Defective contracts, defined
Defective contracts are valid contracts which lacks legal sufficiency due, for example, to incorrect or incomplete following of a required or statutory procedure, and may not be enforceable by the courts. These may either be (a) rescissible contracts; (b) voidable contracts;
and (c) unenforceable contracts.
Rescissible contract, defined
Rescissible contracts are those which have caused a particular economic damage either to one of the parties or to a 3rd person and which may be set aside even if valid. It may be set aside in whole or in part, to the extent of the damage caused.
Rescission is the remedy allowed by law to the contracting parties and to third person\s to repair the damage cause them by a contract.
What are rescissible contracts? ( Art. 1381)
(1) Those which are entered into by guardians whenever the wards whom they represent suffer lesion by more than one-fourth of the value of the things which are the object thereof;
Example: G, a guardian of minor, entered into a Lease Contract Agreement with X over one of the commercial building owned by the minor. The annual lease was P120,000, when the commercial rate for lease on other building occupants was P200,000 per annum. The contract is rescissible since the lesion is more than ¼ of P200,000 (P50,000).
(2) Those agreed upon in representation of absentees, if the latter suffer the lesion stated in the preceding number;
Under Art. 381 of the Civil Code, an absentee is a person who disappears from his domicile, his whereabouts being unknown, and without leaving an agent to administer his property. Thus, if the representative of an absentee sold the former’s property at a price where the absentee would suffer lesion of more than
¼ of the actual value of the thing, the sale is rescissible.
(3) Those undertaken in fraud of creditors when the latter cannot in any other manner collect the claims due them;
Example: A has only 1 property left – a parcel of land worth P500,000. He has a creditor B, which he owes P400,000. To escape payment, A donated his land to his cousin M, thus rendering A insolvent. The donation made was for fraudulent purpose and thus may be rescinded.
(4) Those which refer to things under litigation if they have been entered into by the defendant without the knowledge and approval of the litigants or of competent judicial authority;
Example: A parcel of land was the subject of litigation between parties. A, B and C are co-heirs, however, the land was registered under the name of B only, as trustee for his other co-heirs. B sold the entire lot to X, who has knowledge of the pending claims of other co-heirs. The sale between B and X is rescissible.
(5) All other contracts specially declared by law to be subject to rescission.
Under Article 1382, Payments made in a state of insolvency for obligations to whose fulfillment the debtor could not be compelled at the time they were effected, are also rescissible. Thus, if X owes the following creditors:
A-100,000; B-50,000 and C-200,000. X was in state of insolvency where he has only P120,000 worth of asset left. X then paid the whole P120,000 to C. The payment made by X to C is prejudicial to the rights of other creditors, thus rescissible.
Requisites before there can be a valid rescission
1. The action for rescission is subsidiary; it cannot be instituted except when the party suffering damage has no other legal means to obtain reparation for the same.
Rescission shall be the last recourse (Art. 1383)
2. Rescission shall be only to the extent necessary to cover the damages caused (Art.
1384).
Example: A has only 2 properties left – a parcel of land worth P200,000 and a bank deposit of P400,000. He has a creditor B, which he owes P400,000.
To escape payment, A donated the land to his cousin M, and the bank deposit was also donated to his friend Y, thus rendering A insolvent. The donation made was for fraudulent purpose and thus may be rescinded. However, rescission can only be made to the donation to Y, since rescission shall only be to the extent necessary to cover the damages.
3. In rescission, there must be mutual restitution. Rescission creates the obligation to return the things which were the object of the contract, together with their fruits, and the price with its interest; consequently, it can be carried out only when he who demands rescission can return whatever he may be obliged to restore (Art. 1385)
A party seeking rescission must return whatever he obtained from the contract. The rescission will not lie if the party seeking it cannot comply with such obligation.
