Usury Laws for Excessive and Compound Interest on Loans in the Philippines
A Comprehensive Legal Overview
1. Historical Background of Usury Laws in the Philippines
Act No. 2655 (The Usury Law of 1916)
- Enacted during the American colonial period, Act No. 2655 introduced ceilings on interest rates to protect borrowers from exorbitant or “usurious” rates.
- Over time, the Usury Law was amended by various statutes and circulars, adjusting maximum allowable interest rates depending on economic conditions.
Effect of Subsequent Monetary Board Circulars
- In the early 1980s, the Monetary Board of the Central Bank (now Bangko Sentral ng Pilipinas, or BSP) began issuing circulars that effectively relaxed or lifted interest-rate ceilings.
- Central Bank Circular No. 905 (Series of 1982) notably suspended the imposition of statutory ceilings on interest rates, effectively deregulating them.
- Despite this deregulation, the Usury Law (Act No. 2655) was not repealed. Instead, it is considered to have been rendered practically inoperative in terms of fixed numerical ceilings.
Present-Day Relevance
- While strict numerical caps are no longer enforced, courts continue to rely on general principles under civil law and jurisprudence when evaluating whether an interest rate is “unconscionable,” “iniquitous,” or “excessive.”
2. Governing Legal Provisions and Principles
Civil Code Provisions on Interest
- Article 1956, Civil Code: “No interest shall be due unless it has been expressly stipulated in writing.”
- Article 1959, Civil Code: Allows “compounded interest” or “interest upon interest” if the parties expressly agree and if the interest has accrued.
- Articles 2209, 2212, and 2213, Civil Code: Provide rules on legal interest and scenarios where interest becomes due (e.g., when an obligation is breached).
BSP Circulars and Monetary Board Regulations
- By virtue of BSP Circular No. 905, interest rates are generally deregulated and left to market forces.
- However, if an interest rate is found to be excessive or unconscionable, courts may intervene by applying jurisprudential guidelines and equitable principles.
Key Supreme Court Rulings
- The Supreme Court of the Philippines has consistently ruled that while parties are free to stipulate interest rates, the courts can reduce or nullify such rates if they violate fundamental fairness or public policy.
- In numerous decisions, the Supreme Court has described certain rates—especially those reaching 3% to 5% per month or higher (equivalent to 36%-60% per annum)—as potentially excessive and subject to judicial modification.
3. Excessive Interest and the Concept of Unconscionability
Definition of Unconscionable Interest
- Interest is deemed “unconscionable” when it is so exorbitantly high that it effectively preys on a borrower’s financial distress or lack of bargaining power.
- Courts consider economic context, the relative positions of the parties, and the actual impact on the borrower.
Judicial Reduction of Interest Rates
- If a stipulated interest rate is challenged in court, the judge may employ equitable powers to reduce the rate to a more reasonable level.
- The Supreme Court has often pegged a reduced rate at 12% per annum or 6% per annum, depending on the period covered by the loan or judgment (subject to the evolving rules on legal interest set by BSP circulars and jurisprudence).
Common Scenarios of Excessive Rates
- Payday loans or short-term “5-6” type loans from informal lenders often carry high monthly interest.
- Private lending companies may impose steep rates coupled with penalty clauses, compounding the borrower’s obligation.
- Credit card debts can also become excessive if penalty charges and interest continue to compound without clear, written stipulations or notifications.
4. Compound Interest (Interest Upon Interest)
Legal Basis
- Article 1959, Civil Code expressly provides that interest due and unpaid may earn interest “if it has been judicially demanded and it has been expressly stipulated by the parties.”
- This means compound interest is not automatically illegal, but it must be:
- Expressly agreed upon in writing by the parties, and
- Accrued interest must be demanded judicially (i.e., through a legal action), unless otherwise provided for in the contract.
Court’s Stance on Compound Interest
- Even if compound interest is stipulated, courts will examine whether the resulting effective rate is unconscionable.
- Judges have the power to reduce or disallow compound interest if it creates an effectively usurious rate or if the agreement lacks transparency and valid consent.
