By:  Atty. Gregorio B. Austral, CPA

Validity of escalation clauses

Sometime in 1994, Cua entered into four contracts of lease with Gotesco for the use of the latter’s commercial units in Ever-Gotesco Commonwealth Center. The units were used for the operation of Cua’s two jewelry stores Carmille Jewelry Emporium and Beverly Hills Emporium, and two amusement centers Val and Vhon Amusement and Carl Amusement Center. 

The lease was prepaid for a period of 20 years. In addition to the rent, Gotesco charged Cua CAAD and other charges for the use of the common areas, entrance, hallways, comfort rooms, stairs, escalators, elevators, centralized aircon, janitorial and security services. 

The contracts of lease contain a stipulation regarding the payment of CAAD:

17. Common Area Dues and Other Charges — Unless otherwise arranged with the LESSOR, the LESSEE shall pay monthly common area dues equivalent to Two Pesos (P2.00) per square meter per day and aircon dues of Two and 25/100 Pesos (P2.25) per square meter per day or the gross amount of Four and 25/100 [Pesos] (P4.25) per square meter [per day] on or before the 5th day of each month, without the necessity of demand from the LESSO[R]. Any interruption or disturbance of the possession of the LESSE[E] due to fortuitous events shall not be a cause for non-payment of the common area dues.

The aforementioned common area and aircon dues shall bear an annual escalation, compounded, at eighteen [percent] (18%) effective calendar year 1995 or at a rate to be determined by [the] LESSOR if said dues shall not be sufficient to meet inflation, Peso[ ]devaluation, and other escalation in utility and maintenance costs at any point in time.

From January 1997 to 2003, Gotesco imposed escalation costs on the CAAD, thereby charging Cua an aggregate amount of P2,269,735.64. 

Finding the imposition unfair, Cua protested the escalation costs through Letters dated February 23, 2001 and March 26, 2001. However, Gotesco, through its General Manager Ellen Miranda, insisted on the validity of the escalation charges, as stipulated in the contracts of lease.

The pivotal issue revolves around the validity of the CAAD escalation clause.

The principle of mutuality of contracts

Essentially, a contract is a meeting of minds between two persons whereby one binds himself/herself, with respect to the other, to give something or to render some service.  Parties enjoy the freedom to contract, and may establish such terms and conditions as they deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy. Likewise, parties are bound by the terms of the contract, and compliance to its provisions cannot be left to one side’s will.  Hence, absent the parties’ mutual assent, there can be no contract in its true sense. 

Notably, the binding effect of a contract stems from two settled principles: (i) “that any obligation arising from contract has the force of law between the parties; and [ii] that there must be mutuality between the parties based on their essential equality.” 

Resultantly, a contract which appears heavily skewed in favor of a party, thereby leading to an unconscionable result, must be struck down as void. In the same vein, if compliance to a stipulation depends solely on the will of one of the parties, then said stipulation must be declared invalid. Concomitantly, any modification in the contract should be made with the consent of the contracting parties and mutually agreed upon. The minds of the parties must meet as to the proposed modification, especially when it affects an important aspect of the agreement. Otherwise, it will have no binding effect. 

In relation, stipulations regarding the payment of interest are covered by the principle of mutuality of contracts. The law ordains that “[n]o interest shall be due unless it has been expressly stipulated in writing.”  Consequently, interest rates may only be imposed when reduced in writing and agreed upon by the express stipulation of the parties. Any change to the terms of interest must be mutually agreed upon, or else, it will have no binding effect.

At the core of the instant controversy is the validity of the second paragraph of clause 17 of the lease contracts, which states:

17. x x x

The aforementioned common area and aircon dues shall bear an annual escalation, compounded, at eighteen [percent] (18%) effective calendar year 1995 or at a rate to be determined by [the] LESSOR if said dues shall not be sufficient to meet inflation, Peso[ ]devaluation, and other escalation in utility and maintenance costs at any point in time. 

Ostensibly, the entire second paragraph partakes of an escalation clause. An escalation clause is a stipulation that allows an increase in the interest rate agreed upon by the contracting parties. It is a proviso found in commercial contracts imposed to maintain fiscal stability, and to retain the value of money in long term contracts. 

Jurisprudence holds that an escalation clause is not inherently wrong or void per se. Nonetheless, “an escalation clause ‘which grants the creditor an unbridled right to adjust the interest independently and upwardly, completely depriving the debtor of the right to assent to an important modification in the agreement’ is void.” Such stipulation violates the principle of mutuality of contracts.

Mutuality is absent when the interest rate in a loan agreement is set at the sole discretion of one party, or when there is no reasonable means by which the other party can determine the applicable interest rate. In such situation, the parties are not on equal footing when they negotiated and concluded the terms of the contract.  Imperatively, there must be a meeting of the minds between the parties on any modification, especially when it relates to an important or material aspect of the agreement.

A scrutiny of the second paragraph shows that it allows Gotesco to impose an interest rate of 18% or any rate it determines if the CAAD “shall not be sufficient to meet inflation, peso devaluation, and other escalation in utility and maintenance costs at any point in time.” Clearly, Gotesco reserved the right to unilaterally decide on the interest rate to be imposed.

It is well to note at this point that the CA erred in interpreting the clause to mean that the 18% interest rate applies in case there is no inflation, while the rate subject to Gotesco’s sole determination applies in case of inflation. To stress, the phrase “at [the rate of] x x x (18%) x x x or at a rate to be determined by the [lessor] if [the CAAD is not] sufficient to meet inflation x x x” is not separated by a comma. Hence, this implies that if the CAAD is not sufficient to meet inflation, peso devaluation and other escalation in utility and maintenance costs at any point in time, then Gotesco may impose the interest rate it so desires, which may range from 18% or such other rate.

Indeed, this escalation clause is wholly potestative and solely dependent on Gotesco’s will. Gotesco enjoyed an unbridled right to impose any interest rate it so desired. In fact, the interest rate varied widely and was not subject to any ceiling or discernible standard. Strangely, with the unrestrained imposition of varying interest rates, the CAAD even exceeded the amount of monthly rent. Undeniably, Gotesco’s imposition of shifting interest rates resulted to a modification of the contract that in turn, necessitated Cua’s consent. The parties were not on equal footing as Cua was left with no choice but to accept whatever rate Gotesco wished to impose. (Gotesco Properties, Inc. v. Cua, G.R. Nos. 228513 & 228552, [February 15, 2023])