Chapter Three

Law On Contracts
The law of contracts is actually an integrated subject with the law of obligations. Thus, in
order for one to have a complete framework of study on this particular business law
subject, it is only proper that the law of obligations will be discussed ahead of the law of
contracts.

MEANING OF OBLIGATION
The term “obligation” comes from the latin word “obligare”, meaning to bind. The
civil code defines obligation as a juridical necessity to give, to do or not to do. Under this
definition, an obligation consists either in (a) giving, (b) doing, or (c) not doing
something.

EXAMPLE
Obligation to give. “A” entered into a contract with “B” whereby the former
bound himself to deliver to “B” a specific car on June 5, 2006.
Obligation to do. “A” and “B” entered into an agreement whereby the former
obliged himself to fix the car of “B”.
Obligation not to do. “A” and “B” signed a contract whereby the former bound
himself with “B” not to construct a fence on a land belonging to the latter for the period
of (5) years.

ESSENTIAL REQUISITES OF OBLIGATION

1. PASSIVE SUBJECT – THE DEBTOR OR OBLIGOR
2. ACTIVE SUBJECT – THE CREDITOR OR OBLIGE
3. OBJECT OR PRESENTATION – SUBJECT MATTER
4. JURIDICAL TIE, LEGAL TIE OF THE VINCULUM – EFFICIENT CAUSE
EXAMPLE
“X” promised to construct a condominium for “Y” for one million pesos by virtue of
contract signed by them.
- “X” is the passive subject who has the obligation/duty to construct.
- “Y” is the active subject who has the right to demand the fulfillment.
- “the construction of the condominium” is the object or the presentation.
- “the contract” is the juridical or legal tie that binds the parties to the obligation.

SOURCES OF OBLIGATIONS
Article 1157 of the New Civil Code provides that obligations arise from: Law, Contracts,
Quasi-contract, Acts or omissions punished by law, Quasi-delicts.

I. OBLIGATIONS DERIVED FROM LAW:

Obligations derived from law are not presumed. Only those expressly determined in this
code or in special laws are demandable and shall be regulated by the precepts of the law
which establishes them, and as to what has not foreseen by the provisions of the civil
code.
EXAMPLES: The obligation mandating every person to act with justice, give everyone
his due and observe honesty and good faith in the exercise of his rights and in the
performance of his duties.
II. OBLIGATIONS DERIVED FROM CONTRACTS:
Obligation arising from contracts have the force of law between the contracting parties
and should be complied with in good faith. While it is a truism that an agreement
between the parties has the force of law, the contract must however be valid and
enforceable and must not be contrary to law, morals, good customs, public order or
public policy.
EXAMPLES: “X” agrees to sell his car to “Y” and the latter agrees to buy the car of “X”
voluntarily. The agreement has the force of law. Thus, neither parties should violate the
terms and conditions of the contract for it is required by the law that the same must be
complied with in good faith.
III. OBLIGATIONS DERIVED FROM QUASI-CONTRACTS:
TWO KINDS OF QUASI-CONTRACTS
(a) Negotiorum gestio
(b) Solutio indebiti

(a) Negotiorum gestio- It is the voluntary management of the property or affairs of

another without the knowledge or consent of the other.
EXAMPLE: “A” went abroad with his family without leaving anybody to look after his
house. While abroad, a strong earthquake occurred resulting in the destruction of “A’s”
house. Because of the magnanimity of “B”, “A’s” neighbor, the house was repaired.
However, “B”, incurred some expenses. In this case, “A” is obliged to reimburse the
expenses of “B” in a legal relationship known as negotiorum gestio.

(b) Solutio indebiti- It is a juridical relation which takes place when something is
received when there is no right to demand and was unduly delivered through mistake.
The obligation to return it arises.
EXAMPLE: “A” owes “B” the sum of P2,000.00. “A” paid “B” the sum of P3,000.00 not
knowing that the former incurred only a debt amounting to P2,000.00. In this example,
“B” is duty-bound to return the excess of P1,000.00 based on the principle of solution
indebiti.

