Reducing contractual penalty

Date Published:
Article 1229 of the New Civil Code speaks of instances when the contractual penalty may be reduced. The law says:
"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."
The instances are:
  1. If the principal obligation has been partly complied with.
  2. If the principal obligation has been irregularly complied with.
  3. If the penalty is iniquitous or unconscionable, even if there has been no performance.
The question of whether a penalty is reasonable or iniquitous can be partly subjective and partly objective. Its resolution would depend on such factor as, but not necessarily confined to, the type, extent and purpose of the penalty, the nature of the obligation, the mode of breach and its consequences, the supervening realities, the standing and relationship of the parties, and the like, the application of which, by and large, is addressed to the sound discretion of the court. (Ligutan v CA, G.R. No. 138677, 2002)

In Rizal Commercial Banking Corp. vs. Court of Appeals, the Supreme Court tempered the penalty charges after taking into account the debtor’s pitiful situation and its offer to settle the entire obligation with the creditor bank. The stipulated penalty might likewise be reduced when a partial or irregular performance is made by the debtor. The stipulated penalty might even be deleted such as when there has been substantial performance in good faith by the obligor, when the penalty clause itself suffers from fatal infirmity, or when exceptional circumstances so exist as to warrant it. (G.R. No. 128833, April 20, 1998)
"In exercising this vested power to determine what is iniquitous and unconscionable, the Court must consider the circumstances of each case. It should be stressed that the Court will not make any sweeping ruling that surcharges and penalties imposed by banks for non-payment of the loans extended by them are generally iniquitous and unconscionable. What may be iniquitous and unconscionable in one case, may be totally just and equitable in another. This provision of law will have to be applied to the established facts of any given case."