REYNALDO P. FLOIRENDO, JR., PETITIONER, VS. METROPOLITAN BANK AND TRUST COMPANY, RESPONDENT.

Floirendo versus Metropolitan Bank and Trust Company

The Case

This is a petition for review on certiorari brought by Reynaldo Floirendo, Junior against Metropolitan Bank and Trust Company. Floirendo borrowed money from the bank, secured the loan with a real estate mortgage over four parcels of land, and later found himself being charged interest rates that climbed month after month. He sued for reformation of the mortgage contract and the promissory note, asking the court to correct the documents so that they would reflect what he claims was the true agreement of the parties. The case matters because it is the Supreme Court's clean statement that an escalation clause leaving the adjustment of interest rates to the unilateral will of the bank violates the principle of mutuality of contracts, and that reformation is the proper remedy when a document fails to express the true agreement because of one party's inequitable conduct.

Procedural History

Floirendo filed a complaint for reformation of the real estate mortgage contract and the promissory note before the Regional Trial Court of Cagayan de Oro City, Branch 39. Together with the complaint he sought and obtained a temporary restraining order and later a writ of preliminary injunction to stop the foreclosure and the public auction of his four parcels of land. The trial court rendered judgment dismissing the complaint for reformation, dissolving the writ of preliminary injunction, and directing the sale at public auction of the mortgaged properties. It held that there was a meeting of the minds, that the terms of the promissory note were clear and unequivocal, and that escalation clauses are valid stipulations in commercial contracts. Floirendo moved for reconsideration, but the motion was denied for lack of merit. He then elevated the matter to the Supreme Court through a petition for review on certiorari under Rule 45 of the Rules of Civil Procedure.

Facts

Reynaldo Floirendo, Junior was the president and chairman of the board of Reymill Realty Corporation, a domestic corporation engaged in the real estate business. On March 20, 1996, he obtained a loan of 1,000,000 pesos from the Metropolitan Bank and Trust Company, Cagayan de Oro City Branch, to infuse additional working capital into his company. As security, he executed a real estate mortgage in favor of the bank over four parcels of land situated in Barangay Carmen, Cagayan de Oro City.

The loan was renewed for another year, secured by the same mortgage. Floirendo signed a promissory note dated March 14, 1997 fixing the interest rate at 15.446 percent per annum for the first 30 days, subject to upward or downward adjustment every 30 days thereafter, with a penalty charge of 18 percent per annum on any unpaid principal computed from default until payment. The promissory note also authorized the bank to increase, decrease, or otherwise change the interest rate and bank charges from time to time without advance notice to the borrower, upon the occurrence of specified events such as changes in the rate prescribed by law or the Monetary Board, in the rediscount rate, in deposit and borrowing rates, in reserve requirements, or in the overall cost of funding.

On July 11, 1997, the bank began imposing higher interest rates, which varied through the months and reached as high as 30.244 percent in October 1997. Floirendo could no longer pay, so he negotiated for renewal of the loan. The bank agreed, provided he paid arrears in interest totaling 163,138.33 pesos. He paid, but instead of renewing the loan the bank filed a petition for foreclosure of the mortgage, which was granted, and an auction sale was set for August 17, 1998. On August 11, 1998, Floirendo filed his complaint for reformation, alleging that the increased rates unilaterally imposed were scandalous, immoral, illegal, and unconscionable, and that the documents were contracts of adhesion interpretable by the bank in whatever manner it wished.

Issues

• Whether or not the mortgage contract and the promissory note express the true agreement of the parties on the interest rate.
• Whether or not the escalation clause authorizing the bank to adjust the interest rate every 30 days is valid under the principle of mutuality of contracts.
• Whether or not the requisites for reformation of the instruments are present in this case.

Applicable Provisions

Article 1308 of the Civil Code provides:

Article 1308. The contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them.

This is the provision the Court uses to strike down the unilateral interest adjustments, because the clause left the compliance of the contract to the will of the bank alone.

Article 1310 of the Civil Code provides:

Article 1310. The determination shall not be obligatory if it is evidently inequitable. In such case, the courts shall decide what is equitable under the circumstances.

This provision supplies the Court's authority to reduce or equitably adjust interest rates that are excessive and arbitrary.

Ruling

On the first issue, the Court held that while there was a meeting of the minds on the loan, the documents did not express the parties' true agreement on interest rates. The bank unilaterally raised the rate from 15.446 percent to as high as 30.244 percent, varying month after month, without Floirendo's knowledge and consent. The Court found the increases excessive and arbitrary.

On the second issue, the Court agreed with Floirendo that the unilateral increases violated the principle of mutuality of contracts. The provision authorizing the bank to change the rate without advance notice did not give it unrestrained freedom to charge any rate other than that agreed upon, because the monthly adjustment was left to the will of the bank alone. The Court quoted its earlier ruling that a contract containing a condition which makes its fulfillment dependent exclusively upon the uncontrolled will of one of the contracting parties is void. It also stressed that while the Usury Law ceiling was lifted by Central Bank Circular Number 905, nothing therein granted the bank carte blanche authority to raise interest rates to levels that would enslave the borrower or lead to the hemorrhaging of his assets. The Court added that the bank acted in bad faith when, despite Floirendo's payment of the arrears, it hastily foreclosed the mortgage to gain the upper hand in taking his four parcels of land at bargain prices.

On the third issue, the Court found that the requisites for reformation were present. There was a meeting of the minds, but the documents did not express the true agreement on interest rates, and that failure was due to the bank's inequitable conduct.

Doctrine

An escalation clause that leaves the upward adjustment of interest rates to the unilateral will of the lender violates the principle of mutuality of contracts under Article 1308 of the Civil Code and is void. The lifting of the Usury Law ceiling does not give a bank carte blanche authority to raise interest rates to levels that would enslave the borrower or lead to the hemorrhaging of his assets. Reformation of an instrument is proper when there has been a meeting of the minds, the instrument does not express the true agreement, and the failure is due to mistake, fraud, inequitable conduct, or accident. Under Article 1310, courts may equitably reduce interest rates that are evidently inequitable.

Disposition

The Supreme Court granted the petition, reversed the judgment of the trial court, reformed the real estate mortgage contract and the promissory note so that no increase in interest beyond 15.446 percent per annum could be imposed without Floirendo's consent, and ordered that the interest he paid in excess of that rate be applied to the principal obligation.

Remember This

Memorize this line: a stipulation leaving the validity or compliance of a contract to the will of one party is void for violating mutuality under Article 1308. Examiners use this case to test escalation clauses, contracts of adhesion, and the requisites of reformation of instruments.