Vil-Rey Planners and Builders vs. Lexber, Inc.

A surety's obligation under a performance bond is not extinguished by an extension of time granted by the obligee to the principal obligor, where the extension does not make the surety's obligation more onerous and is directed at completion of the works, which would benefit the surety by discharging its liability.

Vil-Rey Planners and Builders (Vil-Rey) was a construction contractor engaged by Lexber, Inc. (Lexber) to perform land-filling and compaction works on Lexber's 56,565-square-meter property in Barangay Bangad, Cabanatuan City. Stronghold Insurance Company, Inc. (Stronghold) issued surety bonds guaranteeing Vil-Rey's performance under the contracts, with Vil-Rey executing indemnity agreements in favor of Stronghold for whatever amounts the latter might be adjudged to pay Lexber. The parties executed three successive construction contracts, each replacing or modifying the prior arrangement, with Stronghold issuing corresponding surety bonds for the first and third contracts.

Vil-Rey and Lexber entered into a Construction Contract dated 17 April 1996 (first contract) whereby Vil-Rey undertook to work on the compacted backfill of Lexber's 56,565-square-meter property in Barangay Bangad, Cabanatuan City. The first contract required Vil-Rey to complete the project in 60 days for a consideration of ₱5,100,000. Lexber released to Vil-Rey a mobilization downpayment of ₱500,000 secured by Surety Bond G(16) No. 066915 (first surety bond) issued by Stronghold. Vil-Rey agreed to indemnify Stronghold for whatever amount the latter might be adjudged to pay Lexber under the surety bond.

Vil-Rey and Lexber mutually terminated the first contract and entered into a second Construction Contract dated 1 July 1996 to cover the remaining works under revised terms and conditions, with a contract amount of ₱2,988,700.20 and a 60-day completion period. On 23 December 1996, the parties executed Work Order No. CAB-96-09 (third contract) for the completion of the remaining works by 15 January 1997, with a consideration of ₱1,168,728.37. Under the third contract, payment was structured as 50% downpayment to be secured by a surety bond issued by Stronghold upon approval of the work order, and 50% balance upon completion. Accordingly, Stronghold issued Surety Bond G(16) No. 077258 (second surety bond) in the amount of ₱584,364.19 in favor of Lexber, and Vil-Rey again obligated itself to indemnify Stronghold for whatever amount the latter might be held to pay under the surety bond.

In a letter dated 21 January 1997, Vil-Rey requested an extension of the contract period to 31 January 1997, which Lexber granted. However, Vil-Rey failed to complete the works by the end of the extended period, or even after Lexber gave it another five days to finish. Lexber then wrote Stronghold seeking to collect on the two surety bonds. When negotiations failed, Lexber filed a complaint for sum of money and damages against Vil-Rey and Stronghold before the RTC of Quezon City, Branch 93. Vil-Rey denied breach and insisted Lexber owed it ₱1,960,558.40, claiming it had finished 75.33% of the works under the first contract but received payment equivalent to only 50%, and that nearly 100% of the works under the third contract were completed, leaving receivables of ₱668,728.37. Stronghold, for its part, contended that its liability under the surety bonds was limited — the first surety bond covered only the mobilization downpayment which had been fully liquidated, and no collection could be made on the second surety bond absent any allegation of defects in materials and workmanship.

The RTC found Vil-Rey and Stronghold jointly and severally liable, initially for ₱2,988,700.20 and later, on partial reconsideration, for ₱1,084,364.19 representing the total amount of the two surety bonds, with 12% interest per annum and attorney's fees reduced to ₱200,000. On appeal, the CA further reduced the liability to ₱284,084.46 — the amount Lexber paid another contractor to complete the works left unfinished by Vil-Rey — with 6% interest per annum from 11 February 1997 until finality and 12% interest per annum thereafter, and attorney's fees reduced to ₱50,000. The CA ruled that the mutual termination of the first and second contracts waived any claims thereunder, but found a clear breach of the third contract. Both Vil-Rey and Stronghold filed motions for reconsideration, which the CA denied on 1 September 2009.

