Article 1226
In obligations with a penal clause, the
penalty shall substitute the indemnity
for damages and the payment of interests in
case of noncompliance, if there is no
stipulation to the contrary.
Nevertheless, damages shall be paid if
the obligor refuses to pay the penalty
or is guilty of fraud in the fulfillment of
the obligation.
The penalty may be enforced only when
it is demandable in accordance with the
provisions of this Code.
CONCEPT
An obligation with a penal clause is one to
which an accessory undertaking is attached
for the purpose of insuring its performance,
by virtue of which, the obligor is bound to pay
a stipulated indemnity or perform a
stipulated prestation in case of breach.
The penal clause or penalty is an accessory
obligation attached to the principal
obligation.
Purpose of Penalty
1. General purpose: To insure the
performance of the obligation
2. Compensatory purpose: To liquidate the
amount of damages to be awarded to the
injured party in case of breach of the
principal obligation
3. Punitive purpose: To punish the obligor in
case of breach of the principal obligation
KINDS OF PENALTY
As to origin
 Legal – constituted by law
 Conventional – constituted by
agreement of the parties
As to purpose
 Compensatory – when established
for the purpose of indemnifying the
damages suffered by the creditor in
case of breach of the obligation
 Punitive – when established for the
purpose of punishing the debtor in
case of breach
As to effect
 Subsidiary – when only the penalty
may be demanded in case of breach of
the obligation
 Joint – when the injured party may
demand the enforcement of both the
penalty and the principal obligation
What is the difference between a penal
clause and a condition?
- A penal clause constitutes an obligation
although accessory; the condition does not.
Therefore, the penalty may become
demandable in default of the unperformed
principal obligation, and sometimes jointly
with it, while the condition is never
demandable
Note: A penalty may be enforced only when
it is DEMANDABLE. Further, the penalty
may be REDUCED if it is INEQUITOUS or
UNCONSCIONABLE.
SSS vs Moonwalk Dev. Corp
Facts: To be in default ". . . is different
from mere delay in the grammatical sense,
because it involves the beginning of a
special condition or status which has its
own peculiar effects or results." In order
that the debtor may be in default it is
necessary that the following requisites be
present: (1) that the obligation be
demandable and already liquidated; (2)
that the debtor delays performance; and
(3) that the creditor requires the
performance judicially and extrajudicially.
Default generally begins from the moment
the creditor demands the performance of
the obligation. Nowhere in this case did it
appear that SSS demanded from
Moonwalk the payment of its monthly
amortizations. Neither did it show that
petitioner demanded the payment of the
stipulated penalty upon the failure of
Moonwalk to meet its monthly
amortization. What the complaint itself
showed was that SSS tried to enforce the
obligation sometime in September, 1977
by foreclosing the real estate mortgages
executed by Moonwalk in favor of SSS. But
this foreclosure did not push through upon
Moonwalk's requests and promises to pay
in full. The next demand
for payment happened on October 1, 1979
when SSS issued a Statement of Account to
Moonwalk. And in accordance with said
statement, Moonwalk paid its loan in full.
HELD: What is clear, therefore, is that
Moonwalk was never in default because
SSS never compelled performance.
Though it tried to foreclose the mortgages,
SSS itself desisted from doing so upon the
entreaties of Moonwalk. If the Statement
of Account could properly be considered as
demand for payment, the demand was
complied with on time. Hence, no delay
occurred and there was, therefore, no
occasion when the penalty became
demandable and enforceable. Since there
was no default in the performance of the
main obligation — payment of the loan —
SSS was never entitled to recover any
penalty, not at the time it made the
Statement of Account and certainly, not
after the extinguishment of the principal
obligation because then, all the more that
SSS had no reason to ask for the penalties.
Thus, there could never be any occasion
for waiver or even mistake in the
application for payment because there was
nothing for SSS to waive as its right to
enforce the penalty did not arise.
RCBC vs Court of Appeals
Facts: There exists a Comprehensive
Surety Agreement between RCBC and
respondent Ching is admitted. There is no
escaping the attendant liability that binds
respondent Ching, as Surety. He is charged
as an original promissor by virtue of his
primary obligation under the Suretyship
Agreement. That Agreement is bare of
words imputing to respondent Ching any
liability other than that of a Surety who
binds himself to insure a debt in his
personal capacity, lacking consideration
therefor notwithstanding.