4. Neither shall rescission take place when the things which are the object of the contract are legally in the possession of third persons who did not act in bad faith. In this case, indemnity for damages may be demanded from the person causing the loss
Example: A has only 1 property left – a parcel of land worth P500,000. He has a creditor B, which he owes P400,000. To escape payment, A donated his land to his cousin M, thus rendering A insolvent. The donation made was for fraudulent purpose and thus may be rescinded. However, before the contract was rescinded, M was able to secure a new title over the property by virtue of such donation and was registered under his name. M then sold the same land to X, who was in good faith and has no knowledge of the infirmities in the old title.
Rescission in this case is not tenable.
5. The action for rescission must be brought within the time period allowed by law
For person under guardianship – within 4 years from termination of incapacity
For absentee – within 4 years from the time the absentee’s domicile is known Alienations in fraud of creditors
1. Alienation by gratuitous title - all contracts by virtue of which the debtor alienates property by gratuitous title are presumed to have been entered into in fraud of creditors, when the donor did not reserve sufficient property to pay all debts contracted before the donation (Art. 1387).
Thus, if a debtor, has total assets of P1,000,000 and liabilities of P600,000, donates assets more than P400,000, such donation is presumed fraudulent because it will make the debtor insolvent – with a liability of P600,000 and assets of less than P600,000.
2. Alienations by onerous title – these are also presumed fraudulent when made by persons against whom some judgment has been rendered in any instance or some writ of attachment has been issued. The decision or attachment need not refer to the property alienated, and need not have been obtained by the party seeking the rescission.
Example: A borrowed money from B for P500,000. On the maturity date, B failed to pay the loan, hence, B filed a civil case for collection for sum of money. The court decided in favor of B and then issued Writ of Attachment to 2 parcels of land of A, with total value of P600,000. During the pendency of execution of the case decision, A sold the attached land in favor of X. The sale is presumed fraudulent since it was made against the Writ of Attachment issued by court. The same is also true if A sold his specific car to a third person. The law
provides that attachment need not refer to the property alienated, and need not have been obtained by the party seeking the rescission.
Attachment – is the legal process of seizing property to ensure satisfaction of a judgment. Real and personal properties, stocks or shares, debts and credits, can be the subject of attachment.
Liability of person acquiring things in alienation in fraud of creditors
1. If the purchase was made in good faith – he shall not be liable notwithstanding the fraudulent intention of the debtor in disposing the property. Rescission will not be a remedy in this case. If there are subsequent transfers, the transferees shall not be liable for damages even they were in bad faith.
2. If the purchaser is in bad faith (as he knows the intention of the seller to defraud the creditors at the time of sale), he shall indemnify the creditors for damages suffered by them on account of the alienation, whenever, due to any cause, it should be impossible for him to return them (Art. 1388). This rule applies even if the loss be due to fortutios event.
If there are two or more alienations, the first acquirer shall be liable first, and so on successively.
Example: A has only 1 property left – a parcel of land worth P500,000. He has a creditor B, which he owes P400,000. To escape payment, A donated his land to his cousin M, thus rendering A insolvent. The donation made was for fraudulent purpose and thus may be rescinded. However, before the contract was rescinded, M was able to secure a new title over the property by virtue of such donation and was registered under his name. M then sold the same land to X.
If X acted in good faith, the sale between M and X is not rescissible. This is true even if M had previous knowledge of the fraudulent purpose why A donated the property to him.
If X acted in bad faith, as when knew beforehand that the property was originally transferred to M to defraud creditor B, the sale between M and X can be rescinded.
Voidable Contracts Voidable Contracts, defined
Voidable contract refers to a contract that is valid and binding unless avoided or declared void by a party to the contract who is legitimately exercising a power to avoid the contractual obligations. A contract may be voidable on the grounds of fraud, mistake, misrepresentation, lack of capacity, duress, undue influence, or abuse of a fiduciary relationship.
A contract that is based on one of these grounds is not automatically void but is voidable at the option of the party entitled to avoid it.
