Atlantic Erectors, Inc. vs. Court of Appeals and Herbal Cove Realty Corporation

The right of the owner to recover liquidated damages is distinct from, and is not defeated by, the owner's unlawful termination of the construction contract; liability for liquidated damages attaches upon proof of the fact of delay in the completion of the works within the agreed period, absent a validly sought and granted written extension.

Herbal Cove Realty Corporation engaged DP Architects Philippines to prepare architectural designs and RA&A Associates to provide engineering designs for its subdivision project known as "The Herbal Cove" located at Iruhin West, Tagaytay City, and hired Building Energy Systems, Inc. to provide management services for the construction and development of the project. On June 20, 1996, Herbal Cove and Atlantic Erectors, Inc. entered into a Construction Contract whereby the latter agreed to undertake Construction Package A of the project. The contract fixed a completion period of 180 consecutive calendar days from the Notice to Proceed and stipulated liquidated damages of one-tenth of one percent of the contract price per calendar day of delay, capped at ten percent, and contained provisions on failure to complete work, extension of time, and the owner's right to recover liquidated damages. Prior related litigation saw petitioner's civil case before the RTC dismissed on motion of respondent invoking the arbitration clause, which dismissal was affirmed by the Court.

Herbal Cove Realty Corporation engaged DP Architects Philippines to prepare architectural designs and RA&A Associates to provide engineering designs for its subdivision project known as "The Herbal Cove" located at Iruhin West, Tagaytay City, and hired Building Energy Systems, Inc. to provide management services for the construction and development of the project. On June 20, 1996, Herbal Cove and Atlantic Erectors, Inc. entered into a Construction Contract whereby the latter agreed to undertake, accomplish and complete the entire works for the implementation of Construction Package A, consisting of four units of Townhouse B and one unit of Single Detached A1, for a total contract price of P15,726,745.19, later adjusted to P16,726,745.19 as a result of additional works. Petitioner agreed to finish and complete the works and deliver the same within 180 consecutive calendar days reckoned from the date indicated in the Notice to Proceed, and to pay liquidated damages equivalent to one-tenth of one percent of the contract price per calendar day of delay until completion, delivery and acceptance of the works, to a maximum not exceeding ten percent. Petitioner was instructed to commence construction on July 8, 1996.

In a letter dated January 6, 1997, petitioner requested an extension of time equivalent to the number of days of delay in the start of the works brought about by the belated turnover of the building sites, and sought additional extension due to bad weather that prevailed during implementation, again causing excusable delay. In a letter dated January 11, 1997, respondent allowed the requested schedule adjustments with a reminder that liquidated damages would be applied beyond the extended periods. Petitioner was allowed to complete and deliver the housing units until the following dates: SDA-15 on 15 March 1997, or an extension of 67 calendar days; TH 16-A and TH 16-B on 7 March 1997, or an extension of 59 calendar days; and TH 17-A and TH 17-B on 7 April 1997, or an extension of 90 calendar days. Petitioner, however, still failed to complete and deliver the units within the extended period.

On September 22, 1997, respondent required petitioner to submit a formal written commitment to finish and complete the contracted works, otherwise the contract would be deemed terminated and respondent would take over the project on October 1, 1997 with the corresponding charges for the excess cost occasioned thereby, plus liquidated damages. On October 3, 1997, respondent informed petitioner that its management had unanimously agreed to terminate the construction contract for the following reasons: (1) blatant defects in the workmanship of the houses; (2) delayed completion of the project; and (3) lack of interest to make a firm commitment to finish the project. Respondent thereafter entered into a Construction Administration Agreement with Benedict O. Manalo and Associates, Engineers and Construction Managers, to finish, complete and deliver the housing units started by petitioner.

