Mutuality of Contracts: Banks Cannot Unilaterally Raise Interest Rates Without Borrower Consent

The principle of mutuality of contracts stands as a cornerstone of Philippine civil law, ensuring that no party to a contract can unilaterally change its terms. In the 2016 case of Spouses Jonsay v. Solidbank Corporation (G.R. No. 206459), the Supreme Court reaffirmed this principle in the context of banking loans, ruling that a bank cannot unilaterally increase interest rates without the borrower's consent.

The case arose from loans obtained by Momarco Import Co., Inc. from Solidbank in 1995 and 1997, totaling P60 million. The loans were secured by a real estate mortgage over three parcels of land in Calamba City owned by the Spouses Jonsay. The promissory note stipulated an interest rate of 18.75% per annum, but contained an escalation clause that allowed Solidbank to increase the rate based on Central Bank-declared interest rates. Through this clause, Solidbank unilaterally raised the interest rate to as high as 30% per annum.

When Momarco defaulted on its payments due to business reverses from the 1997 Asian financial crisis, Solidbank extrajudicially foreclosed on the mortgaged properties. The petitioners challenged the foreclosure, arguing that the interest rate increases were illegal and that the foreclosure proceedings were defective.

The Escalation Clause and Mutuality of Contracts

The central issue before the Supreme Court was whether the escalation clause in the promissory note, which allowed Solidbank to unilaterally increase interest rates without prior notice to or consent of the borrowers, was valid.

The Court ruled that such a clause is void for violating the principle of mutuality of contracts embodied in Article 1308 of the Civil Code. This principle requires that contracts must bind both contracting parties, and its fulfillment cannot be left to the will of one of them.

Citing prior jurisprudence, the Court emphasized that while escalation clauses are valid in maintaining fiscal stability and retaining the value of money on long-term contracts, giving a bank an unbridled right to adjust interest independently and upwardly would completely take away from the borrower the right to assent to an important modification in their agreement. This negates the element of mutuality in contracts.

The Court also noted that the pro forma promissory note had the character of a contract of adhesion, where the parties do not bargain on equal footing, with the debtor's participation being reduced to the alternative "to take it or leave it."

Interest Rate Reduction to Legal Rate

Having found the unilateral increases void, the Court affirmed the reduction of the interest rate on the petitioners' indebtedness to the legal rate of 12% per annum. This was consistent with the Court's ruling that rates found to be iniquitous or unconscionable are void, as if there were no express contract thereon.

The Court cited the principle that while the Usury Law ceiling on interest rates was lifted by Central Bank Circular No. 905, nothing in that circular grants lenders carte blanche authority to raise interest rates to levels that would either enslave their borrowers or lead to a hemorrhaging of their assets.

Foreclosure Proceedings and Presumption of Regularity

On the issue of the foreclosure proceedings, the Court held that foreclosure proceedings enjoy the presumption of regularity, and the mortgagor who alleges the absence of a requisite has the burden of proving such fact. In this case, the petitioners failed to present sufficient evidence to overcome this presumption regarding the publication of the notice of auction sale.

The Court noted that the newspaper that published the notice had been accredited by the Regional Trial Court to publish legal notices, and the selection of the newspaper was through a court-supervised raffle. The petitioners' bare testimonial allegations that the newspaper was not of general circulation were insufficient to rebut the presumption of regularity.

Dacion en Pago Does Not Novate the Mortgage

The Court also addressed the petitioners' argument that they had offered to settle their obligation through dacion en pago. Citing Tecnogas Philippines Manufacturing Corporation v. Philippine National Bank, the Court ruled that an unaccepted proposal to pay by way of dacion en pago neither novates the mortgage contract nor suspends its execution. There was no meeting of the minds between the parties on whether the loan would be extinguished by way of dacion en pago. Upon default, foreclosure of the mortgage becomes a matter of right on the part of the bank.

Practical Takeaways

• Banks cannot unilaterally change loan terms. Any increase in interest rates must be agreed upon by both parties. A clause that gives a bank the unbridled right to adjust interest rates independently is void for violating mutuality of contracts under Article 1308 of the Civil Code.
• Excessive interest rates may be reduced by courts. When interest rates are found to be iniquitous, unconscionable, or exorbitant, courts have the authority to reduce them equitably, often to the legal rate of 12% per annum.
• Foreclosure proceedings enjoy a presumption of regularity. Borrowers challenging a foreclosure must present clear and convincing evidence of irregularities, such as defective publication of the auction notice.
• An unaccepted dacion en pago offer does not stop foreclosure. A mere proposal to settle a debt by transferring property to the bank has no legal effect unless the bank accepts it.
• Contracts of adhesion are scrutinized strictly against the party that prepared them. Courts will not enforce one-sided provisions that leave the fulfillment of the contract to the uncontrolled will of one party.

This article is general information and not legal advice. For your specific situation, consult a lawyer or ask ASG Legal AI.