Special Modes of Payment Under the Philippine Civil Code: Dation in Payment, Cession, Compensation, and Novation

Philippine context; practitioner-oriented guide with black-letter rules, doctrinal notes, and practical tips.

Overview

Beyond the ordinary rule that “payment” means delivery of money or performance of the thing owed, the Civil Code recognizes special modes of extinguishing obligations that parties and courts regularly use to unwind debt relationships:

Dation in payment (dación en pago) — the debtor transfers ownership of property to the creditor as payment.
Cession (assignment of property to creditors) — an insolvent debtor assigns all or substantially all of their property to several creditors for liquidation and distribution.
Compensation (set-off) — mutual obligations extinguish each other by operation of law (or by agreement), to the concurrent amount.
Novation — a new obligation replaces or modifies an old one (change in object/terms, substitution of debtor, or subrogation).

These appear in Book IV of the Civil Code (Obligations and Contracts), typically around:

Dation: Art. 1245
Cession: Art. 1255
Compensation: Arts. 1278–1290s
Novation & Subrogation: Arts. 1291–1304

(Article numbers are provided for orientation; always consult the official text for verbatim language.)

1) Dation in Payment (Dación en Pago)

Essence

A mode of payment where the debtor conveys ownership of a thing (movable or immovable) to the creditor with the creditor’s acceptance, in satisfaction of an existing debt. Juridically akin to a sale whose cause on the debtor’s side is the extinguishment of the obligation rather than price.

Requisites

A pre-existing debt that is due.
Agreement to extinguish the debt by delivering a specific thing or right.
Transfer of ownership (not mere possession), typically by tradition or registration (for land/condos, annotation and issuance of new title).
Acceptance by the creditor (dation is never unilateral).

Effects

The obligation is extinguished to the extent of the thing’s agreed value (or, absent agreement, fair market value) at the time of delivery. If the agreed value equals the debt, full extinguishment; if less, only pro tanto (the balance remains due unless otherwise stipulated).
Warranties: By default, the debtor warrants title and freedom from hidden defects as in a sale, unless waived.

Distinguish From

Payment in kind: performance of the very thing due. In dation, the thing is a substitute for money/performance originally owed.
Datio ad solvendi causa vs. datio pro solvendo: the mainstream civil-law understanding is that dation is in satisfaction (solutoria). If the creditor merely receives property to sell and apply proceeds, you’re closer to cession or assignment for collection.

Practical & Tax Notes (Philippine context)

Real property: requires a notarized deed (e.g., “Deed of Dación en Pago”), BIR clearance (CGT/creditable withholding, documentary stamp tax, etc.), and Register of Deeds registration to transfer title.
Corporate approvals: If a corporation is debtor or creditor, ensure board approval and related-party safeguards.
Valuation: State an explicit valuation and whether the dation is full or partial satisfaction, to avoid later disputes.

Sample Clause (short-form)

“Debtor hereby conveys and transfers, and Creditor accepts, the Property described in Annex A by way of dación en pago, for the full satisfaction of the Obligation described in Annex B. The parties agree the Property’s value is ₱__, inclusive of all improvements, and that upon registration Creditor shall be the absolute owner, free from all liens except as disclosed in Annex C.”

2) Cession (Assignment of Property to Creditors)

Essence

An insolvent debtor assigns all or substantially all of their property to all creditors so the assets can be liquidated and proceeds distributed pro rata. It is collective and liquidating, not a transfer of ownership to each creditor at once.

Requisites

Plurality of creditors.
Insolvency or general inability to pay debts as they fall due.
Assignment of all or nearly all non-exempt property to the body of creditors.
Acceptance (express or implied per governing terms). Often formalized through a notarial deed and a liquidation framework.

Effects

The debtor is released only up to the net proceeds realized (unless creditors stipulate a full release).
Creditors receive no immediate ownership; they get the right to be paid from liquidation proceeds, respecting preferences (e.g., taxes, mortgagees, preferred credits).
Unlike dation, cessio contemplates several creditors and a global transfer for liquidation.

Practical Interfaces

May be contractual (Civil Code) or occur within insolvency/rehabilitation proceedings (FRIA and related rules), which impose court supervision, creditor voting, and priority regimes.
Debtor keeps exempt property (e.g., family home within statutory limits, certain tools/necessaries).

Short-form Deed Elements

Recitals of insolvency; list of assets; list of creditors; distribution methodology; appointment of assignee/liquidator; treatment of secured claims; reservation of exempt property; reporting and final discharge mechanics.

