In a construction project dispute, the Supreme Court clarified the obligations of a surety under a performance bond. The Court held that a surety, like The Mercantile Insurance Co., Inc., is obligated to immediately indemnify the obligee, DMCI-Laing Construction, Inc. (DLCI), upon the first demand, regardless of any ongoing disputes with the principal debtor, Altech Fabrication Industries, Inc. This ruling reinforces the surety’s direct and primary liability, ensuring that construction projects are not unduly delayed by protracted legal battles between the contractor and subcontractor. The decision underscores the importance of clear contractual language in performance bonds, emphasizing that a surety’s commitment is triggered by a demand, not by the resolution of underlying disputes.

Guaranteeing Performance: When a Surety Must Answer for a Subcontractor’s Default

The case of The Mercantile Insurance Co., Inc. v. DMCI-Laing Construction, Inc. arose from a construction project where DLCI, the general contractor, subcontracted Altech for glazed aluminum and curtain walling work. Altech secured a performance bond from Mercantile to guarantee its obligations. When Altech failed to perform adequately, DLCI demanded fulfillment of the bond from Mercantile. Mercantile refused, leading to a legal battle that reached the Supreme Court. At the heart of the matter was whether Mercantile, as the surety, was obligated to pay DLCI upon the initial demand, despite disputes over Altech’s performance and the exact amount owed.

The Supreme Court emphasized that a contract is the law between the parties, provided it doesn’t contravene legal or moral standards. Reviewing the performance bond’s conditions, the Court highlighted Mercantile’s explicit obligation to immediately indemnify DLCI upon the latter’s demand, irrespective of any dispute regarding Altech’s fulfillment of its contractual duties. The bond stipulated that Mercantile would pay interest at 2% per month from the date it received DLCI’s first demand letter until actual payment. This condition, the Court noted, effectively established a suretyship agreement as defined in Article 2047 of the Civil Code.

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 a suretyship, one party (the surety) guarantees the performance of another party’s (the principal or obligor) obligations to a third party (the obligee). The surety is essentially considered the same party as the debtor, sharing inseparable liabilities. Although the suretyship contract is secondary to the principal obligation, the surety’s liability is direct, primary, and absolute, limited only by the bond amount. This liability arises the moment the creditor demands payment. The Supreme Court cited Trade and Investment Development Corporation of the Philippines v. Asia Paces Corporation to reinforce this point:

[S]ince the surety is a solidary debtor, it is not necessary that the original debtor first failed to pay before the surety could be made liable; it is enough that a demand for payment is made by the creditor for the surety’s liability to attach. Article 1216 of the Civil Code provides that:

Article 1216. The creditor may proceed against any one of the solidary debtors or some or all of them simultaneously.

The demand made against one of them shall not be an obstacle to those which may subsequently be directed against the others, so long as the debt has not been fully collected.

The performance bond in question created a pure obligation for Mercantile. Its liability attached immediately upon DLCI’s demand, with no dependency on future or uncertain events. Thus, the bond was callable on demand, meaning DLCI’s mere demand triggered Mercantile’s obligation to indemnify up to Php90,448,941.60. The Court interpreted the “first demand” requirement in light of Article 1169 of the Civil Code, which states that the obligee is in delay upon judicial or extra-judicial demand. Consequently, Mercantile’s liability became due upon receiving DLCI’s first demand letter.

DLCI’s alleged failure to specify the claim value in its first demand was deemed irrelevant. The Court agreed with the CA that Mercantile’s obligation to guarantee project completion arose at the time of the bond call, and the exact amount, though undetermined, could not exceed the bond’s limit. The Tribunal had seemingly ignored that the First Call was to liquidate the Performance Bond, aiming for the full amount, subject to later adjustments after Altech and DLCI settled their accounts. This interpretation was further supported by the bond’s terms.

Mercantile’s liability was not contingent upon determining the actual amount Altech owed. In the event of overpayment, Mercantile could seek recourse against DLCI based on unjust enrichment principles. Any amount to be reimbursed would then become a forbearance of money, subject to legal interest. The Court also noted that Mercantile never questioned the First Call’s validity before the CIAC proceedings, instead, it initially declined to evaluate DLCI’s claim due to ongoing negotiations with Altech. Therefore, its later objections seemed like an afterthought.

The Court determined that DLCI was entitled to claim costs incurred because of Altech’s delays and subpar workmanship. The performance bond, according to the court, served as assurance that Altech would fulfill its duties and finish the work following specified guidelines, designs, and quantities. The general terms of the Sub-Contract outline these obligations:

6. Commencement [and] Completion

(12) Time is an essential feature of the [Sub-Contract]. If [Altech] shall fail to complete the Sub-Contract Works within the time or times required by its obligations hereunder[, Altech] shall indemnify [DLCI] for any costs, losses or expenses caused by such delay, including but not limited to any liquidated damages or penalties for which [DLCI] may become liable under the Main Contract as a result wholly or partly of [Altech’s] default x x x.

17. [Altech’s] Default

(f) [If Altech] fails to execute the Sub-Contract works or to perform his other obligations in accordance with the Sub-Contract after being required in writing so to do by [DLCI]; x x x

(3) [DLCI] may in lieu of giving a notice of termination x x x take part only of the Sub-Contract Works out of the hands of [Altech] and may[,] by himself, his servants or agents execute such part and in such event [DLCI] may recover his reasonable costs of so doing from [Altech], or deduct such costs from monies otherwise becoming due to [Altech].

The evidence presented demonstrated that Altech failed to complete its work on schedule and to satisfactory standards. DLCI submitted correspondences as evidence, providing Mercantile with an opportunity to challenge their truthfulness, which it did not do, instead arguing that DLCI’s failure to seek damages or rectification costs undermined their case for delays and poor workmanship. The Court dismissed this line of reasoning, noting that the CIAC Complaint requested payment for costs incurred to complete the subcontracted works, directly linked to Altech’s shortcomings.

