Asset Builders Corporation vs. Stronghold Insurance Company, Inc.

A surety's solidary liability under a surety bond and performance bond attaches upon the principal obligor's default and is not extinguished by the obligee's subsequent rescission of the principal contract, because the surety's undertaking is direct, primary, and absolute once the principal fails to perform.

Asset Builders Corporation (ABC) was undertaking the construction of the ACG Commercial Complex in Antipolo City and required the drilling of an exploratory production well. It engaged Lucky Star Drilling & Construction Corporation to supply labor, materials, tools, equipment, and technical supervision for the drilling at a total contract price of ₱1,150,000.00. To secure faithful compliance, Lucky Star procured from Stronghold Insurance Company, Inc. two bonds — a surety bond for ₱575,000.00 guaranteeing repayment of the advance payment, and a performance bond for ₱345,000.00 guaranteeing performance of the contract. The arrangement placed Stronghold in the position of a surety solidarily bound with Lucky Star to ABC.

On April 28, 2006, Asset Builders Corporation entered into an agreement with Lucky Star Drilling & Construction Corporation for the drilling of one exploratory production well at the ACG Commercial Complex site in Antipolo City. Under the Purchase Order, Lucky Star was to supply labor, materials, tools, equipment, and technical supervision at a lump sum price of ₱1,150,000.00. The contract required a 50% downpayment upon submission of a surety bond in an equivalent amount and a performance bond equivalent to 30% of the contract amount, set a completion date of 60 calendar days, and stipulated a penalty of 2/10 of 1% of the total contract amount for every day of delay, with a 10% retention to be released upon project acceptance.

To guarantee faithful compliance, Lucky Star engaged Stronghold Insurance Company, Inc., which issued two bonds in favor of ABC. The first, Surety Bond G(16) No. 141558 dated May 9, 2006, covered ₱575,000.00 and guaranteed repayment of the advance payment through deductions from periodic billings; it was expressly stated to be "callable on demand," with liability expiring on May 9, 2007. The second, Performance Bond G(13) No. 115388, also dated May 9, 2006, covered ₱345,000.00 and guaranteed the full and faithful performance of the contract, including payment to laborers and material suppliers. On May 20, 2006, ABC paid Lucky Star ₱575,000.00 (with 2% withholding tax) as the 50% advance payment.

Lucky Star commenced the drilling work but, by July 18, 2006 — just days before the 60-day completion deadline — had accomplished only 10% of the project. On that same date, ABC sent Lucky Star a demand letter for immediate completion, threatening cancellation of the agreement and forfeiture of the bonds. On August 3, 2006, ABC sent a Notice of Rescission of Contract with Demand for Damages, seeking refund of the downpayment, liquidated damages, payment of the performance bond amount, and other consequential and exemplary damages. On August 16, 2006, ABC sent a Notice of Claim to Stronghold demanding payment under the bonds.

Neither Lucky Star nor Stronghold responded to ABC's demands, prompting ABC to file a Complaint for Rescission with Damages before the RTC on November 21, 2006. Stronghold denied liability, arguing that ABC had not proven the advance payment and that rescission of the contract with Lucky Star had revoked the claims under the bonds and absolved Stronghold from further liability. Lucky Star failed to file a responsive pleading and was declared in default. The RTC ultimately ordered Lucky Star to pay ABC but absolved Stronghold, reasoning that the surety and performance bonds were accessory contracts that were automatically cancelled upon rescission of the principal agreement.

• Continuing Valid Principal Obligation: Petitioner argued that despite rescission, a continuing valid principal obligation guaranteed by respondent's bonds arose out of the contractor's default and non-performance, such that the surety's liabilities had already accrued, attached, and become direct, primary, and absolute even before the exercise of the option to rescind under Article 1191 of the Civil Code.
• Inseparability of Surety's Liability: Petitioner maintained that rescission does not affect the liabilities of respondent Stronghold, as its obligations under the bonds had already become interwoven and inseparable with the liabilities of its principal, Lucky Star.
• Penalties Under the Insurance Code: Petitioner contended that the lower court erred in failing to comply with the "duty of court" to make a finding of unreasonable denial or withholding by respondent Stronghold of petitioner's claims and to impose the penalties provided under Sections 241 and 244 of the Insurance Code.

• Lack of Proof of Advance Payment: Respondent countered that ABC had not shown any proof that it made an advance payment of 50% of the contract price of the project.
• Effect of Rescission: Respondent argued that ABC's rescission of its contract with Lucky Star virtually revoked the claims against the two bonds and absolved both Lucky Star and Stronghold from further liability.

• Surety's Liability After Rescission: Whether the surety, Stronghold Insurance, can be held liable under its surety bond and performance bond notwithstanding the rescission of the principal contract between ABC and Lucky Star.
• Penalties Under the Insurance Code: Whether the lower court erred in failing to impose penalties under Sections 241 and 244 of the Insurance Code for unreasonable denial or withholding of petitioner's claims.

• Surety's Liability After Rescission: Yes. The surety's solidary liability attaches upon the principal obligor's default and is not extinguished by the obligee's subsequent rescission of the principal contract, the surety's undertaking being direct, primary, and absolute under Article 2047 of the Civil Code.
• Penalties Under the Insurance Code: N/A. The decision did not address this issue, as the primary issue identified and resolved was whether the surety could be held liable under its bonds.

