In the Philippine financial landscape, the principle of "freedom of contract" is a cornerstone of civil law. However, this freedom is not absolute. When a borrower, burdened by financial distress, enters into a restructured loan agreement only to find themselves trapped by "sky-high" interest rates and predatory penalties, the law steps in to restore equity.
The Philippine Supreme Court has consistently ruled that while the Usury Law is currently "legally inexistent" (due to Central Bank Circular No. 905), this does not give creditors a license to charge whatever they please.
1. The Legal Foundation: Equity vs. Autonomy
Under Article 1306 of the Civil Code, 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.
When a restructured loan imposes interest rates that are "iniquitous, unconscionable, exorbitant, or shocking to the senses," the courts have the power to intervene. The rationale is that a contract is a meeting of the minds between equals; in many restructured loans, the borrower is often in a "take-it-or-leave-it" position, creating a contract of adhesion.
2. Defining "Unconscionable" Rates
While there is no fixed numerical ceiling for what constitutes an unconscionable rate, jurisprudence provides a clear benchmark:
- The 24% Rule: Historically, the Supreme Court has frequently struck down interest rates of 3% per month (36% per annum) or higher as unconscionable.
- The 12% Standard: When a court voids an unconscionable interest rate, it does not void the loan itself. Instead, the rate is typically reduced to the prevailing legal rate. Following Nacar v. Gallery Frames, the legal rate for loans and forbearance of money is currently 6% per annum, though courts may occasionally revert to the "old" legal rate of 12% if the contract predates 2013 or based on specific equitable considerations.
Penalties and Surcharges
Restructured loans often include a "Penalty Clause." Under Article 1229 of the Civil Code, the judge shall equitably reduce the penalty when the principal obligation has been partly or irregularly complied with, or if the penalty is iniquitous or unconscionable.
3. Remedies for the Borrower
A. Petition for Declaratory Relief
If the loan is still active and the borrower wishes to challenge the validity of the interest stipulations before a breach occurs, they may file a petition for Declaratory Relief under Rule 63 of the Rules of Court. This asks the court to interpret the contract and declare the specific interest provisions void for being contrary to public policy.
B. Annulment of Interest Stipulations (Action for Reformation)
If the borrower was forced into a restructured loan under duress or if the written agreement fails to express the true intent of the parties due to mistake or inequitable conduct, an action for Reformation of Instrument (Articles 1359-1369, Civil Code) may be appropriate.
C. Affirmative Defense in a Collection Suit
Most commonly, this issue arises when a creditor sues for a "Sum of Money." The borrower can raise the Affirmative Defense that the interest rates and penalties are unconscionable.
- Result: If the court agrees, it will "strike down" the stipulated rate and apply the legal rate of 6% or 12%. Any payments already made by the borrower that exceeded the legal rate will be credited against the principal amount.
D. Consignation
If the creditor refuses to accept a "reasonable" payment because they insist on the unconscionable interest, the borrower can perform Consignation (Article 1256, Civil Code). This involves depositing the undisputed amount with the court to stop the accrual of further interests and penalties.
4. The Impact of "Compounding" in Restructuring
Restructured loans often capitalize unpaid interest (turning interest into principal). While Article 1959 of the Civil Code allows for "interest on interest" (Accrued Interest), this must be expressly stipulated in writing. If the restructuring agreement compounds interest in a way that leads to a "debt spiral," the court can look past the form of the contract to the substance of the debt and reduce the total liability.
5. Summary Table: Standard vs. Unconscionable
| Feature | Usually Valid | Potentially Unconscionable |
|---|---|---|
| Annual Interest Rate | 6% to 18% | 36% and above |
| Monthly Penalty | 1% to 2% | 5% or "Double Rule" penalties |
| Attorney's Fees | 10% of total amount | 25% or more of total amount |
| Basis of Law | Art. 1306 (Freedom of Contract) | Art. 1229 & Public Policy |
Conclusion
The Philippine legal system protects the sanctity of contracts, but it does not permit a creditor to "strip a debtor of his means of livelihood." In restructured loans, where the borrower’s bargaining power is at its lowest, the courts serve as a shield. By invoking the principles of equity and the specific provisions of the Civil Code, borrowers can effectively reduce predatory debts to manageable, legally sound levels.