Legal compensation (Article 1290)

Compensation is defined as a mode of extinguishing obligations whereby two persons in their capacity as principals are mutual debtors and creditors of each other with respect to equally liquidated and demandable obligations to which no retention or controversy has been timely commenced and communicated by third parties. The requisites therefor are provided under Article 1279 of the Civil Code which reads as follows:

Art. 1279. In order that compensation may be proper, it is necessary:
  1. That each one of the obligors be bound principally, and that he be at the same time a principal creditor of the other;
  2. That 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. That the two debts be due; 
  4. That they be liquidated and demandable; and
  5. That over neither of them there be any retention or controversy, commenced by third persons and communicated in due time to the debtor.
The rule on legal compensation is stated in Article 1290 of the Civil Code which provides that [w]hen all the requisites mentioned in Article 1279 are present, compensation takes effect by operation of law, and extinguishes both debts to the concurrent amount, even though the creditors and debtors are not aware of the compensation.”In the case of Union Bank v. DBP (G.R. No. 191555. January 20, 2014), Union Bank filed a motion to seek affirmation that legal compensation had taken place in order to effectively offset (a) its own obligation to return the funds it previously received from DBP as directed under the September 6, 2005 Writ of Execution with (b) DBP’s assumed obligations under the Assumption Agreement.

However, the Supreme Court said that legal compensation could not have taken place between these debts for the apparent reason that requisites 3 and 4 under Article 1279 of the Civil Code are not present. Since DBP’s assumed obligations to Union Bank for remittance of the lease payments are “contingent on the prior payment thereof by [FW] to DBP,” it cannot be said that both debts are due (requisite 3 of Article 1279 of the Civil Code). Also, any deficiency that DBP had to make up for the full satisfaction of the assumed obligations “cannot be determined until after the satisfaction of Foodmasters’ obligation to DBP.” In this regard, it cannot be concluded that the same debt had already been liquidated, and thereby became demandable (requisite 4 of Article 1279 of the Civil Code).

In fine, since requisites 3 and 4 of Article 1279 of the Civil Code have not concurred in this case of Union Bank v. DBP, no legal compensation could have taken place between the above-stated debts pursuant to Article 1290 of the Civil Code.