SPOUSES BENJAMIN AND AGRIFINA SIM, PETITIONERS, VS. M.B. FINANCE CORPORATION, RESPONDENT.

Sim versus M.B. Finance Corporation

The Case

This is a petition for review brought by spouses Benjamin and Agrifina Sim against M.B. Finance Corporation, arising from a complaint for sum of money with damages. The spouses bought a motor vehicle on installment, signed a promissory note, and secured it with a chattel mortgage; the financing company later acquired the credit. When the spouses defaulted and the car was carnapped, they claimed the insurance over the vehicle wiped out their debt. The case matters because it is the clean teaching vehicle for novation — why a simultaneous insurance contract with a different party does not extinguish a loan — and for the court's power to cut down an unconscionable penalty and unreasonable attorney's fees.

Procedural History

M.B. Finance Corporation sued the spouses for sum of money with damages before the Regional Trial Court of Makati. The trial court ruled for the financing company, discrediting the spouses' claim that the insurance proceeds extinguished their obligation, and ordered them to pay jointly and severally the sum due plus a penalty charge of five percent per month, attorney's fees equivalent to twenty five percent of the principal, and costs. On the spouses' motion for reconsideration, the trial court reduced the penalty to three percent per month, citing the Medel case and holding the original rate unconscionable.

The spouses appealed to the Court of Appeals, arguing novation and attacking the interest, penalties, and attorney's fees. The appellate court held there was no novation, but reduced the penalty to one percent per month, or twelve percent per annum, citing Article 1229 of the Civil Code, and reduced attorney's fees to ten percent of the amount due. It added that its ruling was without prejudice to any action the spouses might bring against the insurer. The spouses' motion for reconsideration was denied, so they filed the present petition for review before the Supreme Court.

Facts

On the first of August 1997, the spouses purchased a Nissan Terrano from Angus Motors Corporation on installment. They executed a promissory note in favor of Angus for one million one hundred five thousand three hundred forty four pesos, payable in thirty six consecutive monthly installments of thirty thousand seven hundred four pesos, with a penalty for late payment fixed at five percent a month on the installment in arrears. To secure payment, they executed a chattel mortgage over the vehicle, and they insured it with Commonwealth Insurance Company under a commercial vehicle policy.

On the fourteenth of August 1997, Angus assigned its rights, title, and interest over the promissory note and chattel mortgage to M.B. Finance Corporation. Starting January 1998, the spouses defaulted on their monthly installments. On the twenty third of March 1998, the vehicle was carnapped and never recovered. The spouses filed an insurance claim, but the insurer advised them that it was the financing company which was the beneficiary of the policy.

The financing company chose to file a collection suit rather than go after the insurance proceeds. The trial court found no sufficient evidence that the car was insured or that the insurer had actually paid the financing company, and held that the mortgaged car was mere collateral, so its loss is not a mode of extinguishing the loan. The appellate court affirmed liability but tempered the penalty and the attorney's fees, and the spouses elevated the matter to the Supreme Court.

Issues

• Whether or not the insurance contract novated the spouses' obligation under the promissory note, thereby releasing them from liability to the financing company.
• Whether or not the spouses remain liable for attorney's fees, and whether the reduced award is in order.

Applicable Provisions

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 basis for the appellate court's reduction of the penalty charge from five percent to one percent per month.

Article 2208 of the Civil Code, as quoted by the Court, provides:

the attorney's fees and expenses of litigation must be reasonable.

This is the standard against which the stipulated twenty five percent attorney's fees were reduced to ten percent.

Article 1159 of the Civil Code provides:

Article 1159. Obligations arising from contracts have the force of law between the contracting parties and should be complied with in good faith.

This is why the Court honored the stipulation on attorney's fees in the promissory note, subject only to the reasonableness standard.

Ruling

On the first issue, the Court held there was no novation. Novation, the Court explained through the Fabrigas case, may be extinctive or modificatory, and extinctive novation requires four essential requisites: a previous valid obligation; an agreement of all parties concerned to a new contract; the extinguishment of the old obligation; and the birth of a valid new obligation. The Court stressed that novation must be declared in unequivocal terms, or the old and new obligations must be on every point incompatible with each other, and the test of incompatibility is whether the two obligations can stand together, each having its independent existence.

The Court held that novation cannot arise where the parties in the new contract are not the same parties in the old contract, as here. The promissory note was between the spouses and Angus, later assigned to the financing company, with no mention of the insurer; the insurance policy was between Benjamin Sim as insured, the financing company as beneficiary, and the insurer, with no reference to the promissory note. The agreements were executed simultaneously, and the insurance policy was not intended to substitute the promissory note. The mere fact that the financing company is entitled to the insurance proceeds does not release the spouses from their responsibility.

The Court added that the financing company had the option of filing a collection suit, foreclosing the chattel mortgage, or going against the insurance proceeds. It chose the collection suit, and it acknowledged that by doing so it waived its right to go after the insurance proceeds. The spouses' fear of double collection was therefore unfounded, as they presented no proof that the financing company actually collected the proceeds.

On the second issue, the Court upheld the award of attorney's fees. A stipulation in the promissory note bound the spouses to pay attorney's fees in case of breach. Since obligations arising from contracts have the force of law between the parties, the award was in order, and the appellate court's reduction from twenty five percent to ten percent was correct in light of the requirement that attorney's fees and expenses of litigation must be reasonable.

Doctrine

Extinctive novation requires four requisites: a previous valid obligation, an agreement of all parties concerned to a new contract, the extinguishment of the old obligation, and the birth of a valid new obligation. It must be declared in unequivocal terms, or the old and new obligations must be on every point incompatible, and the test of incompatibility is whether the two obligations can stand together, each having its independent existence. There can be no novation where the parties in the new contract are not the same parties in the old contract. The loss of a mortgaged chattel, which is mere collateral, is not a mode of extinguishing the loan obligation, and the creditor may choose among a collection suit, foreclosure, or the insurance proceeds, and choosing one waives the others. Under Article 1229, the court may equitably reduce a penalty that is iniquitous or unconscionable, and under Article 2208, attorney's fees must be reasonable.

Disposition

The petition was denied, and costs were assessed against the spouses, leaving standing the appellate court's ruling holding them liable, with the penalty reduced to one percent per month and attorney's fees reduced to ten percent of the amount due.

Remember This

The single line to memorize: there is no novation where the parties in the new contract are not the same parties in the old contract, and the test is whether the two obligations can stand together. Examiners use this case to test novation requisites, the effect of insurance on a secured loan, and the court's power to reduce unconscionable penalties and unreasonable attorney's fees.