DEFECTIVE CONTRACTS

DEFECTIVE CONTRACTS
Kinds
• RESCISSIBLE CONTRACTS – least defective; contract is
valid; lesion makes the contract defective; valid until
rescinded;
• VOIDABLE CONTRACTS – valid until annulled unless
ratified; incapacity to give consent or vitiated consent
makes the contract defective;
• UNENFORCEABLE CONTRACTS – valid but cannot be
enforced or sued upon unless ratified; non-compliance
of certain legal requirements (e.g. in writing) makes
the contract defective;
• VOID CONTRACTS - absolutely invalid; no legal effects
at all; cannot be ratified
RESCISSION
• To repair damage caused by a contract;
• To restore things to their condition prior to the
rescissible contract;
• Different from Rescission (“Resolution”) under
1191 [which is based on substantial breach and is
not a subsidiary action but a principal action];
• Not all contracts that prejudice other parties are
rescissible, only those provided for by law (1381;
1382)
Elements of Rescission
• Contract is valid; (1380)
• There is Lesion or Damage as defined by law; (1381)
• The law allows rescission; (1381, 1382)
• Rescission is subsidiary [no other legal remedy to
repair damage]; (1383)
• There must be restitution, unless (1) there is
nothing to return; (1385) or (2) other party is
unable or unwilling to return, or (3) property is in
possession of an innocent third person.
• The object of the contract must not be in the legal
possession of a third person who acted in good
faith; (1385) (see also Rosencor Dev’t. case)
• Only to the extent necessary; (1384)
• Filed within the prescriptive period of four (4)
years from the time action accrues, to be
reckoned from the time action is legally possible
(e.g. termination of guardianship, actual or
constructive discovery of fraud); (1389) cf. Khe
Hong Cheng
• By Direct Action only (vs. “collateral action”)
• By the Proper Party only (injured party, heirs,
assigns, successors-in-interest, creditors) see also
Velarde vs. Paez and Rosencor Dev’t. vs. Inquing)
General Rule on Prescriptive Period
“ARTICLE 1150. The time for prescription for all
kinds of actions, when there is no special provision
which ordains otherwise, shall be counted from the
day they may be brought.”
Indeed, this Court enunciated the principle
that it is the legal possibility of bringing the action
which determines the starting point for the
computation of the prescriptive period for the
action (Khe Hong Cheng v. Court of Appeals, G.R.
No. 144169, [March 28, 2001])
Accion Pauliana; Prescriptive Period
An accion pauliana thus presupposes the following:
1) A judgment;
2) the issuance by the trial court of a writ of
execution for the satisfaction of the judgment,
and
3) the failure of the sheriff to enforce and
satisfy the judgment of the court. It requires that
the creditor has exhausted the property of the
debtor. (Khe Hong Cheng v. Court of Appeals,
G.R. No. 144169, [March 28, 2001])
Rescissible Contracts
• By Guardians involving property of Ward/Absentee where
the latter suffers Lesion of more than ¼ of the value of the
property, unless approved by the Court [if without court
approval and involves act of ownership, contract is
unenforceable];
• In fraud of “creditors” (Accion Pauliana);
• Things in Litigation without approval of litigants or competent
court; (note: even if ownership is still an issue)
• “Premature” Payments by Insolvent (with or without judicial
declaration);
• Others as provided for by law (e.g. lesion in partition, non-
compliance of lessor’s obligations in lease contracts, etc.);
• Violation of Right of First Refusal (Guzman, Rosencor, etc.)
Accion Pauliana
• Credit exists before execution of rescissible
contract;
• The rescissible contract prejudices the creditor
such that he cannot anymore recover;
• There is fraud (in some cases, 1387, presumed);
• If contract is onerous, third party must have been
a party to the fraud;
• Creditor has no other legal remedy to recover;
• Object is not in the legal possession of an
innocent third person (in good faith)
“Badges of Fraud”
• Fictitious or Inadequate consideration;
• Transfer of property during pendency of suit against the debtor when
there is no other property to satisfy judgment;
• Sale on credit by an insolvent debtor;
• Transfer of all or substantially all assets;
• Complete Insolvency;
• Transfer is between Parent and Child; (see: Oria vs. McMicking)
• Failure of vendee to take exclusive possession of the property; (see Oria
vs. McMicking)
• Vendee knows of judgment against vendor-debtor;
• Certificate of Title remains with Vendor who continues to pay real
property taxes;
• ETC.
VOIDABLE CONTRACTS
• Valid until annulled;
• Ratifiable by express or tacit ratification
• Grounds: 1. ONE of the Contracting Parties is
Incapable of Giving Consent,
2. Vitiated Consent;
• Prescribes in four (4) years:
a. intimidation/violence/Undue influence = from the
time cause ceases,
b. mistake/fraud = from discovery thereof,
c. incapacity = from the time guardianship ceases
Issues on “Discovery of Fraud”
• Execution of Contract?
• Registration with Assessor’s Office?
• Registration with RD?
Modes of Ratification
• By Prescription of Action (1391)
• Express or Tacit Ratification (1393) by the
Injured person (or Guardian), not by the guilty
party
• Loss of Thing through fraud or fault of injured
party (1401)
Effects of Ratification
• Retroacts from the moment of execution;
• Mutual Restitution under 1398 applies, except
to the extent modified by 1399: incapacitated
person is not obliged to make restitution
except insofar as he has been benefitted by
the thing or price received by him (“benefit”
includes “keeping”)
Who can annul?
• Party-in-interest= Principally or Subsidiarily
Liable under the Contract;
• Not the guilty party or the incapacitated
party!
• See Rules on Relativity of Contracts and its
Exceptions!
• See also Velarde vs. Paez (April 30, 1957)!

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