IV. OBLIGATIONS DERIVED FROM DELICTS OR CRIMES:

- Acts or omissions punished by the law are crimes or delicts. Under the law a person
who commits a criminal offense, such as murder, is obliged to pay for the injury thus
inflicted.
EXAMPLE: “A” boloed “B” resulting in the latter’s death. If “A” is found guilty thereof,
he is liable to indemnify the heirs of the deceased. This indemnification constitutes the
civil liability of the culprit.
V. OBLIGATIONS DERIVED FROM QUASI-DELICTS:
- Is an act or omission by one person which causes damage to another giving rise to the
obligation to pay for the damage done, there being fault, and there is no pre-existing
contractual relation between the parties.
EXAMPLE: A pedestrian who was hit by a speeding jeepney due to negligence may
claim damages by reason of quasi-delict or culpa aquiliana.

SCOPE OF QUASI-DELICTS
Whether punishable by law or not
Whether criminal or not criminal in character
Whether intentional or voluntary
Or negligent, which result in damage to another

PERSON LIABLE FOR DAMAGES ARISING FROM QUASI-DELICTS:

(a) The father and in case of his death or incapacity the mother, with respect to
damages caused by the minor children who live in their company.
(b) Guardians with respect to damages caused by the minor or incapacitated persons
who are under their authority and who live in their company.
(c) The owners and managers of an establishment or enterprise, with respect to
damage caused by their employees in the service of the branches in which the latter are
employed or on the occasion of their functions.
(d) Employers, with respect to damages caused by their employees and household
helpers acting within the scope of their assigned tasks, even though the former are not
engaged in any business or industry.
(e) The state when it acts through a special agent; but not when the damages has been
caused by their pupils and students or apprentices, so long as they remain in their
custody.
NATURE AND EFFECTS OF OBLIGATION
Article 1163 of the New Civil Code provides that, “Every person obliged to give
something is also obliged to take care of it with the proper diligence of a good father of
the family, unless the law or the stipulation of the parties requires another standard of
care”.

OBLIGATION TO GIVE A DETERMINATE THING

Under Article 1166 of the New Civil Code, the obligation to give a determinate
thing includes that of delivering all its accessions and accessories even though they may
not have been mentioned.
Accession pertains to the fruits of a thing or addition to or improvements upon a thing
(the principal) such as trees planted on land and rents on buildings.
Accessories, on the other hand, pertain to things joined to or included with the principal
thing for the latter’s embellishment, better use, or perfection.

OBLIGATION TO DO
Article 1167 of the New Civil Code states that if a person obliged to do something
fails to do it, the same shall be executed at his cost. The same rule shall apply if he does it
in contravention of the tenor of the obligation. Moreover, if he performs his obligation in
a poor manner, it can be ordered undone.

OBLIGATION NOT TO DO
This is a negative obligation. It is the mandate of Article 1168 of the New Civil
Code that when the obligation consists in not doing, and the obligor does what has been
forbidden him, it shall be undone at his expense.

OBLIGATION TO DELIVER
The obligor may bind himself to deliver either a specific (determinate) or generic
(indeterminate) thing. It is generic or indeterminate when it refers only to a class or
genius and cannot be pointed out with particularly, such as a dog, a car, a calendar watch.
RIGHT TO THE FRUITS
The creditor has a right to the fruits of the thing from the time the obligation to
deliver it arises. However, he acquires no real right over it until the same has been
delivered to him.

KINDS OF FRUITS CONTEMPLATED UNDER ARTICLE 1164 OF THE

NEW CIVIL CODE ARE THE FOLLOWING:

NATURAL FRUITS- They are the spontaneous products of the soil, and the young and
other products of animals.
INDUSTRIAL FRUITS- They are produced through cultivation; thus, with intervention
of labor such as vegetables planted in the garden.
CIVIL FRUITS- They pertain to those derived by virtue of juridical or legal relations
such as rents on houses or buildings by virtue of a lease contract.

WHEN ONE INCURS DELAY

A person obliged to deliver or to do something incurs in delay from the time the
obligee (creditor) judicially demands from him the fulfillment of his obligation.

