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Are Stipulated Interest Rates Inherently Unconscionable?: PABALAN v SABNANI


Sabnani obtained a short-term loan from Pabalan amounting to P7.45 Million. As securities for the loan, he executed two Promissory Notes (PN) and a Deed of Real Estate Mortgage (REM) over his condominium unit at the Skyland Plaza Condominium in Makati City. The First PN indicated that the loan amount is P1.45M, with 8% interest per month, payable within three months. Meanwhile, the second PN indicated a principal loan amount of P6M, with 5% interest per month, payable within three months. 

The PNs had provisions on the consequences of default, summarized as follows:

  • If the stipulated interest was not paid when due, Sabnani would be required to pay 20% interest per month on the outstanding principal loan. 
  • If the case is referred to an attorney for collection or legal action, Sabnani will pay:
    • Additional Interest Penalty = 20% per month on total unpaid principal, accrued interest, and penalty;
    • Liquidated Damages = 50% of total unpaid principal, accrued interest, and penalty
    • Attorney’s Fees = 25% of total unpaid principal, accrued interest, and penalty
    • Other costs of expenses and litigation.

The REM reiterated payment terms in the PNs and gave Pabalan the right to foreclose the property in case of default. It also had an acceleration clause stating that such failure to pay any amounts due would render the entire obligation immediately due and demandable. 

Sabnani failed to pay one installment and a demand letter was sent to him, asking him to pay the total amount of P8.9M which consisted of the P7.45M principal loan and interest and penalty charges of P1.49M.

When Sabnani failed to pay again, Pabalan filed an application for the extrajudicial foreclosure of the mortgaged property with the Office of the Clerk of Court and Ex-Officio Sheriff of the RTC of Makati. Sabnani thus tried to annul the REM, PNs, and Notice of Sale, with prayer for Temporary Restraining Order (TRO), Preliminary Injunction (PI), and Damages. Pabalan asserted her right to foreclose the mortgage under the Deed they agreed upon.

Prayers for TRO and PI were denied since Sabnani would not suffer any substantial injury considering that he could still participate in the public bidding or redeem his property within a year.  Sabnani filed an amended complaint praying for the same reliefs, and additionally claimed that Pabalan made unauthorized deductions on the loan amounting to approximately 1M. He also argued that the rates of interest, penalty charges, and other fees imposed in the REM and PNs were illegal, excessive, exorbitant, and unconscionable, and should be voided. 

RTC and CA Rulings

The RTC upheld the validity of the REM, PNs, and the foreclosure sale, rejecting the contention on the deductions as the same is negated by his signature on a Receipt acknowledging that he received the entire amount of the loan despite the deductions being reflected. It further held as to the interest charges that the usury law was no longer in force and that parties can freely impose interest rates as they may agree upon.

Meanwhile, the CA upheld the ruling of the RTC, but modified the rates of interest to 1% per month, and the liquidated damages and attorney’s fees to 10% each. Thus, Pabalan filed a Petition for Review on Certiorari with the Supreme Court.


Are the stipulated rates of interest, penalty charges, liquidated damages, and attorney’s fees under the Promissory Note and the Deed of Real Estate Mortgage agreed by the parties unconscionable?

Ruling of the SC 

The SC granted Pabalan’s Petition and upheld the interest rates, penalty charges, liquidated damages, and attorney’s fees agreed upon. 

While Central Bank Circular No. 905 s. 1982 suspended the Usury Law and has granted contracting parties wide latitude to stipulate interest rates, the SC has previously held that freedom to contract is not absolute and has cautioned that lenders do not have the “carte blanche authority to raise interest rates to levels which will either enslave their borrowers or lead to a hemorrhaging of their assets” and thus has the discretionary power to intervene in certain cases and reduce stipulated interest rates that are found to be unconscionable, iniquitous, and illegal.

However, stipulated interest rates are not inherently conscionable or unconscionable. These interest rates may be deemed unconscionable only “in light of the context in which they were imposed or applied”.

