In a contract of suretyship, an insurer’s obligations under a surety bond are not voided by changes to the principal contract unless those changes fundamentally alter the principal’s obligations. When a principal fails to meet its obligations under the contract, the surety is jointly and severally liable. This ruling clarifies the extent of a surety’s responsibility and underscores the need for insurers to thoroughly assess contract terms.

Did a Waiver Release the Surety? The Case of Doctors vs. People’s General

Doctors of New Millennium Holdings, Inc., (Doctors of New Millennium), an organization of about 80 doctors, entered into a construction agreement with Million State Development Corporation (Million State), a contractor, to build a 200-bed hospital in Cainta, Rizal. Under the agreement, Doctors of New Millennium was to pay P10,000,000.00 as an initial payment, while Million State was to secure P385,000,000.00 within 25 banking days. As a condition for the initial payment, Million State provided a surety bond of P10,000,000.00 from People’s Trans-East Asia Insurance Corporation, now People’s General Insurance Corporation (People’s General). Doctors of New Millennium made the initial payment, but Million State failed to secure the P385,000,000.00 within the agreed timeframe, leading Doctors of New Millennium to demand the return of their initial payment from People’s General. When People’s General denied the claim, citing that the bond only covered the construction itself and not the funding, Doctors of New Millennium filed a complaint for breach of contract.

The Regional Trial Court initially ruled that only Million State was liable. However, the Court of Appeals reversed this decision, holding People’s General jointly and severally liable. The appellate court emphasized that the surety bond covered the initial payment and that a clause allowing Doctors of New Millennium to waive certain preconditions did not increase the surety’s risk. This case reached the Supreme Court, with People’s General arguing that the added waiver clause substantially altered the contract terms, thus releasing them from their obligations as a surety.

At the heart of this case is the interpretation of the surety bond and the extent to which modifications in the principal contract affect the surety’s obligations. A **contract of suretyship** is an agreement where one party, the surety, guarantees the performance of an obligation by another party, the principal, in favor of a third party, the obligee. The surety’s liability is generally joint and several with the principal but is limited to the amount of the bond, as stipulated in the contract.

The Civil Code defines guaranty and suretyship in Article 2047:

Art. 2047. By guaranty a person, called the guarantor, binds himself to the creditor to fulfill the obligation of the principal debtor in case the latter should fail to do so.
If a person binds himself solidarily with the principal debtor, the provisions of Section 4, Chapter 3, Title I of this Book shall be observed. In such case the contract is called a suretyship.

In this instance, People’s General contended that the inclusion of the clause “or the Project Owner’s waiver” in the signed agreement constituted a material alteration that increased their risk, thereby releasing them from their obligations. People’s General argued they were furnished with a *draft* agreement, not the *final* signed one. They insisted this implied novation should automatically relieve them from their undertaking as a surety because it made their obligation more onerous.

However, the Supreme Court found this argument unconvincing, noting that People’s General had a copy of the final signed agreement attached to the surety bond. The court emphasized the surety’s responsibility to diligently review the terms of the principal contract and that People’s General could not simply rely on the assurances of its principal, Million State. In effect, the court ruled that the surety had acquiesced to the terms and conditions in the principal contract because it had the contract when it issued its surety bond.

Moreover, the Supreme Court addressed the issue of whether the waiver clause materially altered People’s General’s obligation. The court determined that the waiver of certain conditions for the initial payment did not substantially change the surety’s obligation to guarantee the repayment of that initial payment. The court noted the following clauses from the signed agreement:

ARTICLE XIII
CONDITIONS TO DISBURSEMENT OF INITIAL PAYMENT
13.1 The obligation of the Project Owner to pay to the Contractor the amount constituting the Initial Payment shall be subject to and shall be made on the date (the “Closing date”) following the fulfillment or the Project Owner’s waiver of the following conditions: …

These conditions related only to the disbursement of the initial payment and did not affect Million State’s overall obligations under the contract, which People’s General had guaranteed. In other words, regardless of whether the pre-conditions were waived, the principal was always bound to its obligations to the obligee.

The ruling underscores that for a modification to release a surety, it must impose a new obligation on the promising party, remove an existing obligation, or change the legal effect of the original contract. In this case, the court found that the waiver clause did none of these things. Thus, Million State’s failure to fulfill its obligations triggered the surety’s liability for the amount of the bond, as defined in Section 176 of the Insurance Code:

Sec. 176.  The liability of the surety or sureties shall be joint and several with the obligor and shall be limited to the amount of the bond.  It is determined strictly by the terms of the contract of suretyship in relation to the principal contract between the obligor and the obligee.

Thus, the Supreme Court affirmed the Court of Appeals’ decision, holding People’s General jointly and severally liable with Million State for the P10,000,000.00 initial payment, including legal interest. However, the Supreme Court deleted the award of attorney’s fees because the lower courts provided no justification for it.

This case serves as a reminder for sureties to exercise due diligence in reviewing principal contracts and understanding the full scope of their obligations. It clarifies that minor modifications, especially those that do not materially increase the surety’s risk, will not release the surety from its bond. This ensures that beneficiaries of surety bonds can rely on the protection they provide, promoting stability and confidence in contractual relationships.

FAQs

What was the key issue in this case?	The central issue was whether the insertion of a waiver clause in the principal contract released the surety, People’s General, from its obligations under the surety bond. The court determined that the surety remained liable.
What is a surety bond?	A surety bond is a contract where a surety guarantees the performance of an obligation by a principal to an obligee. It provides assurance that the obligee will be compensated if the principal fails to fulfill its contractual duties.
What is the liability of the surety?	The surety’s liability is generally joint and several with the principal, meaning the obligee can seek compensation from either party. However, the surety’s liability is limited to the amount specified in the bond.
What constitutes a material alteration that releases a surety?	A material alteration is a change in the principal contract that imposes a new obligation on the principal, removes an existing obligation, or changes the legal effect of the original agreement. The surety must prove the changes increased their risk.
Did People’s General have a responsibility to review the contract?	Yes, the court emphasized that the surety had a responsibility to diligently review the terms of the principal contract. It could not simply rely on the assurances of its principal because sureties have a duty to examine the agreements they are being asked to guarantee.
What was the effect of the waiver clause in this case?	The court determined that the waiver clause, which allowed Doctors of New Millennium to waive certain preconditions for the initial payment, did not materially alter People’s General’s obligation to guarantee the repayment of that initial payment. Million State was always bound by its obligations to the obligee.
Why was the award of attorney’s fees deleted?	The Supreme Court deleted the award of attorney’s fees because the lower courts provided no factual or legal basis for the award. Attorney’s fees must be justified, not automatically granted.
What is the significance of this case for sureties?	This case underscores the importance of due diligence for sureties in reviewing principal contracts. It clarifies that minor modifications, especially those that do not materially increase the surety’s risk, will not release the surety from its obligations.

In conclusion, People’s Trans-East Asia Insurance Corporation v. Doctors of New Millennium Holdings, Inc. provides valuable guidance on the scope of a surety’s liability and the impact of contract modifications on surety bonds. The decision reinforces the principle that sureties must conduct thorough due diligence and cannot easily escape their obligations based on minor alterations in the principal contract.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: People’s Trans-East Asia Insurance Corporation v. Doctors of New Millennium Holdings, Inc., G.R. No. 172404, August 13, 2014