Law on

Obligation
and
Contracts

Compensation
 Art. 1278. Compensation shall take place
when two persons, in their own right, are
creditors and debtors of each other.
• Compensation – it is the extinguishment
to the concurrent amount of the debts of
two persons, who in their own rights are
debtors and creditors of each other.

• It is sometimes called abbreviated or

simplified payment.
Compensation distinguished from payment

• In compensation, partial payment is

always permitted while in payment.

• In compensation, the mode may take place

by operation of law while in payment, it
involves action or delivery of the amount
paid.
 Compensation distinguished form merger

• In compensation, there must be two

persons who are mutually creditor and
debtor to each other.

• Merger or confusion – there is only one

person whom is merged the qualities of
creditor and debtor.
 Kinds of compensation
• As to their effects:
Total – same amount
Partial – not equal
• As to origin:
Legal – by operation of law
Facultative – one party can claim
compensation the other cannot
Conventional – by agreement of the
parties
• Judicial – decreed by the court, in case
where there is counterclaim.

Art. 1279. In order that compensation may

be proper, it is necessary:
That each one of the obligors be bound
principally, and that he be at the same time
a principal creditor of the other.
 Legal compensation or compensation by
operation of law.

The requisites mentioned apply to

compensation by operation of law. Even if
there is no agreement voluntarily and validly
entered into, there is compensation by
operation of law.
 Requisites of legal compensation
exemplified
• That both obligors be bound principally,
and that they be at the same time a
principal creditor of the other.

• That both debts consist in a sum of money,

or if the things due are consumable, they
be of the same kind, and also of the same
quality if the latter has been stated
• That the two debts are due

• Art. 1280. Notwithstanding the provisions

of the preceding article, the guarantor may
set up compensation as regards what the
creditor may owe the principal debtor.
 Guarantor may set up compensation with
respect to principal debt
• Example: D owes C 10,000 guaranteed by
G. C owes D 8,000. On the due date D is
insolvent. How much is the liability of G ?
• Answer: G is liable for 2,000 because the
law states that the guarantor in an
obligation may set up compensation as
regards what the creditor owed the
principal debtor
• Art. 1281 . Compensation may be total or
partial. When two debts are of the same
amount, there is a total compensation.
 Art. 1282. The parties may agree upon the
compensation of the debts which are not yet
due.
 Total or partial compensation.
When the debts are of the same amount, there is
a total compensation. If not of the same amount,
there is a partial compensation.
 Conventional or voluntary compensation.
Debts which are not due or demandable cannot
be compensated, but the parties may compensate
them voluntarily and this is called conventional or
voluntary compensation.
Art. 1283. If one of the parties to a suit over an obligation has
a claim for damages against the other, the former may set it
off by proving his right to said damages and the amount
thereof.

 Judicial compensation or set-off.

In judicial compensation or set-off, the
parties must prove his right on the damages
claimed at the time of pleading. The claim must
be unliquidated because the fixing or
liquidation must be made in the proceeding
itself.
Art. 1284. When one or both debts are rescissible or
voidable, they may be compensated against each
other before they are judicially rescinded or avoided.

 Rescissible or voidable debts can be

compensated.
In a contract where the debts are rescissible or
voidable the same may be compensated, provided
they are not yet declared rescinded or void. This is
because rescissible and voidable debts are valid and
binding until cancelled or declared void.
 Exercises

• Michael owes Sherelyn 143 sacks of macan rice.

Sherelyn owes Michael 143 sacks of wagwag rice.
Is there a compensation?
-None.

• Bianca owes Michael a horse.

Michael owes Bianca a horse.
Is there a compensation?
-Yes.
 Article 1285…

• The debtor who has consented to the assignment

of rights made by a creditor in favor of a third
person, cannot set up against the assignee the
compensation that would pertain to him the
assignor, unless the assignor was notified by the
debtor at the time he gave his consent, that he
reserved his right to the compensation.
 ...
• If the creditor communicated the cession to him
but the debtor did not consent there to, the latter
may set up compensation of debts previous to
cession, but not of subsequent ones.
• If the assignment is made without the knowledge
of the debtor, he may set up the compensation of
all credits prior to the same and also later ones
until he had knowledge of the assignment.
 Article 1285.

