The New Civil Code classified defective contracts into four categories.
1. Rescissible Contracts.
Rescissible contracts are those validly entered into by the contracting parties but may be rescinded by a court of law for equitable reasons such as when it resulted in financial harm to one of the contracting parties or to a third party or where the contract was entered into with the intent to defraud creditors. (See Arts. 1380 and 1381)
Article 1191 provides that the power to rescind obligations is implied in reciprocal ones. However, the concept of rescission in Art. 1191 is different from the idea of rescission in Art. 1381. While a Rescission under Art. 1191 is a principal action, Rescission under Art. 1381 is a subsidiary Remedy. The only ground of a Rescission under Art. 1191 is non-performance of one’s obligation/s while rescission in Art. 1381 have five (5) grounds to rescind a rescissible contract enumerated in Art. 1381. Non-perfomance by the contracting party is not important. The purpose of Rescission under Art. 1191 is to cancel the contract while the purpose of Rescission under Art. 1381 is to seek reparation for the damage or injury caused.
Illustrative Case:
a. Rescission Proper under Art. 1381
Dr. Restituto C. Buenviaje vs. Spouses Jovito R. and Lydia B. Salonga
G.R. No. 216023, October 05, 2016
Pursuant to Articles 1177 and 1313 of the Civil Code, creditors are given remedies whenever their debtors perform acts or omissions or enter into contracts that tend to defraud the former of what is due them. Such remedy comes in the form of rescission under Articles 1381(3) in relation to Articles 1383 and 1384 of the Civil Code. Rescission (as contemplated in Articles 1380 to 1389 of the Civil Code) is a remedy granted by law to the contracting parties and even to third persons, to secure the reparation of damages caused to them by a contract, even if this should be valid, by restoration of things to their condition at the moment prior to the celebration of the contract. It implies a contract, which even if initially valid, produces a lesion or a pecuniary damage to someone. In the rescission by reason of lesion or economic prejudice, the cause of action is subordinated to the existence of that prejudice, because it is the raison d ‘etre as well as the measure of the right to rescind. Hence, where the defendant makes good the damages caused, the action cannot be maintained or continued, as expressly provided in Articles 1383 and 1384.
Essentially, petitioner anchors its case on Art. 1381 of the Civil Code which lists as among rescissible contracts “[T]hose undertaken in fraud of creditors when the latter cannot in any other manner collect the claim due them.”
Contracts in fraud of creditors are those executed with the intention to prejudice the rights of creditors. They should not be confused with those entered into without such ma-intent, even if, as a direct consequence thereof, the creditor may suffer some damage. In determining whehter or not a certain conveying contract is fraudulent, what comes to mind first is the question of whether the conveyance was a bona fide transaction or a trick and contrivance to defeat creditors. To creditors seeking contract rescission on the ground of fraudulent conveyance rest the onus of proving by competent evidence the existence of such fraudulent intent on the part of the debtor, albeit they may fall back on the disputable presumptions, if proper, established under Article 1387 of the Code.
b. Rescission under Art. 1381
George C. Fong vs. Jose v. Dueñas
G.R. No. 185592, June 15, 2015
As a contractual remedy, rescission is available when one of the parties substantially fails to do what he has obligated himself to perform. It aims to address the breach of faith and the violation of reciprocity between two parties in a contract. Under Article 1191 of the Civil Code, the right of rescission is inherent in reciprocal obligations.
The ultimate effect of rescission is to restore the parties to their original status before they entered in a contract. As the Court ruled in Unlad Resources v. Dragon: Rescission has the effect of “unmaking a contract, or its undoing from the beginning, and not merely its termination.” Hence, rescission creates the obligation to return the object of the contract. It can be carried out only when the one who demands rescission can return whatever he may be obliged to restore. To rescind is to declare a contract void at its inception and to put an end to it as though it never was. It is not merely to terminate it and release the parties from further obligations to each other, but to abrogate it from the beginning and restore the parties to their relative positions as if no contract has been made.
Accordingly, when a decree for rescission is handed down, it is the duty of the court to require both parties to surrender that which they have respectively received and to place each other as far as practicable in his original situation.
The right of rescission of a party to an obligation under Article 1191 of the Civil Code is predicated on a breach of faith by the other party who violates the reciprocity between them. The breach contemplated in the said provision is the obligor’s failure to comply with an existing obligation. When the obligor cannot comply with what is incumbent upon it, the obligee may seek rescission and in the absence of any just cause for the court to determine the period of compliance, the court shall decree the rescission.