3) Compensation (Set-Off)

Essence

When two persons are mutually debtor and creditor of each other, their obligations extinguish to the concurrent amount.

Types

Legal compensation — arises by operation of law when requisites are present.
Conventional (voluntary) — parties agree to set off, even if some legal requisites are lacking (e.g., unliquidated debts).
Judicial — court declares set-off in a case (e.g., counterclaims).
Facultative — one party may oppose compensation that would otherwise arise, because the law grants them a privilege to prevent it (e.g., when assignment rules or waivers apply).

Requisites for Legal Compensation (classic five)

Each party is principal debtor and principal creditor in their own right (not merely as guarantor, representative, or trustee).
Both debts are due and demandable.
Both debts consist in money or consumables of the same kind and quality.
Both debts are liquidated (determinable and certain) and enforceable.
No retention or controversy over either debt begun by third persons and communicated in due time (e.g., garnishment).

Effects

When requisites concur, compensation operates automatically and extinguishes both debts to the concurrent amount from the moment of concurrence (even if parties are unaware).
If amounts are unequal, the smaller is extinguished; the excess remains.

Important Limits & Special Rules

No legal compensation with obligations for support by gratuitous title, or debts arising from deposit or commodatum (public-policy protection of depositors/borrowers; the depositary/bailee must return the thing/money, not set it off).
No compensation against claims arising from a penal offense or other protected claims (civil liability ex delicto).
Solidary obligations: a creditor cannot be prejudiced by compensation between one solidary debtor and a third person, except per specific rules; a solidary debtor may set up compensation only up to his share, unless the credit in favor of the debtor is against the same creditor and qualifies for broader set-off.
Assignment of credits:
- If the debtor assented to the assignment without reservation, they cannot set up against the assignee the compensation they could have invoked against the assignor after the assignment.
- If the debtor was notified but did not assent, they may set up compensation for debts existing prior to the notice.
- If the debtor had no knowledge of the assignment, they may set up all compensable credits they had against the assignor before learning of the assignment.

Practical Tips

Always check for third-party claims (garnishments) that block legal compensation.
Use conventional compensation clauses to broaden set-off (e.g., allow set-off of unliquidated damages, future-dated receivables once due, cross-affiliate netting).
In litigation, plead compensation as an affirmative defense or counterclaim with supporting computations.

4) Novation

Essence

Novation is the extinguishment or modification of an obligation by the creation of a new one that is incompatible with or intended to replace the old.

Varieties

Objective (real) novation — change in object or principal conditions (e.g., from money debt to delivery of a specific car).
Subjective (personal) novation — substitution of the debtor (expromisión or delegación) or subrogation of a third person to the rights of the creditor.
Mixed novation — combination of objective and subjective changes.

Extinctive vs. Modificatory

Extinctive (proper) novation — the old obligation is entirely extinguished and replaced.
Modificatory — the old obligation survives but with altered terms. (True novation is not presumed; courts look for a clear animus novandi or absolute incompatibility.)

Requisites (for extinctive novation)

Previous valid obligation (void obligations cannot be novated; voidable ones can be novated if not yet annulled).
Agreement of parties concerned (including third parties when their rights are affected).
Animus novandi (clear intent to novate) or total incompatibility between old and new obligations.
Capacity and authority of parties.

Substitution of Debtor

Expromisión — a third person assumes the debt without the debtor’s initiative, with creditor’s consent; the original debtor is released, unless parties reserve subsidiarity.
Delegación — the debtor proposes a new debtor and the creditor accepts; original debtor is released, subject to warranties (e.g., solvency at the time of substitution, unless waived).

Subrogation (closely tied to novation)

Conventional subrogation — by agreement among creditor, debtor, and third person (or at least creditor and third person with debtor’s knowledge), transferring the former creditor’s rights (including securities, mortgages, guarantees, and priority) to the paying third person.
Legal subrogation — arises by operation of law in classic situations, e.g.:
- A second mortgagee/creditor pays a preferred creditor.
- A third person with an interest pays (e.g., a surety or co-debtor).
- A third person pays with the debtor’s approval in circumstances recognized by law.
Effect: The subrogee steps into the shoes of the original creditor, preserving accessories and securities unless expressly released.

