Equitable Banking Corporation, Inc. vs. Special Steel Products, and Augusto L. Pardo

A bank that accepts crossed checks with the notation "account payee only" from a person other than the named payee, relying solely on oral representations of good title, is guilty of gross negligence constituting a quasi-delict. The bank must exercise the highest degree of diligence in handling crossed checks, and failure to verify the authority of a third party presenting such checks for deposit renders the bank solidarily liable with the converter for damages.

Respondent Special Steel Products, Inc. (SSPI) is a private domestic corporation selling steel products, with Augusto L. Pardo as its President and majority stockholder. International Copra Export Corporation (Interco) was SSPI's regular customer, and Jose Isidoro Uy, alias Jolly Uy, was an Interco employee in charge of the purchasing department and the son-in-law of Interco's majority stockholder. Petitioner Equitable Banking Corporation was the depository bank of both Interco and Uy. The case involves the banking practice governing crossed checks with "account payee only" notations, which are intended for deposit in the named payee's account only.

Respondent Special Steel Products, Inc. (SSPI) is a private domestic corporation selling steel products, with Augusto L. Pardo as its President and majority stockholder. International Copra Export Corporation (Interco) was SSPI's regular customer. Jose Isidoro Uy, alias Jolly Uy, was an Interco employee in charge of the purchasing department and the son-in-law of Interco's majority stockholder. Petitioner Equitable Banking Corporation was the depository bank of Interco and of Uy.

In 1991, SSPI sold welding electrodes to Interco, as evidenced by three sales invoices: Sales Invoice No. 65042 dated February 14, 1991 for ₱325,976.34; Sales Invoice No. 65842 dated April 11, 1991 for ₱345,412.80; and Sales Invoice No. 65843 dated April 11, 1991 for ₱313,845.84. The due dates were March 16, 1991 for the first invoice and May 11, 1991 for the others, with the invoices providing that Interco would pay interest at 36% per annum in case of delay. In payment, Interco issued three checks payable to the order of SSPI on July 10, 1991, July 16, 1991, and July 29, 1991, each crossed with the notation "account payee only" and drawn against Equitable.

The records disclosed that Uy presented each crossed check to Equitable on the day of its issuance and claimed that he had good title thereto, demanding deposit in his personal accounts, Account No. 18841-2 and Account No. 03474-0. Equitable acceded to Uy's demands on the assumption that Uy, as the son-in-law of Interco's majority stockholder, was acting pursuant to Interco's orders, and relied on Uy's status as a valued client. The bank accepted the checks for deposit in Uy's personal accounts and stamped "ALL PRIOR ENDORSEMENT AND/OR LACK OF ENDORSEMENT GUARANTEED" on their dorsal portion. Uy promptly withdrew the proceeds.

In October 1991, SSPI reminded Interco of the unpaid welding electrodes amounting to ₱985,234.98, reiterating its demand on January 14, 1992. Interco replied that it had already issued three checks payable to SSPI and drawn against Equitable, but SSPI denied receipt. On August 6, 1992, SSPI requested information from Equitable regarding the three checks, but the bank refused, invoking the confidentiality of deposits. It was eventually determined that Uy, not SSPI, received the proceeds of the three checks. On June 30, 1993, Interco finally paid the value of the three checks to SSPI plus a portion of the accrued interests, but refused to pay the entire accrued interest of ₱767,345.64 on the ground that it was not responsible for the delay. SSPI was thus unable to collect ₱437,040.35 in interest income at the contracted rate of 36% per annum.

SSPI and Pardo filed a complaint for damages with application for a writ of preliminary attachment against Uy and Equitable Bank, alleging that due to Uy's fraudulent representations and Equitable's indispensable connivance or gross negligence, the restrictive nature of the checks was ignored and the checks were deposited in Uy's account. The trial court granted the application for preliminary attachment on September 20, 1993, upon the filing of plaintiffs' bond for ₱500,000.00, but the attachment was eventually discharged against Equitable upon its motion and filing of a counter-bond. Uy answered that the checks were negotiated to him and that he was a holder for value with good title, but did not explain how he obtained the checks; during trial, he presented no evidence and adopted Equitable's evidence as his own.

