OVERVIEW OF SURETYSHIP
Define contract of suretyship.
A contract of suretyship is an agreement whereby a party called the Surety guarantees the performance by another party called the Principal or Obligor of an obligation or undertaking in favor of a third party called the Obligee. It includes official recognizances, stipulations, bonds or undertakings issued by any company by virtue of Act No. 536, as amended by Act No. 2206. (Insurance Code of the Philippines, Section 177)
If a person binds himself solidarily with the principal debtor, will also be considered a suretyship.
What are the characteristics of the contract of suretyship?
The following are its characteristics:
When is a contract of suretyship considered an insurance contract?
A contract of suretyship shall be deemed to be an insurance contract, within the meaning of this (Insurance) Code, only if made by a Surety who or which, as such, is “doing an insurance business.”
“Doing an insurance business" or "transacting an insurance business", shall include:
Who are the parties to a contract of suretyship?
There are three (3) parties to a contract of suretyship, to wit:
What are the three (3) contracts in a suretyship?
A contract of suretyship is also known as a tripartite agreement. Unlike insurance, there are 3 closely intertwined contracts in the suretyship transaction, namely:
What is the source of this right to full reimbursement by the Surety aside from the Indemnity Agreement?
Article 2066 of the Civil Code assures that "[t]he guarantor who pays for a debtor must be indemnified by the latter," such indemnity comprising of, among others, "the total amount of the debt." Further, Article 2067 of the Civil Code likewise establishes that "[t]he guarantor who pays is subrogated by virtue thereof to all the rights which the creditor had against the debtor. (CCC Insurance Corporation vs Kawasaki Steel Corporation, G.R. No. 156162 [June 22, 2015]
The benefit of subrogation, an extinctive subjective novation by a change of creditor, which "transfers to the person subrogated, the credit and all the rights thereto appertaining, either against the debtor or against third persons," is granted by the Article 2067 of the Civil Code only to the "guarantor (or surety) who pays." (Autocorp Group v. Intra Strata Assurance Corporation, 578 Phil. 804, 822-823 [2008])
What are the differences between an insurance contract and a contract of suretyship?
They are as follows:
Differentiate a contract of suretyship and contract of guaranty?
The distinction between a Surety and a guarantor are as follows:
While a Surety undertakes to pay if the Principal does not pay, the guarantor binds himself to pay if the Principal cannot pay. (Machetti vs Hospicio de San Jose & Fidelity & Surety Co., 43 Phil. 297)
What is a continuing bond?
A continuing bond is one whose period of insurance is indefinite or with no fixed expiration date. The bond shall be in force unless cancelled by the Obligee, or by the Insurance Commissioner, or by a court of competent jurisdiction, as the case may be. As consequence, the premium for furnishing the bond and the obligation to the pay the same subsists for as long as the liability of the Surety shall exists. (Reparations Commission vs. Universal Deep-Sea Fishing Corp., 83 SCRA 764 [1978]; Arranz vs. Manila Fidelity & Surety Co., 101 Phil. 272, [1957])
A continuing bond does not expire but is cancelled by the Obligee by formal notice of cancellation. In the absence of such formal notice of cancellation, the Surety Bond is deemed cancelled if the Principal is able to satisfactorily show that the undertaking of the Surety Bond has been fully performed by it and the same is acknowledged in writing by the Obligee. (Corporate Suretyship by the Philippine Association of Surety Underwriters, Inc., 309)
For purposes of premium collection, the renewal certificates or billings must be issued annually to serve as a basis for the collection of annual premiums. Non-issuance of such renewal certificates or billings still makes the principal liable for unpaid premiums. (Corporate Suretyship by the Philippine Association of Surety Underwriters, Inc., 20-21) The obligation of the Principal shall cease only when the Obligee consents to it. The premium is the consideration for furnishing the bond or the guaranty and the obligation to pay the same subsists for as long as the liability of the Surety shall exist. (Arranzs vs. Manila Fidelity and Surety Co., 101 Phil. 272 [1957]). Moreover, the Principal shall pay the subsequent annual premium as it falls due until the contract of suretyship is cancelled by the Obligee or by the Commissioner or by a court of competent jurisdiction, as the case may be. (Insurance Code of the Philippines, Section 179)
For judicial bonds, the court may order the cancellation of the bond. In case the court does not include in its order or judgment the cancellation of the Surety bond filed, but nonetheless terminates with finality the case, the bond may be considered as already cancelled. However, it is better to file a motion with the court for the cancellation thereof. (Corporate Suretyship by the Philippine Association of Surety Underwriters, Inc., 309). In addition, per Supreme Court Resolution under Administrative Matter No. 03-03-19-SC, “the lifetime or duration of the effectivity of any bond issued in civil actions or proceedings or in any accident therein shall be from its approval by the court until the action or proceedings is finally decided, resolved, or terminated.”
