty is extremely high,
imposed monthly on top of high interest,
effectively compounds,
continues even after acceleration, or
produces a total obligation far beyond the principal in a short time.

Legal handles: Art. 1229 (equitable reduction), Art. 2227, Art. 1306.

2) “Collection fee” added automatically upon default

Risk points:

percentage-based and recurring,
not tied to actual collection costs,
imposed even without any real collection activity.

Legal handles: may be treated as penalty/liquidated damages → reducible; may be struck if unconscionable.

3) Attorney’s fees fixed at 25%–30% of the amount due

Risk points:

automatic fee regardless of actual litigation work,
stacked with other penalty charges,
functions as additional punitive add-on.

Legal handles: Art. 2208 (discretion and reasonableness), unconscionability doctrines.

4) Compounding schemes (interest-on-interest; penalty-on-penalty)

Compounding is not automatically illegal, but it is scrutinized, especially when it causes explosive growth.

Relevant Civil Code concept:

Interest on interest may arise in limited ways, including circumstances involving judicial demand (often discussed in relation to interest already due). Courts are careful not to allow compounding to become a disguised penalty machine.

5) Pre-termination fees / prepayment penalties

These may be valid when clearly disclosed and commercially reasonable, but can be attacked if:

not disclosed,
imposed despite no real loss,
or structured as a punitive barrier to paying off early.

6) “Processing,” “service,” and “admin” fees

These are most defensible when:

charged once upfront,
clearly disclosed,
and reflect real administrative cost.

They become vulnerable when:

repeatedly imposed,
triggered by default,
or computed as a percentage of overdue amounts.

8) What Happens in Court: Typical Outcomes

When a borrower challenges excessive charges, courts commonly do one or more of the following:

Enforce principal but reduce interest for unconscionability.
Reduce penalties under Art. 1229 or Art. 2227.
Disallow undocumented charges (fees not proven by contract or computation).
Trim attorney’s fees to a reasonable amount.
Apply legal interest rules as damages depending on default and the nature of the obligation, especially when contractual interest is invalid or equitably reduced.

Key reality: Courts often aim for a result that (a) prevents unjust enrichment by the lender and (b) still respects that money was borrowed and must be repaid.

9) Practical Red Flags (Borrower-Side) That Often Signal Unconscionability

Interest stated monthly at a very high rate plus a monthly penalty of similar magnitude.
Multiple default-triggered add-ons: “penalty + collection fee + admin fee + attorney’s fee,” all recurring.
Charges computed on gross “amount due” including prior penalties (snowball effect).
Vague clauses (“fees as may be assessed”) with no schedule or formula.
Lack of clear written interest stipulation, or inconsistent disclosures vs. the promissory note/loan agreement.
One-sided provisions that allow the lender to impose new fees unilaterally without borrower consent.

10) Litigation and Defense Toolbox (How These Issues Are Raised)

In a collection case (or when negotiating), borrowers typically invoke:

Article 1956: interest must be in writing.
Article 1229: reduce unconscionable penalty; reduce penalty when there was partial/irregular compliance.
Article 2227: reduce unconscionable liquidated damages.
Article 1306: stipulations cannot violate law/public policy.
Article 2208: attorney’s fees must be justified and reasonable.

These are raised through:

Answer with affirmative defenses (unconscionability, illegality, lack of basis, improper computation),
Opposition to summary claims of “amount due,” demanding breakdown and proof,
Counterclaims when facts support (e.g., bad faith, abusive collection), and
Requests for equitable reduction even when signature is admitted.

11) Bottom Line: When Fees Become “Illegal”

In Philippine practice, loan penalties and charges become “illegal” or unenforceable in four main ways:

They violate a clear statutory requirement (e.g., interest not in writing; mandatory disclosures in covered transactions not complied with; fees not contractually agreed).
They are unconscionable/iniquitous in amount or combined effect (penalty and liquidated damages reduced under Arts. 1229/2227).
They are contrary to public policy (invalid under Art. 1306, sometimes void).
They are unsupported or mischaracterized (fees imposed without proof, or disguised penalties designed to punish rather than compensate).

The most important doctrinal takeaway is this: the enforceability of loan add-ons is not determined solely by what is written—courts will look at fairness, proportionality, disclosure, and real economic effect.