Del Monte Philippines, Inc. vs. Aragones

A contract for the delivery of goods specially manufactured for the customer and upon his special order, and not for the general market, is a contract for a piece of work under Article 1467 of the Civil Code, rendering Article 1729 applicable and creating a constructive vinculum or contractual privity between the owner and those who furnish labor and materials, by way of exception to the relativity of contracts under Article 1311.

Del Monte Philippines, Inc. (DMPI) owned a condiments warehouse in Cagayan de Oro City and engaged MEGA-WAFF (a joint venture between Mega-Engineering Services and WAFF Construction System Corporation), represented by Edilberto Garcia, to supply and install modular pavement at the warehouse. MEGA-WAFF, as contractor, in turn engaged Dynablock Enterprises, represented by its manager Napoleon N. Aragones, as supplier under a "Supply Agreement" to produce the concrete blocks required for the pavement installation. The dispute centers on whether that Supply Agreement was a contract of sale or one for a piece of work, a characterization that determines whether Aragones, as an unpaid subcontractor, may bring a direct action against DMPI as owner under Article 1729 of the Civil Code.

On September 18, 1988, DMPI entered into an "Agreement" with MEGA-WAFF, represented by Managing Principal Edilberto Garcia, whereby MEGA-WAFF undertook the supply and installation of modular pavement at DMPI's condiments warehouse in Cagayan de Oro City within sixty calendar days. To source its supply of concrete blocks for the project, MEGA-WAFF, as contractor, entered into a "Supply Agreement" with Dynablock Enterprises, represented by Aragones as supplier. Under the agreement, Aragones was to provide the labor, machines, equipment, and tools necessary for fabricating the concrete blocks at a casting site designated and provided by MEGA-WAFF. The price was set at ₱7.00 per supplied and accepted piece, with MEGA-WAFF furnishing the cement and aggregates, the cost of which would be deducted from Aragones's billings. The agreement contained an exclusivity clause requiring Aragones to devote the entire plant and casting machines exclusively for MEGA-WAFF's use, a performance bond requirement, and a penalty clause for delay.

Aragones began assembling machines for fabricating the concrete blocks, initially specified by Garcia to be hexagonal in shape. Garcia later directed Aragones to fabricate machines for S-shaped blocks instead. The deadline for installation under the DMPI-MEGA-WAFF agreement was November 18, 1988, but it was not met; installation was completed on or about February 28, 1989, and MEGA-WAFF was penalized for the delay by DMPI, albeit at a reduced amount. Aragones, having learned of the penalty imposed on MEGA-WAFF, wrote DMPI on March 4, 1989 appealing for leniency, noting that the penalty "would affect [him] also although [he] was not a direct party to the contract."

Aragones subsequently failed to collect the full payment from MEGA-WAFF for the concrete blocks. He sent DMPI a letter dated March 10, 1989, received on March 13, 1989, advising it of MEGA-WAFF's unpaid obligation of ₱188,652.65 and requesting that DMPI earmark and withhold that amount from MEGA-WAFF's billing for direct payment to him. DMPI verbally advised Aragones to secure a court order directing it to withhold payment, citing its obligation under its agreement with MEGA-WAFF to release full payment within thirty days from acceptance of the completed work. Aragones reiterated his request by letters dated March 28, 1989 and April 6, 1989. DMPI referred the April 6 letter to Garcia for comment by letter of April 27, 1989. Garcia, by letter of May 3, 1989, stated that MEGA-WAFF was willing to pay Aragones but only based on actual accomplishment and the amount due as per a reconciliation furnished to him.

It turned out that DMPI had, on or about April 6, 1989, released to MEGA-WAFF a check dated April 4, 1989 in the amount of ₱157,863.77, representing DMPI's balance of its obligation to MEGA-WAFF. Aragones thereupon filed a complaint for sum of money with damages against Garcia and/or MEGA-WAFF and DMPI before the RTC of Lanao del Norte, impleading DMPI on the strength of Articles 1729 and 1467 of the Civil Code. The trial court found for Aragones, holding both Garcia/MEGA-WAFF and DMPI jointly and severally liable for ₱188,652.65, plus legal interest, exemplary damages, and attorney's fees. Only DMPI appealed to the Court of Appeals, which affirmed the trial court's decision. DMPI then lodged the present petition.

