Dear Atty. Gab

Musta Atty!

I hope you can shed some light on a very stressful situation I’m facing. A few years ago, I took out a significant business loan from a major bank in Makati to expand my small restaurant. The loan agreement mentioned that the interest rate would be based on “prevailing market rates.” At first, the rate was manageable, around 12% per annum.

However, over the next two years, especially during the recent economic downturn, the bank kept increasing the rate. I would usually receive a phone call from a bank officer informing me about the new, higher rate for the next quarter – sometimes it went up to 18%, even 22%! They never sent any formal letters for me to sign agreeing to these increases, just phone calls. Due to these high rates and business difficulties, I eventually defaulted on my payments.

Last month, the bank foreclosed on the commercial property I used as collateral, selling it at auction for P5,000,000. My original loan principal was P6,500,000. Now, the bank has sent me a demand letter claiming I still owe them a deficiency of almost P3,000,000! They said this huge amount includes all the compounded interest based on those increased rates, plus hefty penalties.

I feel this is incredibly unfair. Was the bank allowed to just keep increasing the interest rate based on phone calls? And how can the deficiency be so large when the principal wasn’t even fully covered by the foreclosure sale? I’m losing sleep over this. Can they legally enforce this deficiency claim against me?

Thank you for any guidance you can offer.

Sincerely,
Regina Gatchalian

Dear Regina,

Thank you for reaching out. I understand how stressful and confusing this situation must be, especially when facing a significant deficiency claim after a foreclosure. Dealing with loan agreements, interest rate changes, and their consequences can indeed be complex.

The core issues you raised – the validity of the interest rate increases based on phone calls and the resulting deficiency claim – touch upon fundamental principles of contract law in the Philippines. While banks can sometimes adjust interest rates under specific conditions, such adjustments are not absolute and must respect the rights of both parties involved. Let’s delve into the legal principles that govern situations like yours.

Navigating Interest Rate Changes in Your Loan Agreement

The foundation of any valid contract, including loan agreements, is the principle of mutuality. This means the contract must bind both parties, and its terms cannot be left to the sole will of one party. The Civil Code clearly states this:

Article 1308. The contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them.

Furthermore, when it comes to interest on loans, the law requires express agreement in writing:

Article 1956. No interest shall be due unless it has been expressly stipulated in writing.

These principles are crucial when evaluating clauses in loan agreements that allow for changes in interest rates, often called escalation clauses. While escalation clauses themselves are not inherently illegal (they can help maintain the value of money in long-term contracts), they are subject to strict limitations to ensure fairness and mutuality.

The Supreme Court has consistently held that an escalation clause is void if it grants the lender an unchecked right to increase the interest rate without the borrower’s explicit consent. Such a situation violates the principle of mutuality.

[A]n escalation clause “which grants the creditor an unbridled right to adjust the interest independently and upwardly, completely depriving the debtor of the right to assent to an important modification in the agreement” is void. A stipulation of such nature violates the principle of mutuality of contracts.

Your loan agreement mentioned interest based on “prevailing market rates.” This, in itself, doesn’t automatically make the clause void, as market rates are theoretically external factors not solely dictated by the bank. However, the implementation of changes based on these rates must still respect mutuality. Simply stating that rates will follow the market isn’t enough license for the bank to impose increases unilaterally.

Even though the Usury Law ceiling on interest rates was lifted by Central Bank Circular No. 905, this deregulation does not give lenders absolute power. The Supreme Court clarified this point:

While a ceiling on interest rates under the Usury Law was already lifted under Central Bank Circular No. 905, nothing therein “grants lenders carte blanche authority to raise interest rates to levels which will either enslave their borrowers or lead to a hemorrhaging of their assets.”

Crucially, any modification to the interest rate, even if potentially allowed by an escalation clause referencing market rates, requires the express conformity of the borrower. Phone calls informing you of rate hikes do not generally satisfy this requirement. For a rate change to be binding, there should ideally be a formal written notice detailing the new rate and its computation, and, most importantly, your clear written consent to this change. Without your explicit agreement to each new rate, the unilateral increases imposed by the bank are likely invalid.

If the interest rate increases are found to be invalid due to a lack of mutuality and your express consent, the interest should be calculated based on the originally agreed-upon rate (12% in your case) or a legally applicable rate if the original stipulation is unclear. This directly impacts the total amount you legally owed at the time of foreclosure.

Regarding the deficiency claim, a lender generally has the right to recover the remaining debt if the proceeds from the foreclosure sale are insufficient to cover the total obligation. However, this deficiency must be based on the valid amount owed, calculated using the legally applicable interest rates and penalties. If the bank’s calculation includes interest based on void unilateral increases, the deficiency amount they are claiming may be incorrect and significantly inflated. You are only liable for the deficiency computed based on the principal, the validly stipulated interest, and reasonable penalties.

Practical Advice for Your Situation

• Review Your Loan Agreement Thoroughly: Carefully examine the exact wording of the interest rate clause and any clauses regarding notices and amendments. Note the originally stipulated rate.
• Document Communications: Gather any records you have of the communications regarding interest rate changes, including dates of phone calls if possible, and note the absence of written notices requiring your signature or consent.
• Request a Detailed Statement of Account: Ask the bank for a complete breakdown of your account, showing the principal, each interest rate applied and the period it covered, penalties charged, the foreclosure sale proceeds, and how the deficiency amount was calculated.
• Challenge Unilateral Increases: If the statement confirms interest rates were increased without your written consent, you have grounds to question the validity of those rates and the resulting calculations.
• Recalculate the Debt: Try to recalculate the amount owed using only the original 12% interest rate (or any rate you explicitly agreed to in writing) and any stipulated penalties (which might also be subject to review for reasonableness). This will give you an idea of the potentially correct deficiency, if any.
• Explore Negotiation: Based on your recalculation and the potential invalidity of the rate hikes, you might be able to negotiate a settlement with the bank for a significantly lower amount.
• Seek Legal Counsel Immediately: Given the complexity and the significant amount involved, consult a lawyer experienced in banking law and foreclosure proceedings. They can analyze your specific documents, advise on the strength of your position, and represent you in negotiations or potential litigation.

The principle of mutuality is central to ensuring fairness in contracts. While loan agreements often contain provisions for variable interest, these cannot override the fundamental requirement for both parties to agree on essential changes like interest rate hikes. Challenging the basis of the deficiency claim, particularly the unilaterally increased interest rates, is crucial in your situation.

Hope this helps!

Sincerely,
Atty. Gabriel Ablola

For more specific legal assistance related to your situation, please contact me through gaboogle.com or via email at connect@gaboogle.com.

Disclaimer: This correspondence is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please schedule a formal consultation.