Examples of a continuing bond are judicial bonds such as injunction bond, attachment bond, replevin bond, and appeal bond.
A contract of suretyship is an agreement whereby a party called the Surety guarantees the performance by another party called the Principal or Obligor of an obligation or undertaking in favor of a third party called the Obligee. It includes official recognizances, stipulations, bonds or undertakings issued by any company by virtue of Act No. 536, as amended by Act No. 2206. (Insurance Code of the Philippines, Section 177)
If a person binds himself solidarily with the principal debtor, will also be considered a suretyship.
What are the characteristics of the contract of suretyship?
The following are its characteristics:
- It is an accessory contract because its validity depends upon the existence of a principal obligation guaranteed by it. It cannot exist without a valid obligation (Article 2052, New Civil Code). It is an indispensable condition that there must be a principal contract, thus, if the principal obligation is void, it is also void.
- It is subsidiary and conditional because it takes effect only when the principal debtor fails in his obligation subject to certain limitations.
When is a contract of suretyship considered an insurance contract?
A contract of suretyship shall be deemed to be an insurance contract, within the meaning of this (Insurance) Code, only if made by a Surety who or which, as such, is “doing an insurance business.”
“Doing an insurance business" or "transacting an insurance business", shall include:
- Making or proposing to make, as insurer, any insurance contract;
- Making or proposing to make, as surety, any contract of suretyship as a vocation and not as merely incidental to any other legitimate business or activity of the surety;
- Doing any kind of business, including a reinsurance business, specifically recognized as constituting the doing of an insurance business;
- Doing or proposing to do any business in substance equivalent to any of the foregoing in a manner designed to evade the provisions of the Insurance Code.
Who are the parties to a contract of suretyship?
There are three (3) parties to a contract of suretyship, to wit:
- Principal – also known as Obligor or the policyholder. The party obligated to perform or to refrain from performing an act. Examples include the following: (1) General contractors and subcontractors in Construction Bonds, (2) a developer, real estate broker and an agent in Housing and Land Use Regulatory Board (HLURB) Bonds, (3) heirs of the deceased person seeking to distribute the assets of the deceased or a loan borrower whose title has an annotation that it is subject to Sections 4 to 5, Rule 74 of the Revised Rules of Court, or (5) the payee of a check in an Indemnity Bond, the subcontractor in compliance with the Article 108 of the Labor Code of the Philippines.
- Surety – also known as the insurer. The party who issues the Surety Bond on behalf of the Principal and in favor of the Obligee. The one who guarantees the performance or compliance of the Principal’s obligations.
- Obligee – also known as the beneficiary. The party in whose favor the bond is issued. He is likewise the one who obligates the Principal to perform or refrain from performing an act. The Obligee can be any of the following: (1) creditor or lessee in a Guarantee Payment Bond, (2) general contractor or project owner or the Housing and Land Use Regulatory Board in a construction project, (3) employer in a fidelity bond, (4) issuer of the stock certificate in an Indemnity Bond or even Heirs Bond, (5) bank in the case of Bonds for Lost Checks, or (6) the Bureau of Customs in the case of Customs Bonds
What are the three (3) contracts in a suretyship?
