Mercantile Insurance Co., Inc. vs. Felipe Ysmael, Jr. & Co., Inc.

A stipulation in an indemnity agreement allowing the surety to recover indemnification from the principal-indemnitor upon the latter's default, even before the surety has paid the creditor, is valid and enforceable, provided the agreement is not contrary to law, morals, good customs, public policy, or public order.

Felipe Ysmael, Jr. & Co., Inc., a corporate entity represented by its president Felipe Ysmael, Jr., sought credit accommodations from the Philippine National Bank in the form of an overdraft line and a credit line, each in the amount of ₱1,000,000.00. PNB was willing to grant the accommodation on the condition that the applicant post a bond to guarantee payment. Mercantile Insurance Co., Inc. acted as surety by issuing two surety bonds, and in consideration thereof, the defendants executed indemnity agreements containing stipulations governing the accrual of the surety's right to seek reimbursement.

Felipe Ysmael, Jr. & Co., Inc., represented by its president Felipe Ysmael, Jr., applied with the Philippine National Bank for an overdraft line of ₱1,000,000.00 and a credit line of ₱1,000,000.00. PNB agreed to grant the total accommodation of ₱2,000,000.00 on the condition that the applicant post a bond in the sum of ₱140,000.00 to guarantee payment. Accordingly, on March 6, 1967, Felipe Ysmael, Jr. & Co., Inc. filed Surety Bond No. G(16) 007, issued by Mercantile Insurance Co., Inc., in the sum of ₱100,000.00. On December 4, 1967, the same principal and Mercantile Insurance executed a second surety bond, MERICO Bond No. G(16) 0030, in the sum of ₱40,000.00. Both bonds provided that they would be null and void if the principal performed and fulfilled its undertakings with PNB.

As security and in consideration of the execution of the two surety bonds, Felipe Ysmael, Jr. & Co., Inc. and Felipe Ysmael, Jr., acting both in his personal capacity and as president of Magdalena Estate, Inc., executed an indemnity agreement with Mercantile Insurance. Under this agreement, the defendants bound themselves jointly and severally to indemnify the surety and hold it harmless from any payments, damages, costs, losses, penalties, charges, and expenses it might incur, plus attorney's fees equal to 20% of the amount due. Paragraph 3 of the indemnity agreement expressly provided that where the obligation involved a liquidated amount for which the company had become legally liable, the company could forthwith proceed against the indemnitors by court action or otherwise to enforce payment, even prior to making payment to the obligee. A second indemnity agreement, executed on September 6, 1967, contained an identical paragraph 3 and was entered into in consideration of the second surety bond.

By an agreement dated September 5, 1967, the amount of the first bond was reduced by ₱40,000.00, bringing the total liability of Mercantile Insurance to PNB to ₱100,000.00 — ₱60,000.00 under Bond No. 0007 and ₱40,000.00 under Bond No. 0030. The defendants subsequently failed to pay their overdraft and credit line obligations with PNB. PNB then demanded that Mercantile Insurance settle the obligations under the surety bonds, which had expired on March 6, 1970 and September 4, 1968, respectively, threatening drastic collection measures if payment was not made.

On December 17, 1970, the Legal Department of Mercantile Insurance wrote letters of demand to the defendants, forwarding PNB's demand and requiring them to settle the account. The defendants received these letters but failed to comply. On February 10, 1971, Mercantile Insurance filed the present action. The defendants moved to dismiss, but the motion was denied. After answering, the defendants failed to appear at the pre-trial and were declared in default, with plaintiff allowed to present evidence ex parte. Upon reconsideration, the case was reopened for reception of the defendants' evidence, after which the parties submitted memoranda and the case was submitted for decision. The trial court found that the defendants had defaulted on their obligations to PNB, that PNB had demanded payment from the surety, and that the indemnity agreements entitled the surety to seek reimbursement even before actual payment to the bank.

• Prematurity of Action: Defendants-appellants maintained that the complaint was premature because the plaintiff surety had paid nothing on the surety bonds and had suffered no actual damage, arguing that a cause of action requires both wrongful violation and damages, neither of which was present.
• Nullity of Indemnity Agreement Stipulation: Defendants-appellants argued that paragraph 3 of the indemnity agreements was void for being contrary to law, public policy, and good morals, contending that allowing the surety to receive indemnification for something it had not yet paid would constitute unjust enrichment at the expense of another, invoking the principle nemo cum alterius detrimento locupletari potest.
• Impropriety of Monetary Award: Defendants-appellants contended that, consequently, the trial court erred in ordering them to pay jointly and severally the sum of ₱100,000.00 plus 15% as attorney's fees and costs.

• Cause of Action: Whether the surety's complaint states a cause of action and is ripe for adjudication despite the surety not having made any actual payment to the creditor.
• Validity of Indemnity Stipulation: Whether paragraph 3 of the indemnity agreements, allowing the surety to proceed against the indemnitors even before paying the creditor, is valid and enforceable.
• Propriety of Award: Whether the trial court correctly ordered the defendants to pay jointly and severally ₱100,000.00 plus 15% as attorney's fees.

• Cause of Action: Yes. The complaint states a cause of action derived from the terms of the indemnity agreement, paragraph 3 of which expressly authorizes the surety to proceed against the indemnitors upon the principal's default even before making payment to the creditor.
• Validity of Indemnity Stipulation: Yes. Paragraph 3 is valid and enforceable, its provisions not contravening any law, public policy, or public good, and being fully sanctioned by established jurisprudence.
• Propriety of Award: Yes. The defendants, being simultaneously principal debtors and indemnitors, are jointly and severally liable with the surety to PNB, and the award of 15% as attorney's fees is not unreasonable.

• Cause of Action: The cause of action was distinctly set forth in the complaint, which alleged that PNB was demanding and collecting from the plaintiff the sum of ₱100,000.00 representing the defendants' account secured by the surety bonds; that under the indemnity agreements, specifically paragraph 3, the plaintiff could forthwith proceed against the defendants even prior to making payment to PNB; that despite demands the defendants failed and refused to pay PNB; and that by reason of the defendants' default, the plaintiff became liable to PNB. The cause of action thus arose from the terms of the indemnity agreement itself, which the defendants voluntarily executed. The contention that the action was premature because the surety had not yet paid the creditor was rejected, as settled jurisprudence holds that the stipulation allowing the surety to recover even before payment to the creditor is enforceable.

• Validity of Indemnity Stipulation: Contracts are respected as the law between the contracting parties, and parties may establish such stipulations, clauses, terms, and conditions as they may want, provided these are not contrary to law, morals, good customs, public policy, or public order. Where the terms of a contract are clear and leave no doubt as to the intention of the contracting parties, the literal meaning of the stipulations shall control. A careful analysis of the indemnity agreement revealed that its provisions did not contravene any law or public policy. The indemnity agreement was executed not for the benefit of the creditors but for the benefit of the surety; if the surety deemed it necessary to impose the stipulation and the indemnitors voluntarily agreed, courts should respect the agreement and require the parties to abide by their contract. Having voluntarily entered into the contract, the defendants could not later be heard to complain.

• Propriety of Award: The defendants occupied the dual position of principal debtor and indemnitor simultaneously, and their liability being joint and several with the surety's, PNB could proceed against either for fulfillment of the obligation. There was therefore no principle of guaranty involved, and Article 2071 of the Civil Code — which would require exhaustion of the principal debtor's properties before proceeding against the guarantor — did not apply. As to attorney's fees, the award of 15% for cases of this nature had been squarely ruled as not unreasonable.

• Autonomy of Contracts — Parties to a contract may establish such stipulations, clauses, terms, and conditions as they may want, provided these are not contrary to law, morals, good customs, public policy, or public order. The Court applied this doctrine to uphold paragraph 3 of the indemnity agreement, finding that its provisions did not contravene any law or public policy and that the defendants, having voluntarily agreed, were bound by its terms.

• Literal Interpretation of Contracts — If the terms of a contract are clear and leave no doubt as to the intention of the contracting parties, the literal meaning of the stipulations shall control. The Court found no dispute as to the meaning of the indemnity agreement's terms and accordingly enforced them according to their plain wording.

• Surety's Right to Indemnification Before Payment to Creditor — A stipulation in an indemnity agreement allowing the surety to recover indemnification from the principal-indemnitor upon the latter's default, even before the surety has paid the creditor, is valid and enforceable. The indemnity agreement is executed for the benefit of the surety, not the creditor, and if the surety deemed the stipulation necessary and the indemnitors voluntarily agreed, courts will respect the agreement.

• Inapplicability of Article 2071 When Principal and Indemnitor Are Identical — Where the principal debtors are simultaneously the same persons who executed the indemnity agreement, their liability is joint and several with the surety's, and there is no principle of guaranty involved; accordingly, Article 2071 of the Civil Code, requiring exhaustion of the principal debtor's properties before proceeding against the guarantor, does not apply.

• "The stipulation in the indemnity agreement allowing the surety to recover even before it paid the creditor is enforceable. In accordance therewith, the surety may demand from the indemnitors even before paying the creditors." — This passage articulates the controlling rule on the surety's right to seek indemnification prior to actual payment, forming the ratio decidendi of the case.

• "The indemnity agreement was not executed for the benefit of the creditors; it was rather for the benefit of the surety and if the latter thought it necessary in its own interest to impose this stipulation, and the indemnitors voluntarily agreed to the same, the court should respect the agreement of the parties and require them to abide by their contract." — This quotation, drawn from Security Bank vs. Globe Assurance and adopted by the Court, defines the rationale for upholding pre-payment indemnity stipulations and is the canonical formulation frequently cited in suretyship jurisprudence.

• "Contracts are respected as the law between the contracting parties ... and as long as such agreements are not contrary to law, morals, good customs, public policy or public order, they shall have the force of law between them." — This passage states the fundamental principle of autonomy of contracts as applied to uphold the validity of the indemnity agreement's stipulations.

• Cosmopolitan Insurance Co., Inc. vs. Reyes, 15 SCRA 528 (1965) — Controlling precedent directly on point, holding that the stipulation in an indemnity agreement allowing the surety to recover even before paying the creditor is enforceable, and that an award of 15% as attorney's fees in such cases is not unreasonable. Followed.

• Security Bank vs. Globe Assurance, 107 Phil. 733 (1960) — Cited for the principle that an indemnity agreement is executed for the benefit of the surety, not the creditors, and that courts should respect the parties' agreement when the surety imposed the stipulation in its own interest and the indemnitors voluntarily agreed. Followed.

• Alto Surety and Ins. Co. vs. Aguilar, et al., G.R. No. L-5625, March 16, 1954 — Cited in support of the enforceability of pre-payment indemnity stipulations. Followed.

• Henson vs. IAC, 148 SCRA 11 (1987) — Cited for the principle that contracts are respected as the law between the contracting parties. Followed.

• Herrera vs. Petrophil Corp., 146 SCRA (1986) — Cited for the rule that parties may establish stipulations not contrary to law, morals, good customs, public policy, or public order. Followed.

• Article 2071, Civil Code — Provides that a guarantor who pays is subrogated to the rights of the creditor and may proceed against the principal debtor. The Court held this provision inapplicable because the defendants were simultaneously the principal debtors and the indemnitors, making their liability joint and several with the surety's, such that no principle of guaranty was involved.

Fernan, C.J., Gutierrez, Jr., Feliciano, and Cortes, JJ., concurred.