• Lack of Cause of Action: Equitable argued that SSPI cannot assert a right against the bank based on the undelivered checks, citing provisions from the Negotiable Instruments Law and the case of Development Bank of Rizal vs. Sima Wei to argue that a payee who did not receive the check cannot require the drawee bank to pay the sum stated on the checks.
• No Liability for Interest: Equitable maintained that interest income is due only when expressly stipulated in writing, and since Equitable and SSPI did not enter into any contract, Equitable is not liable for damages in the form of unobtained interest income.
• Waiver or Extinction: Equitable argued that SSPI's acceptance of Interco's payment on the sales invoices constituted a waiver or extinction of SSPI's cause of action based on the three checks.
• Good Faith Acceptance: Equitable averred that it accepted the three crossed checks in good faith, relying on Uy's close relations with the drawer of the checks, giving the bank basis to assume that the drawer authorized Uy to countermand the original order stated in the check.
• Imagined Fears: Equitable argued that Pardo's fears of prosecution for money laundering and tax evasion were all imagined and should not be compensated, pointing out that none of Pardo's fears materialized.
• Cross-claim Against Uy: Equitable insisted on the allowance of its cross-claim against Uy, arguing that Uy was enriched by the entire scheme and should reimburse Equitable for whatever amounts the Court might order it to pay in damages.
• Wrongful Attachment: Equitable assailed the trial court's dismissal of its counterclaim for wrongful preliminary attachment, maintaining that there was no showing that Equitable was guilty of fraud in allowing Uy to deposit the checks, and that the wrongful attachment compelled it to incur expenses for a counter-bond amounting to ₱30,204.26 and caused damage to its goodwill and business credit.

• Fraud and Gross Negligence: SSPI alleged that the three crossed checks, all payable to the order of SSPI and with the notation "account payee only," could be deposited and encashed by SSPI only, but due to Uy's fraudulent representations and Equitable's indispensable connivance or gross negligence, the restrictive nature of the checks was ignored and the checks were deposited in Uy's account.
• Actual Damages: SSPI claimed actual damages consisting of the unrealized interest income from the proceeds of the checks for the two-year period that the defendants withheld the proceeds, computed at the stipulated 36% per annum rate in its contract with Interco.
• Moral Damages: Pardo claimed ₱3 million in moral damages, alleging that he suffered hypertension, anxiety, and sleepless nights for fear that the government would charge him for tax evasion or money laundering, and that defendants' actions amounted to money laundering that unfairly implicated his company.
• Grounds for Attachment: In support of the application for preliminary attachment, SSPI alleged that the defendants were guilty of fraud in incurring the obligation upon which the action was brought and that there was no sufficient security for the claim sought to be enforced.

• Cause of Action for Quasi-Delict: Whether SSPI has a cause of action against Equitable for quasi-delict.
• Actual Damages: Whether SSPI can recover, as actual damages, the stipulated 36% per annum interest from Equitable.
• Moral Damages: Whether speculative fears and imagined scenarios, which cause sleepless nights, may be the basis for the award of moral damages.
• Wrongful Attachment: Whether the attachment of Equitable's personal properties was wrongful.

• Cause of Action for Quasi-Delict: Yes. SSPI has a cause of action for quasi-delict against Equitable, as the bank's acceptance of crossed checks from a third party based solely on oral representations constitutes gross negligence, which is an act or omission causing damage to another even without a contractual relation.
• Actual Damages: No, not at the stipulated rate. SSPI cannot recover the 36% per annum interest stipulated in its contract with Interco because Equitable was not a party to that contract, and the contractual stipulation did not become operational since Interco was not in delay; however, SSPI is entitled to recover interest at the legal rate of 6% per annum as damages based on quasi-delict.
• Moral Damages: Yes, but the amount was excessive. Moral damages are recoverable when they are the proximate result of the defendant's wrongful act or omission, and it does not matter that the feared events did not materialize; however, the award of ₱3 million was reduced to ₱50,000.00 as reasonable under the circumstances.
• Wrongful Attachment: Yes. The preliminary attachment was wrongful because SSPI's affidavit and complaint were bereft of specific and definite allegations of fraud against Equitable that would justify attachment, and no proof was adduced showing that Equitable had a preconceived plan not to pay SSPI or had knowingly participated in Uy's scheme.

• Cause of Action for Quasi-Delict: The Court found that SSPI's cause of action is not based on the three checks but on quasi-delict, which is an act or omission, there being fault or negligence, which causes damage to another, and which exists even without a contractual relation between the parties. The checks were all crossed, made payable to SSPI's order, and contained the notation "account payee only," creating a reasonable expectation that the payee alone would receive the proceeds. The nature of crossed checks should place a bank on notice to exercise more caution to ascertain whether the payee has authorized the holder to deposit the same in a different account. The Court emphasized that since the banking business is impressed with public interest, the highest degree of diligence is expected of banks. Equitable did not observe this required degree of diligence: the fact that a person other than the named payee presented the crossed check for deposit should have put the bank on guard, and since the named payee did not have an account with Equitable, the bank knowingly assumed the risk of relying solely on Uy's word. This misplaced reliance on empty words was tantamount to gross negligence, defined as the "absence of or failure to exercise even slight care or diligence, or the entire absence of care, evincing a thoughtless disregard of consequences without exerting any effort to avoid them." The bank's knowledge that Uy was the son-in-law of Interco's majority stockholder did not justify disregarding what was clearly ordered on the checks, and the bank did not even make inquiries with the drawer to verify Uy's representation.

