What is compensation?


It is a mode of extinguishing to the concurrent amount, the obligations of those persons who in their own right are reciprocally debtors and creditors of each other (Art. 1232, NCC). It involves the simultaneous balancing of two obligations in order to extinguish them to the extent in which the amount of one is covered by that of the other.


What are the requisites of compensation?

1. Both parties must be mutually creditors and debtors in their own right and as principals;

2. Both debts must consist in sum of money or if consumable, of the same kind or quality;

3. Both debts are due;

4. Both debts are liquidated and demandable;

5. Neither debt must be retained in a controversy commenced by third person and communicated with debtor (neither debt is garnished); and

6. Compensation must not be prohibited by law.


Note: When all the requisites mentioned in Art. 1279 of the Civil Code are present, compensation takes effect by operation of law, even without the consent or knowledge of the creditors and debtors. When one or both debts are rescissible or voidable, they may be compensated against each other before they are judicially rescinded or avoided. (Art. 1284)


What are the debts not subject to compensation?

1. Debts arising from contracts of deposit

2. Debts arising from contracts of commodatum

3. Claims for support due by gratuitous title

4. Obligations arising from criminal offenses

5. Certain obligations in favor of government (e.g. taxes, fees, duties, and others of a similar nature)

Note: 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. (Art. 1289, NCC)



State the essential elements of contracts.

1. Consent;

2. Object or subject matter; and

3. Cause or consideration.


What is the principle of relativity of contracts?

General Rule:

A contract is binding not only between parties but extends to the heirs, successors in interest, and assignees of the parties, provided that the contract involves transmissible rights by their nature, or by stipulation or by provision of law.


1. Stipulation pour autrui (stipulation in favor of a third person) – benefits deliberately conferred by parties to a contract upon third persons.


a. The stipulation must be part, not whole of the contract;

b. Contracting parties must have clearly and deliberately conferred a favor upon third person;

c. Third person must have communicated his acceptance; and

d. Neither of the contracting parties bears the legal representation of the third person.


2. When a third person induces a party to violate the contract


a. Existence of a valid contract

b. Third person has knowledge of such contract

c. Third person interferes without justification


3. Third persons coming into possession of the object of the contract creating real rights

4. Contracts entered into in fraud of creditors