• Surety's Liability After Rescission: The bonds executed by Lucky Star and Stronghold in favor of ABC constitute a surety agreement as defined under Article 2047 of the Civil Code, whereby the surety binds itself solidarily with the principal debtor. Although a surety contract is ancillary to and presupposes a valid principal obligation, the surety assumes liability as a regular party to the undertaking, and its liability to the creditor is direct, primary, and absolute. The surety's role arises upon the obligor's default, at which point it can be directly held liable as a solidary obligor. In this case, Lucky Star's failure to complete the drilling work within the agreed 60-day period — accomplishing only 10% by July 18, 2006 — constituted default. Its liability attached, and as a necessary consequence, Stronghold's liability under the surety agreement arose. The clause "this bond is callable on demand" further underscores the surety's primary and direct responsibility. When Lucky Star reneged on its undertaking and failed to return the ₱575,000.00 advance, Stronghold became solidarily bound with Lucky Star for repayment. Pursuant to Article 1216, the creditor may proceed against any one of the solidary debtors or all of them simultaneously. Rescission of the principal contract did not release Stronghold, because the surety's liability had already accrued upon Lucky Star's default — rescission was merely the mechanism by which ABC sought to prevent further loss from the delay. Stronghold is answerable to ABC on account of Lucky Star's non-performance as guaranteed by the bonds. Under Article 1217, Stronghold is entitled to reimbursement from Lucky Star for amounts it may be required to pay.

• Nature of Suretyship under Article 2047 — A suretyship exists when a person binds himself solidarily with the principal debtor to the creditor. Although the surety contract is in essence secondary and ancillary to a valid principal obligation, the surety's liability to the creditor is direct, primary, and absolute — the surety is directly and equally bound with the principal. The surety assumes liability as a regular party to the undertaking even though it possesses no direct or personal interest in the obligation nor receives any benefit therefrom.
• Accrual of Surety's Liability Upon Principal's Default — The surety's role arises only upon the obligor's default, at which time it can be directly held liable by the obligee for payment as a solidary obligor. Once the principal's liability has attached by reason of default, the surety's liability under the bond accrues and is not extinguished by the obligee's subsequent rescission of the principal contract.
• Creditor's Right to Proceed Against Solidary Debtors (Article 1216) — The creditor may proceed against any one of the solidary debtors or some or all of them simultaneously. A demand made against one does not preclude subsequent demands against the others so long as the debt has not been fully collected.

• "Although the contract of a surety is in essence secondary only to a valid principal obligation, the surety becomes liable for the debt or duty of another although it possesses no direct or personal interest over the obligations nor does it receive any benefit therefrom." — This passage defines the essential nature of a surety's liability as direct and absolute despite the accessory character of the surety contract, and is central to the Court's ruling that Stronghold could not escape liability.
• "Contrary to the trial court's ruling, respondent insurance company was not automatically released from any liability when petitioner resorted to the rescission of the principal contract for failure of the other party to perform its undertaking. Precisely, the liability of the surety arising from the surety contracts comes to life upon the solidary obligor's default." — This is the ratio decidendi of the case, directly rejecting the RTC's reasoning that rescission of the principal contract automatically cancels accessory surety bonds.
• "The surety's role arises only upon the obligor's default, at which time, it can be directly held liable by the obligee for payment as a solidary obligor." — This articulates the doctrinal principle that the surety's liability is triggered by default, not by the continued existence of the principal contract, distinguishing the surety's position from that of an active party to the principal obligee-obligor relationship.

• Stronghold Insurance Company, Inc. vs. Republic-Asahi Glass Corporation, G.R. No. 147561, June 22, 2006 — Followed. This case, reiterating Garcia vs. Court of Appeals, was cited to expound on the nature of the surety's liability as direct, primary, and absolute despite being accessory or collateral to the principal obligation.
• Garcia vs. Court of Appeals, G.R. No. 80201, November 20, 1990 — Followed. Cited as the foundational ruling on the direct, primary, and absolute liability of a surety, reiterated in the Stronghold vs. Republic-Asahi decision.
• Intra-Strata Assurance Corporation vs. Republic, G.R. No. 156571, July 9, 2008 — Followed. Cited for the principle that the surety's role arises only upon the obligor's default and that the obligee's acceptance of the surety's undertaking does not give the surety the right to intervene in the principal contract.
• Security Pacific Assurance Corporation vs. Hon. Tria-Infante, 505 Phil. 609 (2005) — Followed. Cited for the proposition that the surety assumes liability as a regular party to the undertaking notwithstanding the secondary nature of the surety contract.
• Philippine Bank of Communications vs. Lim, 495 Phil. 645 (2005) — Followed. Cited for the same proposition that the surety assumes liability as a regular party to the undertaking.

• Article 2047, New Civil Code — Defines guaranty and suretyship, providing that when a person binds himself solidarily with the principal debtor, the contract is called a suretyship. Applied to classify the bonds issued by Stronghold as surety agreements making Stronghold solidarily liable with Lucky Star.
• Article 1216, New Civil Code — Provides that the creditor may proceed against any one of the solidary debtors or some or all of them simultaneously, and that a demand against one does not bar subsequent demands against the others so long as the debt is not fully collected. Applied to support ABC's right to proceed directly against Stronghold after Lucky Star's default.
• Article 1217, New Civil Code — Recognizes the right of reimbursement from a co-debtor in favor of the one who paid. Applied to confirm Stronghold's right to seek reimbursement from Lucky Star for amounts it may be required to pay ABC under the bonds.
• Article 1191, New Civil Code — Governs the right to rescission of obligations. Referenced in the context of ABC's exercise of the option to rescind the principal contract, which the Court held did not extinguish the surety's already accrued liability.

Antonio T. Carpio (Chairperson), Antonio Eduardo B. Nachura, Teresita J. Leonardo-De Castro, and Diosdado M. Peralta concurred. No separate concurring opinions were written.