I am planning to secure a bank loan that I will be using for my start-up business. I went to several rural banks here in our province to get an idea which bank can give me the most favorable conditions. I noticed from documents given to me by one of the banks that I went to that there is a provision stating that the bank can increase the interest on the loan that I will be taking, depending on prevailing interest rates in the market. I have nothing against it because I really need funding anyway. I just want to be sure that this is legal. Please advise me on this matter.
Provisions in contracts of loans relating to increase in interest rate, depending on prevailing rates in the market, are commonly called escalation clauses. In a long line of cases, our Supreme Court has ruled that these escalation clauses are not invalid or illegal per se. These are recognized and allowed as binding contractual stipulations as long as the creditor is not given an unbridled right to increase the interest rate to the deprivation of the debtor of opportunity to concur thereto. Stated differently, an escalation clause will be considered illegal and void if the choice of its imposition rests solely on the part of the creditor. The reason is that it violates the principle of mutuality of contracts as embodied under Article 1308 of the New Civil Code, which states: “The contracts must bind both contracting parties; its validity or compliance cannot be left to the will of one of them.” (emphasis supplied)
To be certain, the High Court required, for an escalation clause to be considered valid, that the creditor must first inform the debtor in writing of the particular increase in the interest rate that it has to apply or implement, and the debtor should assent to such increase in writing. It pronounced:
“x x x
Respondent’s monthly telephone calls to petitioners advising them of the prevailing interest rates would not suffice. A detailed billing statement based on the new imposed interest with corresponding computation of the total debt should have been provided by the respondent to enable petitioners to make an informed decision. An appropriate form must also be signed by the petitioners to indicate their conformity with the new rates. Compliance with these requisites is essential to preserve the mutuality of contracts.
“Modifications in the rate of interest for loans pursuant to an escalation clause must be the result of an agreement between the parties. Unless such important change in the contract terms is mutually agreed upon, it has no binding effect. x x x” (Juico vs. China Banking Corporation, 695 SCRA 520,G.R. No. 187678, April 10, 2013, Ponente, former Associate Justice of the Supreme Court Martin Villarama Jr.)
Applying the foregoing in the situation that you have presented, we submit that there is nothing inherently wrong in providing escalation clauses in contracts of loans from banking institutions such as the one in your province. If, however, these institutions or similar entities are determined in implementing the same, then they should maintain an adequate procedure of informing the debtors and acquiring their concurrence with any possible modification or increase in applicable interest rates. On the part of the debtors/borrowers, such as yourself, to protect contractual rights, remember that you should not only be informed but also be given an opportunity in writing to assent to such intended modification or increase in the interest rates.
We hope that we were able to answer your queries. Please be reminded that this advice is based solely on the facts you have narrated and our appreciation of the same. Our opinion may vary when other facts are changed or elaborated.
Editor’s note: Dear PAO is a daily column of the Public Attorney’s Office. Questions for Chief Acosta may be sent to email@example.com