SPOUSES JOSE T. VALENZUELA AND GLORIA VALENZUELA, PETITIONERS, VS. KALAYAAN DEVELOPMENT & INDUSTRIAL CORPORATION, RESPONDENT.

Valenzuela versus Kalayaan Development and Industrial Corporation

The Case

This is the story of Spouses Jose and Gloria Valenzuela against Kalayaan Development and Industrial Corporation. The spouses occupied a lot owned by the corporation, negotiated to buy the portion they were occupying, signed a contract to sell, paid part of the price, then stopped paying. The corporation sued for rescission of contract and damages. The case matters because it draws the sharp line between a contract of sale and a contract to sell, and it teaches that when the buyer of land under a contract to sell fails to pay in full, there is nothing to rescind, because the seller's obligation to convey title never arose at all.

Procedural History

Kalayaan filed a complaint for rescission of contract and damages before the Regional Trial Court of Caloocan City, Branch 126. The trial court ruled in favor of Kalayaan, rescinded the contract, ordered the spouses and all persons claiming rights under them to vacate the premises and surrender possession, ordered them to pay 100,000 pesos as attorney's fees, and dismissed their counterclaim for lack of merit.

The spouses appealed to the Court of Appeals, arguing among others that there was no valid formal demand, that novation applied, that rescission was improper, that Kalayaan was barred by estoppel, and that the award of attorney's fees had no basis. The Court of Appeals affirmed the trial court and dismissed the appeal for lack of merit. It denied the spouses' motion for reconsideration. The spouses then came to the Supreme Court by petition for review on certiorari.

Facts

Kalayaan owned a parcel of land covered by a transfer certificate of title. The Valenzuela spouses occupied the property and introduced improvements on it. When Kalayaan discovered the occupation, it demanded that they vacate. The spouses then negotiated to buy the portion they were occupying.

On August 5, 1994, the parties executed a Contract to Sell covering 236 square meters for 1,416,000 pesos. The spouses paid 500,000 pesos upon signing and agreed to pay the balance of 916,000 pesos in twelve equal monthly installments of 76,333 pesos and 75 centavos. They also agreed to a liquidated penalty of three percent a month, compounded monthly, on any unpaid installment. Kalayaan would execute the deed of absolute sale only upon full payment of the total purchase price. The spouses made three payments totaling 208,000 pesos, ending in December 1994, and then stopped paying.

In September 1995, the spouses asked Kalayaan to issue a deed of sale for the 118 square meter portion where their house stood, saying they no longer had the resources to pay the balance. Kalayaan sent reminders and demand letters in December 1995, January 1996, and March 1996. In June 1996, the spouses asked Kalayaan's counsel to propose that Gloria's sister, Juliet, assume payment of the remaining balance for the 118 square meter portion at 10,000 pesos a month. Juliet made eight monthly payments of 10,000 pesos during 1997, which Kalayaan accepted for and in behalf of Gloria. Kalayaan's in-house counsel later demanded payment of the outstanding obligation, and the demands were unheeded. Kalayaan then sued for rescission and damages.

Issues

• Whether or not the spouses are entitled to the benefit of substantial performance in good faith under the Civil Code.
• Whether or not a prior and validly notarized letter of demand is required before rescission of a contract to sell real property may be had.
• Whether or not the contract to sell was novated when Juliet was allegedly substituted as the new debtor.
• Whether or not the award of attorney's fees was proper.

Applicable Provisions

Article 1191 of the Civil Code provides:

Article 1191. The power to rescind obligations is implied in reciprocal ones, in case one of the obligors should not comply with what is incumbent upon him.

The Court holds that this article has no application here, because the seller's obligation to convey title never arose, and rescission presupposes an existing obligation.

Article 1292 of the Civil Code provides:

Article 1292. In order that an obligation may be extinguished by another which substitutes the same, it is imperative that it be so declared in unequivocal terms, or that the old and the new obligations be on every point incompatible with each other.

This governs the claim of novation, which the Court rejects because Kalayaan never agreed to a new contract.

Article 2227 of the Civil Code provides:

Article 2227. Liquidated damages, whether intended as an indemnity or a penalty, shall be equitably reduced if they are iniquitous or unconscionable.

This supports the Court's reduction of the three percent monthly penalty interest.

Article 1229 of the Civil Code provides:

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.

This is the authority the Court invokes in reducing the penalty to one percent a month.

Ruling

On the first issue, the Court holds that the spouses cannot invoke substantial performance, because the nature of a contract to sell controls. Under a contract to sell, the seller retains title until the purchaser fully pays the price, and full payment is a positive suspensive condition. The Court states:

The non-fulfillment by the respondent of his obligation to pay, which is a suspensive condition to the obligation of the petitioners to sell and deliver the title to the property, rendered the contract to sell ineffective and without force and effect.

Since the spouses failed to pay in full, Kalayaan's obligation to convey title did not arise, and Article 1191 does not apply. Kalayaan may validly cancel the contract, not because it had the power to rescind, but because its obligation thereunder never arose.

On the second issue, the demand argument fails for the same reason. There being no obligation to rescind, the requirement of a notarized demand for rescission does not come into play.

On the third issue, the Court holds that there was no novation. Novation is never presumed; the parties must expressly agree to abrogate the old contract in favor of a new one, or the old and new obligations must be incompatible on every point. None of the requisites of novation is present. Kalayaan never agreed to substitute Juliet as debtor. Its acceptance of late payments was, at best, an act of tolerance that did not modify the contract.

On the fourth issue, the Court holds that attorney's fees were warranted, since the spouses' failure to pay constrained Kalayaan to litigate, but reduces the award from 100,000 pesos to 50,000 pesos. The Court also orders Kalayaan to refund the partial payments of 788,000 pesos, there being no provision on forfeiture, as otherwise there would be unjust enrichment. Finally, the Court finds the three percent monthly penalty, equivalent to thirty-six percent a year, iniquitous and unconscionable, and reduces it to one percent a month, or twelve percent a year, to be deducted from the partial payments.

Doctrine

A contract to sell is not a contract of sale. In a contract to sell, ownership is reserved to the vendor and does not pass to the vendee until full payment of the purchase price. Full payment is a positive suspensive condition, and its non-fulfillment is not a breach but an event that prevents the seller's obligation to convey title from arising. Consequently, Article 1191 on rescission does not apply, because rescission presupposes an existing obligation. The parties stand as if the conditional obligation had never existed.

Novation is never presumed. It requires an express agreement or obligations incompatible on every point, and the mere acceptance of late payments is tolerance, not modification.

Liquidated damages and penalty interest that are iniquitous or unconscionable may be equitably reduced by the courts under Articles 2227 and 1229 of the Civil Code.

Disposition

The petition was denied. The Court affirmed the Court of Appeals, modified the trial court's decision by cancelling rather than rescinding the contract, reduced the attorney's fees to 50,000 pesos, and ordered Kalayaan to refund the partial payments after deducting the reduced penalty interest.

Remember This

Memorize this line: in a contract to sell, full payment is a positive suspensive condition, so non-payment is not a breach and there is nothing to rescind. Examiners use this case to test the contract of sale versus contract to sell distinction, the requisites of novation, and the equitable reduction of penalties.