Effects of Novation on Accessories and Third Parties

Accessories (pledges, mortgages, penalties) follow the principal in extinctive novation unless expressly preserved or incompatible.
Guarantors/sureties — released if their consent to novation is not obtained and the change prejudices them.
Third-party rights already acquired (e.g., assignees, pledgees) are respected unless they consent.

When Novation Fails

If the new obligation is void, novation does not take place, and the old obligation subsists (unless the parties clearly intended extinguishment regardless).
If the old obligation is void, novation cannot give it life; the new obligation may stand only if it has an independent cause.

Drafting Playbook

Use explicit language: “The parties hereby novate the Obligation under [agreement/date], which is extinguished and replaced by the following…”
Specify what survives (e.g., mortgages/guarantees) and what is released.
For debtor substitutions, identify expromisión vs. delegación; state warranties (solvency at substitution) and effective date.

Comparative Table

Feature	Dation in Payment	Cession	Compensation	Novation
Core idea	Property for payment	Global assignment for liquidation	Mutual set-off	Replace/modify obligation
Parties	Debtor–Creditor	Debtor–Multiple creditors	Mutual debtors/creditors	As required by change (old/new debtor, creditor)
Ownership transfer	Yes (to creditor)	No immediate (liquidation first)	N/A	Depends (new obligation may involve transfers)
Insolvency required	No	Yes/typically	No	No
Release extent	Agreed value of thing	Net proceeds (unless full release stipulated)	Concurrent amount	As defined (extinctive vs. modificatory)
Formality	As required by type of property (e.g., notarized deed, registration)	Notarial deed; liquidation scheme; may be court-supervised	None per se (legal); agreements/court for conventional/judicial	Written novation strongly advisable
Protects third parties?	Title formalities, liens survive unless cleared	Preferences & liens respected	Bars where third-party claims exist (e.g., garnishment)	Accessories preserved or released per terms

Illustrative Scenarios

Dation: A borrower owing ₱10M transfers a condo valued at ₱10M to the bank via dación en pago; mortgage is cancelled upon registration. If parties value it at ₱8M, only ₱8M is extinguished; ₱2M remains unless waived.
Cession: A business collapses; it assigns its equipment, receivables, and inventory to all creditors for liquidation. After expenses, net proceeds are prorated; balances may subsist unless the creditors grant a discharge.
Compensation: Supplier owes Distributor ₱1.2M for damaged goods; Distributor owes Supplier ₱1M for unpaid invoices. ₱1M compensates; Supplier still owes ₱200k (assuming both are due, liquidated, and no legal bar).
Novation: Lender agrees to replace a short-term cash loan with a 5-year amortizing facility, secured by real estate; the old obligation is extinguished and replaced, mortgage constituted to secure the new terms.

Checklist for Counsel

Dation

☐ Identify debt; ☐ describe property; ☐ valuation and whether full/partial satisfaction; ☐ representations & warranties; ☐ taxes; ☐ delivery/registration steps.

Cession

☐ Insolvency recital; ☐ full asset list; ☐ creditor list; ☐ liquidator; ☐ priority/secured treatment; ☐ exemptions; ☐ discharge terms; ☐ reporting.

Compensation

☐ Map mutual debts; ☐ confirm due/liquidated/enforceable; ☐ check bars (support, deposit, penal liabilities, garnishments); ☐ assignment notifications; ☐ document conventional set-off if requisites aren’t complete.

Novation

☐ State animus novandi; ☐ specify changes (object/terms/debtor/creditor); ☐ address accessories; ☐ guarantor/surety consent; ☐ allocate risks if new obligation fails.

Common Pitfalls

Treating cession like dation: In cession, creditors do not automatically become owners.
Assuming compensation always applies: it fails when one claim is unliquidated, not yet due, or statutorily protected (support, deposit, penal).
Silent novation: Courts do not presume novation; vague amendments may only modify terms, not extinguish the old obligation.
Ignoring taxes/fees on dation (BIR, DST, transfer taxes) or registration requirements—without which ownership does not pass (for registrable property).

Takeaways

Dation trades property for debt cancellation (sale-like, creditor must accept).
Cession is a collective liquidation device for insolvent debtors; release equals net proceeds unless agreed otherwise.
Compensation quietly cancels mutual money debts when the five requisites are present; know its exceptions.
Novation is a powerful remodel—use clear animus novandi and mind the effects on securities and third parties.

For actual transactions or litigation strategy, align the chosen mode with the parties’ goals, the asset/creditor landscape, and the procedural and tax environment, and draft with precision.