• Nature of the Contract: Petitioner argued that the "Supply Agreement" was a contract of sale, not one for a piece of work, because the concrete paving blocks were capable of being mass-produced and, save for the shape, no special needs or requirements of DMPI were taken into account in the design or manufacture. Petitioner invoked the "nature of the object" test from Article 1467 and cited Commissioner of Internal Revenue vs. Arnoldus Carpentry Shop, Inc. and Celestino Co. vs. Collector of Internal Revenue for the proposition that where a manufacturer habitually makes goods for the general market, the fact that a customer requires certain specifications does not alter the nature of the transaction as a sale.
• Inapplicability of Article 1729 and Act 3959: Petitioner contended that since the Supply Agreement was one of sale, Article 1729 (which applies to those who put labor upon or furnish materials for a piece of work) was inapplicable, and DMPI had no privity of contract with Aragones under Article 1311. Petitioner likewise challenged the CA's reliance on Act No. 3959 as an additional basis for liability.
• Damages and Counterclaim: Petitioner disclaimed liability for exemplary damages and attorney's fees, claiming it was the one injured by Aragones's filing in bad faith of a complaint bereft of cause of action and barred by full payment to MEGA-WAFF. Petitioner sought moral damages of ₱50,000 under Article 2217 and attorney's fees and litigation expenses of at least ₱30,000 plus ₱2,500 per hearing under Article 2208.

• Characterization as Piece of Work: Respondent contended, through the proceedings below, that the Supply Agreement was a contract for a piece of work because the concrete blocks were specially manufactured upon MEGA-WAFF's special order, with specific shape requirements (S-shaped blocks), contractor-supplied raw materials, and an exclusivity clause devoting the entire plant for MEGA-WAFF's exclusive use.
• Direct Action Against Owner: Respondent impleaded DMPI on the strength of Articles 1729 and 1467 of the Civil Code, arguing that as one who put labor upon and furnished materials for a piece of work undertaken by the contractor, he had a direct action against the owner up to the amount owing from the latter to the contractor at the time the claim was made.

• Nature of the Contract: Whether the "Supply Agreement" between Aragones and MEGA-WAFF was a contract of sale or a contract for a piece of work.
• Liability of Owner under Article 1729: Whether DMPI, as owner, is liable to Aragones under Article 1729 of the Civil Code for the unpaid obligation of MEGA-WAFF.
• Damages: Whether DMPI is liable for exemplary damages and attorney's fees awarded by the trial court.
• Counterclaim: Whether DMPI is entitled to moral damages, attorney's fees, and litigation expenses on its counterclaim.

• Nature of the Contract: The Supply Agreement was a contract for a piece of work. The concrete blocks were specially manufactured upon MEGA-WAFF's special order — with specified S-shape, contractor-supplied raw materials, and an exclusivity clause — and not for the general market, satisfying the test under Article 1467.
• Liability of Owner under Article 1729: Yes. DMPI was liable to Aragones up to the amount it owed MEGA-WAFF at the time the claim was made, a constructive vinculum having been created by Article 1729 between the owner and the laborer/materialman. DMPI released payment to MEGA-WAFF despite Aragones's prior request to withhold, reflecting apparent connivance.
• Damages: Yes. The award of exemplary damages (₱20,000), attorney's fees (₱10,000), and costs was sustained, Aragones having been compelled to litigate to collect a just and demandable obligation, and DMPI's refusal to pay upon demand being unjustified.
• Counterclaim: No. DMPI's claim for moral damages, attorney's fees, and litigation expenses was denied, the Court finding no basis for the claim that Aragones filed his complaint in bad faith.

