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PEOPLE'S TRANS-EAST ASIA INSURANCE CORPORATION v. DOCTORS OF NEW MILLENNIUM HOLDINGS

FACTS:

The pertinent facts of this case are as follows:

Doctors of New Millennium Holdings, Inc. entered into a construction and development agreement with Million State Development Corporation for the construction of a hospital. According to the agreement, Doctors of New Millennium was obligated to pay P10,000,000 to Million State Development to commence the construction. Million State Development was responsible for 95% of the project cost and committed to securing P385,000,000 within 25 banking days. As part of the conditions prior to the initial payment, Million State Development submitted a surety bond worth P10,000,000 issued by People's Trans-East Asia Insurance Corporation, now known as People's General Insurance Corporation. Doctors of New Millennium made the initial payment. However, Million State Development failed to fulfill its obligation to secure the required funds within the prescribed period. Doctors of New Millennium sent demand letters to Million State Development for the remittance of the funds, but the latter failed to comply. Doctors of New Millennium then sent a demand letter to People's General Insurance for the return of the initial payment, in accordance with the surety bond. People's General Insurance denied the surety claim and Doctors of New Millennium filed an administrative complaint against the insurer. Doctors of New Millennium subsequently filed a complaint for breach of contract with damages against Million State Development and People's General Insurance before the Regional Trial Court of Pasig City. Million State Development was declared in default, and the trial court resolved the issues primarily involving the surety bond.

The case involves a construction and development agreement between Doctors of New Millennium Holdings, Inc. (Doctors of New Millennium) and Million State Development Corporation (Million State). People's General Insurance Corporation issued a surety bond in favor of Doctors of New Millennium to secure the initial payment made by the latter to Million State. The surety bond stated that People's General Insurance would guarantee the construction of a hospital building project and secure the repayment of the downpayment. The surety bond also specified that the liability of People's General Insurance would not exceed ten million pesos. Million State failed to complete the project, and Doctors of New Millennium filed a complaint against both Million State and People's General Insurance for the recovery of the initial payment. The trial court ruled that Million State was solely liable to Doctors of New Millennium and dismissed the complaint against People's General Insurance. Doctors of New Millennium appealed the decision, and the Court of Appeals reversed the ruling, holding both Million State and People's General Insurance jointly and severally liable.

The case involves a dispute between People's General Insurance ("Surety") and Million State Development Corporation ("Principal"), with Doctors of New Millennium as the project owner. The Surety issued a surety bond in favor of the Principal to guarantee the latter's performance of its contractual obligations. The bond was in the amount of P10,000,000.00.

According to the Surety, the Principal furnished them with a copy of the draft agreement, assuring that the same terms and conditions would be included in the signed agreement. However, when the parties inserted the clause "or the Project Owner's waiver," the Surety argued that it substantially altered the terms and conditions of the contract and increased its risk as the surety.

The Surety claimed that the clause effectively deprived them of the opportunity to objectively assess the real risk of undertaking the surety bond and determining the reasonable rate of premium. It argued that this constituted an implied novation, which should relieve it from its undertaking as a surety as it made its obligation more burdensome.

On the other hand, Doctors of New Millennium argued that there was no novation and that the clause did not increase the Surety's risk since it was not material to their undertaking. The trial court dismissed the complaint against the Surety, but on appeal, the Court of Appeals reversed the decision. The appellate court held the Surety jointly and severally liable with the Principal for damages suffered by the plaintiff.

The Surety filed a motion for reconsideration, which the Court of Appeals denied. Hence, the Surety filed a petition for review on certiorari before the Supreme Court seeking the reversal of the Court of Appeals' decision.

ISSUES:

  1. Whether the inclusion of the clause "or the Project Owner's waiver" in the signed agreement constituted an implied novation of the surety contract.

  2. Whether the surety bond guaranteeing the initial payment was released due to the disputed clause.

  3. Whether the insertion of a disputed clause in the signed agreement constitutes an implied novation of the obligation which extinguishes the surety's obligations.

RULING:

  1. The inclusion of the clause "or the Project Owner's waiver" in the signed agreement did not constitute an implied novation of the surety contract. A surety's liability is strictly based on the terms stated in the surety contract in relation to the principal contract. Any material alteration of the principal contract that changes the principal's obligations would constitute an implied novation of the surety contract. In this case, there was no novation as the disputed clause did not materially alter the principal's obligations.

  2. The surety bond guaranteeing the initial payment was not released due to the disputed clause. The surety's obligations are different from the obligations of the contractor to the client under the principal contract. The surety guarantees the performance of the contractor's obligations, and the client may demand against the surety bond upon the contractor's default, even without privity of contract. The disputed clause did not release the surety from its obligations under the bond.

  3. The Supreme Court held that the insertion of the disputed clause in the signed agreement does not operate as a novation of the surety's liability under the surety bond. The court stated that for an obligation to be extinguished by another obligation that substitutes it, it must be so declared in unequivocal terms or the old and new obligations must be incompatible on every point. Novation is not presumed, and in the absence of an express agreement, novation only occurs when the old and new obligations are incompatible on every point. Even if it is assumed that the principal contract in the suretyship was the draft agreement, the addition of the disputed clause in the signed agreement does not materially alter the surety's obligation to guarantee the principal's payment.

PRINCIPLES:

  • A surety's liability is joint and several but limited to the amount of the bond, and its terms are determined strictly by the terms of the contract of suretyship in relation to the principal contract.

  • The surety's liability is direct, primary, and absolute; the surety becomes liable for the debt and duty of another although it possesses no direct or personal interest over the obligations nor receives any benefit therefrom.

  • A material alteration of the principal contract that changes the principal's obligations would constitute an implied novation of the surety contract, relieving the surety from its obligations.

  • A change in a contract that does not make the obligation more onerous for the surety does not release the surety from its obligations.

  • The liability of a surety is determined strictly in accordance with the provisions of the principal contract.

  • Sureties have the responsibility to carefully scrutinize the agreement and cannot simply rely on the assurances of their principal.

  • Novation of a contract is never presumed and requires unequivocal terms or incompatibility on every point between the old and new obligations.

  • The terms and conditions of a surety bond must be read and interpreted together with the provisions of the underlying contract (Annex F).

  • The surety's obligation is not limited to the specific conditions for the release of the initial payment stated under Article XIII but extends to the performance of all obligations under the contract.

  • Any waiver of the conditions for the release of the initial payment does not affect the surety's obligation under the surety bond.

  • Attorney's fees cannot be recovered as part of damages unless there is factual, legal, and equitable justification.

  • The power of the court to award attorney's fees under Article 2208 demands justification.

  • No premium should be placed on the right to litigate.