SECTION 5

Compensation
ARTICLE 1278.
Compensation shall take place when two persons, in their
own right, are creditors and debtors of each other. (1195)
Meaning of compensation
Compensation
- the extinguishment to the concurrent amount of the debts of two
persons who, in their own right, are debtors and creditors of each
other
- involves the simultaneous balancing of 2 obligations in order to
extinguish them to the extent in w/c the amount of one is covered
by that of the other
- often called simplified payment ( it provides a more convenient
& less expensive effectuation of payments between 2 persons who
are reciprocally creditors & debtors)
Object of Compensation
- the prevention of unnecessary litigations & payments;
accomplished through the mutual extinguishment by operation of
law of concurring debts of 2 persons
Compensation and confusion distinguished
Compensation
Confusion
1. 2 persons involved (debtor &
only 1 person (creditor & debtor
creditor of the other)
of himself)
2. two obligations
one obligation
3. indirect payment
there is impossibility of payment
Kinds of compensation
1. By its effect/extent
a. Total- both obligations same amount and are entirely
extinguished
b. Partial- 2 obligations different amounts and a balance remains;
the extinctive effect of compensation will be partial only as regards
the larger debt
2. By its cause/ origin
a. Legal- takes place under the operation of law even w/o the
knowledge of the parties

b. Voluntary- agreement
c. Judicial- takes place by order from a court in a litigation
d. Facultative- can be set up only by one of the parties
ARTICLE 1279.
In order that compensation may be proper, it is necessary:
(1) That each one of the obligors be bound principally, and
that he be at the same time a principal creditor of the
other;
(2) 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;
(3) That the two debts be due;
(4) That they be liquidated and demandable;
(5) That over neither of them there be any retention or
controversy, commenced by third persons and
communicated in due time to the debtor. (1196)
Requisites of legal compensation
1. The parties are principal creditors & principal debtors of each
other.
2. Both debts consist in a sum of money, or of consumable things of
the same kind & quality.
3. The two debts are due/ demandable.
4. The two debts are liquidated.
5. No retention/ controversy commenced by a third person.
ARTICLE 1281.
Compensation may be total or partial. When the two debts
are of the same amount, there is a total compensation. (n)
ARTICLE 1282.
The parties may agree upon the compensation of debts
which are not yet due. (n)
This provision of law is an exception to the general rule that
only debts w/c are due & demandable can be compensated.
Voluntary/ conventional compensation- no special requisites.
The contract agreed by the parties should be valid.
ARTICLE 1286.
Compensation takes place by operation of law, even though
the debts may be payable at different places, but there

shall be an indemnity for expenses of exchange or

transportation to the place of payment. (1199a)
Compensation where debts payable at different places
Applies to legal compensation. The indemnity does not refer to
the difference in the value of the things in their respective
places but to the expenses of monetary exchange (in case of
money debts) & expenses of transportation ( in case of things to
be delivered). Once these expenses are liquidated, the debts
also become compensable. The indemnity shall be paid by the
person who raises the defense of compensation.
Foreign exchange
- conversion of an amount of money/ currency of 1 country into an
equivalent amount of money/ currency of another
Exchange rate
- price of 1 currency expressed/ quoted in relation to another
currency
ARTICLE 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. (1201)
Rules on application of payments apply to order of
compensation
Compensation is similar to payment. If a debtor has various
debts w/c are susceptible of compensation, he must inform the
creditor w/c of them shall be the object of compensation. In
case he fails to do so, then the compensation shall be applied to
the most onerous obligation.
ARTICLE 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, even
though the creditors and debtors are not aware of the
compensation. (1202a)
Consent of parties not required in legal compensation
1. Compensation takes place automatically by mere operation of
law.

- it takes place by operation of law from the day all the necessary
requisites concur, w/0 need of consent on the part of the parties, &
even w/o their knowledge
2. Full legal capacity of parties not required
- as it takes place by operation of law & w/o any act of the parties,
it is not required that the parties have full legal capacity to give or
to receive
SECTION 6- Novation
ARTICLE 1291.
Obligations may be modified by:
(1) Changing their object or principal conditions;
(2) Substituting the person of the debtor;
(3) Subrogating a third person in the rights of the creditor.
(1203)
Meaning of novation
Novation is the total/ partial extinction of an obligation through the
creation of a new one w/c substitutes it; substitution or change of
an obligation by another, w/c extinguishes or modifies the first.
Dual function of novation
Novation is a contract containing 2 stipulations:
1. to extinguish or modify an existing obligation
2. substitute a new one in its place
It does not operate as an absolute but only as a relative
extinction of an obligation w/c is only modified. The novation
is actually a new obligation based upon a former one, but
containing 1 or more material changes.
ARTICLE 1292.
In order that an obligation may be extinguished by another
which substitutes the same, it is imperative that it be so
declared in unequivocal terms, or that the old and the new
obligations be on every point incompatible with each other.
(1204)
Requisites of novation
1. previous valid obligation
2. capacity & intention of the parties to modify/ extinguish the
obligation
3. the modification/ extinguishment of the obligation

4. the creation of a new valid obligation

Novation is not presumed ( the burden of showing novation is
on the party who claim its existence)
Test of incompatibility between 2 obligations or contracts
The test is whether they can stand together, each one having
an independent existence. If they cannot, they are
incompatible, & the subsequent obligation novates the first.
Upon such novation, the former obligation loses all its force &
effect and only the new obligation can be enforced.
The incompatibility should take place in any of the matters
mentioned in Article 1291, otherwise; the change is merely
modificatory & insufficient to extinguish the original obligation.
ARTICLE 1293.

Novation which consists in substituting a new debtor in the

place of the original one, may be made even without the
knowledge or against the will of the latter, but not without
the consent of the creditor. Payment by the new debtor
gives him the rights mentioned in articles 1236 and 1237.
(1205a)
Kinds of personal novation
1. Substitution when the person of the debtor is substituted
2. Subrogation- when a third person is subrogated in the rights of
the creditor
Kinds of substitution
1.