Compensation is a mode of extinguishing obligations that takes place when two persons, in their own right, are creditors and debtors of each other. Instead of each paying the other, their debts cancel out to the extent of the concurrent amount. Legal compensation takes place automatically by operation of law when all the requisites concur: each of the obligors is bound principally and is at the same time a principal creditor of the other; both debts consist of a sum of money or of consumable things of the same kind and quality; both debts are due; both are liquidated (determined) and demandable; and there is no retention or controversy over either debt commenced by a third person and communicated in due time to the debtor. When these concur, both debts are extinguished to the concurrent amount even without the parties' agreement. There are other kinds: voluntary compensation (by agreement even if the requisites are not all present) and judicial compensation (declared by a court, often through a counterclaim). Certain debts cannot be compensated, such as a debt arising from a depositum or the obligations of a depositary or bailee in commodatum, and claims for support due by gratuitous title. Compensation is a practical way debts are settled without actual payment.
What Compensation Is
Compensation (set-off) happens when two persons are creditors and debtors of each other — their debts cancel out to the concurrent amount instead of each paying.
Requisites of Legal Compensation
- Each is principally bound and a principal creditor of the other;
- Both debts are of money or the same kind of consumable things;
- Both are due, liquidated, and demandable; and
- No controversy over either commenced by a third person.
Kinds and Exceptions
There is also voluntary (by agreement) and judicial (by court) compensation. Some debts cannot be compensated — e.g., a debt from a deposit or commodatum, and support due gratuitously.
Practical Takeaways
- Mutual debts cancel out through compensation;
- Legal compensation is automatic when all requisites concur;
- Some debts (deposit, support) cannot be compensated.
Frequently Asked Questions
What is compensation of debts? A mode of extinguishing obligations where two persons who are creditors and debtors of each other have their debts cancel out to the extent of the concurrent amount, instead of each paying the other.
What are the requisites of legal compensation? Each obligor is principally bound and a principal creditor of the other, both debts are of money or the same kind of consumable things, both are due, liquidated, and demandable, and there is no controversy over either commenced by a third person.
Does legal compensation require the parties' agreement? No. When all the requisites concur, legal compensation takes place automatically by operation of law, extinguishing both debts to the concurrent amount even without agreement.
Which debts cannot be compensated? Debts arising from a depositum or the obligations of a bailee in commodatum, and claims for support due by gratuitous title, among others.
This commentary is for general informational purposes only and does not constitute legal advice. For guidance specific to your situation, please consult a licensed attorney.
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