2. Voidable or Annullable Contracts
Contracts that are voidable or annullable are ones in which one party’s assent is invalid because of that party’s inability to consent or because the consent was obtained fraudulently, unintentionally, violently, intimidatorily, or under duress. In other words, any of the vices of consent vitiates the consent. (See Art. 1390)
Illustrative Cases:
a. ECE Realty and Development Inc., vs. Rachel G. Mandap
G.R. No. 196182, September 1, 2014
Article 1338 of the Civil Code provides that “[t]here is fraud when through insidious words or machinations of one of the contracting parties, the other is induced to enter into a contract which, without them, he would not have agreed to.”
In addition, under Article 1390 of the same Code, a contract is voidable or annullable “where the consent is vitiated by mistake, violence, intimidation, undue influence or fraud.”
Also, Article 1344 of the same Code provides that “[i]n order that fraud may make a contract voidable, it should be serious and should not have been employed by both contracting parties.” Jurisprudence has shown that in order to constitute fraud that provides basis to annul contracts, it must fulfill two conditions.
First, the fraud must be dolo causanteor it must be fraud in obtaining the consent of the party. This is referred to as causal fraud. The deceit must be serious. The fraud is serious when it is sufficient to impress, or to lead an ordinarily prudent person into error; that which cannot deceive a prudent person cannot be a ground for nullity. The circumstances of each case should be considered, taking into account the personal conditions of the victim.
Second, the fraud must be proven by clear and convincing evidence and not merely by a preponderance thereof.
b. Salandang Pangadil, et. Al., vs. Court of First Instance of Cotabato
G.R. No. L-32437, August 31, 1982
The action to annul a voidable contract is not imprescriptible, unlike in the case of an inexistent contract. If the action to annul a voidable contract is based on fraud, as in the case herein, it prescribes in four years from the time of the discovery of the fraud. (Art. 1391, Civil Code.)
3. Unenforceable Contracts
Unenforceable contracts are those that cannot be upheld in court for one or more of the following reasons: (1) they were made on someone else’s behalf without authorization or in excess of that person’s authority; (2) the Statute of Frauds was not followed; or (3) both of the contracting parties were incompetent. However, these contracts may be ratified in accordance with the law. (See Arts. 1403, 1406 and 1407).
Illustrative Case:
a. Asia Production Co., Inc., Wang Ta Peng and Winston Wang vs. Hon. Ernani Cruz Paño
G.R. No. L-51058, January 27, 1992
The purpose of the statute is to prevent fraud and perjury in the enforcement of obligations depending for their evidence on the unassisted memory of witnesses by requiring certain enumerated contracts and transactions to be evidenced by a writing signed by the party to be charged. It was not designed to further or perpetuate fraud. Accordingly, its application is limited. It makes only ineffective actions for specific performance of the contracts covered by it; it does not declare them absolutely void and of no effect. The contracts concerned are simply “unenforceable” and the requirement that they — or some note or memorandum thereof — be in writing refers only to the manner they are to be proved. It goes without saying then, as held in the early case of Almirol, et al. vs. Monserrat, 17 that the statute will apply only to executory rather than executed contracts. Partial execution is even enough to bar the application of the statute.
In the words of former Chief Justice Moran: “The reason is simple. In executory contracts there is a wide field for fraud because unless they be in writing there is no palpable evidence of the intention of the contracting parties. The statute has precisely been enacted to prevent fraud.” (Comments on the Rules of Court, by Moran, Vol. III [1957 ed.] p. 178). However, if a contract has been totally or partially performed, the exclusion of parol evidence would promote fraud or bad faith, for it would enable the defendant to keep the benefits already derived by him form the transaction in litigation, and, at the same time, evade the obligations, responsibilities or liabilities assumed or contracted by him thereby.
It follows then that the statute applies only to executory contracts and in actions for their specific performance. It does not apply to actions which are neither for violation of a contract nor for the performance thereof.
4. Void or Inexistent Contracts.
These are contracts that do not exist in the eyes of the law. They produce no legal effect or impact.
Illustrative Cases:
a. Paulina Corpuz, et. Al vs. Leopoldo L. Beltran
G.R. No. L-7487, October 27, 1955
The sales of a parcel of land covered by a homestead patent which were executed within 5 years from the issuance thereof are void ab initio, or are non-existent in contemplation of law (section 116 of Act No. 2874). In an action for the annulment of said sales, the defense of prescription cannot be availed of, for under Article 1410 of the new Civil Code, “the action or defense for the declaration of the inexistence of a contract does not prescribe.” The reason for this rule is obvious. The defect of a void or inexistent contract is pertinent. The right to set up the defense of illegality cannot be waived (Article 1409) .
b. G. Holdings, Inc. vs. Cagayan Electric Power and Light Company, Inc. (CEPALCO)
G.R. No. 226213, September 27, 2017
Under the Civil Code, there are four defective contracts, namely: (1) rescissible contracts; (2) voidable contracts; (3) unenforceable contracts; and (4) void or inexistent contracts. However, it has been opined that, strictly speaking, only the voidable and unenforceable contracts are defective contracts and are the only ones susceptible of ratification unlike the rescissible ones which suffer from no defect and the void or inexistent contracts which do not exist and are absolute nullity. Thus, the four may be more appropriately categorized as species or forms of the inefficacy of contracts.
