South City Homes, Inc. vs. BA Finance Corporation

A continuing suretyship agreement is valid and binding even before the principal obligation it secures has arisen, and the surety becomes bound once that obligation comes into existence. The surety's consent to guarantee future indebtedness is sufficient; no principal obligation need exist at the time of execution.

BA Finance Corporation (BAFC) is a financing company that extended credit facilities to Fortune Motors Corporation (Phils.), a car dealer engaged in retailing motor vehicles. Canlubang Automotive Resources Corporation (CARCO), a car manufacturer, sold and delivered motor vehicles to Fortune Motors under trust receipt and draft arrangements, which CARCO then assigned and discounted to BAFC. To secure Fortune Motors' indebtedness, Joseph L. G. Chua (president of Fortune Motors), Palawan Lumber Manufacturing Corporation, and South City Homes, Inc. each executed continuing suretyship agreements in favor of BAFC, jointly and severally guaranteeing the full and prompt payment of all indebtedness of Fortune Motors to BAFC. The arrangement exemplifies a standard wholesale automotive financing scheme in which manufacturers deliver vehicles to dealers on trust receipts, assign those instruments to financing companies, and sureties back the dealers' obligations.

Prior to the transactions in dispute, Fortune Motors Corporation (Phils.) had been availing of credit facilities from BA Finance Corporation. On January 17, 1983, Joseph L. G. Chua, president of Fortune Motors, executed a Continuing Suretyship Agreement in favor of BAFC, jointly and severally and unconditionally guaranteeing the full, faithful, and prompt payment of any and all indebtedness of Fortune Motors to BAFC. On February 3, 1983, Palawan Lumber Manufacturing Corporation, represented by Chua, George D. Tan, Edgar C. Rodrigueza, and Joselito C. Baltazar, likewise executed a Continuing Suretyship Agreement in favor of BAFC with identical terms. On the same date, South City Homes, Inc., represented by Rodrigueza and Aurelio F. Tablante, executed its own Continuing Suretyship Agreement with the same stipulations guaranteeing Fortune Motors' indebtedness to BAFC.

Subsequently, Canlubang Automotive Resources Corporation (CARCO) drew six drafts in its own favor, payable thirty days after sight, charged to the account of Fortune Motors, dated July 26, July 27, July 28, August 2, August 5, and August 8, 1983, in the aggregate amount of approximately ₱3,345,370.60. Fortune Motors thereafter executed trust receipts covering the motor vehicles delivered to it by CARCO, under which it agreed to remit to the entruster the proceeds of any sale and to immediately surrender the remaining unsold vehicles. CARCO then assigned the drafts and trust receipts to BAFC under deeds of assignment.

Upon Fortune Motors' failure to pay the amounts due under the drafts, remit the proceeds of motor vehicles sold, or return those remaining unsold in accordance with the trust receipt agreements, BAFC sent demand letters to Edgar C. Rodrigueza, South City Homes, Inc., Aurelio Tablante, Palawan Lumber Manufacturing Corporation, Joseph Chua, George Tan, and Joselito Baltazar. When the defendants failed to settle their outstanding account, BAFC filed on December 22, 1983 a complaint for sum of money with prayer for preliminary attachment before the Regional Trial Court of Manila, Branch 1, docketed as Civil Case No. 83-21944. A writ of preliminary attachment was issued on January 3, 1984, subsequently dissolved as to all defendants except Fortune Motors. Defendants moved to dismiss, arguing that conventional subrogation effected a novation without the debtor's consent, that the action was premature under Presidential Decree No. 115, and that the suretyship agreements were void for lack of an existing principal obligation; the motion was denied.

After trial, the RTC on November 25, 1991 rendered judgment ordering Fortune Motors, Palawan Lumber, and Joseph Chua to pay jointly and severally the outstanding balances under the six drafts with legal interest from the date of filing, plus ₱300,000 in attorney's fees and costs of suit, while dismissing the complaint against South City Homes, Tablante, Baltazar, Tan, and Rodrigueza. On motions for reconsideration, the RTC amended its decision on July 22, 1992, modifying the provisions on the return of attached vehicles to intervenors Fortune Equipment, Inc. and South Fortune Motors Corporation. BAFC, Fortune Motors, Palawan Lumber, and the intervenors all appealed to the Court of Appeals, which on September 8, 1998 affirmed the RTC decision with modification, holding South City Homes, Inc. jointly and severally liable with the other defendants for all six drafts. The petitioners elevated the case to the Supreme Court.

