Unconscionable

Generally, courts are not at liberty to ignore the freedom of the parties to agree on such terms and conditions of a contract as they see fit provided they are not contrary to law, morals, public policy or good customs. But can the courts reduce to stipulated penalty in contract? This is the question raised in this case of Mr. De Leon.

The case involves a parcel of land with an area of 2,147 covered by TCT Nos. M-13166 and M-13167 over which an office building is erected. The property is being leased by farmers agricultural cooperative from the Land Bank of the Philippines for a monthly rent of P30,000. The lease contract is effective until December 31, 1995 after which the cooperative will have to surrender possession of the property. It was likewise stipulated in the lease contract that the cooperative shall pay a penalty of P5,000 per day in surrendering the possession of the property.

Prior to the expiration of the lease contract or on November 9, 1995, Mr de Leon acquired from the Land Bank the subject lands and building in an auction sale for P20,170,000. When the lease contract expired, Mr. De Leon as the new owner demanded that the cooperative vacate the leased premises and surrender its possession to him. The cooperative refused on the ground that it was at that time contesting Mr. De Leon’s acquisition of the property in an action for annulment of sale with damages for violation of its pre-emptive right to purchase the property.

So on February 23, 1995, Mr. De Leon filed an action for ejectment before the Metropolitan Trial Court (MTC). He asked, among others, for the imposition of the contractually stipulated penalty of P5,000 per day of delay in surrendering the possession of the property to him. After trial, the MTC decided in favor of Mr. De Leon and ordered the cooperative to vacate the premises, pay P5,000 penalty for every day of delay plus the rental of P30,000 per month from January 1996 until it vacates the property. This was affirmed in its entirety by the Regional Trial Court. But on further appeal to the Court of Appeals (CA), the penalty imposed for each day of delay was reduced from P5,000 to P1,000 per day.

Mr. De Leon questioned this decision of the CA. He contended that the CA had no authority to reduce the penalty awarded by the lower court, the same having been stipulated by the parties.

Was he correct?

No.

Under Article 1229 of the Civil Code, courts may equitably reduce a stipulated penalty if it is uniquitous or unconscionable, or if the principal obligation has been partly or irregularly complied with. The question of whether the penalty is reasonable or iniquitous is addressed to the sound discretion of the court and depends on several factors, including, but not limited to the following: the type, extent and purpose of the penalty, the nature of the obligation, the mode of breach and its consequences, the supervening realities, the standing and relationship of the parties.

In this case, as provided in the contract of lease, the stipulated penalty was pegged at P5,000 for every day of delay or P150,000 per month, a amount five times the monthly rent of P30,000. This penalty was not only exhorbitant but also unconscionable taking into account that the cooperative’s delay in surrendering the leased premises was because of a well-founded belief that its right of pre-emption to purchase the property has been violated. Considering further that the cooperative was collectively owned by farmers with limited resources, ordering it to pay a penalty of P150,000 per month on top of the monthly rent of P30,000 would seriously deplete its income and drive it to bankruptcy. Courts can temper the penalty charges after taking into account the debtor’s pitiful financial condition. So the CA did not commit any error in reducing the penalty from P5,000 a day to P1,000 ( Lo vs. CA et. Al. G.R. 14134 September 23, 2003).

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