• Actual Damages: The Court found the application of the stipulated 36% interest rate erroneous. SSPI did not recover interest payments at the stipulated rate from Interco because it agreed that the delay was not Interco's fault but that of the defendants'. If Interco is not liable to pay the 36% per annum interest rate, then SSPI did not lose that income, as it cannot lose something it was not entitled to in the first place. Moreover, the provisions of a contract generally take effect only among the parties, their assigns and heirs, and SSPI cannot invoke the contractual stipulation against Equitable. Nevertheless, defendants' actions deprived SSPI of the present use of its money for two years, so SSPI is entitled to recover from the tortfeasors the profits it failed to obtain, at the legal rate of 6% per annum, this being an award for damages based on quasi-delict and not for a loan or forbearance of money.

• Moral Damages: The Court held that moral damages are recoverable only when they are the proximate result of the defendant's wrongful act or omission. Both lower courts found that Pardo indeed suffered as a result of the diversion of the three checks, and it does not matter that the things he was worried about did not eventually materialize. So long as the injured party's moral sufferings are the result of the defendants' actions, he may recover moral damages. However, the Court found the award of ₱3 million excessive, as moral damages are given not to punish the defendant but only to give the plaintiff the means to assuage his sufferings, and reduced the award to ₱50,000.00 as reasonable under the circumstances.

• Wrongful Attachment: The Court found that SSPI's affidavit and the allegations of the complaint were bereft of specific and definite allegations of fraud against Equitable that would justify the attachment of its properties. SSPI admitted its uncertainty whether Equitable's participation involved fraud or was a result of negligence, yet applied for and obtained a preliminary attachment on the ground of fraud. The Court cited the rule that "a writ of preliminary attachment is too harsh a provisional remedy to be issued based on mere abstractions of fraud," requiring a recitation of clear and concrete factual circumstances manifesting that the debtor practiced fraud upon the creditor with a preconceived plan or intention not to pay. No proof was adduced showing that Equitable had a preconceived plan not to pay SSPI or had knowingly participated in Uy's scheme. The Court allowed Equitable's counterclaim for actual damages of ₱30,204.36 for the counter-bond premiums, but denied the claim for damages to goodwill and business credit for lack of proof.

• Gross Negligence of Banks in Handling Crossed Checks — A crossed check with the notation "account payee only" can only be deposited in the named payee's account. It is gross negligence for a bank to ignore this rule solely on the basis of a third party's oral representations of having good title thereto. The bank must exercise the highest degree of diligence, and failure to verify the authority of a third party presenting such checks for deposit constitutes gross negligence, defined as the "absence of or failure to exercise even slight care or diligence, or the entire absence of care, evincing a thoughtless disregard of consequences without exerting any effort to avoid them."

• Quasi-Delict — A quasi-delict is an act or omission, there being fault or negligence, which causes damage to another, and exists even without a contractual relation between the parties. The Court applied this doctrine to hold the bank solidarily liable with Uy for damages arising from the bank's gross negligence in accepting crossed checks from a third party.

• Unjust Enrichment — Unjust enrichment exists when (1) a person is unjustly benefited, and (2) such benefit is derived at the expense of or with damages to another. The Court applied this doctrine to allow Equitable's cross-claim against Uy, since Uy was enriched by the fraudulent scheme while Equitable, through its gross negligence, became an unwitting instrument, and disallowing the cross-claim would allow Uy to unjustly enrich himself at Equitable's expense.

• Wrongful Preliminary Attachment — A writ of preliminary attachment is too harsh a provisional remedy to be issued based on mere abstractions of fraud; the rules require a recitation of clear and concrete factual circumstances manifesting that the debtor practiced fraud upon the creditor at the time of the execution of their agreement, showing a preconceived plan or intention not to pay. The wrongfulness of an attachment does not automatically warrant the award of damages; the debtor still has the burden of proving the nature and extent of the injury suffered.

• "A crossed check with the notation 'account payee only' can only be deposited in the named payee's account. It is gross negligence for a bank to ignore this rule solely on the basis of a third party's oral representations of having a good title thereto." — This is the Court's opening statement and the core ratio decidendi of the case, establishing the standard of care required of banks handling crossed checks.

