Is Usurious Lending Without a Written Contract Illegal? Interest Rate Limits and Legal Risks (Philippines)

Introduction

In the Philippines, lending money at interest is a common financial practice, but it raises significant legal questions when the interest rates become excessive or "usurious." Usury traditionally refers to the charging of interest rates that are deemed unreasonably high, exploiting the borrower's vulnerability. This article explores whether usurious lending without a written contract is illegal under Philippine law, examines the applicable interest rate limits, and discusses the associated legal risks. The analysis is grounded in the Philippine Civil Code, relevant jurisprudence, and regulatory frameworks from the Bangko Sentral ng Pilipinas (BSP). It covers the validity of oral loan agreements, the evolution of usury regulations, and remedies available to borrowers and lenders.

Understanding these elements is crucial for individuals, businesses, and financial institutions engaging in lending activities. While the Philippines has moved away from strict usury prohibitions, courts retain the power to scrutinize agreements for fairness, particularly in informal lending scenarios.

Historical and Legal Framework on Usury

The concept of usury in the Philippines has evolved significantly over time. Historically, the Usury Law (Act No. 2655, enacted in 1916) set maximum interest rates for loans, typically capping them at 12% to 14% per annum depending on whether the loan was secured or unsecured. Violations could lead to civil penalties, such as the forfeiture of interest, and in severe cases, criminal liability.

However, in 1982, the BSP issued Central Bank Circular No. 905, which effectively suspended the interest rate ceilings under the Usury Law. This deregulation was intended to promote a market-driven financial system, allowing lenders and borrowers to freely negotiate interest rates. As a result, there is no longer a statutory maximum interest rate for most loans in the Philippines. Instead, the focus shifted to contractual freedom under Article 1306 of the Civil Code, which states that parties may establish stipulations, clauses, terms, and conditions as they deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy.

Despite this liberalization, the Supreme Court has consistently held that interest rates must not be "unconscionable" or "shocking to the conscience." In landmark cases like Medel v. Court of Appeals (G.R. No. 131622, 1998), the Court invalidated interest rates exceeding 5.5% per month (66% per annum) as excessive. Similarly, in Chua v. Timan (G.R. No. 170452, 2008), rates of 7% to 10% per month were deemed usurious and void.

Validity of Lending Without a Written Contract

A key aspect of the topic is whether loans, including those with usurious interest, require a written contract to be enforceable. Under Philippine law, contracts are generally valid in any form as long as there is consent, object, and cause (Article 1318, Civil Code). Oral or verbal agreements for loans are binding and enforceable, provided they meet these essential requisites.

However, the Statute of Frauds (Article 1403, Civil Code) imposes a writing requirement for certain contracts to prevent fraud. Specifically, agreements for the loan of money, goods, or chattels exceeding PHP 500 must be in writing to be enforceable in court. If the loan amount is PHP 500 or less, an oral agreement suffices. For larger amounts, without a written document, the contract may be unenforceable, meaning the lender cannot sue to recover the principal or interest if the borrower defaults.

Even in the absence of a written contract, if partial payments or other acts indicate acknowledgment of the debt (e.g., promissory notes or receipts), the agreement may still be ratified and enforceable under Article 1405. In practice, many informal lending arrangements, such as those between family members or in rural communities (e.g., "5-6" lending schemes where PHP 5 is borrowed and PHP 6 repaid daily), operate without written contracts. These are legally valid but carry evidentiary risks in disputes.

When usurious interest is involved in an oral loan, the lack of writing does not inherently make the lending illegal, but it complicates enforcement. Borrowers can challenge the interest in court, and if proven unconscionable, the court may void the interest stipulation while upholding the principal obligation.

Interest Rate Limits in the Current Regime

Post-deregulation, there are no fixed numerical limits on interest rates for consensual loans between private parties. Lenders can charge rates based on mutual agreement, reflecting factors like risk, inflation, and market conditions. However, this freedom is not absolute:

• Unconscionable Interest Rates: Courts intervene when rates are excessively high. Jurisprudence establishes that rates above 3% per month (36% per annum) are presumptively unconscionable, though this is not a hard rule. In Spouses Silos v. Philippine National Bank (G.R. No. 181045, 2013), a 3% monthly rate was struck down as usurious. Factors considered include the borrower's bargaining power, the loan's purpose, and prevailing economic conditions.

