Principle of Mutuality, A1308 Civil Code

1. Concept

Article 1308. The contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them. (1256a)

1) The principle of mutuality of contracts is embodied in Article 1308 of the Civil Code. (Pabalan v. Sabnani, En Banc, Per Concurring Opinion of Caguioa, J.)

2) Mutuality is one of the characteristics of a contract, its validity or performance or compliance of which cannot be left to the will of only one of the parties.This is enshrined in Article 1308 of the New Civil Code… (GF Equity, Inc. v. Valenzona, G.R. No. 156841, June 30, 2005, Per Carpio-Morales, J.)

3) Thus, there can be no contract in the absence of mutual consent of the parties. In order for contractual obligations to have the force of law between the parties, there must be mutuality between them based on their essential equality. (Security Bank Corporation v. Sps. Mercado, G.R. No. 192934, June 27, 2018, Per Jardaleza, J.)

4) The principle of mutuality of contracts is found in Article 1308 of the New Civil Code, which states that contracts must bind both contracting parties, and its validity or compliance cannot be left to the will of one of them. The binding effect of any agreement between parties to a contract is premised on two settled principles: (1) that any obligation arising from contract has the force of law between the parties; and (2) that there must be mutuality between the parties based on their essential equality.  As such, any contract which appears to be heavily weighed in favor of one of the parties so as to lead to an unconscionable result is void. Likewise, any stipulation regarding the validity or compliance of the contract that is potestative or is left solely to the will of one of the parties is invalid. This holds true not only as to the original terms of the contract but also to its modifications. Consequently, any change in a contract must be made with the consent of the contracting parties, and must be mutually agreed upon. Otherwise, it has no binding effect.

Garcia v. Rita Legarda, Inc., En Banc, G.R. No. L-20175, October 30, 1967, Per Dizon, J.:

• Article 1308 of the New Civil Code reads as follows:

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

• The above legal provision is a virtual reproduction of Article 1256 of the old Civil Code but it was so phrased as to emphasize the principle that the contract must bind both parties. This, of course, is based firstly, on the principle that obligations arising from contracts have the force of law between the contracting parties and secondly, that there must be mutuality between the parties based on their essential equality to which is repugnant to have one party bound by the contract leaving the other free therefrom (8 Manresa 556). Its ultimate purpose is to render void a contract containing a condition which makes its fulfillment dependent exclusively upon the uncontrolled will of one of the contracting parties.

• Paragraph 6 of the contracts in question — which is the one claimed to be violative of the legal provision above quoted — reads as follows:

SIXTH — In case the party of the SECOND PART fails to satisfy any monthly installments, or any other payments herein agreed upon, he is granted a month of grace within which to make the retarded payment, together with the one corresponding to the said month of grace; it is understood, however, that should the month of grace herein granted to the party of the SECOND PART expire, without the payments corresponding to both months having been satisfied, an interest of 10% per annum will be charged on the amounts he should have paid; it is understood further, that should a period of 90 days elapse, to begin from the expiration of the month of grace herein mentioned, and the party of the SECOND PART has not paid all the amounts he should have paid with the corresponding interest up to that date, the party of the FIRST PART has the right to declare this contract cancelled and of no effect, and as consequence thereof, the party of the FIRST PART may dispose of the parcel or parcels of land covered by this contract in favor of other persons, as if this contract had never been entered into. In case of such cancellation of this contract, all the amounts paid in accordance with this agreement together with all the improvements made on the premises, shall be considered as rents paid for the use and occupation of the above mentioned premises, and as payment for the damages suffered by failure of the party of the SECOND PART to fulfill his part of this agreement; and the party of the SECOND PART hereby renounces all his right to demand or reclaim the return of the same and obliges himself to peacefully vacate the premises and deliver the same to the party of the FIRST PART.

• The above stipulation, to our mind, merely gives the vendor “the right to declare this contract cancelled and of no effect” upon fulfillment of the conditions therein set forth. It does not leave the validity or compliance of the contract entirely “to the will of one of the contracting parties”; the stipulation or agreement simply says that in case of default in the payment of installments by the vendee, he shall have (1) “a month of grace”, and that (2) should said month of grace expire without the vendee paying his arrears, he shall have another “period of 90 days” to pay “all the amounts he should have paid”, etc., then the vendor “has the right to declare this contract cancelled and of no effect.” We have heretofore upheld the validity of similar stipulations. In Taylor vs. Ky Tieng Piao, etc., 43 Phil. 873, 876-878 the ruling was that a contract expressly giving to one party the right to cancel, the same if a resolutory condition therein agreed upon — similar to the one under consideration — is not fulfilled, is valid, the reason being that when the contract is thus cancelled, the agreement of the parties is in reality being fulfilled. Indeed, the power thus granted can not be said to be immoral, much less unlawful, for it could be exercised — not arbitrarily — but only upon the other contracting party committing the breach of contract of non-payment of the installments agreed upon. Obviously, all that said party had to do to prevent the other from exercising the power to cancel the contract was for him to comply with his part of the contract. And in this case, after the maturity of any particular installment and its non-payment, the contract gave him not only a month grace but an additional period of 90 days.