Petitioners obtained a loan from
respondent bank in the amount of
P120,000.00 at 15.189% interest per
annum with a 5% penalty per month in
case of default and 10% attorney's fees if a
suit were instituted for collection. When
petitioners defaulted in payment,
respondent bank sued for recovery of the
amount due. Two years after the case was
submitted for decision without petitioners
presenting their evidence, petitioners filed
a motion for reconsideration of the order
declaring them as having waived their
right to present evidence and prayed that
they be allowed to prove their case. The
motion was denied by the trial court which
eventually rendered a decision in favor of
respondent bank ordering petitioners to
pay the amount due with the agreed
interest rate of 15.189%, 5% penalty charge
and 10% attorney's fees.
HELD: A penalty clause is an accessory
undertaking to strengthen the coercive
force of the obligation and that the 3%
penalty interest rate considering the
repeated acts of breach of petitioners'
contractual obligations is not iniquitous.
The issue of reasonableness of interest rate
cannot be raised for the first time on
appeal. In any event, the Court held that
the stipulated interest of 15.189% per
annum is not excessive.
An obligation to pay a sum of money is not
extinctively novated by a new instrument
which merely supplements the old
contract.
EFFECT OF PENALTY
The penal clause may be considered either as
reparation or substitute for damages or as
punishment in case of breach of the
obligation.
As reparation or compensation – the
question of damages is resolved since the
stipulated indemnity or prestation
represents a legitimate estimate made by the
contracting parties of the damages caused by
the nonfulfillment or breach of the obligation.
Hence, proof of actual damages is not
necessary in order that the stipulated penalty
may be demanded.
As penalty – the question of damages is not
yet resolved. Consequently, the right to
damages, besides the penalty, still subsists.
Therefore, if the injured party desires to
recover the damages actually suffered by him
in addition to the penalty, he must prove
such damages.
GENERAL RULE: Penalty is fixed by the
contracting parties as a compensation or
substitute for damages in case of breach of
the obligation. In other words, penalty in its
compensatory aspect (general rule) and
penalty in its strictly penal aspect (exception)
Example:
 Parties to a contract of sale payable in
several installments agree that
should the vendee fail to pay the
amount corresponding to each
installment in due time, the vendor
may rescind the contract and keep
the amount already paid. (Has for its
purpose not only to insure
performance but also to measure
beforehand the damages which
would result from noncompliance.
Here, the penal clause does away with
the duty to prove the existence and
measure of the damages caused by
the breach
Palmares vs Court of Appeals
FACTS: Petitioner signed as co-maker in a
loan. A promissory note was executed whereby
she acknowledged her joint and several
(solidary) liability with the principal, that the
creditor may demand payment in case of
default, and that she fully understood the
contents thereof. Petitioner, when informed
that the debtors defaulted, requested that
creditor try to collect from her principal first
and offered to settle the obligation in case the
creditor fails to collect. She also offered a
parcel of land to settle the obligation which the
creditor refused. Thereafter, a complaint was
filed against petitioner to the exclusion of the
principal debtors. Again petitioner offered to
pay but the amount offered was way below the
amount computed. The trial court dismissed
the complaint and ruled that the complaint
against the petitioner amounted to a discharge
of a prior party, that the offer to pay made by
petitioner who is secondarily liable to the
instrument discharged petitioner. The Court of
Appeals, reversing the trial court, ruled that
petitioner is solidarily liable with the principal
debtors and may be sued for the entire
obligation. Hence, this recourse.
HELD: It is a cardinal rule in interpretations
of contracts that if the terms of a contract are
clear and leave no doubt upon the intention of
the parties, the literal meaning of its
stipulation shall control. Hence, where
petitioner expressly binds herself to be jointly
and severally or solidarily liable with the
principal maker of the note, her liability is that
of a surety and is bound equally and absolutely
with the principal.
Having entered into a contract with full
knowledge of its terms and conditions,
petitioner is estopped to assert that she did so
in ignorance of their legal effect.
The obligee is entitled to demand fulfillment of
the obligation or performance stipulated,
hence, an offer to pay obligation in an amount
less or different from that due does not
discharge liability.
