In Philippine civil law, the concept of compensation is an important mechanism for extinguishing obligations. This involves situations where two persons are reciprocally debtors and creditors of each other, and their respective obligations can be offset against each other, eliminating or reducing the amount owed. Specifically, the rules concerning compensation, as they interact with the assignment of credit, raise important issues regarding the rights and limitations imposed on involved parties.

Legal Basis for Compensation and Assignment of Credit

Under the Civil Code of the Philippines, compensation is generally governed by Articles 1278 to 1290. Compensation operates to extinguish obligations when two parties owe each other amounts that can be balanced against each other. On the other hand, the assignment of credit, covered by Articles 1624 to 1637, involves a creditor transferring the right to collect a debt to a third party, thus introducing a new creditor into the transaction.

When these doctrines intersect, questions arise regarding whether an assignee of a credit may invoke compensation and whether a debtor can continue to invoke compensation even after their original creditor assigns the credit to another party.

Compensation Before Assignment of Credit

Before the assignment of credit, if two persons owe each other debts that are due, liquidated, and demandable, they may generally offset these debts through legal compensation (Art. 1278). Legal compensation occurs automatically by operation of law, provided the following essential conditions are met (Art. 1279):

Both parties are principal creditors and debtors of each other.
Both obligations consist of a sum of money, or if fungible, are of the same kind and quality.
Both debts are due and demandable.
Both debts are liquidated.

When these conditions exist, the law considers both debts extinguished to the extent of the smaller debt (Art. 1281), and neither party needs to take further action to invoke compensation. However, this scenario becomes more complex once an assignment of credit occurs.

Effect of Assignment of Credit on Compensation

The assignment of credit involves the transfer of a creditor’s right to collect a debt to another party. Upon assignment, the assignee steps into the shoes of the assignor (the original creditor) with respect to the right to demand payment. However, specific rules govern the effect of this transfer on the debtor’s right to invoke compensation:

Right to Compensation if Grounds Pre-exist the Assignment: If the debtor’s grounds to invoke compensation existed prior to the notice of assignment, the debtor retains the right to invoke compensation, even after the credit has been assigned. For example, if the debtor had a liquidated claim against the original creditor before learning of the assignment, this pre-existing right is preserved (Art. 1285, par. 1). This rule protects the debtor from unexpected changes in their obligations due to the creditor’s assignment of credit.
Loss of Compensation Rights if Grounds Arise After Assignment: If the debtor’s grounds to invoke compensation arise after they receive notice of the assignment, they generally cannot invoke compensation against the assignee. For example, if the debtor incurs a claim against the original creditor only after being notified of the assignment, they are barred from invoking it against the assignee. This rule prevents the debtor from creating new obligations in their favor that would affect the assignee’s acquired rights.
Notice of Assignment Requirement: Notice of the assignment is a critical factor in determining the debtor’s right to compensation. Until the debtor receives notification of the assignment, they can continue to invoke compensation for any pre-existing claims against the assignor. Once the debtor is notified, however, only pre-existing compensable obligations may be invoked. Without notice, any compensation invoked between the debtor and the original creditor remains valid, even if the credit has technically been assigned.
Extent and Limitations of the Assignee’s Rights: The assignee, upon receiving the assigned credit, does not acquire greater rights than those held by the assignor. Therefore, if the assignor’s claim was subject to compensation prior to the assignment, the assignee inherits this encumbered right. The debtor’s right to invoke compensation against the assignee is thus preserved to the extent of any pre-existing obligation owed to the debtor by the assignor, ensuring fairness and preventing the assignee from unilaterally altering the debtor’s position.

Practical Applications and Jurisprudence

In Philippine jurisprudence, courts have upheld these principles to ensure fairness in the interaction between compensation and assignment of credit:

Protection of the Debtor’s Rights: Courts generally favor protecting the debtor’s pre-existing rights to compensation, especially if they arose before any assignment. This ensures that the assignment does not worsen the debtor’s position.
Requirements for Valid Notice: Jurisprudence also emphasizes the importance of proper notice to the debtor. Without effective notice, the assignment is not enforceable against the debtor, preserving the debtor’s rights as if no assignment took place.
Assignee’s Responsibility to Investigate: Assignees are expected to perform due diligence regarding the original creditor’s rights and obligations with the debtor. Failure to do so could expose the assignee to a scenario where compensation offsets the debt owed, reducing or nullifying the assigned credit’s value.

Conclusion

In Philippine civil law, the assignment of credit does not automatically extinguish the debtor’s right to invoke compensation. Instead, the debtor may invoke compensation if the grounds for compensation existed before the debtor received notice of the assignment. This rule protects debtors from unfair prejudice due to assignments made without their participation and maintains the balance of rights among the debtor, original creditor, and assignee.

The procedural safeguard of notice and the distinction between pre-existing and post-assignment compensation rights maintain a fair and equitable approach, balancing the debtor’s rights with the assignee’s expectations.