Requisites | Compensation | Extinguishment of Obligations | Obligations | OBLIGATIONS AND CONTRACTS

Under Philippine Civil Law, the extinguishment of obligations through compensation is governed by the Civil Code of the Philippines (Articles 1278 to 1290). Compensation, as a mode of extinguishing obligations, occurs when two persons, in their capacity as debtors and creditors of each other, offset their respective debts to the extent of their concurrence. Below is a detailed breakdown of compensation, specifically its requisites, types, and related provisions.

I. Definition of Compensation

Compensation is defined in Article 1278 of the Civil Code as a way of extinguishing two obligations that are reciprocally due between two persons who are principal creditors and debtors of each other. Compensation essentially operates as a "set-off," balancing two obligations against each other, to the degree that one debt extinguishes the other.

II. Types of Compensation

There are four main types of compensation in Philippine law:

1. Legal Compensation - Takes place by operation of law, subject to the conditions set forth in Article 1279 of the Civil Code.
2. Voluntary or Conventional Compensation - Results from an agreement between the parties, even when some requisites for legal compensation are absent.
3. Judicial Compensation - Takes place when declared by a court in a lawsuit where two persons are plaintiffs and defendants reciprocally.
4. Facultative Compensation - Operates when one of the parties, despite not all legal requisites being present, offers and the other accepts compensation.

III. Requisites of Legal Compensation

For legal compensation to occur, the following requisites under Article 1279 must all be met:

1. Both Parties Must Be Principal Creditors and Debtors of Each Other:

   • Each party must hold the role of both creditor and debtor towards the other.
   • Obligations must exist in the capacity of principal, not merely as guarantors or sureties.

2. The Debts Must Be Due and Demandable:

   • Both obligations must be liquidated (certain as to amount) and enforceable.
   • If the debt is conditional or dependent upon a future event, compensation cannot occur until that condition is fulfilled.

3. The Debts Must Be of the Same Kind:

   • The debts involved must consist of fungible things (things that can be replaced by others of the same kind, like money or consumable goods).
   • Different types of obligations (e.g., services vs. money) cannot be set off against each other.

4. Both Debts Must Be Liquidated:

   • Liquidation means the debts must be determined or determinable by computation.
   • An unliquidated debt (e.g., a disputed amount) does not meet this requirement until resolved.

5. There Must Be No Retention or Controversy Filed by a Third Party:

   • If a third party claims a right over the debt (e.g., by attachment or garnishment), compensation may not be possible.
   • Similarly, if a judicial controversy exists over the debt, it must be resolved before compensation can occur.

IV. Rules and Effects of Compensation

1. Extent of Compensation: Compensation extinguishes both debts only to the extent of their concurrence. If one debt exceeds the other, only the portion equivalent to the lesser amount is extinguished.

2. Date of Compensation: Compensation takes effect from the moment all requisites are present, not from the time the parties declare or apply it. This retroactive effect is crucial when determining the status of debts at a specific point.

3. Obligations Not Subject to Legal Compensation (Article 1287):

   • Compensation does not apply to obligations arising from deposits, support due by gratuitous title, or other obligations where the law or contract excludes compensation.
   • Compensation is also not permitted in cases where one of the debts is owed to the government unless mutual debts exist between public entities.

4. Prohibition Against Waiver (Article 1288):

   • A party may waive compensation even when all requisites are met.
   • This waiver may be express or implied, provided it does not prejudice third parties.

V. Judicial Compensation

Judicial compensation is ordered by a court when legal requisites are absent or a judicial determination is necessary. It arises commonly during a lawsuit where each party asserts claims against the other, allowing the court to offset the claims against each other.

VI. Facultative Compensation

Facultative compensation arises when one party has the choice to impose compensation, usually because one requisite for legal compensation is missing, such as when one debt is not yet demandable. Facultative compensation is useful in scenarios where one party agrees to compensation despite the technical absence of certain conditions.

VII. Special Rules and Additional Considerations

1. Subrogation and Compensation (Article 1290):

   • If a third party subrogates (substitutes) into the rights of the creditor, compensation may still be claimed unless the debtor was notified of the subrogation before the compensation took place.

2. Assignment of Rights and Compensation:

   • If a debt is assigned, compensation will only be applicable if the debtor was notified of the assignment after all requisites of compensation had been fulfilled.

Practical Applications of Compensation in Philippine Civil Law

In practice, compensation is beneficial in commercial transactions, debtor-creditor arrangements, and financial negotiations, where mutual debts often arise. Understanding the requisites ensures that parties comply with legal standards, avoid disputes, and protect their financial interests.

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This thorough breakdown of compensation highlights its importance as a practical, efficient mechanism for extinguishing debts in Philippine civil law.