Cabarroguis v. Vincente
Facts: Vicente, owner & operator of the
jeepney on which Cabarroguis (plaintiff)
was a passenger, entered into a
compromise agreement with plaintiff to
pay to her P2, 5000 as damages for the
physical injuries sustained by her when
the said jeepney hit another vehicle.
Additional P200 as liquidated damages in
case defendant fails to complete payment
within 60 days. A balance of P1, 000 was
left unpaid and defendant failed, despite
repeated demands, and refused to comply
with his obligation. Plaintiff brought suit.
CFI sentenced defendant to pay P1, 2000
with legal interest from the date of the
filing of the complaint until full payment.
Is the decision correct?
Held: In obligations with a penal clause,
the penalty shall substitute the indemnity
 for damages and the payment of interest,
except (1) when the contrary is stipulated,
(2) when the obligor refuses to pay the
penalty, or (3) when the obligor is guilty of
fraud in the fulfillment of the obligation.
Hence, applying the law, it is evident that
no interest can be awarded in the principal
obligation because the penalty of P200
took the place of the payment of interest
and indemnity for damages, the case not
falling under any of the exceptions. In
obligations for the payment of a sum of
money when a penalty is stipulated for
default, both the principal obligation and
the penalty can be demanded by the
creditor. Because defendant refused to pay
when demand was made by plaintiff, the
plaintiff is clearly entitled to interest on
the amount of the penalty.
ENFORCEABIITY OF PENALTY
The penalty may be enforceable only when it
is demandable. Consequently, upon the
breach or nonfulfillment of the principal
obligation by the debtor – the penalty
stipulated becomes demanded, PROVIDED
that it is not contrary to law, morals, good
customs, public or public policy.
Note: Where both the contracting parties
are unable to comply with their respective
obligations, although the breach is not wilful
or culpable like fortuitous event, the penal
clause cannot be invoked by anyone of them
to prejudice the other. Rationale: Because
the law must work both ways.
Article 1227
The debtor cannot exempt himself from
the performance of the obligation by
paying the penalty, save in the case
where this right has been expressly
reserved for him. Neither can the creditor
demand the fulfillment of the obligation
and the satisfaction of the penalty at the
same time, unless this right has been clearly
granted him. However, if after the
creditor has decided to require the
fulfillment of the obligation, the
performance thereof should become
impossible without his fault, the
penalty may be enforced.
LIMITATION UPON RIGHT OF
DEBTOR
Debtor cannot exempt himself from the
performance of the principal obligation by
paying the stipulated penalty.
 Exception: When this right has
been expressly reserved for him.
LIMITATION UPON RIGHT OF
CREDITOR
Creditor cannot demand fulfillment of the
principal obligation and the satisfaction of
the s penalty at the same time.
Exception: When the right has been clearly
granted to him. (A tacit or implied grant is
admissible)
If the principal obligation is not
complied with
Creditor can choose between demanding the
fulfillment of the obligation and demanding
the satisfaction of the penalty. HOWEVER,
he cannot demand both at the same time.
If creditor chooses to demand
fulfillment of the obligation and its
performance should become
impossible without his fault
Creditor may still demand the satisfaction of
the penalty.
If there was fault on the part of the
debtor
Creditor may demand not only the
satisfaction of the penalty but also the
payment of damages. If he chooses to
demand the satisfaction of the penalty, he
cannot afterwards demand the fulfillment of
the obligation.
Article 1228
Proof of actual damages suffered by the
creditor is not necessary in order that the
penalty may be demanded.
PROOF OF ACTUAL DAMAGES
Proof of actual damages suffered by the
creditor is NOT necessary in order that the
penalty may be demanded. This is applicable
only to the general rule stated in Art 1226 and
not the exceptions.
General Rule: Penalty is fixed by the
contracting parties as a compensation or
substitute for damages in case of breach of
the obligation. (No need for proof of actual
damages; the penalty is exactly identical with
“liquidated damages”)
Exceptions:
 When there is a stipulation to the
contrary
 When the obligor is sued for refusal
to pay the agreed penalty
 When the obligor is guilty of fraud.
In these cases, the obligee can recover not
only the penalty, but also the damages or
interests resulting from breach. Hence, in
order to be able to recover damages in
addition to the penalty, he must prove the
amount of damages which he had actually
suffered.