• "The fact that a person, other than the named payee of the crossed check, was presenting it for deposit should have put the bank on guard. It should have verified if the payee (SSPI) authorized the holder (Uy) to present the same in its behalf, or indorsed it to him." — This passage articulates the duty of banks to verify the authority of third parties presenting crossed checks for deposit, which is central to the finding of gross negligence.

• "The banking system is placed in peril when bankers act out of blind faith and empty promises, without requiring proof of the assertions and without making the appropriate inquiries." — This statement underscores the public interest dimension of banking and the high standard of diligence expected of banking institutions.

• "[A] writ of preliminary attachment is too harsh a provisional remedy to be issued based on mere abstractions of fraud. Rather, the rules require that for the writ to issue, there must be a recitation of clear and concrete factual circumstances manifesting that the debtor practiced fraud upon the creditor at the time of the execution of their agreement in that said debtor had a preconceived plan or intention not to pay the creditor." — This quotation states the standard for issuing a writ of preliminary attachment on the ground of fraud, which the Court applied to find the attachment of Equitable's properties wrongful.

• Development Bank of Rizal vs. Sima Wei, G.R. No. 85419, March 9, 1993, 219 SCRA 736 — Cited by Equitable to argue that a payee who did not receive the check cannot require the drawee bank to pay the sum stated on the checks; the Court distinguished this case as inapplicable because SSPI's cause of action was based on quasi-delict, not on the undelivered checks.
• Associated Bank vs. Court of Appeals, G.R. No. 89802, May 7, 1992, 208 SCRA 465 — Cited for the accepted banking practice that crossed checks are intended for deposit in the named payee's account only and no other.
• Security Bank and Trust Company vs. Rizal Commercial Banking Corporation, G.R. Nos. 170984 & 170987, January 30, 2009, 577 SCRA 407 — Cited for the principle that the banking system plays a vital role in economic life and that the highest degree of diligence and high standards of integrity and performance are required of banks; also cited for the legal rate of 6% per annum for damages based on quasi-delict.
• Metropolitan Bank and Trust Company vs. BA Finance Corporation, G.R. No. 179952, December 4, 2009, 607 SCRA 620 — Cited for the definition of gross negligence as the "absence of or failure to exercise even slight care or diligence, or the entire absence of care, evincing a thoughtless disregard of consequences without exerting any effort to avoid them."
• Allied Banking Corporation vs. Lim Sio Wan, G.R. No. 133179, March 27, 2008, 549 SCRA 504 — Cited for the elements of unjust enrichment: (1) a person is unjustly benefited, and (2) such benefit is derived at the expense of or with damages to another.
• Tanchan vs. Allied Banking Corporation, G.R. No. 164510, November 25, 2008, 571 SCRA 512 — Cited for the rule that a writ of preliminary attachment requires a recitation of clear and concrete factual circumstances manifesting fraud with a preconceived plan or intention not to pay.
• Carlos vs. Sandoval, 508 Phil. 260 (2005) — Cited for the principle that even if the evidence warrants judgment in favor of the applicant, the proofs may nevertheless establish that the proffered ground for attachment was inexistent or specious, and hence the writ should not have issued at all.
• Lorzano vs. Tabayag, G.R. No. 189647, February 6, 2012 — Cited for the principle that moral damages are given not to punish the defendant but only to give the plaintiff the means to assuage his sufferings.
• Go vs. Metropolitan Bank and Trust Company, G.R. No. 168842, August 11, 2010, 628 SCRA 107 — Cited for the reasonableness of the ₱50,000.00 award for moral damages under the circumstances.

• Article 2200, Civil Code — Defines actual damages as encompassing the value of the loss sustained by the plaintiff and the profits that the plaintiff failed to obtain; applied to determine SSPI's entitlement to damages for the two-year deprivation of the use of its money.
• Article 1311, Civil Code — Provides that the provisions of a contract generally take effect only among the parties, their assigns and heirs; applied to bar SSPI from invoking the 36% per annum contractual stipulation against Equitable, which was not a party to the contract.
• Article 2217, Civil Code — Provides that moral damages are recoverable only when they are the proximate result of the defendant's wrongful act or omission; applied to affirm Pardo's entitlement to moral damages despite the non-materialization of his fears.

Teresita J. Leonardo-De Castro (Acting Chairperson), Lucas P. Bersamin, Martin S. Villarama, Jr., and Estela M. Perlas-Bernabe concurred in the decision.