Lara's Gifts & Decors v. Midtown Industrial Sales (2019)

Lara's Gifts & Decors makes and exports handicrafts. From January to December 2007 it bought industrial and construction materials from Midtown Industrial Sales worth ₱1,263,104.22. The purchases were on a 60-day credit term. The sales invoices said 24% interest a year would be charged on overdue accounts.

Lara's Gifts paid with postdated checks, which bounced. The replacement checks also bounced, first for insufficient funds and then because the account was closed. Midtown's demand letter was received on January 22, 2008. Midtown filed a collection case on February 5, 2008. Lara's Gifts admitted the purchases but said many of the materials were substandard.

The trial court in Caloocan City ordered Lara's Gifts to pay ₱1,263,104.22 with 24% interest a year from February 5, 2008 until fully paid, plus ₱50,000 in attorney's fees. The Court of Appeals agreed. Lara's Gifts went to the Supreme Court. Midtown did not appeal.

Were the sales invoices valid proof? Was Lara's Gifts in default? Was the 24% rate void for being excessive? And if it was valid, did it apply only until the judgment became final, with the legal rate after that?

The 2019 Decision. The Court denied Lara's Gifts' petition and modified the award.

• The invoices count. Lara's Gifts did not deny their genuineness under oath and did not say what it claimed the true facts were, so it was deemed to admit them. It also gave no proof that the materials were substandard.
• The 24% rate is valid. Lara's Gifts had been in business since 1990 and had bought from Midtown since 2004. It could not claim it was misled by a rate printed on the invoices.
• The agreed rate runs until full payment. The Court said the wording of the earlier guidelines had led to several of its own rulings that switched from the agreed rate to the legal rate once a judgment became final. That was wrong: "The stipulated interest remains in force until the obligation is satisfied." The legal rate applies only when no rate was agreed, and that rate is the one prescribed by the Bangko Sentral ng Pilipinas (BSP).
• No compounding unless agreed. Interest, whether agreed or legal, is not compounded unless compounding is expressly agreed in writing or required by law or regulation.
• Article 2209 was amended. Article 2209 of the Civil Code fixes legal interest at 6% a year, but a 1973 decree amended it and let the Monetary Board set the legal rate. So the rate is now 6% a year, or what the BSP Monetary Board fixes.

The Court rewrote the Nacar v. Gallery Frames guidelines on that basis. It ordered 24% from the extrajudicial demand of January 22, 2008 until full payment. It also added legal interest on the 24% interest that had accrued by February 5, 2008: 12% a year until June 30, 2013 and 6% a year after that.

The 2022 Resolution. On September 20, 2022, the Court partly granted Lara's Gifts' motion for reconsideration. The resolution was written by Leonen, Acting Chief Justice.

• A sale on credit is not a loan. The Court changed its 2019 view and held that the deal was a sale of goods on credit, not a loan or forbearance of money, goods or credit. The 24% ran only after a missed due date, so it was compensatory interest: damages for late payment under Article 2209.
• The extra interest was deleted. Interest on interest could in principle apply. But the trial court had awarded only the price, 24% interest and attorney's fees, and Midtown never appealed. So the extra award, made in an appeal brought by Lara's Gifts, was beyond the Court's power and was deleted.
• Final award. Lara's Gifts must pay ₱1,263,104.22 with 24% a year from January 22, 2008 until full payment, ₱50,000 in attorney's fees, and costs. The total earns 6% a year from the finality of the Resolution until full payment.

The 2022 Resolution also restated the general rules on interest:

• Two kinds of interest. Conventional interest is the price of borrowing money. It is due only if it is expressly agreed in writing, as Article 1956 of the Civil Code requires. Compensatory interest is damages for delay and does not need a written agreement.
• Unconscionable rates. Every agreed rate, conventional or compensatory, can be reduced if it is unconscionable. The Court noted that it had struck down monthly rates of 2.5%, 5%, 6% and 10%, but had upheld 6% to 7% a month in one case on its special facts. Repeating earlier rulings, it said a creditor who charges more than twice the prevailing legal rate must show that market conditions require it and that the parties were on equal footing.
• Only the rate falls. If an agreed rate of interest on a loan is unconscionable, only the rate is struck out. The promise to pay interest stays, and the legal rate at the time of the agreement applies.
• Interest on interest. As a rule, unpaid interest does not earn interest. For a loan, it does only if interest was agreed in writing in the first place and either the parties agreed to compound it or the unpaid interest is demanded in court. Under Article 2212, interest already due earns legal interest from the time it is demanded in court; the Court said this is fixed by law and not left to the court's discretion. It also said the 24% compensatory interest in this case could, in principle, earn such interest.
• Restated guidelines. For loans and forbearance, compensatory interest is the agreed penalty rate; if none, the agreed conventional rate; if neither, or if they are unconscionable, the BSP legal rate. It runs from demand until full payment. For other money obligations with a known amount, the fallback rate is 6%. For damages whose amount was not certain at the time of demand, the court may impose 6% from the date of the trial court's judgment. One justice, who concurred only in the result, wrote that the discussion of interest on interest and the new guidelines were not needed to decide the case.

A rate of interest agreed in writing applies until full payment if it is not unconscionable; interest is not compounded unless compounding is agreed in writing or required by law or regulation; without an agreed rate, the legal rate prescribed by the BSP applies; and, under the 2022 Resolution, the sale of goods on credit in this case was not a loan or forbearance, so the agreed 24% charge for late payment was compensatory interest, and every agreed rate can be reduced if it is unconscionable.

Lara's Gifts is the case to read with Nacar when a contract, an invoice or a promissory note sets its own interest. It answers three common questions. Does the agreed rate stop when the court decides? No. Can a lender add interest on interest every month? Only if this was agreed in writing or the law requires it. Can a very high rate be collected? Not if a court finds it unconscionable.

Here is a made-up illustration, with invented names. Rina borrows ₱100,000 from Tess. The signed note says "5% a month", which is 60% a year. That is far above twice the 6% legal rate. If Tess sues, she must prove that market conditions required the rate and that she and Rina were on equal footing. If the court finds the rate unconscionable, it strikes out only the rate and applies the legal rate instead. The court decides this case by case; there is no fixed ceiling.

For plain answers, read Is 5% monthly interest legal? and What is the legal interest rate in the Philippines?. The 2019 Decision has separate opinions, and the 2022 Resolution is long, with a table of the new rules. Read the full texts on the Supreme Court E-Library (links in the sources below) before relying on them. For help with a debt of your own, see where to find legal help.