Judicial Compensation

In almost all legal systems, legal compensation, conventional compensation and judicial compensation are regulated.

It is very common in contractual relations that the parties intend to compensate for non-compliance and performance. Or at least, that one of them, in the face of a breach by the other, intends to make a compensation agreement by reducing the agreed price.

The problem is that in practice it is difficult to determine this type of compensation by mutual agreement. More, in those cases in which nothing has been provided for in the contract. This causes the most favored party to file a lawsuit in order to claim its debt. By favored party, we refer to the one that has accredited the existence, in its favor, of a due and payable debt. But, what happens if the other party is also a creditor but its debt is not due and payable? Will it be able to defend itself by requesting a compensation of amounts?

We know that compensation is a simple concept known by practically everyone. It allows the settlement of outstanding balances when one person is simultaneously a debtor and creditor of another.  However, there are different types of compensation, with different requirements. In this publication we are going to study which are the types and, in particular, how the Judges operate and apply the judicial compensation.

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Types of Compensation and Requirements

Compensation is regulated by Articles 1,195 and following of the Civil Code, stating:

“compensation will take place when two persons, in their own right, are reciprocally creditors and debtors of each other”. And it will have the effect of “extinguishing one and the other debt in the concurrent amount, even if the creditors and debtors are not aware of it” (Art. 1202 CC).

With respect to the modalities of compensation we can affirm that there are three types: the legal, the conventional and the judicial.

Legal compensation

It is that contained in our civil code, (arts. 1195 to 1.202) for which the requirements of article 1.196 must be met:

For the compensation to be applicable, it is necessary that:

1. Each one of the obligated ones is primarily obligated, and is at the same time principal creditor of the other one.
2. Both debts consist of an amount of money, or, being fungible the things owed, they are of the same species and also of the same quality, if this one had been designated.
3. The two debts are overdue.
4. They are liquid and enforceable.
5. On neither of them there is retention or contention promoted by third persons and notified opportunely to the debtor.

It is therefore required duality of titles, determined amount, due, liquid and enforceable. And that there is no judicial retention that prevents the release of such payment.

Notwithstanding the foregoing, it should be pointed out that there are cases in which, if the above requirements are met, compensation is not possible. We refer to those in which the parties have contractually excluded it (principle of autonomy of the will 1.255 CC). And to those prohibited by Law which are reflected in article 1.200 CC, which are summarized as follows:

• The depositary cannot compensate the loss of the thing deposited with another that the depositor has against him.
• Nor can the creditor be opposed the maintenance compensation owed gratuitously.
• Finally, by provision of article 605 LEC (LEC, Ley de Enjuiciamiento Civil. In English, Civil Procedural Law), the part of the credits that are non-seizable cannot be compensated. That is to say, those that are essential for the debtor’s support.

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Impossible enforcement of a court decision

The execution of sentences is part of the right to effective judicial protection. However, it may happen that its execution becomes impossible to determine whatever the characteristics of the procedure and the content of the Judgment.

Conventional compensation.

It is the one that arises from the will of the parties, without the need for the requirements demanded by law exposed in the previous point. However, it cannot be valid if there is a legal provision that in any case excludes it.

Judicial compensation.

It is the one dictated by a Judge at the request of one of the parties. It occurs in those cases in which the legal requirements for compensation had not been met until the Judgment was rendered. That is to say, of amounts that were not liquid, due and payable. And what the Judge does is to rule that the credit (or part of it), is compensated with the one held by the defendant. Its treatment is contained in article 408.1.3 LEC:

“1. If, against the plaintiff’s claim for the payment of a sum of money, the defendant alleges the existence of a compensable credit, such allegation may be disputed by the plaintiff in the manner provided for in the answer to the counterclaim, even if the defendant only seeks acquittal and not the award of the balance that may result in his favor. (…)”

“3. The final judgment shall rule on the points referred to in the preceding paragraphs of this article and the pronouncements contained in the judgment on such points shall have the force of res judicata.”

Let’s see the following point examples of the application of this compensation by the Courts.