On June 3, 1998, respondent filed with the CIAC a Request for Arbitration against petitioner praying for payment of liquidated damages, cost to remedy defective workmanship, excess costs incurred to complete the work, attorney's fees and litigation expenses, docketed as CIAC Case No. 13-98. Prior thereto, or on November 21, 1997, petitioner had instituted with the RTC a civil case against respondent seeking to recover the sum representing unpaid construction service already rendered, unpaid construction materials, equipment and tools, and cost of income by way of rental from equipment held by respondent; that case was dismissed on motion of respondent invoking the arbitration clause, which dismissal was affirmed by the Court. In its answer to the request for arbitration, petitioner alleged that the delay was attributable to (1) delayed turnover of the site; (2) two typhoons; (3) change orders and additional works; (4) late approval of shop drawings; (5) non-arrival of the chimney expert; (6) delayed payments; and (7) non-payment of the last two billings. It also argued that respondent suspended the construction works, depriving it of the opportunity to complete the works on or before November 15, 1997, and insisted that there was unlawful termination of the construction contract.

The CIAC found that petitioner incurred delay in the completion of the project; that while it filed a request for extension which was granted until April 7, 1997, the project remained incomplete and no further extension was asked; that the termination of the contract was illegal for respondent's failure to comply with the requirement of a 15-day notice; that petitioner's delay was overridden by the unlawful termination; and that, as of the last certified billing, petitioner's percentage accomplishment was only 62.57%. The CA, on respondent's separate appeal, sustained the finding that the termination was illegal for failure to comply with the 15-day notice, but held that notwithstanding the illegality of the termination, petitioner could still be charged with liquidated damages by reason of the delay in the completion of the project, because the right to liquidated damages is available whether or not the contract was terminated, delay alone being decisive.

• Attribution of Delay: Petitioner alleged that the delay was attributable to (1) delayed turnover of the site; (2) two typhoons; (3) change orders and additional works; (4) late approval of shop drawings; (5) non-arrival of the chimney expert; (6) delayed payments; and (7) non-payment of the last two billings.
• Suspension of Works: Petitioner argued that respondent suspended the construction works, thereby depriving it of the opportunity to complete the works on or before November 15, 1997.
• Unlawful Termination: Petitioner insisted that there was unlawful termination of the construction contract.
• Impropriety of Liquidated Damages: Petitioner maintained that the award of liquidated damages made by the CA should be deleted because it was not given the chance to finish the works within the period of commitment to do so on or before November 15, 1997.

• Forum Shopping: Respondent questioned the CIAC's failure to dismiss petitioner's counterclaims on the ground of forum shopping.
• Illegality of Termination: Respondent insisted that the CIAC erred in concluding that the termination of the construction contract was illegal.
• Entitlement to Damages: Respondent argued that the CIAC erred in ruling that it is not entitled to liquidated damages and the excess cost to complete the project.
• Cost of Correction: Respondent contended that it is entitled to a reduced amount for the correction of petitioner's defective work.
• Value of Materials and Equipment: Respondent argued that the CIAC erred in ruling that petitioner is entitled to the value of the materials, equipment and tools left at the jobsite.

• Liability for Liquidated Damages: Whether the Court of Appeals decided a question of substance, or decided it in a way not in accord with law or with applicable decisions of the Supreme Court, when it ruled and modified the CIAC decision finding petitioner liable to pay respondent liquidated damages.

• Liability for Liquidated Damages: No. The petition is denied for lack of merit. The right to liquidated damages is a distinct remedy from the right to terminate the contract, and liability attaches upon proof of the fact of delay in the completion of the works within the agreed period, absent a validly sought and granted written extension.

