JSP Meeting #2 Transcript

Ralph Ronald S. Catipay

Start 1:11:30

Recitation of Student
Solidbank Case
Q: Whats the difference between Solidbank vs PNB v. Manalo?
A: in latter case, the discretion as to payment of interest lies solely on the bank, however in the
instant case, even though there was an escalation clause to increase the interest, the borrower can
opt not to pay the interest.
Q: how much was involved in the case of Solidbank?
A: P60M
JSP: Lets say Borrower borrows 60M for construction. First year, borrower does not have the
P60M, but he has properties, so this loan was secured by a mortgage. So borrower used the money
to construct and develop property for the first year, and completion will happen in 2 years. In the
2nd year, the bank increased the interest rate from 8% per annum to 16% per annum. What should
the borrower do? The borrower now has double the interest cost. Does the borrower have an option
to reject and prepay?
JSP: The SC said that this was a valid escalation clause, and yes, the bank can adjust unilaterally,
but the borrower ought to or must consent. And if Borrower rejects, B has option to pre-pay. So
the question now is that is this realistic or possible for the Borrower?
Student: No its not realistic. I dont think the borrower would be able to pay the prepayment agreed
upon plus the interest agreed upon.
JSP: So, lets start here, normally if you have a long-term loan contract, you would have an
escalation clause, or a periodic change in interest rates, normally annually or quarterly. Here in the
case of PNB v. Manalo, there was a loan that ballooned or was increased to 7M, and there was
also an escalation clause. This escalation clause stated that the interest rate shall be the banks
prime rate plus the spread. Whats this prime rate? It means the rate given by the bank to valued
clients who are not credit-risk clients. So, lets say ordinary buyers will be paying 10% per annum,
a prime rate would be as low as 2.5% per annum if you are a valued- client of a bank or considered
as a non-risky client by the bank. Whats the spread? Its the add-on interest to account for the risk
related to the borrower. So if youre a borrower who has a risky business or is deemed likely a
default risk, your rate will be higher. The margin for the risk accounts for the risk related to the
borrower or the transaction. So theres a spread of lets say 3.5%. So there will be an adjustment,
so this rate can adjust depending on what the banks prime rate annually is, but the spread would
also change. Its basically the bank determining the prime rate, as well as the spread. So, although
it looked like a formula, its actually discretionary on the part of the bank. So the SC said, this
violated the mutuality of contracts because the bank determined an essential term of the loan
contract. The bank increased the interest rate without the consent of the borrower, in this case the
Manalos. Theres a long line of PNB cases involving these situations. In other PNB cases, the
clause would state like this the bank shall periodically adjust the interest rate after considering
prevailing market rates, reserve requirements of bank, and other factors. So it would seem that
its not discretionary but it really is! Because the bank would consider those factors but eventually
be the one determining the interest rates. So, this provision then would violate the mutuality of
contracts.
Now, there was an issue in Solidbank, and a student who recited earlier mentioned about a notice
given by the bank to the borrowers. Did this notice cure the defect? No! it was not the notice, and
even if said notice was given, it would not cure the defect, because whats required is for the
borrower to CONSENT to such interest rate change, and this notice by the bank would not amount
to a consent to the borrower. But there was a notice given, so does this mean the borrower should
object or reject? The SC said that silence (in this case by the borrower) does not mean consent.
Meaning, in a context wherein a party HAS NO OBLIGATION TO REPLY, SILENCE
CANNOT BE INTEREPRETED AS CONSENT. So the SC said that the Manalos were under
NO OBLIGATION REPLY TO THE BANKS NOTICES, and even if the Manalos paid the
interest based on the increased/adjusted rate, the Manalos were NOT ESTOPPED to question the
unilateral adjustment of the rate, which was in violation of the mutuality of contracts.
