Usury Under Scrutiny: How the Supreme Court Uncovers Hidden Interest in Loan Agreements

A loan can look perfectly lawful on paper and still be usurious. In First Metro Investment Corporation v. Este del Sol Mountain Reserve, Inc. (G.R. No. 141811, November 15, 2001), the Supreme Court affirmed that fees dressed up as underwriting, supervision, and consultancy charges were in truth devices to conceal excessive interest — and that borrowers can recover what they paid under such schemes.

The loan and the side agreements

On January 31, 1978, First Metro Investment Corporation (FMIC) lent Este del Sol Mountain Reserve, Inc. P7,385,500.00 to develop a sports and resort complex in Montalban, Rizal. Interest was set at 16% per annum on a diminishing balance, payable over 36 monthly amortizations.

On the same day, the parties signed an Underwriting Agreement and a Consultancy Agreement. These required Este del Sol to pay a one-time underwriting fee of P200,000.00, an annual supervision fee of P200,000.00 for four years, and a consultancy fee of P332,500.00 per annum for four years. The Loan Agreement itself made the underwriting agreement a condition for releasing the loan.

FMIC billed these fees on February 22, 1978 — the same occasion as the first partial release of P2,382,500.00 — and deducted P1,730,000.00 from the loan proceeds. In effect, part of the money lent went straight back to the lender as fees.

Default, foreclosure, and the collection suit

Este del Sol fell behind on its revised amortization schedule. By FMIC's own statement of account dated June 23, 1980, the total obligation had ballooned to P12,679,630.98, reflecting a one-time 20% penalty, past-due interest at 19% and later 21% per annum, and other charges. FMIC foreclosed the real estate mortgage extrajudicially and was the highest bidder at P9,000,000.00. After deducting publication, sheriff's, and attorney's fees, a deficiency of P6,863,297.73 remained.

FMIC sued Este del Sol and its individual sureties to collect that deficiency plus 21% interest and 25% attorney's fees. The trial court ruled for FMIC, but the Court of Appeals reversed — finding the fees were subterfuges for usurious interest and the penalties unconscionable.

Why the Court upheld the finding of usury

FMIC argued that Central Bank Circular No. 905, which removed interest ceilings effective January 1, 1983, should apply retroactively. The Supreme Court rejected this. The law in force when the contract was made governs it, and a Central Bank circular cannot repeal the Usury Law — only a law can repeal another law.

The Court also affirmed that courts are not bound by the legal form of a contract. Parol evidence is admissible to show that a written document, though legal in form, was a device to cover usury. Several circumstances gave FMIC away:

• The Underwriting and Consultancy Agreements were dated the same day as the Loan Agreement, and the four-year fee period coincided with the loan term.
• The Loan Agreement made the underwriting agreement a condition precedent to the loan.
• Este del Sol was billed P1,330,000.00 in consultancy fees even though the Consultancy Agreement provided only P332,500.00 per annum.
• The fees were deducted from the first loan release, returning P1,730,000.00 to FMIC.
• FMIC never organized an underwriting syndicate and did not perform the consultancy services.

Article 1957 of the Civil Code is explicit: contracts and stipulations, under any cloak or device whatever, intended to circumvent the laws against usury are void. But only the usurious interest stipulation is void — the principal debt remains valid. Borrowers may recover amounts paid as usurious interest because such payment is deemed made under restraint, not voluntarily.

Excessive penalties and attorney's fees

The Court also upheld the reduction of the stipulated charges. Article 1229 allows a judge to equitably reduce a penalty when the principal obligation has been partly or irregularly complied with, or when the penalty is iniquitous or unconscionable. Article 2227 allows the same for liquidated damages. Attorney's fees stipulated in penal clauses are treated as liquidated damages and may be reduced if unconscionable. The Court found the 25% attorney's fees — P3,168,666.75 — manifestly exorbitant, and affirmed the appellate court's reduction to 10%.

The net result: FMIC was ordered to reimburse Este del Sol P971,000.00, the difference between the usurious fees collected and the reduced deficiency.

Practical takeaways

• Substance prevails over form. Courts will look beyond the labels of side agreements to see whether they are genuinely separate transactions or disguised interest.
• Simultaneous agreements are a red flag. Fees imposed on the same day as the loan, tied to the loan term, and deducted from loan proceeds invite scrutiny.
• Fees for services never rendered are recoverable. A borrower may recover amounts paid as usurious interest, since the payment is considered made under restraint.
• Only the interest stipulation is void. The principal loan remains valid and enforceable even if the usurious interest is annulled.
• Penalties and attorney's fees can be reduced. Courts may equitably reduce iniquitous or unconscionable penalties and liquidated damages under Articles 1229 and 2227 of the Civil Code.

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