• Nature of the Contract: The test under Article 1467 distinguishes a contract of sale from a contract for a piece of work by inquiring whether the thing transferred is one not in existence and which never would have existed but for the order of the party desiring to acquire it, or a thing which would have existed and has been the subject of sale to others even without the order. Petitioner's own cited authorities confirm this: if the thing is manufactured specially for the customer and upon his special order, it is a contract for a piece of work; if manufactured for the general market in the ordinary course of business, it is a sale. The Supply Agreement was replete with specifications and conditions showing a piece of work: Aragones was obliged to fabricate machines for casting the concrete blocks specified by Garcia, machines he did not have in his usual business; Garcia initially specified hexagonal blocks then directed Aragones to fabricate machines for S-shaped blocks; Garcia furnished the cement and aggregates; and the entire plant and casting machines were devoted exclusively for MEGA-WAFF's use. These features belie petitioner's contention that the blocks were mass-produced for the general market. The concrete blocks were "manufactured specifically for, and upon the special order" of Garcia, placing the agreement squarely within Article 1467's definition of a contract for a piece of work.

• Liability of Owner under Article 1729: Article 1729 provides that those who put their labor upon or furnish materials for a piece of work undertaken by the contractor have an action against the owner up to the amount owing from the latter to the contractor at the time the claim is made. Aragones specially fabricated three casting machines and furnished materials for the production of concrete blocks specially ordered and specified by MEGA-WAFF, which were for MEGA-WAFF's exclusive use. Under Velasco vs. CA, the intention of Article 1729 is to protect laborers and materialmen from unscrupulous contractors and possible connivance between owners and contractors, creating a constructive vinculum or contractual privity by way of exception to Article 1311. DMPI was liable because Aragones's request for direct payment was made before DMPI's obligation to MEGA-WAFF was due, yet DMPI settled its obligation to MEGA-WAFF on or about April 6, 1989 by releasing its check payment. DMPI's referral of Aragones's April 6 letter to Garcia for comment on April 27, 1989 — after it had already released full payment to MEGA-WAFF on or about April 6 — reflected a futile attempt to cover up the apparent connivance between it and MEGA-WAFF to Aragones's prejudice. The CA's additional reliance on Act No. 3959 was noted but the Court observed that said Act had been repealed in 1974 by Presidential Decree No. 442 (the Labor Code), without affecting the result under Article 1729 alone.

• Damages: The trial court's award of exemplary damages and attorney's fees was approved. Aragones was compelled to litigate to collect a just and demandable obligation, and the refusal of both DMPI and MEGA-WAFF to pay upon demand could not be justified in law. DMPI's argument that it was contractually bound to pay MEGA-WAFF within thirty days absent a court injunction was dismissed as "too shallow" under the circumstances, given that Aragones's request to withhold payment was made before DMPI's obligation was due and DMPI nonetheless released full payment.

• Counterclaim: DMPI's counterclaim for moral damages, attorney's fees, and litigation expenses was denied. The Court found no basis for the claim that Aragones filed his complaint in bad faith; to the contrary, the evidence showed Aragones was compelled to litigate to enforce a legitimate claim, and it was DMPI's own conduct in releasing payment despite prior notice that gave rise to its liability.

• Distinction between sale and piece of work (Article 1467 test) — A contract for the delivery at a certain price of an article which the vendor in the ordinary course of his business manufactures or procures for the general market is a contract of sale; but if the goods are to be manufactured specially for the customer and upon his special order, and not for the general market, it is a contract for a piece of work. The test is whether the thing transferred is one not in existence and which never would have existed but for the order of the party desiring to acquire it, or a thing which would have existed and has been the subject of sale to others even without the order. In this case, the S-shaped blocks, the specially fabricated casting machines, the contractor-supplied raw materials, and the exclusivity clause all established that the blocks were manufactured specially for MEGA-WAFF and not for the general market.

• Direct action of laborers and materialmen against the owner (Article 1729) — Those who put their labor upon or furnish materials for a piece of work undertaken by the contractor have an action against the owner up to the amount owing from the latter to the contractor at the time the claim is made. The provision creates a constructive vinculum or contractual privity between the owner and the laborer/materialman, by way of exception to the relativity of contracts under Article 1311. Its purpose is to protect laborers and materialmen from being taken advantage of by unscrupulous contractors and from possible connivance between owners and contractors. In this case, Aragones, having specially fabricated casting machines and furnished materials for the concrete blocks, had a direct action against DMPI up to the amount DMPI owed MEGA-WAFF when the claim was made.

