In the realm of Philippine credit and lending, the tension between "freedom of contract" and "equity" is a recurring legal theme. While parties are generally free to stipulate terms in their agreements, the Philippine legal system provides safeguards to prevent predatory lending and unconscionable penalties.
1. The Status of the Usury Law
Historically, the Usury Law (Act No. 2655) set a hard ceiling on interest rates. However, with the issuance of Central Bank Circular No. 905 in 1982, the ceilings on interest rates were suspended.
- Legally "Ineffective" but not "Repealed": The Usury Law was not technically repealed by Congress; rather, its interest ceilings were rendered ineffective by the Central Bank.
- Current Rule: Currently, there is no legally mandated maximum interest rate for loans in the Philippines. This allows for a "floating rate" system where interest is determined by market forces and mutual agreement.
2. The Doctrine of Unconscionable Interest Rates
Despite the suspension of the Usury Law, the Philippine Supreme Court has consistently intervened when interest rates and late payment penalties become "excessive, iniquitous, unconscionable, and exorbitant."
Even if a debtor voluntarily signs a contract with high interest, the Court reserves the power to reduce these rates based on Article 1229 and Article 2227 of the New Civil Code.
The "Rule of Thumb" Threshold
While there is no fixed statutory limit, jurisprudence (notably cases like Medel v. Court of Appeals) has established certain benchmarks:
- 24% per annum (2% per month): Generally viewed as the upper limit of what is considered "reasonable" for combined interest and penalty charges.
- 36% per annum (3% per month) or higher: These rates are frequently struck down by the Supreme Court as "contrary to morals" (contra bonos mores). When a rate is declared unconscionable, it is voided, and the Court typically imposes the prevailing legal rate of 6% per annum instead.
3. Penalties vs. Interest: The Liquidated Damages Clause
In Philippine law, a late payment penalty is technically a Penalty Clause under Article 1226 of the Civil Code. It serves as a pre-determined measure of damages (liquidated damages) intended to substitute for indemnity for damages and payment of interest in case of non-compliance.
- The Power to Reduce: Under Article 1229, the judge shall equitably reduce the penalty when the principal obligation has been partly or irregularly complied with, or even if there has been no performance, if the penalty is iniquitous or unconscionable.
- Compounding Interest: For interest to be compounded (interest on interest), it must be expressly stipulated in writing by the parties, as per Article 2212 of the Civil Code.
4. Special Laws and Regulations
A. The Truth in Lending Act (Republic Act No. 3765)
This law requires creditors to provide full disclosure to the borrower prior to the consummation of the transaction. The disclosure must include:
- The cash price.
- The finance charge (including interests, fees, and service charges).
- The percentage that the finance charge bears to the total amount to be financed (Effective Interest Rate).
Failure to disclose these details does not void the loan, but it subjects the creditor to a fine and allows the borrower to recover the finance charges.
B. Credit Card Limits (BSP Circular No. 1102)
In response to the economic impact of the pandemic, the Bangko Sentral ng Pilipinas (BSP) imposed specific caps on credit card transactions:
- Interest/Finance Charge: Capped at 3% per month (36% per annum).
- Late Payment Fees: Capped at P840.00 per month (or a specific percentage of the amount due).
- Installment Loans: Capped at a monthly add-on rate of 1%.
5. Summary of Key Legal Principles
| Concept | Legal Basis | Current Standing |
|---|---|---|
| Usury Ceiling | Act No. 2655 / CB Circular 905 | Suspended; No fixed statutory ceiling. |
| Legal Interest | BSP Circular No. 799 | 6% per annum for loans or forbearance of money (when not stipulated). |
| Unconscionable Rates | Art. 1306, Civil Code | Rates deemed "shocking to the conscience" are void. |
| Penalty Reduction | Art. 1229, Civil Code | Courts can reduce penalties if they are iniquitous. |
| Disclosure | R.A. No. 3765 | Creditors must disclose all costs before the loan is finalized. |
Conclusion
In the Philippines, the "freedom to contract" is not absolute. While the Usury Law is dormant, the Judiciary acts as a check against predatory lending. Any stipulated interest or penalty that is deemed "excessive" under prevailing jurisprudence can be challenged in court, potentially resulting in the rate being slashed to the legal floor of 6% per annum. For both creditors and debtors, the standard of "reasonableness" remains the ultimate yardstick for the validity of late payment penalties.