DEMAND NOT NECESSARY TO PUT DEBTOR IN DELAY

The general rule is “No demand, no delay”. However, under the following
instances, demand is not necessary to put debtor in delay.

OBLIGOR NOT LIABLE FOR FORTUITOUS EVENT

Generally, the obligor is not liable for fortuitous event, that is, any event which
cannot be foreseen, or which, though foreseen is inevitable, except in cases expressly
specified by the law, or when it is otherwise declared by stipulation or when it is
otherwise declared by stipulation or when the nature of the obligation requires the
assumption of risk.
RESPONSIBILITY ARISING FROM FRAUD
There is fraud when a party to the contract intentionally evades the performance of
his obligation through deceit thereby causing injury or damage to other.

RESPONSIBILITY ARISING FROM NEGLIGENCE

Negligence is the failure to use such care as a reasonably prudent and careful
person would use under similar circumstances. The term refers also to that legal
delinquency which results whenever a man fails to exhibit care whether it be slight,
ordinary or great.
Negligence is the result of failure to observe diligence. It is characterized chiefly
by inadvertence, thoughtlessness, inattention and the like.

KINDS OF OBLIGATION
The primary classifications of obligation under the Civil Code are: (a) Pure and
conditional, (b) Obligations with a period, (c) Alternative and facultative obligations, (d)
Joint and solidary obligations, (e) Divisible and indivisible obligations, and (f)
Obligations with a penal clause.
The secondary classifications of obligations includes: (a) Unilateral and bilateral
obligations, (b) Real and personal obligations, (c) Determinate and generic obligations,
(d) Civil and natural obligations, and (e) Legal, conventional, and penal obligations.

PURE OBLIGATION
An obligation which is not subject to any condition or burden and whose performance
does not depend upon a future or uncertain event or upon a past event unknown to the
parties and immediately demandable.

Example
“A” promise to give “B” the sum of P1000.00. The obligation to pay is
demandable at once because there is no specific date mentioned for its performance.
CONDITIONAL OBLIGATION
An obligation whose performance is subject to any condition. A condition is classified
into suspensive and resolutory. A suspensive condition is one the fulfillment of which
gives rise to an obligation. Ex. “A” binds himself to give “B” a car as soon as “A’s”
mother arrives from Canada. The obligation is demandable only upon the fulfillment of
the condition. A resolutory condition is one the fulfillment of which extinguishes an
obligation already existing. Ex. I will allow you to use my car until you pass the Bar
Examinations. Here, the obligation is immediately demandable but it will be extinguished
upon the happening of the condition.

OBLIGATION WITH A PERIOD

An obligation whose performance is subject to the expiration of said period or term.
Legally, a period or term is a future and certain event, the arrival of which, either give
rise or terminates the obligation. It is a day certain which must necessarily come although
it may not be known.
The Law classifies period into: (a) Ex die; (b) In diem; (c) Legal; (d) Voluntary; and (e)
Judicial
• Ex die or suspensive period. It is a period having a suspensive effect.
• In diem or resolutory period. It is that which takes effect immediately but is
terminated upon the arrival of the day certain.
• Legal period. If the period for compliance is fixed by the law such as payment of
taxes.
• Conventional or voluntary period. One that is agreed upon by the parties.
• Judicial period. One that is provided or fixed by the courts.

ALTERNATIVE OBLIGATION
An alternative obligation is one wherein various prestations are due, but the performance
of one of them is sufficient. The right to choose belongs to the debtor (obligor) unless it
has been granted expressly to the creditor (obligee).
Example:
“A” binds himself to deliver to “B” either gold ring or gold watch. “A” should
deliver any of the two.
FACULTATIVE OBLIGATION
An obligation where one prestation is due but the obligor (debtor) may substitute another.
Example:
“A” binds himself to deliver to “B” a Volkswagen car but they mutually agree that
the former may deliver a Toyota car as a substitute.