A contract of suretyship is also known as a tripartite agreement. Unlike insurance, there are 3 closely intertwined contracts in the suretyship transaction, namely:
- Principal Contract – the agreement between the Principal and the Obligee. The faithful compliance of the terms of which is the one that will be guaranteed by the Surety Bond. Examples of which include, but is not limited to, Construction Contract, Service Agreement, Lease Agreement, or Loan Agreement. It could be a provision of the law like the the following: (1) Rules of Court in the case of Heirs Bond, Administrators Bond, Executors Bond, and Replevin Bond, (2) Republic Act No. 26 in the case of Reconstituted Title Bond (3) Presidential Decree No. 957 in the case of Performance Bond required by HLURB, (4) Presidential Decree No. 1464, otherwise known as the Tariff and Customs Code of the Philippines, in the case of Customs Bonds.
- Surety Bond – the agreement by and between the Principal and the Surety in favor of the Obligee. In this contract, the Surety guarantees that the Principal shall perform its obligations set forth in the Principal Contract. If not, the Surety shall be solidarily liable with the Principal to indemnify the Obligee.
- Indemnity Agreement – is a contract executed by the Principal and its co-indemnitor in favor of the Surety. It is a form of a side agreement between the Principal and its co-indemnitors and Surety. Under this agreement, the Principal undertakes to indemnify the Surety for any loss, damage, expense, and costs which it may incur by reason of its default.
What is the source of this right to full reimbursement by the Surety aside from the Indemnity Agreement?
Article 2066 of the Civil Code assures that "[t]he guarantor who pays for a debtor must be indemnified by the latter," such indemnity comprising of, among others, "the total amount of the debt." Further, Article 2067 of the Civil Code likewise establishes that "[t]he guarantor who pays is subrogated by virtue thereof to all the rights which the creditor had against the debtor. (CCC Insurance Corporation vs Kawasaki Steel Corporation, G.R. No. 156162 [June 22, 2015]
The benefit of subrogation, an extinctive subjective novation by a change of creditor, which "transfers to the person subrogated, the credit and all the rights thereto appertaining, either against the debtor or against third persons," is granted by the Article 2067 of the Civil Code only to the "guarantor (or surety) who pays." (Autocorp Group v. Intra Strata Assurance Corporation, 578 Phil. 804, 822-823 [2008])
What are the differences between an insurance contract and a contract of suretyship?
They are as follows:
- The former is a contract of indemnity while the latter is a more of contract of guaranty.
- The former is a principal contract, whereas, the latter is an accessory contract. The latter cannot exist without a principal obligation requiring it.
- There are only two (2) parties to the former, namely, the insurer and the insured, whereas, there are three (3) parties to the latter, namely: Surety, Principal, and Obligee.
- In the former, there is no right of recovery for the loss of the insurer may sustain except in case when the insurer is entitled to subrogation, whereas, in the latter, the Surety is entitled to reimbursement from the principal and his guarantors for the loss it may suffer under the contract.
- In the former, guarantors and collateral is not a requirement, whereas, in the latter, a Surety may require the principal to post collateral or submit a list of guarantor as a condition for the issuance of a bond.
- In the former, non-payment of premium is a ground for cancellation of the policy, whereas, in the latter, the Surety cannot cancel the bond unless the Obligee consents to its cancellation.
- In the former, the period of insurance is one (1) year, whereas, in the latter, it depends on the length of the principal contract to be guaranteed. In the case judicial bonds, it is indefinite because it shall continue to be in force unless the court of competent jurisdiction orders its cancellation.
Differentiate a contract of suretyship and contract of guaranty?
The distinction between a Surety and a guarantor are as follows:
- The Surety is primarily liable, whereas, the guarantor is secondarily liable;
- The Surety is a party to the undertaking, whereas the liability of the guarantor depends upon an independent agreement to pay if the primary debtor fails to do so;
- The Surety is not entitled to the benefit of exhaustion of debtor’s assets (also known as benefit of excussion) while such right is available to the guarantor.
