DEFECTIVE CONTRACTS

DEFECTIVE CONTRACTS
• RESCISSIBLE CONTRACTS
• VOIDABLE CONTRACTS
• UNENFORCEABLE CONTRACTS
• VOID OR INEXISTENT CONTRACTS
 RESCISIBLE CONTRACTS
• What are rescissible contracts?
– Contracts that are susceptible to rescission, which is a
process, a remedy, a relief to protect one of the
parties or a third person from all injury or damages
which the contract may cause.
– The contract is valid until rescinded
– It has the effect of restoration of things to their
condition prior to the celebration of the said contract
– There is an extrinsic defect consisting of economic
damage or lesion
– Voidable Contracts may be rescinded
 TWO TYPES OF RESCISSION
• Article. 1380 • Article 1191
– Rescission in general – Resolution
– This is based on lesion or – This is based on non-
fraud upon creditors fulfillment or non-
– Courts cannot grant a performance of the
period to comply obligation
– Non-performance is – Court may grant period
immaterial to comply
– Non-performance is
material
 REQUISITES OF RESCISSION
1. Contract must be validly agreed upon
2. There must be lesion or economic or financial or
pecuniary prejudice to someone either a party or not
3. Rescission is based upon a case especially provided by
law
4. There must be no other legal remedy provided by law
5. Party asking for rescission must be able to return what
he is obliged to restore by reason of the contract
6. Object must not be in the legal possession of a third
person who is in good faith
7. Period to file for rescission must not have prescribed
 Laws on RESCISSIBLE CONTRACTS
• Article 1380. Contracts validly agreed upon may be
rescinded in the cases established by law.

• “Validly agree” – means all the essential elements of

the contract are present.
• “In the cases established by law” – means rescissible
contracts are those only determined by the law and
not by the parties.
Contracts which can be RESCINDED
Article 1381. The following contracts are
rescissible:
(1) Those which are entered into by guardians
whenever the wards whom they represent suffer
lesion by more than one-fourth of the value of
the things which are the object thereof;

• “Lesion” – disparity between PRICE and VALUE

• “Ward” – A person under guardianship by reason
of some incapacity
Contracts which may be rescinded cont….
• (2) Those agreed upon in representation of
absentees, if the latter suffer the lesion stated in the
preceding number;
- “Absentee” – person who disappears from his
domicile (permanent residence) his whereabouts
being unknown, without no agent to administer
property.
- Requisite: absentee suffers lesion by more than ¼ the
value of the object
Contracts which may be rescinded cont….
• (3) Those undertaken in fraud of creditors
when the latter cannot in any other manner
collect the claims due them
– the action to rescind this contract is called
“Accion Pauliana”
– Requisites for ACCION PAULIANA:
• Existing credit/creditor prior to the contract
sought to be rescinded
• Alienation must be subsequent to such credit
• Party alienating is in bad faith (meaning he
knew damages would cause creditors)
• Inability of creditor to collect claims due them
– Debtor need not be judicially declared insolvent
Contracts which may be rescinded cont….
• (4) Those which refer to things under litigation if they
have been entered into by the defendant without the
knowledge and approval of the litigants or of
competent judicial authority;
– This refers to “THINGS UNDER LITIGATION”
– Competent Judicial Authority means COURTS
• (5) All other contracts specially declared by law to be
subject to rescission.
– Partition – heir can rescind if value of things
entitled to receive is less by least ¼ or more
– Sale of Real Estate – lack of area is not less than
1/10 of the stated
– Lease contracts - when lessor, lessee do not
comply with obligations
Another instance when rescission can be done
• PAYMENT.
• Article 1382. Payments made in a state of insolvency
for obligations to whose fulfillment the debtor could
not be compelled at the time they were effected, are
also rescissible
• REQUISITES:
a. debtor-payer must be insolvent
b. Debt was not yet due and demandable
• Article 1383. The action for rescission is subsidiary; it
cannot be instituted except when the party suffering
damage has no other legal means to obtain
reparation for the same.

– Action is subsidiary or of the last resort

– Policy of the law is to give effect to the contract
NOT extinguish it
• Article 1384. Rescission shall be only to
the extent necessary to cover the
damages caused.