• Liability for Liquidated Damages: The resolution of respondent's entitlement to liquidated damages hinges on whether petitioner was in default in the performance of its obligation. Liability for liquidated damages is governed by Articles 2226 to 2228 of the Civil Code, under which parties to a contract are allowed to stipulate on liquidated damages to be paid in case of breach; such a stipulation is attached to an obligation to ensure performance and has a double function—to provide for liquidated damages and to strengthen the coercive force of the obligation by the threat of greater responsibility in the event of breach. The amount agreed upon answers for damages suffered by the owner due to delays in the completion of the project, but as a pre-condition to the award, there must be proof of the fact of delay in the performance of the obligation. Contracts constitute the law between the parties, who are bound by their stipulations so long as these are not contrary to law, morals, good customs, public order, or public policy. Section 4, Article IX of the Construction Contract provides that the obligation of the contractor to pay damages due to unexcused delays shall not relieve it from the obligation to complete and finish the performance of the works; Article 21.05 of the General Conditions amplifies the contractor's liability for damages, stating that time is an essential feature of the contract and that upon failure to complete the contract within the contract time the contractor shall pay the owner liquidated damages in the amount stipulated; and Article 29.04 explains the owner's right to recover liquidated damages, providing that neither the taking over by the owner of the work for completion by administration nor the re-letting of the same to another contractor shall be construed as a waiver of the owner's rights to recover damages against the original contractor and/or its sureties for failure to complete the work as stipulated. Respondent's entitlement to liquidated damages is thus distinct from its right to terminate the contract, and petitioner's liability for liquidated damages is not inconsistent with respondent's takeover of the project, termination of the contract, or even the eventual completion of the project; what is decisive is the fact of delay in the completion of the works. As long as the contractor fails to finish the works within the period agreed upon by the parties without justifiable reason and after the owner makes a demand, liability for damages as a consequence of such default arises. It is undisputed that petitioner failed to perform the contracted works within the period originally agreed upon, and that although an extension was requested and granted, petitioner was obliged to perform the works and deliver the units only until April 7, 1997, yet it still reneged on its obligation and did not seek additional time within which to complete the project. Petitioner never sent notice to respondent regarding a request for extension of time to finish the work despite its claim of circumstances fairly entitling it to an extension; assuming such reasons existed, petitioner should bear the consequences for the delay as it deprived respondent of its right to determine the length of extension to be given and to adjust the period to finish the extra work. Article 21.04 of the General Conditions requires the contractor, within fifteen (15) days from the occurrence of the delay, to file the necessary request for extension, and Section 3, Article V of the Construction Contract emphasizes that any extension in the contract period must be in writing. No further extension was sought after the expiration of the first extension, and any claim of entitlement to period adjustment should not be granted as would excuse petitioner from liability for delay. Respondent's letter dated September 22, 1997 requiring petitioner to submit a formal written commitment to finish and complete the project should not be deemed a waiver of its right to collect liquidated damages, as the request was only necessary in determining whether petitioner could still complete the works or whether there was already a need for respondent to take over the project or engage the services of another contractor—relevant only in the exercise of the right to terminate, not in the entitlement to liquidated damages. Respondent's January 11, 1997 letter, which allowed the extension and fixed the new date of completion (the latest of which was April 7, 1997), specified that liquidated damages shall be applied beyond the extended period, thereby constituting a demand for payment of said damages should delay be incurred beyond the new agreed dates. As no extension was validly agreed upon and petitioner failed to complete the works within the stipulated period, petitioner's liability for liquidated damages arose at one-tenth of one percent of the contract price per calendar day of delay to a maximum of ten percent of the contract price. Petitioner failed to meet its new deadline of April 7, 1997 and even proposed to complete the works until November 15, 1997, way beyond the original and extended contract period; it may thus be held to answer for liquidated damages in the maximum amount of ten percent of the contract price. While the Court has reduced the amount of liquidated damages in some cases because of partial fulfillment of the contract and/or because the amount is unconscionable, those circumstances are not applicable here, given the CIAC finding that as of the last certified billing petitioner's percentage accomplishment was only 62.57%; the general rule not to ignore the freedom of the parties to agree on such terms and conditions as they see fit, so long as they are not contrary to law, morals, good customs, public order or public policy, applies.