• "if the goods are to be manufactured specially for the customer and upon his special order, and not for the general market, it is a contract for a piece of work." — This is the Court's application of Article 1467, identifying the controlling test for distinguishing sale from piece of work and forming the ratio decidendi for characterizing the Supply Agreement.

• "a constructive vinculum or contractual privity was created between petitioner and Aragones." — This passage articulates the doctrinal basis for DMPI's liability: Article 1729 creates a legal privity between owner and subcontractor that overrides the general rule of relativity of contracts under Article 1311.

• "Aragones' request, based on a provision of law, to petitioner for it to pay directly to him his account receivable from MEGA-WAFF/Garcia out of petitioner's account payable to MEGA-WAFF was made before petitioner's obligation to it was due. Yet petitioner settled such obligation to MEGA-WAFF on or about April 6, 1989 when it released to it its check-payment." — This passage establishes the factual basis for finding apparent connivance between DMPI and MEGA-WAFF, justifying the award of damages against DMPI.

• Commissioner of Internal Revenue vs. Engineering Equipment and Supply Company, G.R. No. L-27044, June 30, 1975 — Cited by the CA for the test distinguishing sale from piece of work: whether the thing transferred is one not in existence and which never would have existed but for the order, or a thing which would have existed regardless. Followed and applied.
• Velasco vs. Court of Appeals, G.R. No. L-47544, January 28, 1980 (95 SCRA 616) — Cited for the principle that Article 1729 creates a constructive vinculum or contractual privity between the owner and those who furnish labor and/or materials, by way of exception to Article 1311. Followed and applied.
• Commissioner of Internal Revenue vs. Arnoldus Carpentry Shop, Inc., 159 SCRA 199 (1988) — Cited by petitioner for the proposition that what determines whether a contract is one of work or of sale is whether the thing has been "manufactured specially for the customer and upon his special order." The Court found this authority supported the characterization as a piece of work, not petitioner's position.
• Celestino Co. vs. Collector of Internal Revenue, 99 Phil. 841 (1956) — Cited by petitioner for the proposition that habitual manufacture for the general market makes a transaction a sale despite customer specifications. Distinguished, as the concrete blocks here were not habitually manufactured by Aragones for the general market but were specially fabricated upon MEGA-WAFF's order.
• Flores vs. Ruelo, CA 52 OG 850 — Cited by the trial court for the principle that the owner of a building is liable for materials and labor furnished to the contractor up to the amount owing, and the law allows the person furnishing labor or materials to bring a direct action against the owner. Followed.

• Article 1467, Civil Code — Defines the distinction between a contract of sale and a contract for a piece of work: if goods are manufactured specially for the customer and upon his special order, and not for the general market, it is a contract for a piece of work. Applied to hold the Supply Agreement was one for a piece of work.
• Article 1729, Civil Code — Provides that those who put their labor upon or furnish materials for a piece of work undertaken by the contractor have an action against the owner up to the amount owing from the latter to the contractor at the time the claim is made. Applied to hold DMPI directly liable to Aragones.
• Article 1311, Civil Code — Establishes the principle of relativity of contracts. Held inapplicable where Article 1729 operates, the latter creating a constructive vinculum by way of exception.
• Act No. 3959 — Required owners of works executed by contract to require contractors to furnish a bond guaranteeing payment of laborers. The CA relied on it as additional justification for DMPI's liability, but the Supreme Court noted it had been repealed in 1974 by Presidential Decree No. 442 (the Labor Code), without affecting the result under Article 1729 alone.
• Article 2217, Civil Code — Governs moral damages. Invoked by petitioner in its counterclaim; the claim was denied.
• Article 2208, Civil Code — Governs attorney's fees and litigation expenses. Invoked by petitioner in its counterclaim; the claim was denied, while the award of attorney's fees to Aragones was sustained.

Panganiban (Chairman), Sandoval-Gutierrez, Corona, and Garcia, JJ., concurred.