52 Phil. 346 
MAIN TOPIC – Obligations with a Penal Clause
Bachrach Motor Co., filed two cases – Nos. 28497 and 28498 which were tried together, against defendants. The cases involve an action for the recovery of total amount of P11,940.37 representing the unpaid balance of White truck purchases within the periods agreed upon. To secure the payment, defendant executed mortgage deeds and promissory note. In both sales it was agreed that 12% interest would be paid upon the unpaid portion of the price at the execution of the contracts, and in case of non-payment of the total debt upon its maturity, 25% thereon, as penalty. The trial courts rendered judgments in favor of the plaintiff. However, the defendants contended that the 25 % penalty upon the debt, in addition to the interest of 12% per annum makes the contract usurious.
Whether or not the 25% penalty upon the debt, in addition to the interest of 12%, would make the contract usurious.
No. Such a contention is not well founded. Article 1152 of the Civil Code permits the agreement upon a penalty apart from the interest. Should there be such an agreement, the penalty, as was held in the case of Lopez vs. Hernaez (32 Phil., 631), does not include the interest, and as such the two are different and distinct things which may be demanded separately. According to this, the penalty is not to be added to the interest for the determination of whether the interest exceeds the rate fixed by the law, since said rate was fixed only for the interest. But considering that the obligation was partly performed, and making use of the power given to the court by article 1154 of the Civil Code, this penalty is reduced to 10 per cent of the unpaid debt. With the sole modification that instead of 25 % upon the sum owed, the defendants need pay only 10% thereon as penalty.
Art. 1226. In obligations with a penal clause, the penalty shall substitute the indemnity for damages and the payment of interests in case of noncompliance, if there is no stipulation to the contrary. Nevertheless, damages shall be paid if the obligor refuses to pay the penalty or is guilty of fraud in the fulfillment of the obligation.
The penalty may be enforced only when it is demandable in accordance with the provisions of this Code.
Art. 1229. The judge shall equitably reduce the penalty when the principal obligation has been partly or irregularly complied with by the debtor. Even if there has been no performance, the penalty may also be reduced by the courts if it is iniquitous or unconscionable. (1154a)
DISCUSSION AND APPLICATION
As a general rule, in an obligation with a penal clause, the penalty takes the place of the indemnity for damages and the payment of interests in case of non-compliance. However, damages in addition to penalty may be demanded. They are:
(1) when there is a stipulation to the contrary,
(2) when the obligor is sued for refusal to pay the agreed penalty;
(3) when the obligor is guilty of fraud.
Applying the case of Bachrach v Espiritu, it was held that the penalty was demandable apart from the interest because of stipulation between the parties. In all of these cases, it is evident that the purpose of the penalty is to punish the obligor. While the parties are free to stipulate a particular amount which the debtor must pay, under Art. 1229, the court may equitably reduce the stipulated penalty if the penalty is iniquitous or unconscionable even if there has been no performance. As a matter of fact, it has been held that the amount stipulated may be reduced even if it is not contrary to law, morals, good customs, public order, or public policy, provided it is unreasonable or unconscionable.