Importance of Clear Contractual Terms
- Lenders must specify how interest is computed (simple vs. compound), the frequency of compounding, and any penalty rate.
- Vague or ambiguous interest provisions may be interpreted against the lender (the party who drafted the contract), following the civil law principle that ambiguities are construed against the party causing them.
5. Legal and Practical Consequences for Violating Usury Principles
Nullification or Reduction of Unconscionable Interest
- Courts may declare the excessive portion of the interest void, leaving only a reasonable rate in force.
- If the borrower has already paid amounts under an excessive rate, they may seek restitution or credit for the overpayment.
Possible Criminal or Administrative Liability
- Technically, certain usurious practices can open lenders to criminal liabilities under the old Usury Law and other special laws, though prosecutions are rare.
- Informal lenders operating without proper licenses also risk sanctions from regulatory bodies (e.g., the Securities and Exchange Commission for lending companies).
Enforcement Challenges
- Borrowers facing onerous or compound interest might be reluctant to litigate due to cost, time, or intimidation.
- Lending institutions rely heavily on out-of-court settlements, factoring in the possibility that a court might reduce the interest rate if challenged.
6. Noteworthy Supreme Court Doctrines and Examples
Reduction of Interest on Grounds of Equity
- The Supreme Court has repeatedly invoked its equity jurisdiction to reduce interest rates from, for example, 5% per month (60% p.a.) to 12% p.a. or even 6% p.a., depending on the time frame.
- This equitable power is based on the Civil Code’s broad provisions allowing courts to moderate penalty clauses and usurious stipulations.
Distinguishing Interest from Penalties and Charges
- Penalty charges, late fees, or attorney’s fees may be imposed on top of the principal and stipulated interest.
- Courts will review the totality of these charges; if the combined effect is deemed unconscionable, they may be reduced.
“Free Market” vs. Public Policy
- While the Philippines adheres to the principle of freedom to contract, it does not permit the enforcement of contracts that violate public policy.
- Therefore, even though interest rates are generally “deregulated,” there is still a public policy safety net in place through judicial review.
7. Practical Tips and Best Practices
For Lenders
- Ensure that interest rate stipulations (including the rate, how it is computed, and when it is due) are laid out in clear, written agreements.
- Avoid imposing rates that could be construed as exorbitant, especially if they exceed the typical market range (e.g., higher than 24%-36% annual).
- Disclose all penalty charges and the possibility of compounding in the contract.
For Borrowers
- Read and understand the loan agreement before signing. Specifically, check if there is a clause on compounding interest and the penalty rate.
- In case of a dispute or suspicion of an excessively high rate, consult an attorney and consider seeking judicial relief to have the rates reviewed and possibly reduced.
- Keep clear documentation of all payments made, as these records are crucial if one seeks restitution or a recomputation in court.
For Legal Practitioners
- Examine thoroughly whether the loan agreement’s interest rate, penalties, and compounding provisions were validly agreed upon and are not contrary to public policy.
- Present evidence of economic hardship, imbalanced bargaining positions, or other factors to support a claim of unconscionability.
- Use Supreme Court precedent to argue for or against the adjustment of stipulated interest rates.
8. Conclusion
Although the Usury Law (Act No. 2655) remains on the statute books, Philippine interest rate ceilings have been effectively deregulated by Monetary Board circulars. Nonetheless, the principle against usury survives through the courts’ power to strike down or modify iniquitous, unconscionable, or excessive interest rates—whether simple or compound.
In practice, lenders and borrowers alike must remain aware that freedom of contract has limits set by considerations of equity and public policy. Where an interest rate or penalty provision is so high as to become oppressive, Philippine courts can and will intervene. This interplay of contractual autonomy and judicial oversight defines the modern landscape of usury in the Philippines, ensuring that while market forces largely guide interest rates, basic fairness remains a paramount concern.
Disclaimer: This overview is for informational purposes only and does not constitute legal advice. For any specific concerns regarding usury, excessive interest, or contract enforcement in the Philippines, it is prudent to consult a qualified attorney.