While a Surety undertakes to pay if the Principal does not pay, the guarantor binds himself to pay if the Principal cannot pay. (Machetti vs Hospicio de San Jose & Fidelity & Surety Co., 43 Phil. 297)
What is a continuing bond?
A continuing bond is one whose period of insurance is indefinite or with no fixed expiration date. The bond shall be in force unless cancelled by the Obligee, or by the Insurance Commissioner, or by a court of competent jurisdiction, as the case may be. As consequence, the premium for furnishing the bond and the obligation to the pay the same subsists for as long as the liability of the Surety shall exists. (Reparations Commission vs. Universal Deep-Sea Fishing Corp., 83 SCRA 764 [1978]; Arranz vs. Manila Fidelity & Surety Co., 101 Phil. 272, [1957])
A continuing bond does not expire but is cancelled by the Obligee by formal notice of cancellation. In the absence of such formal notice of cancellation, the Surety Bond is deemed cancelled if the Principal is able to satisfactorily show that the undertaking of the Surety Bond has been fully performed by it and the same is acknowledged in writing by the Obligee. (Corporate Suretyship by the Philippine Association of Surety Underwriters, Inc., 309)
For purposes of premium collection, the renewal certificates or billings must be issued annually to serve as a basis for the collection of annual premiums. Non-issuance of such renewal certificates or billings still makes the principal liable for unpaid premiums. (Corporate Suretyship by the Philippine Association of Surety Underwriters, Inc., 20-21) The obligation of the Principal shall cease only when the Obligee consents to it. The premium is the consideration for furnishing the bond or the guaranty and the obligation to pay the same subsists for as long as the liability of the Surety shall exist. (Arranzs vs. Manila Fidelity and Surety Co., 101 Phil. 272 [1957]). Moreover, the Principal shall pay the subsequent annual premium as it falls due until the contract of suretyship is cancelled by the Obligee or by the Commissioner or by a court of competent jurisdiction, as the case may be. (Insurance Code of the Philippines, Section 179)
For judicial bonds, the court may order the cancellation of the bond. In case the court does not include in its order or judgment the cancellation of the Surety bond filed, but nonetheless terminates with finality the case, the bond may be considered as already cancelled. However, it is better to file a motion with the court for the cancellation thereof. (Corporate Suretyship by the Philippine Association of Surety Underwriters, Inc., 309). In addition, per Supreme Court Resolution under Administrative Matter No. 03-03-19-SC, “the lifetime or duration of the effectivity of any bond issued in civil actions or proceedings or in any accident therein shall be from its approval by the court until the action or proceedings is finally decided, resolved, or terminated.”
Examples of a continuing bond are judicial bonds such as injunction bond, attachment bond, replevin bond, and appeal bond.
KINDS OF BONDS
What are the main classes of contracts of suretyship.
Bonds may be classified into two (2) main categories, to wit:
Enumerate the kinds of bonds based on the six (6) categories by the Insurance Commission
I. Contractors Bonds - It refers to a class of bonds relating to construction projects. Examples of which are as follows:
II. Judicial Bonds - It refers to bonds that are required to be posted by the court are required by law or the Rules of Court. An insurance company cannot issued bonds under duly-accredited by the Supreme Court. The most commonly used judicial bonds are the following:
III. Fidelity Bond - It guarantees the honest and fidelity of an employee. It shall answers for the loss incurred by employer by reason of its employees’ dishonest acts. Those who are required to post this are cashier, collectors and any person involved in handling money.
IV. Guarantee Payment Bond - It guarantees the payment of one’s financial obligations as they become due. Examples of contracts guaranteed by this type of bond include lease contract, promissory note, distributorship agreement, and loan agreement.