Article 1229
The judge shall equitably reduce the
penalty when the principal obligation
has been partly or irregularly
complied with by the debtor. Even if there
has been no performance, the penalty
may also be reduced by the courts if it
is iniquitous or unconscionable.
WHEN PENALTY MAY BE REDUCED
The court may equitably reduce the
stipulated penalty when:
1. The principal obligation has been partly
complied with
2. The principal obligation has been
irregularly complied with
3. The penalty is iniquitous or
unconscionable even if there has been no
performance
The principal obligation has been
partly complied with
Some, but not all of the prestations are
complied with by the debtor. Refers to the
quantity or quality of the performance.
The principal obligation has been
irregularly complied with
All of the prestations are complied with but
not in accordance with the tenor of the
agreement. Refers to the form.
The penalty is iniquitous or
unconscionable even if there has been
no performance
Contemplates a case in which he only
question raised is whether the amount of the
stipulated penalty is reasonable or
unconscionable. While the parties are free to
stipulate a particular amount which the
debtor must pay by way of attorney’s fees and
costs in case of non-fulfillment of obligation,
it is within the sound discretion of the courts
to determine whether the amount should be
reduced or not depending upon whether it is
excessive or reasonable.
Can the Court delete the penalty clause?
 When there has been substantial
performance in good faith by the
obligor.
 When the penalty clause itself suffers
from fatal infirmity
 When exceptional circumstances so
exists as to warrant it.
Lough vs BPI
Facts: The respondent, Bank of the Philippine
Islands (BPI), issued a credit card in William's
name, with Irene as the extension card holder.
Pursuant to the terms and conditions of the
cards' issuance, 3.5% finance charge and 6%
late payment charge shall be imposed monthly
upon unpaid credit availments. The Spouses
Louh made purchases from the use of the
credit cards and paid regularly based on the
amounts indicated in the Statement of
Accounts (SOAs). However, they were remiss
in their obligations starting October 14, 2009.
By September 14, 2010, they owed BPI the total
amount of P533,836.27. Despite repeated
verbal and written demands, the Spouses Louh
failed to pay BPI.
Held: The Court affirms the herein assailed
decision and resolution, but modifies the
principal amount and attorney's fees awarded
by the RTC and the CA. The Spouses Louh
failed to show that they exerted due diligence The nullity of the penal clause does not
in timely pursuing their cause so as to entitle carry with it that of the principal
them to a liberal construction of the rules, obligation.
which can only be made in exceptional cases.
The nullity of the principal obligation
carries with it that of the penal clause.
Umali v. Miclat
Facts: Umali, president and general EFFECT OF NULLITY OF PENALTY
manager of Maharlika Pictures, executed If the principal obligation is void, it follows
contract by which he agreed to pay that the penal clause shall also be void.
plaintiff Miclat a certain amount for his Rationale: Because the penalty is merely an
services. It was expressly stipulated that accessory obligation.
shold Umali fail to pay after the lapse of 30
days, he shall pay a subcharge of 10% for However, if the penal clause is void, the
every 30 days of default until the amount validity of the obligation is NOT affected.
has been fully paid. Umali failed to pay
hence Miclat filed an action to recover the Rationale: Since the efficacy of such
amount plus damages. obligation is not dependent upon the efficacy
of the penal clause.
Lower court ruled that Umali pay the
amount plus 10% subcharge for every 30
days of default and 6% interest per annum
as damages from the date of the filing of
the complaint. Umali claims that the
subcharge is unconscionable because it is
tantamount to imposing an interest of 10%
a month and therefore should be reduced.
He also claims that the award of 6%
interest per annum by way of damages is
contrary to law since Art 1226 states that
the penalty shall be a substitute for
damages or interests.

Held: The subcharge is unconscionable

because while it partakes of the nature of a
penal clause which the parties may freely
stipulate, the same is unconscionable.
However, the award of 6% interest per
annum by way of damages is not contrary
to law because under Art 1226, the penalty
takes the place of the interest only if there
is no stipulation to the contrary, and even
them damages may still be collected if the
obligor refuses to pay the penalty. In this
case, not only is there an express
stipulation to pay damages in addition to
penalty, but Umali also failed to pay his
obligation as well as the penalty. Hence,
the imposition of interest is justified.

Article 1230