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Requisites of Legal Compensation

1. The parties are principally creditors and principal debtors of each other.

2. Both debts consists in a sum of money, or of consumable things of the same kind. 3. The two debts are due or demandable.

4. The two debts are liquidated.

5. No retention or controversy commenced by a third person.

Article 1280. Notwithstanding the provisions of the preceding article, the guarantor may set up compensation as regards to what the creditor may owe the principal debtor. (1197)

*Guarantor is given the right to set up compensation because the extinguishment of principal obligation through compensation carries with it the accessory obligations.

Article 1281. Compensation may be total or partial. When two debts are of the same amount, there is a total compensation. (n)

 Two persons are involved, each of whom is a creditor and debtor of each other.

 Two obligations  Indirect payment

 Only one person who is both a creditor and debtor of himself.  One obligation

Total Compensation – results when the two debts are equal or the same amount.

Partial Compensation – when the two obligations are of the different amounts and a balance remains. The extinctive effect of the compensation will be partial only as regards the larger debt.

Article 1282. The parties may agree upon the compensation of debts which are not yet due. (n)

Voluntary or Conventional Compensation- includes any compensation which takes place by agreement of the parties even if all the requisites for egal compensation are not present.

Article 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. (n)

* Compensation may also take place when so declared by final judgment of a court in a suit

Article 1284. When one or both the debts are rescissible or voidable, they may be compensated against each other before they are judicially rescinded or avoided. (n)

* Prior to rescission or annulment, the debts may be compensated aginst each other.

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 which would pertain to him against 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 thereto, the latter may set up the compensation of debts previous to the 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. (1198a)

Where compensation has taken place before assignment

When compensation takes effect by operation of law or automatically, the debts are extinguished to the concurrent amount. If the extinguished debt is assigned to a third person, the debtor can raise the defense of compensation and the remedy of the assignee is against the assignor.

Where compensation has taken place after assignment

1. Assignment with the consent of debtor- The debtor cannot set up consignment but has the right to collect from the original creditor, unless he has reserved hi right to compensation.

2. Assignment with the knowledge but without the consent of the debtor- There is partial compensation depending upon the maturity of the debts. 3. Assignment without the knowledge of the debtor- the crucial time is when the debtor acquired the knowledge of assignment. If he learned after the

debts have matured, he can raise the defense of compensation, otherwise, he cannot.

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)

*the indemnity shall be paid by the person who raises the defense of compensation

Foreign Exchange- the conversion of an amount of money or currency of one country into an equivalent amount of money or currency of another. Exchange Rate- the price of one currency expressed or quoted in relation to another currency.

Article 1287. Compensation shall not be proper when one of the debts arises from a depositum or from the obligations of a depositary or of a bailee in commodatum.

Neither can compensation be set up against a creditor who has a claim for support due by gratuitous title, without prejudice to the provisions of paragraph 2 of Article 301. (1200a)

Article 1288. Neither shall there be compensation if one of the debts consists in civil liability arising from a penal offense. (n)

Instances when legal compensation is not allowed by law

1. Where one of the debts arises from a depositum- a depositum is constituted from the moment a person receive a thing belonging to another with the obligation of safely keeping it and of returning the same. However, a bank has the right to set-offs deposits in its hands for the payment of any indebtedness to it on the part of the depositor.

2. Where one of the debts arises from a commadatum- a commodatum is a gratuitous contract whereby on of the parties delivers to another something not consumable so that the latter may use the same for a certain time and return it.

NOTE: PROPERTY OF BMS. UNOFFICIAL OBLICON REVIEWER.

THIS SPECIAL PRIVILEGE IS STRICTLY FOR BMS MEMBERS ONLY!!!

4. Where one of the debts consists in civil liability arising from a penal offense- compensation would be improper because the satisfaction of such obligation is imperative.

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

The rules on application of payments apply where there are several debts capable of being compensated. Debtor must inform the creditor on which object shall be the object of compensation. If the debtor fails to inform the creditor, the compensation would 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)

* Legal compensation is automatic. It is not required that the parties have full legal capacity to give or to receive, as the case may be.

CHAPTER 4; Sec.6: Novation

Article 1291. Obligations may be modified by: