Machetti vs. Hospicio de San Jose

A contract denominated as a "guaranty" in the English language creates an obligation of guaranty, not suretyship, where the undertaking is separate from the principal contract, rests on separate consideration, and is a collateral undertaking in which the principal does not join; the guarantor's liability arises only when the principal is shown to be unable to pay, which is not sufficiently established by a mere declaration of insolvency.

Romulo Machetti was a building contractor who undertook construction work for Hospicio de San Jose, a charitable institution in Manila. The Fidelity and Surety Company of the Philippine Islands, a corporate surety enterprise, issued a written endorsement on the construction contract guaranteeing compliance with its terms. The distinction between guaranty and suretyship under Philippine law—and the differing conditions under which each type of obligor becomes liable—forms the legal backdrop of the dispute.

On July 17, 1916, Romulo Machetti entered into a written agreement to construct a building on Calle Rosario in the City of Manila for Hospicio de San Jose, the contract price being P64,000. One of the conditions of the agreement required the contractor to obtain the "guarantee" of the Fidelity and Surety Company of the Philippine Islands in the amount of P128,800. A corresponding endorsement appeared on the contract, dated July 15, 1916, stating: "For value received we hereby guarantee compliance with the terms and conditions as outlined in the above contract," signed by Otto Vorster as Vice-President of the Fidelity and Surety Company.

Machetti proceeded to construct the building under the supervision of architects representing Hospicio de San Jose. As the work progressed, payments were made to him from time to time upon the architects' recommendation, until the entire contract price was paid except for the sum of P4,978.08. Subsequently, it was discovered that the work had not been carried out in accordance with the specifications forming part of the contract and that the workmanship fell below the required standard. Hospicio de San Jose accordingly answered Machetti's complaint and presented a counterclaim for damages for partial noncompliance with the agreement, in the total sum of P71,350.

After issue was joined, Machetti was declared insolvent on February 27, 1918, upon petition of his creditors, and on March 4, 1918, proceedings in the case were suspended pursuant to section 60 of the Insolvency Law (Act No. 1956). Hospicio de San Jose then moved, on January 29, 1919, to have the Fidelity and Surety Company made cross-defendant to the exclusion of Machetti, requesting that proceedings continue as to the company while remaining suspended as to Machetti. This motion was granted, and on February 7, 1920, Hospicio filed a complaint against the Fidelity and Surety Company seeking judgment for P12,800 upon its guaranty. After trial, the Court of First Instance rendered judgment against the company for P12,800, giving rise to the present appeal.

• Nature of the Obligation: Whether the Fidelity and Surety Company's endorsement on the construction contract constitutes a contract of guaranty or one of suretyship.
• Condition Precedent for Liability: Whether the guarantor's obligation may be enforced upon the mere declaration of the principal's insolvency, or whether it must first be shown that the principal is unable to pay.

• Nature of the Obligation: The endorsement is a contract of guaranty, not suretyship. The undertaking was a separate and collateral obligation in which the principal did not join, resting on separate consideration, and the English-language terms "guarantee" and "guaranty" must be given their ordinary signification.

• Condition Precedent for Liability: No. The guarantor cannot be compelled to pay until it is shown that the principal cannot pay; a mere declaration of insolvency under Philippine statutes is insufficient because the extent of the insolvent's inability to pay is not determined until final liquidation of his estate.

• Nature of the Obligation: The contract of guaranty was written in the English language, and the terms employed must be given the signification ordinarily attaching to them in that language. In English, the term "guarantor" implies an undertaking of guaranty as distinguished from suretyship. While circumstances may be shown that convert a contract denominated as guaranty into one of suretyship, no such circumstances existed here. On the contrary, the record affirmatively established the contract as the guarantor's separate undertaking in which the principal did not join, resting on a separate consideration moving from the principal, and—although written in continuation of the construction contract—constituting a collateral undertaking separate and distinct from the latter. All of these are distinguishing features of contracts of guaranty. The undertaking, though perhaps not exactly a fianza under the Civil Code, is a perfectly valid contract and must be given the legal effect it ordinarily carries.

