Extinguishment; Compensation (2008)

No. XV. Eduardo was granted a loan by XYZ Bank for the purpose of improving a
building which XYZ leased from him. Eduardo, executed the promissory note ("PN") in favor
of the bank, with his friend Recardo as co-signatory. In the PN, they both
acknowledged that they are "individually and collectively" liable and waived the need for
prior demand. To secure the PN, Recardo executed a real estate mortgage on his own
property. When Eduardo defaulted on the PN, XYZ stopped payment of rentals on the
building on the ground that legal compensation had set in. Since there was still a balance
due on the PN after applying the rentals, XYZ foreclosed the real estate mortgage over
Recardo's property. Recardo opposed the foreclosure on the ground that he is only a co-
signatory; that no demand was made upon him for payment, and assuming he is liable,
his liability should not go beyond half the balance of the loan. Further, Recardo said
that when the bank invoked compensation between the reantals and the amount of
the loan, it amounted to a new contract or novation, and had the effect of extinguishing
the security since he did not give his consent (as owner of the property under the real estate
mortgage) thereto.

(A). Can XYZ Bank validly assert legal compensation? (2%)

SUGGESTED ANSWER: Yes, XYZ Bank can validly assert legal compensation. In the
present case, all of the elements of legal compensation are present: (1) XYZ Bank is
the creditor of Eduardo while Eduardo is the lessor of XYZ Bank; (2) both debts consist
in a sum of money, or if the things due are consumable, they be of the same kind, and
also of the same quality if the latter has been stated; (3) the two debts be due; (4) they
be liquidated and demandable, and (5) over neither of them there be any retention or
controversy, commenced by third persons and communicated in due time to the debtor
(Art. 1279, Civil Code).

(B). Can Recardo's property be foreclosed to pay the full balance of the loan? (2%)

SUGGESTED ANSWER: Yes, Recardo's property can be foreclosed to pay the full
balance of the loan because when he signed as co-signatory in the promissory note,
he acknowledged he is solidarily liable with Eduardo. In solidary obligations, a
creditor has the right to demand full payment of the obligation from any of the
solidary debtors (Art. 1207, Civil Code).

(C). Does Recardo have basis under the Civil Code for claiming that the original
contract was novated? (2%)

SUGGESTED ANSWER: No. Recardo has no basis for claiming novation of the
original contract when the bank invoked compensation because there was simply
partial compensation (Art. 1290, Civil Code) and this would not bar the bank from
recovering the remaining balance of the obligation.

ALTERNATIVE ANSWER: No. In order that an obligation may be extinguished by

another, it is imperative that it be so declared in unequivocal terms, or that the old
and new obligations be on every point compatible with each other. Novation is never
presumed (Art. 1292, Civil Code).
Rescission of Contract; Fortuitous Event (2008)

No.XVIII. AB Corp. entered into a contract with XY Corp. whereby the former agreed to
construct the research and laboratory facilities of the latter. Under the terms of the contract,
AB Corp. agreed to complete the facility in 18 months, at the total contract price of P10
million. XY Corp. paid 50% of the total contract price, the balance to be paid upon
completion of the work. The work stated immediately, but AB Corp. later experienced work
slippage because of labor unrest in his company. AB Corp.'s employees claimed that
they are not being paid on time; hence, the work slowdown. As of the 17th month, work
was only 45% completed. AB Corp. asked for extension of time, claiming that its labor
problems is a case of fortuitous event, but this was denied by XY Corp. When it became
certain that the contruction could not be finished on time, XY Corp. sent written notice
cancelling the contract, and requiring AB Corp. to immediately vacate the premises.

(A). Can the labor unrest be considered a fortuitous event? (1%)

SUGGESTED ANSWER: No. The labor unrest cannot be considered a fortuitous

event under Art. 1174 of the Civil Code. A fortuitous event should occur independent
of the will of the debtor or without his participation or aggravation (Paras, Civil Code
Annotated, vol. IV, 2000 ed., p 159). As mentioned in the facts, labor unrest of the
employees was caused by AB Corp.'s failure to pay its employees on time.

(B). Can XY Corp. unilaterrally and immediately cancel the contract? (2%)

SUGGESTED ANSWER: No, XY Corp. cannot unilaterally and immediately cancel

the contract. In the absence of any stipulation for automatic rescission, rescission
must be judicial (Art. 1191, Civil Code).

(C). Must AB Corp. return the 50% downpayment? (2%)

SUGGESTED ANSWER: AB Corp. need not return the 50% down payment because
45% of the work was already completed, otherwise, XY Corp. would be unjustly
enriching itself at the expense of AB Corp.