GF Equity, Inc. v. Valenzona, G.R. No. 156841, June 30, 2005, Per Carpio-Morales, J.:

• The ultimate purpose of the mutuality principle is thus to nullify a contract containing a condition which makes its fulfillment or pre-termination dependent exclusively upon the uncontrolled will of one of the contracting parties.

• Not all contracts though which vest to one party their determination of validity or compliance or the right to terminate the same are void for being violative of the mutuality principle. Jurisprudence is replete with instances of cases12 where this Court upheld the legality of contracts which left their fulfillment or implementation to the will of either of the parties. In these cases, however, there was a finding of the presence of essential equality of the parties to the contracts, thus preventing the perpetration of injustice on the weaker party.

• In the case at bar, the contract incorporates in paragraph 3 the right of GF Equity to pre-terminate the contract — that “if the coach, in the sole opinion of the corporation, fails to exhibit sufficient skill or competitive ability to coach the team, the corporation may terminate the contract.” The assailed condition clearly transgresses the principle of mutuality of contracts. It leaves the determination of whether Valenzona failed to exhibit sufficient skill or competitive ability to coach Alaska team solely to the opinion of GF Equity. Whether Valenzona indeed failed to exhibit the required skill or competitive ability depended exclusively on the judgment of GF Equity. In other words, GF Equity was given an unbridled prerogative to pre-terminate the contract irrespective of the soundness, fairness or reasonableness, or even lack of basis of its opinion.

• To sustain the validity of the assailed paragraph would open the gate for arbitrary and illegal dismissals, for void contractual stipulations would be used as justification therefor.

• The assailed stipulation being violative of the mutuality principle underlying Article 1308 of the Civil Code, it is null and void.

2. When violated

a. Potestative condition

Philippine National Bank v. Sps. Rocamora, G.R. No. 164549, September 18, 2009, Per Brion, J.:

• Escalation clauses are valid and do not contravene public policy. These clauses are common in credit agreements as means of maintaining fiscal stability and retaining the value of money on long-term contracts. To avoid any resulting one-sided situation that escalation clauses may bring, we required in Banco Filipino  the inclusion in the parties’ agreement of a de-escalation clause that would authorize a reduction in the interest rates corresponding to downward changes made by law or by the Monetary Board.

• The validity of escalation clauses notwithstanding, we cautioned that these clauses do not give creditors the unbridled right to adjust interest rates unilaterally. As we said in the same Banco Filipino case, any increase in the rate of interest made pursuant to an escalation clause must be the result of an agreement between the parties. The minds of all the parties must meet on the proposed modification as this modification affects an important aspect of the agreement. There can be no contract in the true sense in the absence of the element of an agreement, i.e., the parties’ mutual consent. Thus, any change must be mutually agreed upon, otherwise, the change carries no binding effect. A stipulation on the validity or compliance with the contract that is left solely to the will of one of the parties is void; the stipulation goes against the principle of mutuality of contract under Article 1308 of the Civil Code. As correctly found by the appellate court, even with a de-escalation clause, no matter how elaborately worded, an unconsented increase in interest rates is ineffective if it transgresses the principle of mutuality of contracts.

• We repeated this rule in the 1994 case of PNB v. CA and Jayme-Fernandez and the 1996 case of PNB v. CA and Spouses Basco. Taking no heed of these rulings, the escalation clause PNB used in the present case to justify the increased interest rates is no different from the escalation clause assailed in the 1996 PNB case; in both, the interest rates were increased from the agreed 12% per annum rate to 42%. We held:

PNB successively increased the stipulated interest so that what was originally 12% per annum became, after only two years, 42%. In declaring the increases invalid, we held:

We cannot countenance petitioner bank’s posturing that the escalation clause at bench gives it unbridled right to unilaterally upwardly adjust the interest on private respondents’ loan. That would completely take away from private respondents the right to assent to an important modification in their agreement, and would negate the element of mutuality in contracts.

x x x x

In this case no attempt was made by PNB to secure the conformity of private respondents to the successive increases in the interest rate. Private respondents’ assent to the increases cannot be implied from their lack of response to the letters sent by PNB, informing them of the increases. For as stated in one case, no one receiving a proposal to change a contract is obliged to answer the proposal. [Emphasis supplied.]

