Rescission and forfeiture of payments
In the law of Obligations and Contracts, there is the principle of rescission. It is sometimes confused with cancellation or termination of a contract, but these remedies are not the same.
Rescission is the “unmaking of a contract, or its undoing from the beginning, not merely its termination.” The result is that it is as if the contract never existed. On the other hand, termination refers to an “end in time or existence; a close, cessation, or conclusion” of the contract, releasing the parties from further obligations to each other.
The Supreme Court has explained that rescinding a contract means declaring it void from its inception and putting an end to it as if it never existed. It is not merely about terminating the contract and releasing the parties from future obligations. Rescission effectively abrogates the contract from the start and restores the parties to their positions as if no contract had been made. When a rescission is properly made, both parties must return to each other what they received and place each other as far as possible in their original situations. (Fong v. Dueñas, GR 185592, June 15, 2015)
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Rescission is applicable in contracts where the parties have reciprocal obligations — where each party is obligated to the other. For example, in a contract to sell a property, one party (the seller) is obligated to deliver the property, and the other party (the buyer) is obligated to pay the price. If the buyer violates the agreement and the seller rescinds the contract, the seller must return the money paid by the buyer, and the buyer must return the property. Afterward, it is as if no contract to sell was ever made between the two parties.
A question arises: if the seller seeks to keep the payments made by the buyer, while also recovering the property sold, on the grounds that the seller violated the contract, would this be consistent with rescission and the law?
In the case of Kim, et al. v. Quicho, et al., the Supreme Court ruled in favor of the seller.
The case involved the rescission of a contract where the parties disagreed on the consequences of rescission. The seller argued that they were entitled to both the return of the property and the forfeiture of the payments made by the buyer, which represented rental payments for the property. The buyer, however, contended that since the contract was rescinded, the parties should only return what they received by virtue of the contract. In their view, the forfeiture provision was erased along with the contract. (GR 249247, March 15, 2021)
The facts of the case were as follows:
Ms. Kim owned a portable crusher, which was installed on her property in Floridablanca. She agreed to sell it to Mr. Quicho, who intended to use it for his crushing plant business. They executed a Deed of Conditional Sale, under which the buyer was to pay P18 million in three installments: P5 million upon signing, PhP5 million one month after signing, and P8 million within one year of starting the business. The parties also entered into a lease agreement, wherein the buyer would lease the property where the crusher was installed.
The Deed of Conditional Sale included a clause stating that if the buyer failed to make any installment payments, the contract would be rescinded, and any money paid would be forfeited as rental payments. The buyer would also be required to return the property, which the seller could then sell to someone else.
The lower court ruled in favor of the seller. However, the Court of Appeals modified the decision, holding that while the seller had the right to rescind the contract, she must return the money paid by the buyer, as the principle of rescission requires the mutual restitution of benefits received by both parties. The Court of Appeals emphasized that “rescission abrogates the contract from its inception and restores the parties to their original positions before the contract was made.”
The Supreme Court reversed the decision of the Court of Appeals, affirming the lower court’s ruling that the seller was entitled to keep the payments made by the buyer in addition to recovering the property sold.
Although rescission nullifies the contract from its inception, it does not disregard the consequences created by the contract.
One such consequence is the validity of the forfeiture or penalty clause. The Court noted that under Article 1191 of the Civil Code, the injured party in a contract has two remedies: to demand performance or to rescind the contract, with damages in either case. The Court recognized that, since the parties can agree to extrajudicial rescission under Article 1191, they also have the right to stipulate the terms of damages in the event of rescission.
The Court declared that rescission did not render the forfeiture or penalty clause inoperative, but rather highlighted its application. Additionally, partial payments made by the buyer could be retained and considered as rental payments by the seller if the buyer had possession or use of the property before the transfer of title.
The Court compared the partial payments made by the buyer to the payment of earnest money, which compensates the seller for the opportunity cost of not seeking other buyers.
In this case, the seller, Ms. Kim, had not been able to use her property for at least eight years. As such, the Court allowed the seller to retain the partial payments as rental compensation for the use of her property.
To reconcile the principle of rescission with the forfeiture of payments, the Court established that, as a general rule, the rescission of a contract under Article 1191 of the Civil Code results in the mutual restitution of benefits received by the parties. However, there are two exceptions:
- If there is an express stipulation to the contrary in a forfeiture or penalty clause, recognizing the parties’ autonomy to contract.
- If the buyer had possession or use of the property before the transfer of title, in which case partial payments may be retained and considered as rental payments by the seller to avoid unjust enrichment.
(The author, Atty. John Philip C. Siao, is a practicing lawyer and founding Partner of Tiongco Siao Bello & Associates Law Offices, an Arbitrator of the Construction Industry Arbitration Commission of the Philippines, and teaches law at the De La Salle University Tañada-Diokno School of Law. He may be contacted at [email protected]. The views expressed in this article belong to the author alone.)
