This Supreme Court decision clarifies the responsibilities of contractors and their sureties when construction projects face delays or non-completion. The Court ruled that Vil-Rey Planners and Builders (Vil-Rey) was liable for breach of contract for failing to complete contracted works, while also addressing the extent of Stronghold Insurance Company, Inc.’s (Stronghold) obligations as a surety. This case underscores the importance of fulfilling contractual obligations and the legal consequences of failing to do so in the construction industry, as well as the nuanced role of surety bonds in securing project completion.

Broken Promises, Bounded Guarantees: Who Pays When Construction Falters?

This case arose from a series of construction contracts between Vil-Rey and Lexber, Inc. for land filling works. The initial contracts were mutually terminated, leading to a third contract, Work Order No. CAB-96-09, for the remaining work. Under this third contract, Vil-Rey was to receive a downpayment secured by a surety bond from Stronghold, with the balance payable upon completion. The core legal question revolves around whether Vil-Rey breached the third contract and, if so, whether Stronghold, as the surety, is liable for the resulting damages, especially considering an extension granted to Vil-Rey.

Vil-Rey failed to complete the project by the extended deadline, prompting Lexber to demand payment from Stronghold under the surety bonds. Negotiations failed, leading Lexber to file a complaint against both Vil-Rey and Stronghold. Vil-Rey argued it was owed money for work completed under previous contracts and the third contract. Stronghold contended its liability was limited and extinguished by the contract extension. The Regional Trial Court (RTC) initially ruled in favor of Lexber, holding Vil-Rey and Stronghold jointly and severally liable, a decision later modified upon reconsideration. The Court of Appeals (CA) further modified the RTC’s decision, reducing the liability but affirming Vil-Rey’s breach and Stronghold’s responsibility, leading to the present petitions before the Supreme Court.

The Supreme Court addressed the issue of whether Vil-Rey breached the contract. The Court emphasized that breach of contract occurs when a party fails to comply with the terms of an agreement without legal justification. Vil-Rey’s managing partner admitted to not completing the works due to a lack of funds, which the Court found to be an admission of failure to fulfill the contractual obligation. The Court highlighted the reciprocal nature of the obligations: Lexber was obligated to pay the balance upon Vil-Rey’s completion of the work, but Vil-Rey’s failure to complete the work triggered its liability for damages.

The Court referenced Article 2201 of the Civil Code, which distinguishes between damages for obligors acting in good faith versus those acting in bad faith. In this case, absent a showing of bad faith, Vil-Rey was liable for damages that were the natural and probable consequences of the breach. Since Lexber had to hire another contractor to complete the work, the amount paid to the new contractor represented such damages. Therefore, Vil-Rey was liable for this amount, subject to legal interest from the date of delay until full satisfaction.

However, the Supreme Court also noted that Lexber was in delay regarding its obligation to provide the full downpayment. While the contract stipulated a 50% downpayment against a surety bond, Lexber only paid a partial amount. Thus, Lexber was also liable for damages to Vil-Rey, calculated as interest on the unpaid portion of the downpayment.

Turning to Stronghold’s liability, the Court addressed the argument that the contract extension extinguished Stronghold’s obligation under the surety bond. Stronghold contended that as a surety, it was discharged from its obligation because the extension was granted without its consent. It relied on the principle that a material alteration of the principal contract, such as an extension of time, releases the surety unless a continuing guarantee exists. The Court rejected this argument, stating that the surety bond guaranteed the full and faithful performance of Vil-Rey’s obligations, and the extension did not make Stronghold’s obligation more onerous.

The Supreme Court emphasized that the extension aimed to facilitate the completion of the works, which would have ultimately benefited Stronghold by discharging its liability. The Court also noted that Stronghold itself had urged Vil-Rey to complete the project even after the initial deadline. Moreover, Stronghold’s argument about the extension was raised late in the proceedings, which the Court deemed inappropriate. Importantly, the Court reiterated the right of a surety to indemnification from the principal debtor, as stated in Escaño v. Ortigas, Jr.:

[E]ven as the surety is solidarity bound with the principal debtor to the creditor, the surety who does pay the creditor has the right to recover the full amount paid, and not just any proportional share, from the principal debtor or debtors. Such right to full reimbursement falls within the other rights, actions and benefits which pertain to the surety by reason of the subsidiary obligation assumed by the surety.

Finally, the Court addressed the issue of attorney’s fees. While the contracts stipulated attorney’s fees equivalent to a percentage of the amount adjudged, the Court reduced the award, citing equitable considerations. The Court considered Vil-Rey’s financial difficulties and Lexber’s partial delay in providing the downpayment. The liquidated damages were reduced to a more reasonable amount to reflect the circumstances.

FAQs

What was the key issue in this case?	The key issue was determining the liability of a contractor for breach of contract due to project delays and the extent of a surety’s obligation in guaranteeing the contractor’s performance. The Court balanced the responsibilities of both parties involved in the construction project.
Was Vil-Rey found liable for breach of contract?	Yes, the Supreme Court affirmed the Court of Appeals’ decision that Vil-Rey was liable for breach of contract because it failed to complete the construction project as agreed upon in the third contract. The Court found that Vil-Rey’s failure to complete the project on time was a violation of the contractual terms.
Did the extension of the contract affect Stronghold’s surety obligation?	No, the Court ruled that the extension of the contract, granted to Vil-Rey, did not extinguish Stronghold’s obligation as a surety. The Court reasoned that the extension was aimed at completing the works, which would have benefited Stronghold by discharging its liability.
What damages were awarded to Lexber?	Lexber was awarded damages amounting to the cost it incurred to hire another contractor to complete the project, with interest. Additionally, Lexber was awarded attorney’s fees, although the amount was reduced by the Court.
Was Lexber also found to have any liability?	Yes, the Court found that Lexber was also liable for delay in providing the full downpayment as required under the third contract. As a result, Lexber was ordered to pay damages to Vil-Rey, calculated as interest on the unpaid portion of the downpayment.
What is a surety bond and its purpose?	A surety bond is a contract where a surety (like Stronghold) guarantees the performance of an obligation by the principal debtor (Vil-Rey) to the creditor (Lexber). It ensures that if the principal debtor fails to fulfill the obligation, the surety will compensate the creditor for the loss.
How did the Court determine the amount of attorney’s fees?	The Court reduced the attorney’s fees, initially stipulated in the contract, considering the circumstances of the case. The Court took into account Vil-Rey’s financial difficulties and Lexber’s delay in making the full downpayment.
What is the significance of Article 2201 of the Civil Code in this case?	Article 2201 distinguishes between damages for obligors acting in good faith versus those acting in bad faith. It states that an obligor acting in good faith is liable for damages that are the natural and probable consequences of the breach, while an obligor acting in bad faith is liable for all damages reasonably attributed to the non-performance.

This case provides valuable insights into the dynamics of construction contracts and surety obligations, offering a balanced perspective on the responsibilities and liabilities of both contractors and sureties. The Supreme Court’s decision reinforces the importance of fulfilling contractual obligations and clarifies the circumstances under which sureties can be held liable for the defaults of their principals.

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: Vil-Rey Planners and Builders vs. Lexber, Inc., G.R. Nos. 189401 & 189447, June 15, 2016