• Validity of Suretyship: Petitioners asserted that the suretyship agreements they signed are void because there was no principal obligation existing at the time of signing, the principal obligation having been incurred six months later.
• Novation by Assignment: Petitioners posited that a novation resulted from the assignment of the drafts and trust receipts by CARCO in favor of BAFC without the consent of the principal debtor, Fortune Motors, thereby extinguishing the liabilities of the sureties.
• Premature Action: Petitioners argued that as an entruster, BAFC must first demand the return of the unsold vehicles from Fortune Motors pursuant to the terms of the trust receipts; having failed to do so, BAFC had no cause of action and the action for collection of sum of money was premature.

• Validity of Suretyship: Whether the suretyship agreement is valid notwithstanding the absence of a principal obligation at the time of its execution.
• Novation: Whether the assignment of the drafts and trust receipts by CARCO to BAFC without the debtor's consent constituted a novation that extinguished the liability of the sureties.
• Cause of Action: Whether BAFC has a valid cause of action for a sum of money under the drafts and trust receipts transactions without first demanding the return of unsold goods from the entrustee.

• Validity of Suretyship: Yes. The suretyship agreement is valid and binding, the Civil Code expressly allowing a guaranty to secure future debts whose amount is not yet known under Article 2053.
• Novation: No. The assignment of credits did not effect a novation; the debtor's consent is not essential for the validity of an assignment, and the obligation to pay subsists against the assignee to the same extent as against the assignor.
• Cause of Action: Yes. BAFC has a valid cause of action; upon default of the entrustee, the entruster has the discretion to cancel the trust and take possession of the goods or to seek alternative remedies, including a civil action for collection.

• Validity of Suretyship: Article 2053 of the Civil Code expressly provides that a guaranty may be given as security for future debts, the amount of which is not yet known. A surety is not bound under any particular principal obligation until that obligation is born, but the suretyship agreement itself is valid and binding even before the principal obligation arises — analogous to obligations subject to a condition precedent being valid before the condition occurs. Comprehensive or continuing surety agreements are commonplace in modern financial and commercial practice, as banks and financing companies routinely require projected principal debtors to execute continuing surety agreements to cover a series of credit transactions without the need for a separate surety bond for each accommodation. The Court had previously so held in Fortune Motors (Phils.) Corporation vs. Court of Appeals, which involved the same parties and the same financing scheme. Because the suretyship agreements here were continuing in nature and expressly guaranteed any and all indebtedness of Fortune Motors to BAFC, they validly secured the obligations subsequently incurred under the six drafts and trust receipts.

• Novation: An assignment of credit is an agreement by which the owner of a credit transfers it and its accessory rights to another by a legal cause, without the consent of the debtor, who acquires the power to enforce it to the same extent as the assignor. The third party steps into the shoes of the original creditor as subrogee. The debtor's consent is not essential for the validity of the assignment under Article 1624 in relation to Article 1475 of the Civil Code; the debtor's knowledge affects only the validity of payments made. Article 1626 mandates that payment of an existing obligation shall be made to the new creditor from the time the debtor acquires knowledge of the assignment. What the law requires is notice to the debtor, not consent — otherwise, all creditors would be prevented from assigning their credits due to the possibility of the debtor's refusal. Because the assignment merely substituted BAFC for CARCO as creditor, the petitioners' obligations were not extinguished and no novation occurred.

• Cause of Action: A trust receipt is a security transaction intended to aid in financing importers and retail dealers who lack sufficient funds to acquire merchandise, utilizing the merchandise itself as collateral. In the event of default by the entrustee, the law uses the word "may" in granting the entruster the right to cancel the trust and take possession of the goods, signifying that the remedy is discretionary. The entruster may avail of that right or seek any alternative action — such as a third party claim or a separate civil action — which it deems best to protect its interests, at any time upon default or failure of the entrustee to comply with the terms of the trust agreement. Because BAFC was not required to first demand return of the unsold vehicles before filing a collection suit, its action was not premature and a valid cause of action existed.

• Continuing Suretyship for Future Debts — A suretyship agreement may validly secure obligations incurred subsequent to its execution, even when the amount of the future debt is not yet known. The agreement itself is binding before the principal obligation arises; the surety becomes bound only when the principal obligation comes into existence. Continuing or comprehensive surety agreements are recognized as commonplace in modern financial practice, enabling a series of credit transactions under a single surety contract without separate bonds for each accommodation. Applied here to uphold the validity of the suretyship agreements executed by South City Homes, Palawan Lumber, and Joseph Chua, which guaranteed Fortune Motors' future indebtedness to BAFC.