On the strength of this ruling, PNB’s argument – that the spouses Rocamora’s failure to contest the increased interest rates that were purportedly reflected in the statements of account and the demand letters sent by the bank amounted to their implied acceptance of the increase – should likewise fail.

b. Unconscionable interest rates

1) [U]nconscionable rates are deemed illegal because they violate mutuality of contracts. (Pabalan v. Sabnani, En Banc, Per Concurring Opinion of Caguioa, J.)

2) The principle of mutuality of contracts as expressed in Article 1308 of the Civil Code provides that a contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them. Art. 1956 of the Civil Code likewise ordains that “no interest shall be due unless it has been expressly stipulated in writing.” (Land Bank of the Philippines v. Sprint Business Network and Cargo Services, Inc., G.R. No. 244414, January 16, 2023, Per Hernando, J.)

Security Bank Corporation v. Sps. Mercado, G.R. No. 192934, June 27, 2018, Per Jardaleza, J.:

• The principle of mutuality of contracts is found in Article 1308 of the New Civil Code, which states that contracts must bind both contracting parties, and its validity or compliance cannot be left to the will of one of them. The binding effect of any agreement between parties to a contract is premised on two settled principles: [(1)] that any obligation arising from contract has the force of law between the parties; and (2) that there must be mutuality between the parties based on their essential equality. As such, any contract which appears to be heavily weighed in favor of one of the parties so as to lead to an unconscionable result is void. Likewise, any stipulation regarding the validity or compliance of the contract that is potestative or is left solely to the will of one of the parties is invalid. This holds true not only as to the original terms of the contract but also to its modifications. Consequently, any change in a contract must be made with the consent of the contracting parties, and must be mutually agreed upon. Otherwise, it has no binding effect.

• Stipulations as to the payment of interest are subject to the principle of mutuality of contracts. As a principal condition and an important component in contracts of loan, interest rates are only allowed if agreed upon by express stipulation of the parties, and only when reduced into writing. Any change to it must be mutually agreed upon, or it produces no binding effect:

Basic is the rule that there can be no contract in its true sense without the mutual assent of the parties. If this consent is absent on the part of one who contracts, the act has no more efficacy than if it had been done under duress or by a person of unsound mind. Similarly, contract changes must be made with the consent of the contracting parties. The minds of all the parties must meet as to the proposed modification, especially when it affects an important aspect of the agreement. In the case of loan contracts, the interest rate is undeniably always a vital component, for it can make or break a capital venture. Thus, any change must be mutually agreed upon, otherwise, it produces no binding effect.21 x x x (Emphasis supplied; citations omitted)

• Thus, in several cases, we declared void stipulations that allowed for the unilateral modification of interest rates. 

3. When not violated

a. Stipulated interest rates

1) Stipulations as to the payment of interest are subject to the principle of mutuality of contracts. As a principal condition and an important component in contracts of loan, interest rates are only allowed if agreed upon by express stipulation of the parties, and only when reduced into writing. Any change to it must be mutually agreed upon, or it produces no binding effect…(Security Bank Corporation v. Sps. Mercado, supra.)

2) Basic is the rule that there can be no contract in its true sense without the mutual assent of the parties. If this consent is absent on the part of one who contracts, the act has no more efficacy than if it had been done under duress or by a person of unsound mind. Similarly, contract changes must be made with the consent of the contracting parties. The minds of all the parties must meet as to the proposed modification, especially when it affects an important aspect of the agreement. In the case of loan contracts, the interest rate is undeniably always a vital component, for it can make or break a capital venture. Thus, any change must be mutually agreed upon, otherwise, it produces no binding effect. (Philippine Savings Bank v. Castillo, G.R. No. 193178, May 30, 2011, Per Nachura, J.)

4E Steel Builders Corporation v. Maybank Philippines, Inc., G.R. No. 230013, March 13, 2023, Per Lopez, J., J.:

• The principle of mutuality of contracts is embodied in Article 1308 of the Civil Code which states that the contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them. There must be a true parity between the parties for the contract to have obligatory force. Consequently, “[i]f a condition in the contract depends solely on the will of one of the contracting parties, it is void.”

• The same principle also applies to interest rates. The parties are free to stipulate on the rates that will apply to their loans.When applied to monetary interest, “there is no mutuality of contracts when the determination or imposition of interest rates is at the sole discretion of a party to the contract.”

b. Escalation clauses

Philippine Savings Bank v. Castillo, G.R. No. 193178, May 30, 2011, Per Nachura, J.:

• Escalation clauses are generally valid and do not contravene public policy. They are common in credit agreements as means of maintaining fiscal stability and retaining the value of money on long-term contracts. To prevent any one-sidedness that these clauses may cause, we have held in Banco Filipino Savings and Mortgage Bank v. Judge Navarro  that there should be a corresponding de-escalation clause that would authorize a reduction in the interest rates corresponding to downward changes made by law or by the Monetary Board. As can be gleaned from the parties’ loan agreement, a de-escalation clause is provided, by virtue of which, petitioner had lowered its interest rates.