• Vil-Rey — No Breach of Contract: Vil-Rey argued that the CA's findings were based on a misapprehension of facts, contending that the consideration for the third contract was ₱1,168,728.37 of which it was paid only ₱500,000, leaving a balance of ₱668,728.37 more than enough to offset the amount Lexber incurred to finish the works.
• Stronghold — Extension Without Consent: Stronghold argued that the extension of time for completion of the third contract from 15 January 1997 to 31 January 1997 was made without its consent as surety, and that an extension of payment given by the creditor to the debtor without notice to or consent of the surety extinguishes the surety's obligation unless a continuing guarantee was executed.
• Stronghold — Scope of Bond Limited to Materials and Workmanship: Stronghold contended that the second surety bond guaranteed only the materials and workmanship utilized by Vil-Rey, and that the absence of any complaint from Lexber in this regard discharged Stronghold.
• Stronghold — Erroneous Construction as Continuing Guarantee: Stronghold insisted that the CA erred in construing the second surety bond as a continuing guarantee despite clear stipulations to the contrary.

• Breach of Contract: Whether Vil-Rey is liable for breach of contract.
• Surety's Liability: Whether Stronghold's liability under the second surety bond was extinguished by the extension of the third contract.
• Attorney's Fees: Whether Lexber is entitled to attorney's fees.

• Breach of Contract: Yes. Vil-Rey failed to complete the works under the third contract despite extensions, and its defense of non-payment was unavailing because the 50% balance was due only upon completion under the reciprocal obligations of the parties.
• Surety's Liability: No. The extension of the third contract did not extinguish Stronghold's liability under the second surety bond, as the extension did not make the surety's obligation more onerous and was aimed at completion, which would have benefited Stronghold.
• Attorney's Fees: Yes, but reduced. Lexber was entitled to attorney's fees as liquidated damages under the contractual stipulation, but the award was equitably reduced to 10% of ₱284,084.46 pursuant to Article 2227 of the Civil Code.

• Breach of Contract: Breach of contract is the failure of a party, without legal reason, to comply with the terms of a contract. Vil-Rey's managing partner, Moises Villarta, admitted in testimony that Vil-Rey failed to complete the compaction and density test because it lacked funds and was not paid anymore. Even assuming Vil-Rey accomplished 95% of the works, this fell short of its obligation to finish 100%. The third contract established reciprocal obligations: Lexber's payment of the 50% balance was due upon Vil-Rey's completion of the works on or before 15 January 1997. Because the next payment would have fallen due only upon completion, Vil-Rey could not invoke non-payment as justification for its failure. Under Article 1167, the obligation of a person who fails to fulfill it shall be executed at that person's cost. Under Article 2201, in the absence of bad faith, the obligor is liable only for damages that are the natural and probable consequences of the breach. The ₱284,084.46 paid by Lexber to another contractor to complete the works was such a consequence. Because the obligation was not a loan or forbearance of money, legal interest at 6% per annum was imposed from 17 February 1997 until finality, and 6% per annum thereafter until satisfaction, pursuant to Nacar vs. Gallery Frames. However, the Court also found Lexber guilty of delay in its reciprocal obligation: the third contract required Lexber to make a 50% downpayment equivalent to ₱584,364.19 upon Vil-Rey's acquisition of the second surety bond in the same amount, but Lexber paid only ₱500,000 on 24 December 1996. Under Article 1169, delay by one party in a reciprocal obligation begins from the moment the other fulfills its obligation. Lexber was thus liable for damages to Vil-Rey in the form of 6% interest per annum on the unpaid ₱84,364.19 from 24 December 1996 until finality, and 6% per annum thereafter, with the parties allowed to compensate the amounts due them to the extent of their respective obligations.

• Surety's Liability: The second surety bond expressly guaranteed Vil-Rey's "obligations" and answered for "any defects in the materials used and workmanship utilized," up to ₱584,364.19. The bond was not limited to materials and workmanship; it was a performance bond guaranteeing the full and faithful performance of Vil-Rey's obligations under the third contract, such that if Vil-Rey defaulted, Stronghold itself would complete the contract or pay damages up to the bond's limit. As an accessory contract dependent on the principal obligation, the second surety bond could not be severed from the third contract. While a surety is discharged by a material alteration of the principal contract that imposes a new obligation, takes away an existing one, or changes the legal effect of the original contract, no release occurs when the change does not make the obligation more onerous to the surety. The 15-day extension and the additional five-day grace period were aimed at completion of the works, which would have discharged Stronghold from liability — thus benefiting, not prejudicing, the surety. Stronghold's own letter dated 25 March 1997 demonstrated that it sought completion of the works and even gave Vil-Rey five days to fulfill its commitments, belying its claim of prejudice. Furthermore, Stronghold raised the extension argument for the first time in its motion for partial reconsideration before the CA; its consistent theory before the RTC and CA had been that the bond covered only materials and workmanship. Issues not brought to the attention of the trial court cannot be passed upon by reviewing courts, and a party may not change its theory on appeal. As surety, Stronghold retained its right to full reimbursement from Vil-Rey under Articles 2066 and 2067 of the Civil Code, which extend to sureties notwithstanding the reference in Article 2047 to the provisions on solidary obligations.