• Assignment of Credits Without Debtor's Consent — An assignment of credit transfers the credit and its accessory rights to the assignee without the debtor's consent, the latter's knowledge affecting only the validity of payments made. Notice to the debtor, not consent, is the sole requirement. The assignee steps into the shoes of the original creditor and may enforce the obligation to the same extent. Applied here to reject the claim that the assignment of drafts and trust receipts by CARCO to BAFC constituted a novation extinguishing the sureties' liability.

• Entruster's Discretionary Remedies Upon Default — Upon default of the entrustee under a trust receipt agreement, the entruster has the discretion to cancel the trust and take possession of the goods or to pursue alternative remedies, including a separate civil action for collection of sum of money. The use of "may" in the statute confers this discretion. Applied here to sustain BAFC's cause of action for collection without prior demand for return of unsold vehicles.

• "Of course, a surety is not bound under any particular principal obligation until that principal obligation is born. But there is no theoretical or doctrinal difficulty inherent in saying that the suretyship agreement itself is valid and binding even before the principal obligation intended to be secured thereby is born, any more than there would be in saying that obligations which are subject to a condition precedent are valid and binding before the occurrence of the condition precedent." — This passage, quoted from Fortune Motors (Phils.) Corporation vs. Court of Appeals, articulates the ratio decidendi on the validity of continuing suretyship agreements for future obligations and is the canonical formulation relied upon in this case.

• "What the law requires in an assignment of credit is not the consent of the debtor but merely notice to him. A creditor may, therefore, validly assign his credit and its accessories without the debtor's consent." — This passage states the controlling rule on assignment of credits, distinguishing consent from notice and establishing that assignment does not extinguish the debtor's obligation.

• "Significantly, the law uses the word 'may' in granting to the entruster the right to cancel the trust and take possession of the goods. Consequently, petitioner has the discretion to avail of such right or seek any alternative action, such as a third party claim or a separate civil action which it deems best to protect its right, at any time upon default or failure of the entrustee to comply with any of the terms and conditions of the trust agreement." — Quoted from Prudential Bank vs. NLRC, this passage defines the entruster's discretionary remedies upon default under the Trust Receipts Law.

• Fortune Motors (Phils.) Corporation vs. Court of Appeals, 335 Phil. 315 (1997) — Controlling precedent on the validity of continuing suretyship agreements for future debts. The case involved the same parties and the same wholesale automotive financing scheme. Followed and quoted extensively for the proposition that a suretyship agreement is valid and binding even before the principal obligation arises.

• Rodriguez vs. Court of Appeals, 207 SCRA 553 (1992) — Followed for the rule that assignment of credits does not require the debtor's consent, that notice suffices, and that the debtor's obligation to pay subsists upon knowledge of the assignment.

• Prudential Bank vs. NLRC, 321 Phil. 798 (1995) — Followed for the rule that the entruster's right to cancel the trust and take possession of goods upon default is discretionary, permitting alternative remedies including a separate civil action.

• Nacu vs. Court of Appeals, 231 SCRA 237 (1994) — Cited for the definition and nature of a trust receipt as a security transaction intended to aid in financing importers and retail dealers.

• Sison & Sison vs. Yap Tico and Avanceña, 37 Phil. 587 (1918) — Cited for the early ruling that consent is not necessary for an assignment to produce legal effects.

• National Investment and Development Co. vs. De Los Angeles, 40 SCRA 489 (1971) — Cited for the proposition that a creditor may validly assign credit and its accessories without the debtor's consent.

• Article 2053, Civil Code — Provides that a guaranty may also be given as security for future debts, the amount of which is not yet known. Applied to uphold the validity of the continuing suretyship agreements executed before the principal obligations under the six drafts arose.

• Article 1624, in relation to Article 1475, Civil Code — Governs assignment of credits, providing that the debtor's consent is not essential for the validity of the assignment. Applied to reject the claim of novation by assignment.

• Article 1626, Civil Code — Provides that the debtor's knowledge of the assignment affects only the validity of payments made, mandating that payment be made to the new creditor from the time the debtor acquires knowledge of the assignment. Applied to establish that the obligation to pay subsists notwithstanding the absence of the debtor's consent.

• Presidential Decree No. 115 (Trust Receipts Law) — Governs trust receipt transactions. Relied upon for the rule that upon default of the entrustee, the entruster has the discretion to cancel the trust and take possession of the goods or to pursue alternative remedies, including a separate civil action for collection.

Davide, Jr., C.J., Puno, Kapunan, and Ynares-Santiago, JJ., concurred.