JOINT OBLIGATION
An obligation where the whole obligation is to be fulfilled proportionately by the
different debtors and each one of the creditors is entitled to a proportionate part of the
credit. Other terms used to indicate joint liability are : (a) mancomunada;
mancomunadamente; pro rata; proportionately; individually; separately. “We promise to
pay” signed by two or more persons.
Example:
“A” and “B” are jointly indebted to “C” in the sum of P2000.00. In this example
“C” can only demand P1000.00 each from “A” and “B”. Thus, “A” is liable for P1000.00
and “B” is likewise liable for P1000.00.

SOLIDARY OBLIGATION
An obligation where each of the debtors is liable for the whole obligation and each of the
creditors has a right to demand compliance of the entire obligation. Observe that there is
solidary liability when: (a) the obligation expressly so states; (b) the law require
solidarity; or (c) the nature of the obligation requires solidarity. Other terms used to
indicate solidarity are: (a) jointly and/or severally ; solidaria ; in solidum; together and/or
separately; individually and/or collectively; juntos separadamente ; “I promise to pay”
signed by two or more persons.

Example:
“A” and “B” are solidary debtors of “X” and “Y” in the amount of P10000.00. In this
example, either “A” or “B” maybe compelled by either “X” or “Y” to pay the entire
obligation of P10000.00. If “A” pays P10000.00 to “X” the obligation is extinguished,
but he is entitled to be reimbursed by his co-debtor “B”.
DIVISIBLE OBLIGATION
An obligation capable of partial performance.
Example:
If “A” agrees to pay “B” P6000.00 in two installments, the obligation is divisible
because it is capable of partial performance.

INDIVISIBLE OBLIGATION
An obligation not capable of partial performance.
Example:
If “A” agrees to deliver a car to “B”, the car must be delivered as a whole for the
car itself is indivisible.

OBLIGATION WITH A PENAL CLAUSE

An obligation which contains an accessory undertaking to assume greater liability in case
of breach. It is attached to the principal obligation primarily to insure their performance.
Observe that there are two types of penalty to wit: (a) subsidiary; and (b) joint. In
subsidiary penalty, in case of breach, only the penalty ca be demanded. On the other
hand, both the principal obligation and the penalty (accessory obligation ) can be
enforced in joint penalty. It is however provided in one case, that iniquitous, merciless
and shocking to conscience shall not be enforced.

Example:
“A” promised to paint the house of “B” in the amount of P5000.00. An agreement
with a penal clause was signed that in case of breach, “A” would have to pay P500.00. If
“A” fails to perform his principal obligation, he can be compelled to pay the amount of
P500.00.
MODES OF EXTINGUISHING OBLIGATIONS
Under the New Civil Code obligations are extinguished by the following
namely:
• Payment or performance

• Loss of the thing due

• Condonation or remission of the debt

• Confusion or merger of the rights of the creditor and debtor

• Compensation and

• Novation

Other causes of extinguishment of obligations include annulment, recession, fulfillment

of a resolutory condition and prescription. Also, the following are the modes of
extinguishing obligations to with:
• Death of a party in personal obligation

• Impossibility of fulfillment

• Happening of fortuitous event

• Arrival of a resolutory period

• Compromise agreement

• Mutual disagreement of parties. This is based on the principle of mutuality of

contracts, that is, the validity or compliance of a contract between the parties
cannot be left to the will of one of them.

PAYMENT OR PERFORMANCE
• Ordinarily, payment is the delivery of money. As a concept in civil law, the term
payment consists of not only the delivery of money but also the performance, in
any other manner, of an obligation. Thus, a debt is not considered to have been
 paid unless the thing or service in which the obligation consists has been
completely delivered or rendered, as the case may be.

Example.

“ A” binds himself to deliver to “B” P5,000.00, but he delivered only P4,500.00. In this
example, there is no payment of “A”.

SUBSTANTIAL PERFORMANCE IN GOOD FAITH.

The law provides that if the obligation has been substantially performed in good faith, the
obligor may recover as though there had been a strict and complete fulfillment less
damages suffered by the obligee (creditor).