• This is PARTIAL RESCISSION

 Mutual Restitution/What should be restored?
• Article 1385. Rescission creates the obligation to
return the things which were the object of the
contract, together with their fruits, and the price
with its interest; consequently, it can be carried out
only when he who demands rescission can return
whatever he may be obliged to restore.
– What should be returned? TFPI
– Fruits will only be returned if there is already
delivery
• Neither shall rescission take place when the things
which are the object of the contract are legally in the
possession of third persons who did not act in bad
faith.
– “Legal Possession” means registered in proper
registry
– Rescission is a direct action not collateral
– “Good faith” – no knowledge of fraud
– Required: LEGAL POSSESSION + GOOD FAITH
• Lacking one, not sufficient
• In this case, indemnity for damages may
be demanded from the person causing
the loss
– This applies if there is already a third person legally
possessing and in good faith, the things
– The one who defrauded
• Article 1386. Rescission referred to in Nos. 1 and 2 of
article 1381 shall not take place with respect to
contracts approved by the courts.
– If approved by court, it means that the interest of
the ward and absentee is already well protected,
hence, no need for rescission
• Article 1387. All contracts by virtue of which the
debtor alienates property by gratuitous title are
presumed to have been entered into in fraud of
creditors, when the donor did not reserve sufficient
property to pay all debts contracted before the
donation.
– Presumption is PRIMA FACIE, meaning it can be
rebutted by adequate proof
– Doctrine of Anticipatory Fraud
• Alienations by onerous title are also presumed
fraudulent when made by persons against whom
some judgment has been rendered in any instance or
some writ of attachment has been issued. The
decision or attachment need not refer to the
property alienated, and need not have been
obtained by the party seeking the rescission.
• In addition to these presumptions, the design to
defraud creditors may be proved in any other
manner recognized by the law of evidence.
• “any instance” - even though not yet final
• Alienation has to be after judgment, for presumption
of fraud to apply
• BEFORE judgment – presumption cannot apply
• Writ of Attachment - properties are levied to secure
judgment
 BADGES OF FRAUD
• These are instances of fraud of Creditors.
• These are anything that defeats the rights of
Creditors
• Rescindable as to Creditors, although good between
parties
Badges of Fraud
1. Consideration is fictitious/inadequate
2. Transfer made by a debtor after suit is began or
while suit is pending
3. Sale upon credit by insolvent debtor
4. Transfer of all or nearly all of his property by debtor
when embarassed financially
5. Large indebtedness
6. Transfer between father and son
7. Failure of vendee to take exclusive possession of all
property
• Article 1388. Whoever acquires in bad faith the
things alienated in fraud of creditors, shall indemnify
the latter for damages suffered by them on account
of the alienation, whenever, due to any cause, it
should be impossible for him to return them.
– “due to any cause” – includes fortuitous
event/force majeure
• If there are two or more alienations, the first
acquirer shall be liable first, and so on successively.
– Rules:
• If transferee is in Good Faith: the good faith or bad faith
of the next transferee is NOT IMPORTANT
• If transferee is in Bad Faith: the next transferee is liable
if he is also in Bad faith, that is if the first transferee
cannot pay
• BAD FAITH: connotes ill will, self-interest
• Article 1389. The action to claim rescission must be
commenced within four years.
• For persons under guardianship and for absentees,
the period of four years shall not begin until the
termination of the former's incapacity, or until the
domicile of the latter is known.
– For wards: it means within 4 yrs after reaching
age of majority (18-22 yrs old)
 Who can bring action for rescission?

• Injured party or defrauded creditor(s)

• His Heir/successor in interest
 VOIDABLE CONTRACTS
• Article 1390. The following contracts are voidable or
annullable, even though there may have been no
damage to the contracting parties:
• (1) Those where one of the parties is incapable of
giving consent to a contract;
• (2) Those where the consent is vitiated by mistake,
violence, intimidation, undue influence or fraud.
• These contracts are binding, unless they are annulled
by a proper action in court. They are susceptible of
ratification.
• Article 1391. The action for annulment shall be
brought within four years.
This period shall begin:
- In cases of intimidation, violence or undue influence,
from the time the defect of the consent ceases.-
- In case of mistake or fraud, from the time of the
discovery of the same.
- And when the action refers to contracts entered into
by minors or other incapacitated persons, from the
time the guardianship ceases.
RATIFICATOIN
• CLEANSES THE CONTRACT
• Ratification extinguishes the action to annul a
voidable contract
• Ratification may be effected expressly or tacitly.
• may be effected by the guardian of the incapacitated
person.
• does not require the conformity of the contracting
party who has no right to bring the action for
annulment.
WHO CANNOT AVAIL OF ANNULMENT
• persons who are capable cannot allege the incapacity
of those with whom they contracted;
• those who exerted intimidation, violence, or undue
influence, or employed fraud, or
• caused mistake base their action upon these flaws of
the contract.
• Article 1398. An obligation having been annulled, the
contracting parties shall restore to each other the
things which have been the subject matter of the
contract, with their fruits, and the price with its
interest, except in cases provided by law.
• In obligations to render service, the value thereof
shall be the basis for damages.
UNENFORCEABLE
CONTRACTS
What are unenforceable contracts?
• Contracts which cannot be sued upon
• Cannot be given effect
• Does not have legal effect until ratified
• Can only be brought by a contracting party
• Cannot be assailed by third persons
Unenforceable contracts