Since the Deed of Assignment is being questioned for being both rescissible and, at the same time, an absolute simulation, it may be apropos to compare rescissible contracts with void or inexistent contracts.
Rescission has been defined as a remedy to make ineffective a contract validly entered into and which is obligatory under normal conditions by reason of external causes resulting in a pecuniary prejudice to one of the contracting parties or their creditors. Rescission, which is a specie or form of the inefficacy of contracts and operates by law and not through the will of the parties, requires the following: (1) a contract initially valid and (2) a lesion or pecuniary prejudice to someone.
Under Article 1381 of the Civil Code, the following contracts are rescissible: (1) those which are entered into by guardians whenever the wards whom they represent suffer lesion by more than one-fourth of the value of the things which are the object thereof; (2) those agreed upon in representation of absentees, if the latter suffer the lesion stated in the preceding number; (3) those undertaken in fraud of creditors when the latter cannot in any manner collect the claims due them; (4) those which refer to things under litigation if they have been entered into by the defendant without the knowledge and approval of the litigants or of competent judicial authority; and (5) all other contracts specially declared by law to be subject to rescission.
It is further provided under Article 1383 that the action for rescission is a subsidiary one, and cannot thus be instituted except when the party suffering damage has no other legal means to obtain reparation for the same.
On the other hand, void or inexistent contracts are those which are ipso jure prevented from producing their effects and are considered as inexistent from the very beginning because of certain imperfections.
Under Article 1409 of the Civil Code, the following contracts are inexistent and void from the beginning: (1) those whose cause, object or purpose is contrary to law, morals, good customs, public order or public policy; (2) those which are absolutely simulated or fictitious; (3) those whose cause or object did not exist at the time of the transaction; (4) those whose object is outside the commerce of men; (5) those which contemplate an impossible service; (6) those where the intention of the parties relative to the principal object of the contract cannot be ascertained; and (7) those expressly prohibited or declared void by law.
These contracts cannot be ratified and the right to set up the defense of illegality cannot be waived. Further, the action or defense for the declaration of the inexistence of a contract does not prescribe.
Rescission and nullity can be distinguished in the following manner: (a) by reason of the basis — rescission is based on prejudice, while nullity is based on a vice or defect of one of the essential elements of a contract; (2) by reason of purpose — rescission is a reparation of damages, while nullity is a sanction; (3) by reason of effects — rescission affects private interest while nullity affects public interest; (4) by reason of nature of action — rescission is subsidiary while nullity is a principal action; (5) by reason of the party who can bring action — rescission can be brought by a third person while nullity can only be brought by a party; and (6) by reason of susceptibility to ratification — rescissible contracts need not be ratified while void contracts cannot be ratified.
They can likewise be distinguished as follows: (1) as to defect: In rescissible contracts, there is damage or injury either to one of the contracting parties or to third persons; while in void or inexistent contracts, one or some of the essential requisites of a valid contract are lacking in fact or in law; (2) As to effect: The first are considered valid and enforceable until they are rescinded by a competent court; while the latter do not, as a general rule, produce any legal effect; (3) As to prescriptibility of action or defense: In the first, the action for rescission may prescribe; while in the latter, the action for declaration of nullity or inexistence or the defense of nullity or inexistence does not prescribe; (4) As to susceptibility of ratification: The first are not susceptible of ratification, but are susceptible of convalidation; while the latter are not susceptible of ratification; (5) As to who may assail contracts: The first may be assailed not only by a contracting party but even by a third person who is prejudiced or damaged by the contract; while the latter may be assailed not only by a contracting party but even by a third party whose interest is directly affected; (6) As to how contracts may be assailed: the first may be assailed directly, and not collaterally; while the latter may be assailed directly or collaterally.
Rescissible contracts and void or inexistent contracts belong to two mutually exclusive groups. A void or inexistent contract cannot at the same time be a rescissible contract, and vice versa. The latter, being valid and until rescinded, is efficacious while the former is invalid. There is, however, a distinction between inexistent contracts and void ones as to their effects. Inexistent contracts produce no legal effect whatsoever in accordance with the principle “quod nullum est nullum producit effectum” In case of void contracts where the nullity proceeds from the illegality of the cause of object, when executed (and not merely executory) they have the effect of barring any action by the guilty to recover what he has already given under the contract.