Example.
“A” binds himself to paint the house of “B” with the brand name Dutch Boy. Due to
scarcity of such brand in the market the remaining portion of the house , the patio was not
painted with such brand, despite his desire to comply in good faith his obligation . In this
example, “A” can recover less the damages suffered by the obligee (creditor).

INCOMPLETE PERFORMANCE
When the obligee (creditor) accepts the performance knowing its incompleteness or
irregularity, and without expressing any protest or objection, the obligation is deemed
complied with.

Example.
“A” binds himself to deliver to “B” (10) bottles of Carlos Primero on the latter’s birthday.
“A” delivered only (9) bottles and “B” did not make any protest. In this example, the
obligation is deemed complied with because “B” knowing the incompleteness or
irregularity of the delivery did not make any objection and instead accepted the
performance.
WHO MAY MAKE PAYMENT.
Naturally, payment must be made by one having an interest in the performance of an
obligation. Under the law, the creditor is not bound to accept payment or performance by
a third person who has no interest in the fulfillment of the obligation, unless there is an
agreement to the contrary. Whoever pays for another may demand form the debtor what
he has paid, except that if he paid without the knowledge or against the will of the debtor,
he can recover only in so far as the payment has been beneficial to the debtor.

Example.
“A” owes “B” the amount of P5,000.00. Here “A” is the one who has an interest in the
performance of the obligation. “B” the obligee (creditor) cannot be compelled to accept
payment from “X”, a third person. If, however, “B” accepts payment without the
knowledge or against the will of “A”, the latter (debtor “A”), shall be liable to “X” only
to the extent the payment benefited him.

TO WHOM PAYMENT SHALL BE MADE.

Payment shall be made to the person in whose favor the obligation has been constituted,
or his successor-in-interest, or any person authorized to receive it. In other words it shall
be made to: a) the creditor (obligee) b) successor-in-interest, like an heir; and c) any
person authorized to receive it. In one case, it was ruled that “a person authorized to
receive it” is any person authorized by the creditor; a person authorized by law, such as
guardian or executor or administrator of the estate of the deceased; or assignee or
liquidator of a partnership or corporation.

EFFECT OF PAYMENT TO AN INCAPACITATED PERSON.

Payment to a person who is incapacitated to administer his property shall be valid if he
has kept the thing delivered, or insofar as the payment has been beneficial to him.
Payment made to a third person shall also be valid insofar as it has redounded to the
benefit of the creditor.
Example.
“A” owes ”B” in the amount of P5,000.00 which will mature on June 5, 2006. Before the
maturity date, “A” complied with his obligation but payment was made to “X”, a minor
under guardianship. If “X” kept the money or spent it to something beneficial to him, the
payment is valid. However, if “X” lost apart of it, say P2,000.00 through ignorance,
payment should apply only to the extent of P3,000.00.

PLACE OF PAYMENT
The following rules should apply in determining place of payment:
• If there is stipulation, the payment shall be made at the place designated in the
obligation.

• If there is no stipulation and the thing to be delivered is generic, the place of

payment shall be the domicile of the debtor. Note that in this case, the creditor
should bear th expenses in going to debtor’s place for the purpose of accepting
payment.

Example
• “A” binds himself to deliver to “B” a specific car. In the contract, it shall be to the
place of “B”.

• In the above example, if there is no agreement and the car is located in the place of
“A” at the time of the perfection of the contract, the delivery shall be made at
“A’s” place.

• If “A” binds himself to pay “B” a sum of money, payment shall be made at the
place designated in the agreement. Otherwise, the law mandates “B” the creditor
to accept payment from the place of “A” the domicile of the debtor. However, “A”
would liable for whatever expenses “B” incured in going to “A’s” place.
MANNER OF PAYMENT
The debtor of a thing cannot compel the creditor to receive a different one although the
latter maybe of the same value as, or more valueble than which is due. In obligation to do
or not to do, an act or forbearence cannot be substituted by another act or forbearance
against the obligee’s will. Observe that in faculative obligations, the obligator is given the
right to perform another prestation in suostation. This is by virtue of a valid contract.