Examples of Judicial Compensation

The doctrine of the Supreme Court (TS) admits this compensation without the need for the debts to be liquid and due at the time the litigation is initiated. It is sufficient that reciprocal credits and titles concur.

For these purposes, STS (Supreme Court Resolution) number 1254/2007 is very interesting, which considers judicial compensation to be appropriate:

“as stated in the STS of 26 March 2001 ( RJ 2001, 4761) , the doctrine of this Court does not require for judicial compensation that the debts be liquid and due at the time the litigation arises, but it does require that reciprocal credits and titles concur and that the parties, with correspondence from one to the other, are creditors and debtors in their own right ( SSTS of 23 December 1991 [ RJ 1991, 9476] and 8 June 1998 [ RJ 1998, 4284] ), as occurs in the case under discussion. (…)”

Also, Judgment number 1375/2007 of January 5 is enlightening:

“The second ground of cassation is formulated under article 1692, 4 LECiv (LEG 1881, 1), for infringement of article 1195 of the Civil Code (LEG 1889, 27). It is considered that judicial compensation is not possible when it was not proven by Mr. Rosendo that he was a creditor of the amount to be compensated, by virtue of the debt owed to Rodare, SL; the appellant claims that the situation that leads to compensate has not occurred and therefore Article 1195 of the Civil Code has been violated.

The appellant forgets, however, three fundamental issues in relation to the judicial compensation correctly applied by the  Court of Appeal in the judgment that is now being appealed:

1ª. That although it is not expressly included in article 1195 of the Civil Code, the so-called judicial compensation has been admitted in numerous rulings of this Court, in which it has been configured as “a type of compensation in which not all the requirements established by the Code for legal compensation are required and which is ordered by the court in a ruling and as a result of a proceeding” (ruling of 17 July 2000 [ RJ 2000, 6803] ). We are therefore faced with a power of the judge that can take place when any of the legal requirements are lacking or when the assumptions of voluntary compensation are not met, but the existence of concurrent debts has been proven ( judgments of 18 January 1999 [ RJ 1999, 39] , 8 June 1998 [ RJ 1998, 4284] ).

Certainly, judicial compensation requires that reciprocal credits and titles concur and that the parties be creditors and debtors in their own right ( judgment of 26 March 2001 [ RJ 2001, 4761] , citing many others), although it is not necessary that all the requirements of the Civil Code be met for legal set-off to proceed, among them, that the debts be liquid ( judgment of 18 January 1999 [ RJ 1999, 39] ). (…)”

“In addition and as the now appealed judgment states, the purposes sought with the compensation are fulfilled, namely, “the convenience of simplifying the operations of fulfillment” of the obligation, and therefore, when a judgment must contain different sentences given the claim of different obligations by the parties in litigation, it is a technical necessity to issue a single sentence that has as its object the balance. This will obviously be possible provided that the interests of both parties are not prejudiced (Article 13:102 of the Principles of European Contract Law), which has not been the case in the present dispute. (…)”

Conclusions

In conclusion to what has been said, it should be noted that;

• The compensation is a simple concept known practically by everybody. And a very recurrent figure in contractual relations.
• However, there are different types of compensation whose validity will depend on the concurrence of a series of requirements.
• The legal compensation is regulated in our Civil Code and requires that the amounts are liquid, due and payable. And that there is no judicial retention that prevents the release of such payment.
• However, and even if the legal requirements are met, there are certain cases that prohibit the compensation. (Article 1.200 CC)
• Conventional compensation is that which will depend exclusively on the will of the parties, unless expressly prohibited by law.
• The judicial compensation, is one dictated by means of Sentence, without needing that the legal requirements are previously fulfilled. It is a power granted to the Judges when all the requirements for legal compensation are not met.
• The SC admits it for “the convenience of simplifying compliance operations”. And for being a technical necessity the “issuance of a single sentence that has as its object the balance.”

If this article has been of interest, we also suggest you to read the following article published on our website: Redhibitory action, hidden defects and different performance