• Liquidated Damages (Articles 2226–2228, Civil Code) — Liquidated damages are those agreed upon by the parties to a contract, to be paid in case of breach thereof; whether intended as an indemnity or a penalty, they shall be equitably reduced if iniquitous or unconscionable; and when the breach committed is not the one contemplated by the parties in agreeing upon the liquidated damages, the law determines the measure of damages rather than the stipulation. The stipulation is attached to an obligation to ensure performance and has a double function: to provide for liquidated damages and to strengthen the coercive force of the obligation by the threat of greater responsibility in the event of breach. As a pre-condition to the award, there must be proof of the fact of delay in the performance of the obligation. The Court applied the doctrine by holding petitioner liable for the stipulated liquidated damages upon proof of its failure to complete the works within the agreed and extended periods.
• Distinct Remedies Doctrine (Right to Liquidated Damages vs. Right to Terminate) — The owner's entitlement to liquidated damages is distinct from its right to terminate the construction contract. Liability for liquidated damages is not inconsistent with the owner's takeover of the project, termination of the contract, or even the eventual completion of the project; what is decisive is the fact of delay in the completion of the works. The Court applied this doctrine in holding that even though the CIAC and the CA both found the termination of the contract illegal for respondent's failure to comply with the 15-day notice requirement, petitioner could still be charged with liquidated damages by reason of its delay.
• Contract as Law Between the Parties — As a general rule, contracts constitute the law between the parties, and they are bound by their stipulations. For as long as they are not contrary to law, morals, good customs, public order, or public policy, the contracting parties may establish such stipulations, clauses, terms and conditions as they may deem convenient. The Court applied this principle in upholding the contractual stipulation on liquidated damages at one-tenth of one percent of the contract price per calendar day of delay, capped at ten percent, and in declining to reduce the award.
• Written Extension Requirement — Under Article 21.04 of the General Conditions, the contractor must, within fifteen (15) days from the occurrence of the delay, file the necessary request for extension, and under Section 3, Article V of the Construction Contract, any extension in the contract period must be in writing. The Court applied this requirement in holding that because no further extension was sought after the expiration of the first extension, petitioner's claim of entitlement to a period adjustment could not excuse it from liability for delay.

• "As a pre-condition to such award, however, there must be proof of the fact of delay in the performance of the obligation." — This passage states the threshold requirement for an award of liquidated damages, anchoring liability on the factual establishment of delay rather than on the validity of the contract's termination.
• "Clearly, respondent's entitlement to liquidated damages is distinct from its right to terminate the contract. Petitioner's liability for liquidated damages is not inconsistent with respondent's takeover of the project, or termination of the contract or even the eventual completion of the project. What is decisive of such entitlement is the fact of delay in the completion of the works." — This is the ratio decidendi of the case, articulating the distinct-remedies doctrine that allowed the award of liquidated damages notwithstanding the illegal termination of the construction contract.
• "As a general rule, contracts constitute the law between the parties, and they are bound by its stipulations. For as long as they are not contrary to law, morals, good customs, public order, or public policy, the contracting parties may establish such stipulations, clauses, terms and conditions as they may deem convenient." — This passage restates the controlling principle on the binding force of contractual stipulations, which the Court used to sustain the stipulated liquidated damages and to decline any equitable reduction.
• "Without doubt, no further extension was sought after the expiration of the first extension given by respondent. Any and all claims of its entitlement to period adjustment should not be granted to petitioner as would excuse it from liability for delay." — This passage disposes of petitioner's claim of entitlement to a period adjustment, grounding the finding of default on the absence of a validly sought written extension.