When is a contract voidable?
1. When one of the contracting parties is incapable of giving consent to a contract.
The following are incapable of giving consent:
a. Unemancipated minors
b. Insane or demented person
c. Deaf-mutes who do not know how to write
2. When consent is vitiated by mistake, violence, intimidation, undue influence or fraud
Mistake - an error in comprehending facts, meaning of words or the law, which causes one party or both parties to enter into a contract without understanding the obligations or results.
Violence - Physical force exerted for the purpose of violating, damaging, or abusing a person.
Intimidation - implies the presence or operation of a fear-inspiring force to frighten into submission, compliance, or acquiescence
Undue influence - refers to any improper or wrongful constraint, machination, or urgency of persuasion, by which one's will is overcome and he is induced to do or forbear an act which he would not do, or would do, if left to act freely. Undue
influence may result from family affiliations, religious affiliations and similar group influence.
Fraud – refers to deception deliberately practiced in order to secure unfair or unlawful gain.
Rules on annulment of voidable contracts
1. Prescriptive period of annulment – the action for annulment must be brought within the time prescribed by law. Otherwise, the contract can no longer be set aside.
The action for annulment shall be brought within four (4) years. This period shall begin:
In cases of intimidation, violence or undue influence, from the time the defect of the consent ceases.
In case of mistake or fraud, from the time of the discovery of the same
When the action refers to contracts entered into by minors or other incapacitated persons, from the time the guardianship ceases.
2. Who may bring action for annulment?
The action for the annulment of contracts may be instituted by all who are thereby obliged principally or subsidiarily. However, persons who are capable cannot allege the incapacity of those with whom they contracted; nor can those who exerted intimidation, violence, or undue influence, or employed fraud, or caused mistake base their action upon these flaws of the contract. Thus, the following person can bring action for annulment:
a. The guardian, during the incapacity of his ward
b. The incapacitated person after he has attained capacity
c. The party whose consent is vitiated by mistake, violence, intimidation, undue influence or fraud.
3. Effects of annulment
An obligation having been annulled, the contracting parties shall restore to each other the things which have been the subject matter of the contract (Article 1398).
Thus,
a. In obligation to give – parties shall return to each other the thing which have been the subject matter of the contract, with the fruits, and the price together with interests.
Example: M, minor, sold a parcel of land to B for P300,000. After 5 years and M attained the age of majority, he brought an action to annul the sale with B. When the contract is annulled, M is obliged to return to B the price of P300,000 plus the legal interest (12% per annum). B on the
other hand, shall return to M the parcel of land plus the fruits of the land for the last 5 years while B is in the possession of it.
b. In obligation to render service, the value thereof shall be the basis of damage.
c. When the defect of the contract consists in the incapacity of one of the parties, the incapacitated person is not obliged to make any restitution except insofar as he has been benefited by the thing or price received by him.
Example: M, a minor, sold his Samsung Galaxy Notepad to X for P1,000. M then spent the P1,000 for internet video games. Upon knowledge of the sale, the guardian of M immediately asked for annulment of contract. X must return the notepad to the minor, but M has no obligation to make restitution ( return the P1,000). If, however, he minor spent P500 to buy materials for his school projects, and spent the rest for internet computer games, then the minor is obliged to return the P300 he benefited from the transaction.
d. Whenever the person obliged by the decree of annulment to return the thing cannot do so because it has been lost through his fault, he shall return the fruits received and the value of the thing at the time of the loss, with interest from the same (Art. 1400).
e. As long as one of the contracting parties does not restore what in virtue of the decree of annulment he is bound to return, the other cannot be compelled to comply with what is incumbent upon him.
Example: M, minor, sold a parcel of land to B for P300,000. M then placed the amount in a time deposit with XXX Bank, for a maturity term of 5 years. After 5 years and M attained the age of majority, he brought an action to annul the sale with B. XXX Bank however was closed, and the deposit of M was frozen and cannot be withdrawn. B cannot be compelled to return the land and its fruits, unless M delivers the price plus interests to B. Mutual restitution is required in annulment of contracts between parties.
