Arco Pulp and Paper Co., Inc. and Santos vs. Lim

Novation must be stated in clear and unequivocal terms to extinguish an obligation and cannot be presumed; it may be implied only if the old and new contracts are incompatible on every point. A memorandum of agreement that does not expressly declare the extinguishment of an original obligation or substitute a new debtor with the creditor's consent does not constitute novation, and the original obligation remains enforceable.

Dan T. Lim, operating under the business name Quality Paper and Plastic Products Enterprises, engaged in supplying scrap papers, cartons, and other raw materials to paper mill factories. From February 2007 to March 2007, he delivered scrap papers worth P7,220,968.31 to Arco Pulp and Paper Company, Inc. through its Chief Executive Officer and President, Candida A. Santos. The parties agreed that petitioner corporation could either pay the value of the raw materials or deliver finished products of equivalent value as compensation.

• Dan T. Lim delivered scrap papers worth P7,220,968.31 to Arco Pulp and Paper Co., Inc. from February 2007 to March 2007 through its President and CEO, Candida A. Santos.
• The parties agreed that Arco Pulp and Paper would either pay the value of the raw materials or deliver finished products of equivalent value to Dan T. Lim, constituting an alternative obligation.
• Arco Pulp and Paper issued a post-dated check dated April 18, 2007 in the amount of P1,487,766.68 as partial payment, which was dishonored for being drawn against a closed account when deposited on the same date.
• On the same day the check was dishonored, Arco Pulp and Paper executed a memorandum of agreement with Eric Sy (owner of Megapack Container Corporation) binding Arco to deliver 600 tons of Test Liner to Megapack for Sy's account, with raw materials to be supplied by Dan T. Lim through his company.
• Dan T. Lim was not a party to the memorandum of agreement, which was exclusively between Candida A. Santos and Eric Sy.
• On May 5, 2007, Dan T. Lim sent a demand letter to Arco Pulp and Paper for payment of P7,220,968.31, but no payment was made.
• The memorandum of agreement did not contain any provision stating that the original obligation to Dan T. Lim was extinguished or that Eric Sy substituted Arco Pulp and Paper as debtor.

• The execution of the memorandum of agreement constituted a novation of the original obligation because Eric Sy became the new debtor of respondent Dan T. Lim.
• There is no legal basis to hold petitioner Candida A. Santos personally liable for the transaction entered into by petitioner corporation, as no evidence proved it was her personal undertaking.
• The Court of Appeals erred in awarding moral and exemplary damages and attorney's fees to respondent who failed to show proof of entitlement to such damages.
• Respondent allowed petitioners to deliver finished products to Eric Sy, thereby novating the original obligation.

• No proper novation occurred because the memorandum of agreement was an exclusive and private agreement between Arco Pulp and Paper and Eric Sy, and respondent's name was mentioned only for supplying scrap papers, not as a party to the contract.
• The debt of petitioners remains unpaid, justifying the award of damages.
• Candida A. Santos was correctly held solidarily liable as the "prime mover" of the outstanding corporate liability and due to her bad faith in issuing an unfunded check and attempting to evade liability.

• Procedural Issues: N/A
• Substantive Issues:
  • Whether the obligation between the parties was extinguished by novation through the execution of the memorandum of agreement.
  • Whether petitioner Candida A. Santos is solidarily liable with petitioner corporation for the corporate obligation.
  • Whether moral damages, exemplary damages, and attorney's fees may be awarded to respondent.

• Procedural: N/A
• Substantive:
  • The obligation between the parties was an alternative obligation under Article 1199 of the Civil Code, where Arco Pulp and Paper had the option to either pay the price of raw materials or deliver finished products of equivalent value.
  • No novation occurred because the memorandum of agreement did not declare in unequivocal terms that the original obligation was extinguished, nor did it substitute Eric Sy as the new debtor with the consent of Dan T. Lim; novation cannot be presumed and requires either express declaration or incompatibility on every point between old and new obligations.
  • The corporate veil must be pierced to hold Candida A. Santos solidarily liable with the corporation because she acted in bad faith by issuing an unfunded check and contracting with a third party to evade liability, making her the "prime mover" of the fraudulent scheme.
  • Moral damages are awardable under Article 2220 of the Civil Code because the breach of contract was attended by bad faith, evidenced by the issuance of a check drawn against a closed account and the attempt to shift liability to a third party without the creditor's consent.
  • Exemplary damages are proper under Article 2232 to serve as a deterrent to fraudulent evasion of contractual obligations.
  • Attorney's fees are recoverable under Article 2208(1) of the Civil Code when exemplary damages are awarded.
  • The interest rate is modified from 12% to 6% per annum from the time of demand (May 5, 2007) until finality of judgment, and 6% per annum from finality until full satisfaction, in accordance with Nacar v. Gallery Frames.