Mercantile attempted to differentiate between costs incurred before and after the Sub-Contract termination, arguing that overpayment reimbursements fall outside the Performance Bond’s scope. The Court deemed these distinctions irrelevant because Mercantile’s bond guaranteed Altech’s full compliance with the Sub-Contract, covering all costs DLCI incurred due to Altech’s failures. Limiting the bond to costs before termination would create an unfounded condition. The Court also clarified that DLCI’s claim was not merely for overpayment reimbursement. DLCI had to spend additional amounts to complete the subcontracted works due to Altech’s delay and poor workmanship. Thus, DLCI’s claim was directly linked to additional expenses incurred to complete the subcontract works due to the failures of Altech.

Altech’s obligation to perform the Sub-Contract constituted an obligation to do. Under Article 1167 of the Civil Code, when a person fails to fulfill an obligation to do something, it should be executed at their cost. Mercantile, as Altech’s surety, was bound to cover DLCI’s costs incurred as a result of Altech’s non-fulfillment. Mercantile had the opportunity to contest these costs but did not. Hence, DLCI’s calculated sum was deemed payable. Mercantile argued that it should be released from its obligations because DLCI’s delay in filing the CIAC Complaint deprived Mercantile of its right to subrogation against Altech, based on Article 2080 of the Civil Code. However, the Court had already established that DLCI was not guilty of delay in filing the CIAC Complaint. Even assuming DLCI was guilty of delay, Mercantile’s argument still failed.

Article 2080 applies to guarantors, not sureties. The Court emphasized the difference between the two:

A surety is an insurer of the debt, whereas a guarantor is an insurer of the solvency of the debtor. A suretyship is an undertaking that the debt shall be paid; a guaranty, an undertaking that the debtor shall pay. Stated differently, a surety promises to pay the principal’s debt if the principal will not pay, while a guarantor agrees that the creditor, after proceeding against the principal, may proceed against the guarantor if the principal is unable to pay. A surety binds himself to perform if the principal does not, without regard to his ability to do so. A guarantor, on the other hand, does not contract that the principal will pay, but simply that he is able to do so. In other words, a surety undertakes directly for the payment and is so responsible at once if the principal debtor makes default, while a guarantor contracts to pay if, by the use of due diligence, the debt cannot be made out of the principal debtor.

The Court ruled that Article 2080 does not apply in a contract of suretyship. A surety’s liability exists regardless of the debtor’s ability to fulfill the contract. Therefore, Mercantile’s reliance on Article 2080 was misplaced. The Court ultimately found that DLCI was also entitled to reimbursement for litigation expenses because Mercantile acted in bad faith. Mercantile was explicitly required to immediately indemnify DLCI regardless of disputes regarding Altech’s fulfillment of contractual obligations. Mercantile’s refusal to acknowledge DLCI’s claim seemed to be a deliberate delay until the bond’s expiration.

Despite all this, only Mercantile was held liable in this case because the records did not show the CA had jurisdiction over Altech. Because of this, judgment against Altech was erroneous. The Court stated Mercantile has the right to seek reimbursement from Altech under Article 2066 of the Civil Code in a separate case.

FAQs

What was the key issue in this case?	The key issue was whether the surety, Mercantile Insurance, was obligated to pay DMCI-Laing Construction under a performance bond upon the first demand, despite disputes with the subcontractor, Altech, regarding the quality and timeliness of work.
What is a performance bond?	A performance bond is a surety agreement where a surety company guarantees to an obligee (here, DMCI-Laing) that the principal (here, Altech) will fulfill its contractual obligations. If the principal defaults, the surety is liable for damages up to the bond amount.
What does it mean for a surety to be ‘solidarily liable’?	Being solidarily liable means the surety is jointly and severally liable with the principal debtor. The creditor can demand full payment from either the principal or the surety without first exhausting remedies against the other.
Why did the Supreme Court rule against Mercantile Insurance?	The Supreme Court ruled against Mercantile because the performance bond explicitly required immediate indemnification of DMCI-Laing upon the first demand, irrespective of any ongoing disputes. Mercantile’s refusal was seen as a breach of this contractual obligation.
What is the significance of the ‘first demand’ in this case?	The ‘first demand’ is the initial claim made by the obligee (DMCI-Laing) to the surety (Mercantile) for payment under the performance bond. According to the bond’s terms and the Court’s interpretation, this demand immediately triggers the surety’s obligation to pay.
How did the Court differentiate between a surety and a guarantor?	The Court emphasized that a surety is an insurer of the debt, directly liable upon the principal’s default, while a guarantor is an insurer of the debtor’s solvency, only liable after the creditor has exhausted remedies against the principal.
What was the outcome regarding litigation expenses?	The Supreme Court modified the Court of Appeals’ decision to include litigation expenses in the award to DMCI-Laing, finding that Mercantile had acted in bad faith by refusing to honor a plainly valid claim.
Was Altech Fabrication Industries held liable in this case?	No, Altech was not held liable in this particular case because the Court of Appeals did not properly acquire jurisdiction over Altech. However, Mercantile retains the right to pursue a separate claim against Altech for reimbursement.

This case clarifies the extent of a surety’s obligations in construction contracts, emphasizing the importance of honoring the terms of performance bonds. The ruling ensures that obligees can rely on these bonds for prompt payment when contractors fail to meet their obligations. It also underscores that sureties cannot delay payment based on ongoing disputes with the principal, as the bond’s purpose is to provide immediate financial security.

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: THE MERCANTILE INSURANCE CO., INC. VS. DMCI-LAING CONSTRUCTION, INC., G.R. No. 205007, September 16, 2019