V. Customs Bonds - In general, it shall answer for the payment of taxes and duties imposed by the Bureau of Customs. Examples of which are as follows:
VI. License and Permit Bonds – are required for certain areas of business which are regulated by the State.
A License Bond is one that is required by the government or any of its agencies to guarantee compliance with the terms and condition to operate a certain business. Examples of which are as follows:
A Permit Bond, on the other hand, guarantees compliance in exchange for the exercise of a privilege like to own or carry a firearm or stay in the country. Examples of which are the following:
Bonds may be classified into two (2) main categories, to wit:
- Judicial Bonds – this refers to a class of bonds that are required by the court either in compliance with the Rules of Court or a law. It may be further classified to Civil and Criminal Bonds. A Surety must obtain accreditation with the Supreme Court before it can issue either Civil or Criminal Judicial Bonds or both.
- Non-Judicial Bonds – this refers to a class of bonds that are required by the parties by virtue of private contract or agreement. In some cases, they are required by a statute. Examples of which are HLURB Bonds for real estate developers, License and Permit Bonds like in the Department of Labor and Employment Bonds for travel agencies or Real Estate Brokers Bond requirement of Philippine Regulatory Commission.
Enumerate the kinds of bonds based on the six (6) categories by the Insurance Commission
I. Contractors Bonds - It refers to a class of bonds relating to construction projects. Examples of which are as follows:
- Bid bond - It guarantees if the Principal will win in the bid, it shall enter into a contract with the Obligee and will subsequently post the necessary bonds such as Performance Bond.
- Performance Bond - It guarantees that the Principal will perform the obligations set forth in the construction agreement, such as: (1) Guarantees the construction and completion of a project in accordance with the approved plans, specifications, and terms and conditions of the contract, (2) guarantees the principal’s obligations under a supply and delivery and/ or installation contract with respect to equipment, material, supplies and similar items.
- Downpayment Bond - It is also known as Advance Payment Bond. It guarantees that the advance or deposit payment to be made by the Obligee will be used for the project and shall be liquidated within the agreed period.
- Payment Bond - It is bond that guarantees payment of wages as prescribed by Article 108 of the Labor Code of the Philippines. It provides that an "employer or indirect employer may require the contractor or subcontractor to furnish a bond equal to the cost of labor under contract, on condition that the bond will answer for the wages due the employees should the contractor or subcontractor, as the case may be, fail to pay the same.".
- Warranty Bond - it guarantees the correction and repair of hidden defects in the materials and workmanship used by the contractor in the project found or becoming evident within one year from the date of final acceptance of the project, or within one (1) year or other prescribed period from the date of final and substantial completion or provisional acceptance of the project.
II. Judicial Bonds - It refers to bonds that are required to be posted by the court are required by law or the Rules of Court. An insurance company cannot issued bonds under duly-accredited by the Supreme Court. The most commonly used judicial bonds are the following:
- Replevin Bond – is a bond posted by the petitioner to repossess a personal property. The purpose of this bond is to answer for any and all expenses that the opposing party may suffer if the petitioner is not entitled to the remedy of repossession. (See Rule 60 of the Rules of Court)
- Supersedeas Bond – is a bond posted by the losing party as a requirement for perfecting an appeal. The purposes of the bond is to stay the execution of the judgment pending appeal and to answer for any and all damages that the opposing party may suffer if it will sustain the inferior court’s decision.