 Assignment of the creditor’s right.

a. When the consent of the debtor.
The debtor, who has consented to the
assignment of the creditor’s right to a third person,
cannot set up against the assignee the
compensation which pertains to him against the
assignor, unless he reserved his right to
compensate.
 Article 1285.

b. With notice from the creditor but without

the debtor’s consent.
The debtor can set up against the
assignee the compensation of debts previous
to the cession, but not of subsequent ones.
 Article 1285.
 May the debtor who has consented to the
assignment of rights made by a creditor in favor
of a third person set up against the assignee the
compensation which would pertain to him
against the assignor?
No, unless the assignor was notified by the
debtor at the time he gave his consent that he
reserved his right to the compensation.
• Art. 1286. Compensation takes place by
operation of law, even though the debts
may be payable at different places, but
there shall be and indemnity for expenses
of exchange or transportation to the place
of payment
1.Automatic Compensation

• When the requisites as stated in Article

1279 are present, there is automatic
compensation even if the two debts are
payable at different places. However, there
shall be an indemnity for expenses of
exchange or transportation to the place of
payment.
• Illustrative Case:
•
• D obliged himself to deliver to C a horse at Minalin,
Pampanga on June 15. In another obligation, C obliged
also to deliver to D a horse at Paniqui, Tarlac, on June 15.
Both parties are residents of Manila. The transportation
fare to Angeles is P150.00 while that to Paniqui is P250.
In here, the obligations of both parties are extinguished,
but C is to give D P100, the difference of the
transportation expenses.
• Art. 1287. Compensation shall not be
proper when one of the debts arises from a
depositum or from the obligations of a
depository or of a bailee in commodatum.
• Neither can compensation be set
against a creditor who has a claim for
support due by gratuitous title, without to
the provisions of paragraph 2 of article
301.
• Art. 1288. Neither shall there be
compensation if one of the debts consists
in civil liability arising from a penal
offense.
• Reasons for the prohibition.

• Contract of depositum and commodatum are

based on confidence and trust. It is but natural
that the depository (in contract of deposit) and
the borrower (in commodatum) must perform
their obligation, otherwise, the trust or
confidence of the depositor or lender would be
violated.
• Future support cannot also be
compensated because this is given for
the benefit of the recipient. Otherwise
he will be exposed to misery and
starvation. Support in arrears
however can be compensated
• When legal compensation cannot take place.

1. When one debt arises from a depositum in a contract of

deposit (not in bank deposit, for this is really a loan).

2. When one debt arises from the obligation of a bailee in

commodatum.

3. When one debt arises because of a claim for support.

4. When one of the debts consists in civil
liability arising from criminal offense.

• Note: In No. 1, the relation of a

depositor with a bank is considered as a
debtor-creditor relation, so the bank may
set up compensation.
• Illustrative Cases:

• No. 1: C deposited with W (a warehouseman) 100

cavans of wagwag rice valued at P10,000. However, C is
indebted to W for P10,000. When C is withdrawing the
deposited rice, W refuses to deliver, claiming
compensation. Is W allowed to compensate?

• No. 2: D deposited with Banco Fino P10,000. However,

D is indebted to Banco Fino also for P10,000. Can the
bank set up compensation?
• Art. 1289. If a person should have
against him several debts which are
susceptible of compensation, the rules
on the application of payments shall
apply to the order of the
compensation.
• Art. 1290. When all the requisites
mentioned in Article 1279 are present,
compensation takes effect by operation of
law, and extinguishes both debts to the
concurrent amount, event though the
creditors and debtors are not aware of the
compensation.
1. Application of payment will apply on
several debts susceptible of compensation.

2.Compensation will take place by operation

of law if all the requirements of Article
1279 are present and extinguishes the
obligation to their concurrent amount.