Now lets go to this case of Solidbank, basically the first part of the escalation clause was the same
as the PNB case. The bank could adjust the interest rate, it could be upward or downward
adjustment. But there was an additional clause, that the borrower, upon receipt of the notice of
the adjustment of the rate, could either accept the adjusted rate, or reject said adjusted rate and
pre-pay the loan. The SC said that this clause VALIDATED THE ESCALATION CLAUSE
because now there was an OPTION on the part of the borrower to reject the adjusted rate. So the
SC said that there was no violation of mutuality, because if the borrower would not accept the
adjusted rate, then the borrower can just pre-pay. BUT AS I SAID, this option is ILLUSORY.
And why is this illusory? Ill give you an example. Lets say you have a 10 year loan, in the first
year most likely you do not have the money to pay, and the rate was doubled after the 1 st year.
Would you really have an option to pre-pay? Not likely, and the borrower (you) would just assume
or accept the higher interest cost, because it would be very difficult to borrow somewhere else.
But its there. So take note of this. It would have been better if the parties could not have a fixed
rate. Normally a lender would not agree to a fixed rate because of the fluctuation in the cost of
lending. So the borrower, would want an interest rate that would be adjusted periodically. So how
do you adjust the interest rate periodically, would it be quarterly or annually? PNB had the right
idea to have a formula, but it should be a formula whose factors DO NOT DEPEND
SOLELY ON THE WILL OF PNB. So for example, the usual is you have a reference rate or
benchmark, and then you have a margin. This is how you set interest. So you have a loan contract,
and you want an interest rate that is not controlled by 1 party. So you can have a reference rate or
benchmark plus a given margin, lets say your reference rate will be for example, the traditional
reference is the Treasury bill (T-Bill). TBills have maturity dates of less than 1 year, I think its
91/182/364. Why these numbers? Because its supposed to be divisible by 7, so the maturity date
should end on a business day, supposedly. So thats the reference rate? Why is this a benchmark?
The answer is because a TBill rate is basically a borrowing by the government. So the govt, by
selling TBills, is actually borrowing from the public and there would be a bidding, on what the
rate shall be. So, there will be a rate, and lets use the 91 day Tbill rate. Lets say this is 2% per
annum. The margin as I said will account for the risk related to the transaction as well as the
borrowers. Lets also say the margin is 3%. So you now have a formula. What will the interest
rate in the escalation clause provide? The clause would lets say state The interest rate shall be
adjusted quarterly based on the most recent rate for 91- day TBills plus 3%. So every quarter, the
parties will just check what the most recent 91-day TBill rates are, and just add 3%. So it would
be an automatic adjustment based on factors not involving the discretion on either party.
This is a VALID stipulation since this complies with the MUTUALITY PRINCIPLE of contracts.
Now of course in certain cases, banks would be make sure that they get at least a minimum,
meaning they will have a floor rate a.k.a. the lowest rate, lets say 5.5%. So using the provision in
the escalation clause aforementioned, there is an addendum which states in no case shall the rate
be lower than 5.5% per annum. So if you have this situation, automatically the rate will be 5.5%.
(since the rate aforementioned only amounts to 5% flat). Banks really want to have discretion on
the interest rate. This case of solidbank I think, was a bank industry lobby, because right now if
you borrow, you will still encounter the PNB clause, where the bank would determine unilaterally
the interest rate. When this was introduced or validated by the SC, a number of banks added an
additional clause, that should the borrower reject the interest rate, the borrower should pre-pay.
So now this one was meant to be or considered to be non-violative of the mutuality principle in
contracts. But if you look at PNB, there was another citation that which stated that the interest
rate approximated the market rates, which should not really be the basis, because the PNB rates
approximated the market rates at that time. So the real distinction therefore, is the OPTION OF
THE PART ON THE BORROWER TO PRE-PAY.
On Present Value of Money
You have to understand the concept of the present value of money. So lets say you have year 1 up
to year 5. Lets say you want to receive P1000 on year 5. And you want to sell that P1000 today.
