While the parties to a loan agreement may depart from the legal interest rate, any deviation therefrom must be reasonable and fair.

This was the ruling of the Supreme Court’s Second Division, through Associate Justice Mario V. Lopez, denying the petition for review on certiorari filed by Manila Credit Corporation (MCC). The petition challenged the rulings of the Court of Appeals (CA) which had affirmed the judgment of the Regional Trial Court (RTC) declaring the interest rates imposed by MCC on Ramon S. Viroomal (Ramon) and Anita S. Viroomal (collectively, Spouses Viroomal) void for being patently exorbitant and unconscionable.

Spouses Viroomal obtained a loan from MCC in 2009 under Promissory Note No. 7155 (PN 7155) in the amount of PhP467,600 payable in 60 months, with an interest rate of 23.36% per annum and secured by a real estate mortgage over Ramon’s property in Parañaque City.

They later requested a loan restructuring, resulting in the execution of a second promissory note, Promissory Note No. 8351 (PN 8351), in the amount of PhP495,840 payable in 84 months at 24.99% interest per annum. The restructured amount represents the unpaid balance in PN 7155, including interests and penalty charges.

When Spouses Viroomal failed to make timely authorizations, MCC demanded full payment of the outstanding obligation of PhP549,029.69 as of October 15, 2016. The spouses, however, claimed they had already paid a total of PhP1,175,638.12 and thus asked for a recomputation, but was ignored by MCC.

MCC then proceeded with the extrajudicial foreclosure of the real estate mortgage, prompting Spouses Viroomal to file a complaint with the RTC for the declaration of nullity of real estate mortgage as well as of the interest rate and other charges for being unconscionable, iniquitous, and immoral. The spouses argued that their loan obligation was already fully paid, had they not been burdened with the 36% per annum effective interest rate (EIR) and other charges which they claim were surreptitiously imposed by MCC.

Meanwhile, MCC was declared the highest bidder in the foreclosure sale, and, upon the lapse of the redemption period, the title over the mortgaged property was consolidated in MCC’s name.

The RTC subsequently rendered a Decision in favor of Spouses Viroomal, declaring void PN 8351 and the interests compounded by MCC in PN 7155 for being grossly excessive. The spouses were thus allowed to recover from MCC overpayment in the amount of PhP417,859.58. The RTC also ordered the title in the name of MCC cancelled, and Ramon’s title reinstated.

The RTC was affirmed by the CA, hence the recourse of MCC to the Court.

In resolving MCC’s petition, the Court stressed that while parties to a contract are free to agree on stipulations, clauses, terms, and conditions as they may deem convenient, these must not be contrary to law, morals, good customs, public order, or public policy.

Further, under Article 1409 of the Civil Code, such contracts contrary to morals are inexistent and void from the beginning.

In loan agreements, in particular, while the contracting parties may depart from the legal interest rate, any deviation therefrom must be reasonable and fair. “If the stipulated interest for a loan is more than twice the prevailing legal rate of interest, it is for the creditor to prove that this rate is justified under the prevailing market conditions,” held the Court.

The Court added that while Central Bank of the Philippines Circular No. 905-82 has effectively removed the interest ceilings prescribed under the Usury Law, lenders may not impose interest rates that would “enslave borrowers or hemorrhage their assets.”

Reiterating its 2021 ruling in Megalopolis Properties, Inc. v. D’Nhew Lending Corporation, the Court held that while there is no “numerical limit on conscionability, the rate of 3% per month or 36% per annum is three times more than the 12% legal interest rate, and therefore excessive and unconscionable.”

The Court added that the “willingness of the debtor in assuming an unconscionable rate of interest is inconsequential to its validity.”

Applying the foregoing to the present case, the Court ruled that the 3% per month or 36% per annum EIR imposed by MCC on Spouses Viroomal cannot be considered reasonable. “It is unacceptable particularly in this case where the EIR was charged on top of the stipulated 23.36% per annum monetary interest and the penalties of 1/10 of 1% per day and 1.5% per month, compounded monthly…MCC’s scheme exponentially bloated the principal loan amount of PhP467,000,” misleading the spouses into continuously paying on the belief that their balance was increasing because of several delayed payments.

The Court likewise found excessive the stipulated interest rate of 23.36% per annum and the additional 1/10 of 1% per day and 1.5% per month penalty under PN 7155, which, all compounded monthly is 42% per annum. Such unconscionable interest rate is thus nullified and deemed not written in the contract of loan.

As the Court is empowered to equitably reduce the penalties charged to Spouses Viroomal, especially considering the substantial payments already made, the Court ordered the reduction of the stipulated interest rates and penalties to the applicable 12% per annum legal interest.

The Court noted, however, that as the obligation to pay the principal is separate from the void interest and charges, the contract of loan between MCC and Spouses Viroomal still subsists, with only the EIR and the stipulated interest rates and penalties declared void.

As to the validity of the second promissory note, the Court held that the same should be nullified for lack of consideration as it was only executed by the spouses to cover the supposed “unpaid balance” in PN 7155. The Court also modified the amount of overpayment to cover not only the payments made in PN 8351 but overpayments in PN 7155 amounting to PhP203,532.47, with legal interest of 6% per annum from the date of filing of the complaint, until finality.

Finally, the Court ruled that the foreclosure of the real estate mortgage should likewise be nullified as the principal obligation by Spouses Viroomal had already been extinguished by their full payment, automatically terminating the real estate mortgage. The title issued in the name of MCC is thus also void, and the title in the name of Ramon properly reinstated.  (Courtesy of the Supreme Court Public Information Office)

Full text of G.R. No. 258526 (Manila Credit Corporation v. Viroomal, January 11, 2023) at: https://sc.judiciary.gov.ph/258526-manila-credit-corporation-vs-ramon-s-viroomal-and-anita-s-viroomal-office-of-the-clerk-of-court-and-ex-officio-sheriff-of-the-regional-trial-court-of-paranaque-city-as-represented-by-atty/