The Supreme Court, quoting Vitug v. Abuda, held: “The freedom to stipulate interest rates is granted under the assumption that we have a perfectly competitive market for loans where a borrower has many options from whom to borrow. It assumes that parties are on equal footing during bargaining and that neither of the parties has a relatively greater bargaining power to command a higher or lower interest rate. It assumes that the parties are equally in control of the interest rate and equally have options to accept or deny the other party’s proposals. In other words, the freedom is granted based on the premise that parties arrive at interest rates that they are willing but are not compelled to take either by force of another person or by force of circumstances.”

However, these premises are not always true and only in such cases should the Court step in to correct market imperfections resulting from unequal bargaining positions of the parties. 

Even in the landmark case of Lara’s Gifts and Decors Inc. v. Midtown Industrial Sales, it was recognized in the ponencia of Senior Associate Justice Marvic M. V .F. Leonen that the standard used in determining the conscionability of a conventional interest rate is twice the legal rate of interest. BUT if the stipulated interest rate is higher than this standard, the creditor has the burden to prove that this was necessary under market conditions or show that the parties stood on equal footing when they agreed on it. 

It bears stressing that the new rules on conventional and compensatory interest rates established in Lara’s Gifts will not apply here considering that Pabalan sufficiently discharged her burden to prove that she and Sabnani were on equal footing when they reached their agreement. No greater interest of justice or equity would be served if the Court intervened.

The determination of whether or not the parties stood on equal footing is necessarily done on a case-to-case basis after careful consideration of relevant factors.

The Court shall examine the parties’ respective backgrounds and personal circumstances. It must compare the parties to verify if one of them was possibly disadvantaged due to moral dependence, mental weakness, tender age, or other handicap, to warrant protection.

The history and relationship of the contracting parties could likewise be significant. The Court can look into how they were acquainted or if they had previously entered in similar or other transactions. Does the agreement involve an isolated transaction or was it part of a bigger series of agreements or a mere continuation of past agreements?

It must also be wary of external factors that could have compelled either party to enter into the agreement. There should have been no undue pressure or exigent circumstances that affected the voluntariness of the parties’ decision-making process. The Court must ultimately satisfy itself that an agreement was reached which both parties were willing to freely accept and not because they were compelled to do so by reason of force from another person or force of circumstances.

If the Court determines that the agreement was voluntarily agreed upon by all parties who stood on equal footing, it must refrain from intervening out of respect for their civil right to contract. It must be remembered that what may ostensibly seem iniquitous and unconscionable in one case, may be totally just and equitable in another. This is also in adherence to the fundamental principle that obligations arising from contracts have the force of law between the parties and must be complied with in good faith.

Being an experienced businessman, Sabnani’s claim that he was not fully aware of the terms of the REM and PNs, becomes highly doubtful. There is also a presumption that a person takes ordinary care of his/her concerns and would not sign any document without knowing its contents and consequences.

The factual context and background of the parties’ transaction showed that neither Sabnani nor Pabalan was compelled to enter into it. There was no proof that Sabnani was under any external or undue pressure to obtain the loan from Pabalan and execute the REM and PNs in her favor. He did not do it out of dire necessity, nor was he under any financial distress. The money loaned was not necessary for his subsistence or to meet urgent contingencies. He could have easily declined the terms under the REM and PNs and obtained a loan from somebody else. However, he did not do so and voluntarily agreed to these.

Sabnani voluntarily agreed to the terms of the loan since he had legitimate business reasons and benefited from it. In reality, he made business on the amount loaned. The loan was part of a bigger series of transactions which he considered in total beneficial for him to expand his business.

Sabnani benefitted from the loan and can no longer be permitted to assail its validity. He consistently asserted that the loan proceeds would be used as an investment in one of his projects in the Philippines. It is a general principle in equity that a party who has validly executed a contract and availed of its benefits cannot escape their contractual obligations by seeking to invalidate it.

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