So we will assume that you will definitely receive P1000 on year 5, and you want to sell that P1000
TODAY and you want to get cash. How much should you get today? Definitely not P1000, because
P1k today will be more valuable than P1k 5 yrs from now. So you have to find the present value
of this P1000 5 yrs from now. How do you find it? theres a formula. The formula for finding the
present value is, PV = C / (1 + i)t , t is the number of years, i is the discount rate or factor. So
lets compute, C here is P1000, and lets assume that i (discount rate) is at 10% per annum. So
its P1000 divided by (1.10 raised to the 5th power), and eventually you will get P620. 921. So, the
problem in computing present value is knowing how to discount the income stream. So if youre
receiving P1000, 5 yrs from now, and you want to sell it now, the value, if you have a discount
rate of 10% per annum, will be P620.921.
Compounding on the other hand is this. Example, in a span of 5 yrs, with interest at 10% per
annum. The loan is P620.91, the one above. So in the first year you multiply P620.91 with 1.10 ;
in the 2nd year you multiply the product in the 1st year with 1.10, and so on until the 5th year. After
the 5th year, you will eventually get the final answer of P999.98, that is already equivalent to P1000.
Why am I teaching you this? so that youll understand that basically, compounding is discounting
in reverse. And where did you see compounding? In the case I assigned, in the case of Heirs of
Trias, the separate opinion of Justice Leonen. Although it was illustrated as present value, what
he was doing was actually compounding. If you reverse the process, you will have the
determination of present value. So in compounding, it is prospective and easy, because you will
know the interest rate from the start. The problem in present value on the other hand is the
determination of the discount factor or rate. So you have to understand that. JSP: THIS WONT
APPEAR IN EXAM, BUT IS SOMETHING YOU CAN BRAG ABOUT TO YOUR FRIENDS.
LOL
So just a recap, interest will be due only if the parties agree to the payment of interest in writing.
Even if there is NO agreement, interest will be due BY WAY OF DAMAGES in a loan or
forbearance of money at the 6% per annum as per BSP Circular (this 6% legal rate for
loans/forbearance of money is effective only from july 1, 2013 ; before this date, the rate was 12%
per annum). On the other hand, if there is a transaction NOT INVOLVING loan/forbearance of
money, and there is DEFAULT, interest will also be due but BY WAY OF DAMAGES. How
much is the interest rate here? The answer is 6%, as per Article 2209 of the civil code. And you
can see this situation in the case of Vitarich. In vitarich, it was a case involving a sales contract.
So the applicable rate was 6% to measure damages, based on Art. 2209 of the civil code. BUT, if
there is already an award, you always use the legal rate for loans or forbearance of money
(6% annually). Because the award here becomes a monetary obligation, so the legal rate of 6%
annually in the BSP Circular will be used. Of course, we are assuming that there is NO
AGREEMENT, but if there is an agreement as to the interest rate, then follow said agreement. The
agreement will trump all the other rates. Of course, if the rate is high, what can the court do? If the
rate is characterized as unconscionable, the court can reduce the interest rate BUT NOT REMOVE
THE INTEREST ALTOGETHER. Court can only reduce, if it finds the rate as unconscionable.
Whats unconscionable? Based on jurisprudence, if you hit 3% per month, or 36% per annum, then
the court will deem it as unconscionable, but if its lower than this, then such lower interest rate has
a better chance of being validated. This is based on current jurisprudence. Of course, the best
way to defend an interest rate is just to show the process by which the parties agreed on the
interest rate, like how they negotiated, or who advised them during the transactions, then you can
show now the QUALITY of the consent they gave to the interest rate. This then would take care
any question as to the reasonableness of the interest rate.
Now, for compounding of interest, this can only be done if the parties agreed in writing on the
compounding of interest. The formula for this compounding should be, interest shall be
compounded and then you add the frequency of the compounding, either its being compounded
monthly, quarterly or annually.
Now, even if there is NO agreement on compounding, ACCRUED INTEREST shall earn its
own interest at the agreed rate, OR the legal rate as per art. 2212 of the Civil Code. From when?
Answer is from the date of judicial demand. Take note. On other hand, which is interest by way of
damages, will accrue beginning the date of default. Compounding, in the absence of written
agreement, will happen only upon judicial demand meaning from the time an action is filed by
the relevant party.