Example
“A” binds himself to deliver to “B” a 2006 Toyota Corolla Sedan. In this example, “B”
cannot be compelled to accept another brand, say, a 2006 Lancer Lambda. However, if
“A” delivered another brand, and “B” willingly accepted it, it is valid.

DEBTS IN MONEY PAYABLE IN LEGAL CURRENCY.

Payments of debts in money shall be made in the currency stipulated, and if it is not
possible to deliver such currency, then in the currency which is legal tender in the
Philippines. By the term legal tender is meant that which an obligor (debtor) may compel
an obligee (creditor) to accept payment of debt, public or private. All notes and coins
issued by the Central Bank of the Philippines, being the Central Monetary Authority, are
legal tender. Coins of denominations from P 0.05 or less are valid legal tender for the
amounts not to exceed P 20.00

SPECIAL FORMS OF PAYMENT

A person obliged to make payment may avail of the following special forms which
include:
• DATION IN PAYMENT OR DACION EN PAGO.

It simply means giving by the debtor (obligor) and receipt by the creditor (obligee) of
something in payment of debt, instead of a sum of money. Note that under this type of
payment, consent of the parties is needed for it governed by the law on sales.
Example
“A” is indebted to “B” for the sum of P5,000.00. Instead of paying the amount, “A”
delivered a gold watch worth P5,000.00, which “B” willingly accepted.
b) APPLICATION OF PAYMENT
It is the designation of the debt to which payment should be applied made by a debtor
who has various debts of the same kind in favor of one and the same creditor.

Example
“A” owes “B” the amount of P5,000.00 payable june 5, another P5,000.00 with legal in
june 5 or june 21 obligation. However, if “A” chose to apply it to the second obligation, it
is not deemed paid until and unless the legal interest is also paid.

SPECIAL FORM OF PAYMENT

c.) PAYMENT BY CESSION – It is the assignment of all the properties of the debtor to
his creditors in payment of debts.
Example:
“A” binds himself to pay “B” the amount of P10,000.00. However since “A” has
no substantial cash, he may assign properties also valued P10,000.00 to his creditor. After
the sale of such properties, the creditor may apply the net proceeds to his credit.

d.) TENDER OF PAYMENT AND CONSIGNATION – by the term “Tender of

Payment” is means the act by which a debtor (Obligor) offers to the creditor (Obligee)
the thing, or the amount of money which he considers to be due.
NOTE that the consignation may also be made in the following instances:
• When the creditor is absent or unknown, or does not appear at the place of
payment.
• When he/she is incapacitated to receive payment at the time it is due.
• When, without just cause, he refuses to give receipt.
• When two or more persons claim the same right to collect; and
• When the title of the obligation has been lost.
Example:
“A” owes “B” the sum of P5,000.00. When the obligation became due, “A”
offered to pay “B” the sum of P5,000.00 in cash. However, “B” unreasonably refused to
accept payment. In this case, “A” could validly deposit the amount in court of competent
jurisdiction by giving notice to “B” before and after consignation is made. After taking
the formalities required by the law, “A” may then ask the court to issue an order
cancelling the obligation.

LOSS OF THE THING DUE

It is understood that the thing is lost when it perishes, or goes out of commerce, or
disappears in such a way that its existence is unknown or it cannot be recovered.

CONDONATION OR REMISSION OF THE DEBT

Condonation or Remission is Spanish law is the gratuitous abandonment by the creditor
of his right. It is essentially gratuitous for it signifies the liberality of the creditor
(obligee). Thus, it needs acceptance by the obligor. Note the law of donation governs this
mode of extinguishing obligation.
Example:
“A” binds himself to pay “B” the sum of P2,000.00. On maturity date, “B”
remitted the debt of “A”. As a sign of gratitude “A” sends a card of thanks. In this
example, there is complete condonation which extinguishes the obligation.