• Novatio non praesumitur (Novation is never presumed) — Novation must be clearly and unequivocally established either by express declaration that the old obligation is extinguished or by showing that the old and new obligations are incompatible on every point; it cannot be implied from mere acts showing a different mode of payment or performance.
• Alternative Obligations — Under Article 1199 of the Civil Code, a debtor alternatively bound by different prestations must completely perform one of them, and the creditor cannot be compelled to receive part of one and part of the other; the debtor has the right of election until it is communicated to and consented by the creditor or declared proper by a competent court.
• Piercing the Corporate Veil — The separate juridical personality of a corporation may be disregarded when it is used as a means to perpetrate fraud, evade an existing obligation, or as a vehicle for the circumvention of statutes; a corporate officer may be held personally liable for corporate obligations when guilty of bad faith or gross negligence clearly and convincingly proven.
• Damages for Breach of Contract in Bad Faith — Moral damages may be recovered for breach of contract only when the breach is attended by fraud or bad faith, requiring proof by clear and convincing evidence that the defendant acted with dishonest purpose, moral obliquity, or conscious doing of wrong.

• "Novation must be stated in clear and unequivocal terms to extinguish an obligation. It cannot be presumed and may be implied only if the old and new contracts are incompatible on every point."
• "In the civil law setting, novatio is literally construed as to make new. So it is deeply rooted in the Roman Law jurisprudence, the principle — novatio non praesumitur — that novation is never presumed."
• "The test of incompatibility is whether the two obligations can stand together, each one with its own independent existence."
• "Bad faith does not simply connote bad judgment or negligence. It imports a dishonest purpose or some moral obliquity and conscious doing of a wrong, a breach of known duty through some motive or interest or ill will that partakes of the nature of fraud."

• Garcia v. Llamas — Cited as the leading case discussing the requisites of novation, distinguishing between extinctive and modificatory novation, and explaining the modes of substituting the person of the debtor (expromision and delegacion).
• Nacar v. Gallery Frames — Applied to modify the rate of interest from 12% to 6% per annum in accordance with BSP-MB Circular No. 799, establishing the current guidelines for legal interest on monetary obligations.
• Heirs of Fe Tan Uy v. International Exchange Bank — Cited for the rule that corporate officers are generally not liable for corporate obligations unless they assent to unlawful acts or are guilty of gross negligence or bad faith.
• Livesey v. Binswanger Philippines — Cited for the doctrine that piercing the veil of corporate fiction is an equitable remedy when the corporate entity is used for non-legitimate purposes such as evading just obligations or perpetrating fraud.
• Adriano v. Lasala — Cited for the standard that bad faith in breach of contract requires proof by clear and convincing evidence and imports dishonest purpose or moral obliquity, not merely bad judgment or negligence.

• Article 1199 of the Civil Code — Governs alternative obligations where a person is bound by different prestations and must completely perform one of them.
• Articles 1291-1293 of the Civil Code — Define the modes of novation (changing object/principal conditions, substituting debtor, subrogating creditor) and require that novation be declared in unequivocal terms or that old and new obligations be incompatible on every point.
• Article 1159 of the Civil Code — States that obligations arising from contracts have the force of law between contracting parties and should be complied with in good faith.
• Article 19 of the Civil Code — The general principle that every person must act with justice, give everyone his due, and observe honesty and good faith in the exercise of rights and performance of duties.
• Article 2220 of the Civil Code — Allows the award of moral damages for breach of contract where the defendant acted fraudulently or in bad faith.
• Article 2232 of the Civil Code — Authorizes the award of exemplary damages in contracts when the defendant acted in a wanton, fraudulent, reckless, oppressive, or malevolent manner.
• Article 2208(1) of the Civil Code — Provides that attorney's fees may be recovered when exemplary damages are awarded.