• Legal Interest Rate: In the absence of a stipulated rate, or if the stipulated rate is void, the legal interest applies. Under BSP Circular No. 799 (2013), this is 6% per annum on the principal from the date of judicial demand until full payment. For obligations before July 1, 2013, it was 12%.

• Special Rules for Certain Loans:

  • Credit card transactions are governed by BSP regulations, with maximum finance charges around 3% per month.
  • Pawnshops are capped at 5% per month under Presidential Decree No. 114.
  • Banks and financial institutions must comply with truth-in-lending disclosures under Republic Act No. 3765, but no rate caps apply.
  • Salary loans or microfinance may have implied limits through regulatory oversight by the Securities and Exchange Commission (SEC) for lending companies.

• Compounding and Other Charges: Interest can be compounded only if stipulated and not excessive. Penalties, service fees, and other charges must be reasonable; otherwise, they may be reduced by courts (Article 1229, Civil Code).

In usurious cases, the excess interest is void, but the principal remains due. If paid, the borrower can recover the excess under the principle of solutio indebiti (Article 2154).

Legal Risks Associated with Usurious Lending

Engaging in usurious lending, especially without a written contract, exposes lenders to several risks:

• Civil Risks:

  • Void Interest Stipulation: Courts can declare the interest clause null and void, allowing the borrower to repay only the principal (Article 1420, Civil Code). In Asian Cathay Finance and Leasing Corporation v. Spouses Gravador (G.R. No. 186550, 2010), excessive interest was forfeited.
  • Reduction of Penalties: Even if not usurious, courts may equitably reduce penalties if iniquitous.
  • Damages and Attorney's Fees: Borrowers may claim moral or exemplary damages if the lending was oppressive.
  • Foreclosure Issues: For secured loans, usurious terms can invalidate foreclosure proceedings.

• Criminal Risks:

  • While usury itself is no longer a crime post-deregulation, related acts may trigger liability. For instance, if the lender uses deceit or false pretenses to induce the loan, it could constitute estafa under Article 315 of the Revised Penal Code.
  • Threats or violence in collection can lead to charges of grave threats, coercion, or even robbery.
  • Unregistered lending businesses violate SEC rules, potentially leading to fines or imprisonment under Republic Act No. 9474 (Lending Company Regulation Act).
  • In extreme cases involving organized usurious lending (e.g., loan sharks), anti-racketeering laws like Republic Act No. 10883 (New Anti-Carnapping Act) or anti-money laundering provisions may apply if linked to broader criminal activities.

• Regulatory Risks:

  • Lending companies must register with the SEC; failure to do so renders operations illegal, with penalties up to PHP 1,000,000.
  • BSP oversees banks, imposing sanctions for non-compliance with disclosure rules.
  • Consumer protection laws, such as Republic Act No. 7394 (Consumer Act), prohibit deceptive practices in lending.

• Risks for Borrowers: While lenders bear most risks, borrowers defaulting on valid principals may face civil suits, asset attachment, or credit blacklisting.

Without a written contract, proving terms becomes challenging, often leading to "he-said-she-said" disputes resolved based on evidence like text messages, witnesses, or bank transfers.

Jurisprudential Insights

Philippine courts have shaped the landscape through key decisions:

• In Banco Filipino Savings and Mortgage Bank v. Court of Appeals (G.R. No. 129227, 2000), the Court emphasized that post-1982, interest rates are negotiable but subject to equity.
• Advincula v. Advincula (G.R. No. 190864, 2014) highlighted that oral loans are valid but require proof of terms.
• Recent cases like Nacar v. Gallery Frames (G.R. No. 189871, 2013) adjusted legal interest rates in line with economic realities.

These rulings underscore a balance between contractual autonomy and protection against exploitation.

Conclusion

In summary, usurious lending without a written contract is not per se illegal in the Philippines, as there are no fixed interest rate caps, and oral agreements can be valid. However, excessive rates are unconscionable and voidable, exposing lenders to civil forfeiture, reduced recoveries, and potential criminal charges for related offenses. Borrowers benefit from judicial safeguards, but must repay principals. To mitigate risks, parties should use written contracts with clear, reasonable terms and comply with registration requirements. Consulting legal professionals is advisable for tailored advice, ensuring lending practices align with equity and law. This framework promotes fair financial dealings while adapting to modern economic needs.