Effects of loss of the thing while in the possession of the party
1. If lost by the party who can bring the action for annulment ( incapacitated, those consent was vitiated )
If lost through his fault, the action for annulment is extinguished, whether such party is incapacitated or his consent is vitiated.
If lost without his fault and the party is incapacitated, he cans still bring an action for annulment. However, he will be required to return the value of the thing and its fruits, and only up to the extent he has benefited.
2. If lost by party who employ force, intimidation, undue influence etc., he is still oblige to pay the value of damages in case the contract is annulled.
Ratification, meaning
Ratification is the adoption, confirmation or affirmation of the previous act. Ratification cleanses the defects in consent and the effect retroacts on the date the contract was originally constituted.
Rules governing ratification 1. How ratification is made?
a. Express ratification – when made orally or in writing
b. Implied or tacit ratification - It is understood that there is a tacit ratification if, with knowledge of the reason which renders the contract voidable and such reason having ceased, the person who has a right to invoke it should execute an act which necessarily implies an intention to waive his right (Art. 1393).
Example: X threatens Y to kill the latter if Y will not execute a Deed of Sale a parcel of land in favor of X payable 3 months later. Meanwhile, X and Y fixed their personal differences and become good acquaintances. After 3 months, Y delivers to X the title of the land and other documents needed for the transfer of title from Y to X. The act of X constitutes ratification of the preivous sale transaction executed between parties.
2. Who may ratify?
a. The guardian of the incapacitated person during the latter’s incapacity b. The incapacitated person after he has attained capacity
c. The party whose consent is vitiated by mistake, violence, intimidation, undue influence or fraud.
Notes:
Person who can ratify are also those person who can bring action for annulment.
Ratification does not require the conformity of the person who has no right to bring the action for annulment.
3. Effects of ratification
a. It extinguishes the action to annul a voidable contract
b. It cleanses the contract from its all defect from the moment it was constituted.
Thus, the contract is considered not defective from the very beginning.
Unenforceable contracts Unenforceable contracts, defined
Unenforceable contract is a contract which cannot be legally enforced because of some deficiency in the agreement. It cannot be enforced unless ratified.
Who may avail the defense of unenforceability of the contract?
Only the contracting parties can avail the defense of unenforceability of the contract.
Unenforceable contracts cannot be assailed by third persons (Art. 1408).
The following are unenforceable contracts (Art. 1403)
1. Those entered into in the name of another person by one who has been given no authority or legal representation, or who has acted beyond his powers
Under Article 1317 of the Civil Code, it states that “No one may contract in the name of another without being authorized by the latter, or unless he has by law a right to represent him. A contract entered into in the name of another by one who has no authority or legal representation, or who has acted beyond his powers, shall be unenforceable, unless it is ratified, expressly or impliedly, by the person on whose behalf it has been executed, before it is revoked by the other contracting party.”
Examples:
a. Given no authority – “X sold a parcel of land to Y. The registered owner of the said land is M. Y cannot enforce the contract to M as X has given no authority to sell the land in M’s behalf.
b. Agent acted in excess of authority – “M authorized X to sell his land for P1,000,000 cash. X then sold the land to Y for P1,000,000 payable in installment. Y cannot enforce the contract to M, since the agent X acted in excess of his authority.
2. Those that do not comply with the Statute of Frauds.
Statute of Frauds is type of law, modeled after an old English Law that requires certain types of contracts to be in writing. Hence, an agreement hereafter made shall be unenforceable by action, unless the same, or some note or memorandum, thereof, be in
Statute of Frauds is type of law, modeled after an old English Law that requires certain types of contracts to be in writing. Hence, an agreement hereafter made shall be unenforceable by action, unless the same, or some note or memorandum, thereof, be in