• Attorney's Fees: Section 9.3 of the first contract stipulated attorney's fees equivalent to not less than 25% of the total amount adjudged, and this provision was adopted in the second and third contracts. Attorney's fees so stipulated are in the nature of liquidated damages, payable upon breach necessitating judicial intervention without necessity of proof of damages. Vil-Rey's failure to complete the works compelled Lexber to seek judicial intervention, entitling it to attorney's fees. However, under Article 2227, liquidated damages may be equitably reduced if iniquitous or unconscionable. Given that Vil-Rey's failure was apparently caused by financial difficulties and Lexber was itself guilty of delay in its reciprocal downpayment obligation, the Court exercised its power to equitably reduce the award to 10% of ₱284,084.46.

• Breach of Contract — The failure of a party, without legal reason, to comply with the terms of a contract or perform any promise that forms either a part or the whole of it. Applied: Vil-Rey's admitted failure to complete the works under the third contract constituted breach, entitling Lexber to damages for the natural and probable consequences thereof under Article 2201.

• Reciprocal Obligations — Obligations that arise from the same cause, such that the obligation of one is dependent upon that of the other. Under Article 1169, delay by one party begins from the moment the other fulfills its obligation. Applied: The third contract imposed reciprocal obligations — Lexber's 50% balance was due upon Vil-Rey's completion, and Lexber's 50% downpayment was due upon Vil-Rey's acquisition of the surety bond. Both parties were found in delay as to their respective obligations.

• Surety Bond as Accessory Contract — A surety bond is an accessory contract dependent for its existence upon the principal obligation it guarantees, and cannot be separated or severed from its principal. Applied: The second surety bond, as a performance bond, guaranteed Vil-Rey's obligations under the third contract and was necessarily tied to the third contract's terms, including its completion date.

• Material Alteration Doctrine in Suretyship — A surety is discharged from its obligation when there is a material alteration of the principal contract that imposes a new obligation, takes away an existing one, or changes the legal effect of the original contract. However, no release occurs when the change does not make the obligation more onerous to the surety. Applied: The extension of the completion period did not make Stronghold's obligation more onerous; it was aimed at completion, which would have discharged Stronghold's liability.

• Right to Indemnification and Subrogation of Sureties — Articles 2066 and 2067 of the Civil Code, which grant the guarantor the right to indemnification and subrogation, extend to sureties as defined under Article 2047. Applied: Stronghold's right to full reimbursement from Vil-Rey for whatever it pays Lexber is grounded not merely on the indemnity agreements but on the Civil Code provisions themselves.

• Equitable Reduction of Liquidated Damages — Under Article 2227, liquidated damages, whether intended as an indemnity or a penalty, shall be equitably reduced if they are iniquitous or unconscionable. Applied: The contractual stipulation of 25% attorney's fees was reduced to 10% of the adjudged amount due to Vil-Rey's financial difficulties and Lexber's own delay.

• Legal Interest on Non-Loan Obligations — Pursuant to Nacar vs. Gallery Frames, when an obligation not constituting a loan or forbearance of money is breached, interest on damages may be imposed at 6% per annum from the time the claim is established with reasonable certainty, and at 6% per annum from finality of judgment until satisfaction. Applied: The ₱284,084.46 award and the ₱84,364.19 counter-obligation both earned 6% per annum interest.

• "The second surety bond clearly guaranteed the full and faithful performance of the 'obligations' of Vil-Rey under the third contract, and it was not secured just to answer for 'defects in the materials used and workmanship utilized.' As a performance bond, the second surety bond guaranteed that Vil-Rey would perform the contract, and provided that if the latter defaults and fails to complete the contract, Stronghold itself shall complete the contract or pay damages up to the limit of the bond." — This passage defines the nature and scope of a performance surety bond, distinguishing it from a bond limited to materials and workmanship, and establishes the surety's duty to complete or pay upon the principal's default.

