Escalation clauses: Fair or over-the-top?
(First of two parts)
“The cost of living is going up and the chance of living is going down,” said American comedian Flip Wilson. But, this perspective has not stopped parties from executing contracts concerning their land, such as those on lease and sale, which stipulate an escalation or escalator clause.
In one case, the Supreme Court held that while fixing a base price, an escalation clause, which can also be referred to as a costs of living index adjustment clause, authorizes the lessor, seller, or some other party to raise it up to a fixed percentage, in view of specified cost increases. Despite this clause being challenged as indefinite and arbitrary for supposedly allowing one party to unilaterally determine the price, it is universally recognized as valid because it seeks to maintain fiscal stability and retain the currency value of prices stated in long-term contracts.
Not all escalation clauses have been upheld as valid under Philippine law, however, as in Gotesco Properties, Inc. v. Victor Cua.
In this case, respondent Victor Cua executed lease contracts with petitioner Gotesco Properties, Inc. (GPI) concerning the latter’s commercial units in Ever-Gotesco Commonwealth Center. Cua leased these units for his jewelry business and amusement center operations.
Under one provision in these lease contracts, which is the subject of dispute in this case, the lessee shall pay GPI monthly common area and aircon dues (CAAD), subject to an 18 percent annual, compounded escalation rate, effective calendar year 1995 or at a rate determined by the latter if these dues would be insufficient to meet inflation, peso devaluation, and other escalation in utility and maintenance costs at any point in time.
GPI imposed escalation costs on the CAAD, which validity Cua had questioned for being unfair. GPI insisted that these were valid, prompting Cua to file the instant complaint for injuctive relief, restitution, and damages before the Regional Trial Court (RTC) Manila.
After trial on the merits, the RTC held that the escalation clause, which GPI had relied on imposing said costs, was void because it allowed for its unrestrained right to unilaterally adjust the CAAD escalation costs, thus preventing Cua from assenting to an important modification in their contracts. Moreover, GPI failed to establish how it had determined, computed, and arrived at its assessment to increase the CAAD escalation costs, which by then exceeded the monthly rent itself.
Upon appeal, the Court of Appeals modified the RTC’s decision. It interpreted the subject escalation clause to refer to two situations—that is: (a) absent inflation, GPI shall impose an 18% interest; or otherwise, (b) GPI shall determine the interest rate it wishes to impose. While the first scenario is valid, the Court of Appeals held that the second is void for violating the principle of mutuality of contracts.
Both parties filed their appeals before the Supreme Court, which invalidated the CAAD escalation costs. In so doing, it first referred to the principle of mutuality of contracts, under which parties are bound by their terms and their compliance cannot be left to one side’s will.
Consequently, a contract which appears heavily skewed in favor of a party, leading to an unconscionable result, must be struck down as void. Relatedly, if compliance with a clause depends solely on the will of one of the parties, then it must be declared void. Thus, any modifications in the contract should be made with the consent of the contracting parties and mutually agreed upon.
In this case, the Supreme Court held that the disputed clause in the lease contracts violates this principle. While it partakes the nature of an escalation clause, which is not inherently wrong per se, it should be invalidated when it grants the creditor, such as GPI, an unbridled right to adjust the interest independently and upwardly, completely depriving the debtor, such as Cua, from assenting to an important modification in the contract.
Contrary to the Court of Appeals’ findings, the disputed clause authorizes GPI from imposing the interest rate it desires, ranging from 18 percent or such other rate, when the CAAD is insufficient to meet inflation, peso devaluation, and other escalation in utility and maintenance costs. According to the Supreme Court, this clause is wholly potestative, solely dependent on GPI’s will, and thus, void.
(To be continued)
