This article is for general information only and is not legal advice.

1) What “daily penalty charges” usually mean

In Philippine lending practice, “daily penalty” may refer to any of the following, often used in combination:

Compensatory (regular) interest – the price of using money (e.g., 2% per month on the outstanding principal).
Default interest / penalty interest – additional interest that applies only after maturity or missed installments (e.g., +1% per month after due date).
Penalty clause / liquidated damages – a pre-agreed amount or rate meant to answer for breach or delay (e.g., “penalty of 0.3% per day of the overdue amount”).
Surcharge / late payment fee – commonly a one-time fee per missed installment or per billing cycle.
Collection fees / attorney’s fees – amounts sought when collection is turned over to counsel or agency (subject to reasonableness rules).

A “per day” formulation is not automatically illegal in the Philippines. The key legal question is whether the charge is validly stipulated, properly disclosed, within applicable regulatory limits, and not unconscionable or iniquitous.

2) Core rule: penalties are generally allowed, but not unlimited

A. Contractual freedom—within limits

Philippine law recognizes freedom to contract (Civil Code, Art. 1306), but contracts must not be “contrary to law, morals, good customs, public order, or public policy.”

Daily penalties therefore live in a balancing act:

Allowed as a contractual remedy for delay or breach; but
Subject to statutory controls, disclosure rules, and judicial reduction.

B. “Penalty clause” under the Civil Code

A penalty clause is governed by Civil Code Arts. 1226–1230. Key points:

Art. 1226: A penalty clause substitutes for indemnity for damages and payment of interest in case of non-compliance, unless the parties stipulate otherwise.
Art. 1229: Courts shall equitably reduce the penalty when:
1. the principal obligation has been partly or irregularly complied with; and/or
2. the penalty is iniquitous or unconscionable (this is crucial for harsh daily penalties).
Art. 1230: If the principal obligation is void, the penalty is also void.

In short: A daily penalty can be valid on paper but still reduced by the courts.

3) Interest vs. penalty: why classification matters

A. No interest unless in writing (loan context)

For loans, Civil Code Art. 1956 is often decisive:

No interest shall be due unless it has been expressly stipulated in writing.

So if the “daily penalty” is functionally interest (especially if computed as a percentage of the outstanding balance over time), enforceability becomes stronger when the rate is clearly written in the loan documents.

B. Even if not written, “legal interest” may still apply as damages for delay

Even when contractual interest is not enforceable due to lack of a written stipulation, the creditor may still claim legal interest as damages for delay under Civil Code Art. 2209, once the debtor is in default (usually after a due date plus demand requirements, depending on the obligation).

C. Interest-on-interest (anatocism / compounding) is controlled

If the lender’s method effectively charges interest on unpaid interest (e.g., unpaid interest is added to principal and then the daily penalty applies to the increased balance), Philippine law limits this absent clear basis. The Civil Code contains rules restricting interest-on-interest unless conditions are met (commonly discussed under Art. 1959 and Art. 2212, and related jurisprudence). In practice, compounding needs clear contractual footing and remains reviewable for fairness.

4) When does “default” start for purposes of charging penalties?

Under Civil Code Art. 1169 (delay/mora), default generally begins:

When the obligation is due and demandable, and
The debtor fails to perform, often after demand, unless demand is not required under recognized exceptions (e.g., time is of the essence; demand would be useless; obligation or law provides otherwise).

Many loan contracts attempt to define default contractually (missed installment, maturity date, covenant breach, etc.). Even then, courts examine the reality of delay, notice, and fairness, especially for consumer loans.

5) The “Usury Law” is not the whole story

A. The Anti-Usury Law and the “lifting” of ceilings

Historically, the Philippines had statutory ceilings (Act No. 2655, the Anti-Usury Law). Interest rate ceilings were later effectively suspended by policy changes (commonly associated with Central Bank/BSP issuances), which is why many loans today cite “no usury cap.”

B. But courts still police unconscionable interest and penalties

Even without a fixed usury ceiling, Philippine courts routinely invoke:

Art. 1229 (reduce unconscionable penalties),
Art. 1306 (public policy limits),
Arts. 19, 20, 21 (abuse of rights and bad faith),
Art. 24 (courts’ vigilance when a party is disadvantaged), and related jurisprudence, to strike down or reduce oppressive rates.

A daily penalty that converts into an extreme effective annual rate (e.g., 1% per day ≈ 365% per year simple) is a classic candidate for being labeled iniquitous or unconscionable, depending on circumstances.

6) The court’s power to reduce: the most important practical safeguard

A. Reduction of penalty (Civil Code Art. 1229)

Courts may reduce a daily penalty when it is:

Grossly excessive, or
Operating more like a punishment than a fair pre-estimate of loss.

This applies even when the borrower clearly agreed—because Art. 1229 is a mandatory equitable control.

B. Reduction of interest rates in jurisprudence

The Supreme Court has repeatedly treated shocking or unconscionable interest as contrary to public policy and has reduced rates to more reasonable levels depending on the case’s date and posture. A frequently cited landmark is Medel v. Court of Appeals (1998) (unconscionable stipulated interest reduced).

Separately, for court-awarded interest frameworks, Nacar v. Gallery Frames (2013) is widely cited for the structure of legal interest in judgments and the effect of the shift to 6% per annum legal interest from July 1, 2013 (linked to BSP policy on legal interest).

No single “magic number” automatically voids an interest or penalty, but the more extreme and consumer-abusive the outcome, the more likely a court will reduce it.

7) Can lenders charge BOTH regular interest and a penalty?