• Nevertheless, the validity of the escalation clause did not give petitioner the unbridled right to unilaterally adjust interest rates. The adjustment should have still been subjected to the mutual agreement of the contracting parties. In light of the absence of consent on the part of respondents to the modifications in the interest rates, the adjusted rates cannot bind them notwithstanding the inclusion of a de-escalation clause in the loan agreement.

• The order of refund was based on the fact that the increases in the interest rate were null and void for being violative of the principle of mutuality of contracts. The amount to be refunded refers to that paid by respondents when they had no obligation to do so. Simply put, petitioner should refund the amount of interest that it has illegally imposed upon respondents. Any deficiency in the payment of the obligation can be collected by petitioner in a foreclosure proceeding, which it already did.

Land Bank of the Philippines v. Sprint Business Network and Cargo Services, Inc., G.R. No. 244414, January 16, 2023, Per Hernando, J.:

• The binding effect of any agreement between parties to a contract is premised on two settled principles: (1) that any obligation arising from contract has the force of law between the parties; and (2) that there must be mutuality between the parties based on their essential equality. Any contract which appears to be heavily weighed in favor of one of the parties so as to lead to an unconscionable result is void. Any stipulation regarding the validity or compliance of the contract which is left solely to the will of one of the parties, is likewise, invalid.

• Based on the promissory notes, the loan obtained by Sprint is not subject to a fixed annual interest rate, but to an initial interest rate of 10% and 10.25% for the first quarter, and further at the prevailing rate, subject to quarterly repricing. In adjusting the said rates, petitioner bank used as basis the escalation clause contained in the promissory notes…

• Here, the promissory notes and other loan documents were voluntarily signed by Sprint. By signing the contract, Sprint agreed upon the interest rate, as well as, the stipulations on the adjustments thereon, if any. There was no evidence adduced by Sprint to show that it was forced or compelled to sign the loan documents. While the loan documents are in the nature of a contract of adhesion, as the terms thereof are solely prepared by petitioner bank, the same should not be automatically struck down as null and void since Sprint was free to negotiate, re-negotiate, or reject them entirely. It cannot also be said that the parties were on unequal footing in dealing with each other especially since Sprint is a corporation engaged in business, and thus, can reasonably be presumed to have encountered commercial and financial documents in its daily operations.

• Meanwhile, this Court has declared that escalation clauses are not basically wrong or legally objectionable as long as they are not solely potestative but based on reasonable and valid grounds. In Polotan, Sr. v. Court of Appeals, the Court declared that there is nothing inherently wrong with escalation clauses, and are valid stipulations in commercial contracts to maintain fiscal stability and to retain the value of money in long term contracts. In the said case, the Court upheld the adjustments in the interests based on the fluctuation in the market rates since the same is beyond the control of the private respondent credit card company.

b. Sole option granted to a party

Allied Banking Corporation v. CA, G.R. No. 124290, January 16, 1998, Per Bellosillo, J.:

• Article 1308 of the Civil Code expresses what is known in law as the principle of mutuality of contracts. It provides that “the contract must bind both the contracting parties; its validity or compliance cannot be left to the will of one of them.” This binding effect of a contract on both parties is based on the principle that the obligations arising from the contracts have the force of law between the contracting parties, and there must be mutuality between them based essentially on their equality under which it is repugnant to have one party bound by the contract while leaving the other free therefrom. The ultimate purpose is to render void a contract containing a condition which makes its fulfillment dependent solely upon the uncontrolled will of one of the contracting parties.

• An express agreement which gives the lessee the sole option to renew the lease is frequent and subject to statutory restrictions, valid and binding on the parties. This option, which is provided in the same lease agreement, is fundamentally part of the consideration in the contract and is no different from any other provision of the lease carrying an undertaking on the part of the lessor to act conditioned on the performance by the lessee. It is a purely executory contract and at most confers a right to obtain a renewal if there is compliance with the conditions on which the rights is made to depend. The right of renewal constitutes a part of the lessee’s interest in the land and forms a substantial and integral part of the agreement.

• The fact that such option is binding only on the lessor and can be exercised only by the lessee does not render it void for lack of mutuality. After all, the lessor is free to give or not to give the option to the lessee. And while the lessee has a right to elect whether to continue with the lease or not, once he exercises his option to continue and the lessor accepts, both parties are thereafter bound by the new lease agreement. Their rights and obligations become mutually fixed, and the lessee is entitled to retain possession of the property for the duration of the new lease, and the lessor may hold him liable for the rent therefor. The lessee cannot thereafter escape liability even if he should subsequently decide to abandon the premises. Mutuality obtains in such a contract and equality exists between the lessor and the lessee since they remain with the same faculties in respect to fulfillment.