• Empire East Land Holdings, Inc. vs. Capitol Industrial Construction Groups, Inc., G.R. No. 168074, September 26, 2008, 566 SCRA 473 — Cited for the rule that the resolution of the entitlement to liquidated damages hinges on whether the obligor was in default, and for the requirement of proof of the fact of delay as a pre-condition to the award.
• Philippine Charter Insurance Corporation vs. Petroleum Distributors & Service Corporation, G.R. No. 180898, April 18, 2012 — Cited for the double function of a liquidated damages stipulation and for the principle that contracts constitute the law between the parties so long as their stipulations are not contrary to law, morals, good customs, public order, or public policy.
• Filinvest Land, Inc. vs. Court of Appeals, G.R. No. 138980, September 20, 2005, 470 SCRA 260 — Cited alongside Philippine Charter Insurance for the nature and function of liquidated damages.
• H.L. Carlos Construction, Inc. vs. Marina Properties Corporation, G.R. No. 147614, January 29, 2004, 421 SCRA 428 — Cited for the principle that the amount agreed upon as liquidated damages answers for damages suffered by the owner due to delays in the completion of the project.
• Advanced Foundation Construction Systems Corporation vs. New World Properties and Ventures, Inc., G.R. No. 143154, June 21, 2006, 491 SCRA 557 — Cited for the consequence that a contractor who fails to give notice of a request for extension bears the consequences of the delay, having deprived the owner of its right to determine the length of the extension.
• R.S. Tomas, Inc. vs. Rizal Cement Company, Inc., G.R. No. 173155, March 21, 2012 — Cited for the general rule upholding the freedom of the parties to agree on such terms and conditions as they see fit, and for the circumstances under which liquidated damages may be equitably reduced.
• Atlantic Erectors, Inc. vs. Herbal Cove Realty Corporation, G.R. No. 148568, March 20, 2003, 399 SCRA 409 — Cited in the recital of facts as the earlier ruling affirming the dismissal of petitioner's civil case before the RTC on the ground of the arbitration clause.

• Article 2226, Civil Code — Defines liquidated damages as those agreed upon by the parties to a contract, to be paid in case of breach thereof; applied to uphold the contractual stipulation of one-tenth of one percent of the contract price per calendar day of delay.
• Article 2227, Civil Code — Provides that liquidated damages, whether intended as an indemnity or a penalty, shall be equitably reduced if they are iniquitous or unconscionable; considered but held inapplicable because the Court found no basis to reduce the stipulated amount.
• Article 2228, Civil Code — Provides that when the breach of the contract committed by the defendant is not the one contemplated by the parties in agreeing upon the liquidated damages, the law shall determine the measure of damages and not the stipulation; cited as part of the governing statutory framework on liquidated damages.
• Article IX, Section 4, Construction Contract — States that the obligation of the contractor to pay damages due to unexcused delays shall not relieve it from the obligation to complete and finish the performance of the works; relied upon to show that the right to damages survives the owner's takeover or termination of the contract.
• Article 21.05, General Conditions — Provides that time is an essential feature of the contract and that upon failure to complete the contract within the contract time the contractor shall pay the owner liquidated damages in the amount stipulated, the payment to be made as liquidated damages and not by way of penalty; relied upon to amplify petitioner's liability for damages.
• Article 29.04, General Conditions — Explains the owner's right to recover liquidated damages, providing that neither the taking over by the owner of the work for completion by administration nor the re-letting of the same to another contractor shall be construed as a waiver of the owner's rights to recover damages against the original contractor and/or its sureties for failure to complete the work as stipulated; relied upon to establish that termination does not defeat the right to liquidated damages.
• Article 21.04, General Conditions — Requires the contractor, within fifteen (15) days from the occurrence of the delay, to file the necessary request for extension, and provides that any time allowance for extension and increases shall be as agreed upon in writing; applied to hold that no valid extension was obtained beyond April 7, 1997.
• Section 3, Article V, Construction Contract — Emphasizes that any extension in the contract period must be in writing; applied to reject petitioner's claim of entitlement to a period adjustment.

Presbitero J. Velasco, Jr. (Chairperson), Roberto A. Abad, Jose Portugal Perez, and Jose Catral Mendoza.