Article 1403. The following contracts are

unenforceable, unless they are ratified:
• (1) Those entered into in the name of another
person by one who has been given no authority or
legal representation, or who has acted beyond his
powers;
– Bert sold Alona’s car to Camille w/o authority
– Bert sold upon credit Alan’s car to Conie in excess
of authority to sell in case only.
 Statute of Frauds
• (2) Those that do not comply with the Statute of
Frauds as set forth in this number. In the following
cases an agreement hereafter made shall be
unenforceable by action, unless the same, or some
note or memorandum, thereof, be in writing, and
subscribed by the party charged, or by his agent;
evidence, therefore, of the agreement cannot be
received without the writing, or a secondary
evidence of its contents:
Statute of Frauds
• Purpose: Prevent Fraud; Memory unreliable
• Properly called Statute of Frauds and Perjuries
• Written: means any form of writing, note/memo/any
paper/letter as long as legible
• Application:
– Applies to executory contracts (NO PERFORMANCE)
– Applies to cases involving damages or specific
performance
– Defense is waivable
Contracts under Statute of Frauds
• (a) An agreement that by its terms is not to be
performed within a year from the making thereof;
– Full performance must be done a year after
• (b) A special promise to answer for the debt, default,
or miscarriage of another;
– Guaranty and not Surety
– Collateral promise
Contracts under Statute of Frauds cont..

• (c) An agreement made in consideration of marriage,

other than a mutual promise to marry;
– Marriage settlements
– Donations propter nuptias
– In consideration : means by virtue of
Contracts under Statute of Frauds cont..
• (d) An agreement for the sale of goods, chattels or things in action, at a
price not less than five hundred pesos, unless the buyer accept and
receive part of such goods and chattels, or the evidences, or some of
them, of such things in action or pay at the time some part of the
purchase money; but when a sale is made by auction and entry is made by
the auctioneer in his sales book, at the time of the sale, of the amount
and kind of property sold, terms of sale, price, names of the purchasers
and person on whose account the sale is made, it is a sufficient
memorandum;
– Chattels (movable property)
– Amount is AT LEAST 500
– Things in action means credit, shares of stock, incorporeal properties
Contracts under Statute of Frauds cont..
• (e) An agreement for the leasing for a longer period than one
year, or for the sale of real property or of an interest therein;
– four contracts here:
1. Lease of REAL PROPERTY
2. Lease of INTEREST in real property
3. Sale of REAL PROPERTY (regardless of price)
4. Sale of INTEREST in real property
- Longer period than one year : means
- Lease PERSONAL PROPERTIES: enforceable regardless of
period
• ( f ) A representation as to the credit of a third
person.
– Representation induces extension of credit
– Representation needs to be in writing
– Person does not promise to answer debt
RATIFICATION OF CONTRACTS under statute of
fraud
• Failure to object to the presentation of oral evidence
to prove the contract
• Acceptance of benefits, contracts are no longer
exceutory
• Article 1406. When a contract is enforceable under
the Statute of Frauds, and a public document is
necessary for its registration in the Registry of Deeds,
the parties may avail themselves of the right under
Article 1357.
– Again when contract is BOTH valid and
enforceable, parties can compel execution of
public document
• Article 1407. In a contract where both parties are
incapable of giving consent, express or implied
ratification by the parent, or guardian, as the case
may be, of one of the contracting parties shall give
the contract the same effect as if only one of them
were incapacitated.
• If ratification is made by the parents or guardians, as
the case may be, of both contracting parties, the
contract shall be validated from the inception.
• Article 1408. Unenforceable contracts cannot be
assailed by third persons.
– Only those who are privy
– Personal defense
VOID OR INEXISTENT
CONTRACTS
Void Contracts
• No force and effect whatsoever
• Cannot be ratified
• Right to set up defense of illegality cannot be waived
• Action or defense is imprescriptible
• Defense of illegality is not available to third persons
whose interest are NOT directly affected
• It cannot give rise to a valid contract
Article 1409 – VOID CONTRACTS
The following contracts are inexistent and void from the beginning:
(1) Those whose cause, object or purpose is contrary to law, morals, good
customs, public order or public policy;
(2) Those which are absolutely simulated or fictitious;
(3) Those whose cause or object did not exist at the time of the transaction;
- Not applicable to future thing
(4) Those whose object is outside the commerce of men;
(5) Those which contemplate an impossible service;
(6) Those where the intention of the parties relative to the principal object of
the contract cannot be ascertained;
- There is doubt to the principal object
(7) Those expressly prohibited or declared void by law.
Declared by law to be void
• Future Inheritance
• Sale bet. Husband and wife
– Guardians, agents, executors, administrators, public officers, judges,
lawyers
• Purchase by those disqualified by law
• Donation DURING marriage EXC. Moderate gifts/family rejoicing
• Testamentary provision in favor of disqualified person
• Household service w/o compensation
• Members of Congress, prohibited interest with any contract with govt.
PARI DELICTO RULE Art.1411 and 1412
– When both guilty, law leaves them where they are
– No action against each other
– No remedy
– Both are prosecuted
– No recovery
• Innocent however can