• Condition Precedent for Liability: A surety undertakes to pay if the principal does not pay, whereas a guarantor binds himself to pay only if the principal cannot pay. The one is the insurer of the debt; the other is the insurer of the solvency of the debtor. The Fidelity and Surety Company assumed the latter liability. Because the company bound itself to pay only in the event its principal, Machetti, cannot pay, it follows that it cannot be compelled to pay until Machetti's inability to pay is shown. Such inability may be proven by the return of a writ of execution unsatisfied or by other means, but it is not sufficiently established by the mere fact of a declaration of insolvency in proceedings under Philippine statutes, in which the extent of the insolvent's inability to pay is not determined until the final liquidation of his estate.

• Guaranty vs. Suretyship — A surety undertakes to pay if the principal does not pay; the surety is an insurer of the debt. A guarantor binds himself to pay only if the principal cannot pay; the guarantor is an insurer of the solvency of the debtor. The distinction determines when the secondary obligor's liability matures: a surety is liable upon default of the principal, while a guarantor's liability arises only upon proof of the principal's inability to pay. Distinguishing features of a contract of guaranty include: (a) it is the guarantor's separate undertaking in which the principal does not join; (b) it rests on a separate consideration moving from the principal; and (c) it is a collateral undertaking separate and distinct from the principal contract, even if written in continuation of it. Notwithstanding the use of the words "guarantee" or "guaranty," circumstances may be shown that convert the contract into one of suretyship, but absent such circumstances, the ordinary English-language signification controls.

• Insolvency as Proof of Inability to Pay — A declaration of insolvency under Philippine statutes does not conclusively establish a principal debtor's inability to pay for purposes of triggering a guarantor's liability, because the extent of the insolvent's inability is not determined until the final liquidation of the estate. Inability to pay may instead be proven by the return of a writ of execution unsatisfied or by other competent means.

• "Now, while a surety undertakes to pay if the principal does not pay, the guarantor only binds himself to pay if the principal cannot pay. The one is the insurer of the debt, the other an insurer of the solvency of the debtor." — This passage articulates the canonical distinction between suretyship and guaranty that the Court applied to determine the nature and timing of the Fidelity and Surety Company's obligation.

• "The Fidelity and Surety Company having bound itself to pay only the event its principal, Machetti, cannot pay it follows that it cannot be compelled to pay until it is shown that Machetti is unable to pay. Such ability may be proven by the return of a writ of execution unsatisfied or by other means, but is not sufficiently established by the mere fact that he has been declared insolvent in insolvency proceedings under our statutes, in which the extent of the insolvent's inability to pay is not determined until the final liquidation of his estate." — This passage defines the condition precedent for enforcing a guarantor's obligation and clarifies that a declaration of insolvency alone does not satisfy that condition.

• Saint vs. Wheeler & Wilson Mfg. Co., 95 Ala. 362 — Cited as authority for the distinction between a surety as insurer of the debt and a guarantor as insurer of the debtor's solvency.
• Campbell vs. Sherman, 151 Pa. St. 70 — Cited in support of the same distinction between suretyship and guaranty.
• Castellvi de Higgins and Higgins vs. Sellner, 41 Phil. 142 — Philippine precedent cited alongside the foreign authorities for the surety-guaranty distinction.
• U.S. vs. Varadero de la Quinta, 40 Phil. 48 — Philippine precedent cited in support of the same distinction.

• Section 60, Insolvency Law (Act No. 1956) — Provided the basis for the suspension of proceedings against Machetti upon his declaration of insolvency. The Court noted that under this statutory framework, the extent of an insolvent's inability to pay is not determined until the final liquidation of his estate, which is why a mere insolvency declaration does not suffice to trigger a guarantor's liability.

Araullo, C.J., Malcolm, Villamor, Johns, and Romualdez, JJ., concurred.