Yes, if the contract clearly allows it, because:

A penalty clause may substitute for damages and interest unless the parties stipulate otherwise (Art. 1226).
Many loan contracts explicitly provide for:
- Regular interest up to maturity,
- Default interest after maturity,
- Penalty/liquidated damages for delay,
- Collection fees/attorney’s fees.

However, stacking multiple charges (interest + default interest + daily penalty + surcharge + collection fee) is a frequent ground for judicial reduction where the total becomes oppressive, duplicative, or punitive.

8) Disclosure and consumer protection: daily penalties can be unlawful if hidden or misleading

Even when the Civil Code allows stipulations, consumer-protection and disclosure regimes can render charges vulnerable if they were not properly explained.

A. Truth in Lending Act (RA 3765)

RA 3765 requires meaningful disclosure of the finance charge and key credit terms. A “daily penalty” that materially affects the cost of credit but is:

buried,
ambiguously phrased,
not included in effective cost disclosures, or presented deceptively, can expose the lender to regulatory issues and weaken enforceability arguments in disputes.

B. Financial Products and Services Consumer Protection Act (RA 11765)

RA 11765 strengthens consumer protection across regulated financial products, targeting unfair, deceptive, abusive conduct and empowering regulators to act. Extremely harsh daily penalties, especially where paired with aggressive collection or confusing disclosures, can raise issues under this framework.

9) Regulator-specific limits may apply depending on the lender

Daily penalties are evaluated differently depending on who the lender is:

A. Banks and BSP-supervised institutions

Banks and many financial institutions operate under BSP supervision and consumer rules. Even where pricing is contractual, the BSP’s consumer protection regime, disclosure standards, and product-specific rules (e.g., credit cards) can shape what is permissible.

B. Lending and financing companies (SEC-regulated)

SEC-registered lending and financing companies are governed by statutes such as the Lending Company Regulation Act of 2007 (RA 9474) and the Financing Company Act (RA 8556, as amended), plus SEC rules. In recent years, the SEC has issued detailed rules and enforcement actions addressing excessive interest/fees and abusive penalty practices, especially in consumer and digital lending. Where such sectoral rules apply, a “daily penalty” may be invalid administratively even if a Civil Code analysis might otherwise treat it as a contractual penalty.

C. Informal / private lenders (individual-to-individual)

Private loans are primarily governed by the Civil Code. Even then:

Interest must still be in writing to be collected as interest (Art. 1956),
Penalties remain reducible (Art. 1229),
Abusive terms can be struck down on public policy and equity grounds.

10) Attorney’s fees and “collection fees” are not automatic windfalls

Many lenders add “collection fees” upon default. Philippine law allows attorney’s fees in certain circumstances (Civil Code Art. 2208), including when stipulated—but courts commonly reduce attorney’s fees that are unreasonable, unconscionable, or not supported by the circumstances.

A contract clause like “25% attorney’s fees plus daily penalty plus default interest” is not automatically collectible in full; it is reviewable.

11) Practical legality checklist for daily penalties (Philippine context)

A daily penalty is more likely to be upheld (or at least partially enforced) when:

Clear written stipulation exists (rate, base amount, start date, computation method).
It is properly disclosed as part of the cost of credit (especially for consumers).
The penalty is tied to a reasonable rationale (risk, administrative cost, collection cost) and is not purely punitive.
There is no improper compounding or hidden “interest-on-interest” without contractual/legal basis.
The total charges (interest + penalties + fees) are not grossly disproportionate to the principal.
The lender complies with regulator rules applicable to its license/type.

A daily penalty is more likely to be reduced or disallowed when:

It produces an extreme effective annual rate and overwhelms the principal quickly.
It is stacked with multiple overlapping charges (double or triple recovery in substance).
It was not clearly disclosed, or appears in fine print, or is ambiguous.
It is imposed even when the borrower is not properly in default under the contract/law.
It is used in a way that courts see as iniquitous/unconscionable (Art. 1229), or abusive (Arts. 19–21, 24).

12) Illustrative computation (why “per day” can become legally risky)

Suppose a loan has ₱50,000 overdue principal and a “penalty” of 0.5% per day on the overdue amount.

0.5% of ₱50,000 = ₱250/day
In 30 days: ₱250 × 30 = ₱7,500 penalty (15% of principal in one month)
In 180 days: ₱45,000 penalty (90% of principal)

Even before adding regular/default interest and fees, the penalty alone can approach principal—an outcome courts may view as punitive rather than compensatory, making Art. 1229 reduction a realistic possibility.

13) Key legal sources (Philippines)

Civil Code of the Philippines

Art. 1169 (delay / default)
Arts. 1226–1230 (penalty clauses; Art. 1229 on reduction)
Art. 1306 (freedom to contract within limits)
Art. 1956 (interest must be expressly stipulated in writing)
Art. 2209 (interest as damages for delay)
Art. 2212 (interest on interest from judicial demand, subject to rules)
Art. 2208 (attorney’s fees as damages, subject to standards)

Statutes

RA 3765 (Truth in Lending Act)
RA 9474 (Lending Company Regulation Act of 2007)
RA 8556 (Financing Company Act, as amended)
RA 11765 (Financial Products and Services Consumer Protection Act)

Selected jurisprudence often cited in disputes on excessive interest/penalties

Medel v. Court of Appeals (1998) (unconscionable interest reduced)
Nacar v. Gallery Frames (2013) (structure of legal interest in judgments; recognizes the shift to 6% p.a. legal interest effective July 1, 2013 in accordance with BSP policy)