• "Nevertheless, no release from the obligation shall take place when the change in the contract does not have the effect of making the obligation more onerous to the surety." — This articulates the controlling exception to the material alteration doctrine in suretyship: extensions or modifications that do not increase the surety's burden do not discharge it.

• "Accordingly, the rights to indemnification and subrogation as established and granted to the guarantor by Articles 2066 and 2067 extend as well to sureties as defined under Article 2047." — This passage resolves the question whether the Civil Code provisions on guaranty apply to sureties, adopting Tolentino's view that suretyship remains governed by the provisions on guaranty notwithstanding Article 2047's reference to solidary obligations.

• "Liquidated damages, whether intended as an indemnity or a penalty, shall be equitably reduced if they are iniquitous or unconscionable." — This quotation of Article 2227 underpins the Court's discretionary reduction of the stipulated attorney's fees, illustrating the equitable power of courts to temper contractual penalties.

• Nacar vs. Gallery Frames, G.R. No. 189871, 13 August 2013, 703 SCRA 439 — Controlling authority on the applicable legal interest rates for breached obligations not constituting loans or forbearances of money; the Court applied the 6% per annum rate from breach and from finality of judgment until satisfaction.

• Escaño vs. Ortigas, Jr., 553 Phil. 24 (2007) — Followed for the proposition that a surety who pays the creditor has the right to recover the full amount paid from the principal debtor, and that Articles 2066 and 2067 of the Civil Code extend to sureties.

• Stronghold Insurance Co., Inc. vs. Tokyu Construction Co., Ltd., 606 Phil. 400 (2009) — Followed for the rule that no release of a surety from its obligation takes place when the change in the principal contract does not make the obligation more onerous to the surety.

• General Credit Corp. vs. Alsons Development and Investment Corp., 542 Phil. 219 (2007) — Followed for the rule that issues, grounds, points of law, or theories not brought to the attention of the trial court cannot be passed upon by reviewing courts.

• J Plus Asia Development Corp. vs. Utility Assurance Corp., G.R. No. 199650, 26 June 2013, 700 SCRA 134 — Followed for the definition of a performance bond as one guaranteeing that the principal will perform the contract, with the surety undertaking to complete the contract or pay damages upon default.

• Prudential Guarantee & Assurance, Inc. vs. Anscor Land, Inc., 644 Phil. 634 (2010) — Followed for the principle that a surety bond is an accessory contract dependent for its existence upon the principal obligation it guarantees.

• Article 2201, Civil Code — Governs damages in contracts and quasi-contracts; the obligor in good faith is liable for natural and probable consequences of the breach. Applied to limit Vil-Rey's liability to the ₱284,084.46 paid by Lexber to another contractor, absent any showing of bad faith.

• Article 1169, Civil Code — In reciprocal obligations, delay by one party begins from the moment the other fulfills its obligation. Applied to find both Vil-Rey in delay for non-completion and Lexber in delay for shortpayment of the downpayment.

• Article 1167, Civil Code — The obligation of a person who fails to fulfill it shall be executed at that person's cost. Applied to hold Vil-Rey liable for the cost of completing the unfinished works.

• Article 1170, Civil Code — Those who in the performance of their obligations are guilty of fraud, negligence, or delay are liable for damages. Applied to support the award of damages against Lexber for its delay in the downpayment.

• Article 2047, Civil Code — Defines suretyship and provides that the provisions on joint and several obligations apply to sureties. Construed in conjunction with Articles 2066 and 2067 to confirm that sureties enjoy the same rights to indemnification and subrogation as guarantors.

• Articles 2066 and 2067, Civil Code — Article 2066 provides that the guarantor who pays for a debtor must be indemnified, including the total amount of the debt; Article 2067 provides that the guarantor who pays is subrogated to all rights of the creditor against the debtor. Held to extend to sureties, forming the legal basis for Stronghold's right to reimbursement from Vil-Rey.

• Article 2227, Civil Code — Liquidated damages, whether intended as indemnity or penalty, shall be equitably reduced if iniquitous or unconscionable. Applied to reduce the contractual attorney's fees from 25% to 10% of the adjudged amount.

Leonardo-De Castro, Bersamin, Reyes, and Caguioa, JJ., concurred.