RENUNCIATION OF THE PRINCIPAL DEBT

Under the law, the renunciation of the debt shall extinguish the accessory obligation, but
the waiver of the latter shall leave the former in force. This is consistent with the legal
maxim, accessory follows the principal.
Example:
“A” owes “B” the sum P5,000.00 with a 10% interest. The remission by “B” of the
principal obligation (P5,000.00) will necessarily extinguish the accessory obligation
(10% interest). However, if what is remitted is the 10% interest, the principal debt
remains to exist.

CONFUSION OR MERGER
It is the union of the qualities of debtor and creditor in the same person, the effect of
which is generally to extinguish the debt.
Example:
“A” owes “B” P5,000.00 for which “A” issued a promissory note in favor of “B”
bearer. “B” indorsed the promissory note to “C”, and then to “D”. “D” indorsed back
promissory note to “A. in this example, the obligation arising from the issuance of
promissory note becomes absurd. “A” cannot enforce the obligation against himself.

MERGER IN THE PERSON OF PRINCIPAL DEBTOR OR CREDITOR

Under the law, merger which takes place in the principal debtor or creditor benefits the
guarantors.
Example:
“A” owes “B” the sum of P5,000.00 guaranteed by “C”. The merger of the
qualities of creditor and debtor in “A” extinguishes the obligation of “C”. The guaranty
being an accessory obligation is extinguished upon the extinguishment of the principal
obligation. Parenthetically, this is based on the legal maxim, accessory follows the
principal.

MERGER IN THE PERSON OF GUARANTOR

Merger which takes place in the person of guarantor does not extinguish the principal
obligation although it extinguishes the guaranty. It is settled that the extinguishment of
the guaranty (accessory) does not include the extinguishment of the principal obligation.
Example:
 In the former example, “B” may assign his credit to a third party, say “X”.
Supposed “X” assigns his credit to “C” the guaranty is extinguished. However, “C”
becomes the creditor of “A” for the latter’s obligation still subsists.

COMPENSATION
As a concept in civil law, compensation is set-off. Under the law, compensation takes
place when two persons, in their own right are creditors and debtors of each other. In
other words, compensation takes effect by operation of law and extinguishes the
concurrent amount of both debts although the parties (creditors and debtors) are not
aware of the compensation.
Example:
“A” owes “B” P5,000.00. In return, “B” owes “A” the sum of P5,000.00. Both
debts are due and demandable. Compensation takes place because “A” and “B” in their
own right, are creditors and debtors of each other.

KINDS OF COMPENSATION
• LEGAL. It takes place by operation.
• VOLUNTARY OR CONVENTIONAL. It takes place by agreement of the parties.
• JUDICIAL. It takes place with the concurrence of the court of competent
jurisdiction.
• PARTIAL. It takes place when two obligations are of different amounts and a
balance remains unextinguished.
• TOTAL. It takes place when two debts are the same amount.

NOVATION
A novation takes place when it substitutes a new party and discharges one of the original
parties to a contract by agreement of all parties. A new contract is created with the same
terms as the original one, but only the parties are changed.
REQUISITE OF A NOVATION ARE:
• A previous valid obligation;
• The agreement of all the parties to the new contract;
• The extinguishment of the old obligations; and
• The validity of the new one.

KINDS OF SUBSTITUTION
• EXPROMISION. It takes place when a third person at his own initiative and
without the knowledge or against the will of the original debtor assumes the
latter’s obligation with the consent of the creditor.

Example:
“A” owes “B” P5,000.00. A third person, “X” went to “B” and told the
latter that he will be the one to make the payment. If “B” agrees that “X” will take
the place of “A” even without the consent of knowledge of the later, there will be
a novation of obligation known as “expromision”.

• DELEGACION. Takes place when the creditor accepts a third person to the place
of the debtor with the consent of the latter. It is necessary that all the parties, the
old debtor, the new debtor and the creditor must agree to the substitution.

Example:
“A” bind himself to deliver to “B” three (3) sacks of rice. Subsequently,
“A” brought with him his friend “X”, to “B”, and requested the latter to accept
“X” as the one who will undertake the delivery of three (3) sacks of rice. If “B”
agreed to the proposal of “A”, “A’s” obligation will thus be extinguished and
substitution by delegacion took place.