- Administrator’s Bond – a pre-condition for the issuance of the letter of administration. It is a security for the satisfaction of any judgment. The property subject of the attachment is a real or immovable property. (See Rule 81 of the Rules of Court)
- Attachment Bond – it guarantees the payment of all costs which may be adjudged to the adverse party and all damages which he may sustain by reason of attachment if the court finds that the Principal is not entitled to the remedy of attachment. (See Rule 57 of the Rules of Court). At the commencement of the action or at any time before entry of judgment, a plaintiff or any proper party may have the property of the adverse party attached as security for the satisfaction of any judgment that may be recovered in the following cases: (a) In an action for the recovery of a specified amount of money or damages, other than moral and exemplary, on a cause of action arising from law, contract, quasi-contract, delict or quasi-delict against a party who is about to depart from the Philippines with intent to defraud his creditors; (b) In an action for money or property embezzled or fraudulently misapplied or converted to his own use by a public officer, or an officer of a corporation, or an attorney, factor, broker, agent, or clerk, in the course of his employment as such, or by any other person in a fiduciary capacity, or for a willful violation of duty; (c) In an action to recover the possession of property unjustly or fraudulently taken, detained or converted, when the property, or any part thereof, has been concealed, removed, or disposed of to prevent its being found or taken by the applicant or an authorized person; (d) In an action against a party who has been guilty of a fraud in contracting the debt or incurring the obligation upon which the action is brought, or in the performance thereof; (e) In an action against a party who has removed or disposed of his property, or is about to do so, with intent to defraud his creditors; or (f) In an action against a party who does not reside and is not found in the Philippines, or on whom summons may be served by publication.
- Heir’s Bond – It answers for the payment of any claim by an heir who has been deprived of his lawful participation in the estate and/ or any creditor who has a claim against the estate which has not been paid. (See Rule 74 of the Rules of Court)
- Injunction Bond - shall finally adjudge that the plaintiff was not entitled to such provisional remedy. A preliminary injunction bond is an order by the court at any stage of an action prior to final judgment, requiring a person to refrain from doing a particular act. It shall answer for all the damages which the party enjoined by order of injunction is directed, in such amount the court may fix. (See Rule 58 of the Rules of Court). A preliminary injunction or temporary restraining order may be granted only when:(a) The application in the action or proceeding is verified, and shows facts entitling the applicant to the relief demanded; and (b) Unless exempted by the court the applicant files with the court where the action or proceeding is pending, a bond executed to the party or person enjoined, in an amount to be fixed by the court, to the effect that the applicant will pay to such party or person all damages which he may sustain by reason of the injunction or temporary restraining order if the court should finally decide that the applicant was not entitled thereto. Upon approval of the requisite bond, a writ of preliminary injunction shall be issued. (4a) (c) When an application for a writ of preliminary injunction or a temporary restraining order is included in a complaint or any initiatory pleading, the case, if filed in a multiple-sala court, shall be raffled only after notice to and in the presence of the adverse party or the person to be enjoined. In any event, such notice shall be preceded, or contemporaneously accompanied, by service of summons, together with a copy of the complaint or initiatory pleading and the applicant's affidavit and bond, upon the adverse party in the Philippines. However, where the summons could not be served personally or by substituted service despite diligent efforts, or the adverse party is a resident of the Philippines temporarily absent therefrom or is a nonresident thereof, the requirement of prior or contemporaneous service of summons shall not apply. (d) The application for a temporary restraining order shall thereafter be acted upon only after all parties are heard in a summary hearing which shall be conducted within twenty-four (24) hours after the sheriff's return of service and/or the records are received by the branch selected by raffle and to which the records shall be transmitted immediately.
III. Fidelity Bond - It guarantees the honest and fidelity of an employee. It shall answers for the loss incurred by employer by reason of its employees’ dishonest acts. Those who are required to post this are cashier, collectors and any person involved in handling money.
IV. Guarantee Payment Bond - It guarantees the payment of one’s financial obligations as they become due. Examples of contracts guaranteed by this type of bond include lease contract, promissory note, distributorship agreement, and loan agreement.
V. Customs Bonds - In general, it shall answer for the payment of taxes and duties imposed by the Bureau of Customs. Examples of which are as follows:
- General Bond for Bonded Warehouse
- General Warehousing Bond
- Embroidery Bond
- General Transportation Bond
- Ordinary Re-Export Bond
- Customs Broker's Bond
- Advance Baggage Bond
- Anti-Dumping Bond
- Countervailing Bond
- Bond to Pay Penalties
- Arrastre Bond
- Bond to Pay Wharfage Dues
- Bond to Pay Tonnage Dues
- Bond to Pay Berthing Charges
VI. License and Permit Bonds – are required for certain areas of business which are regulated by the State.
A License Bond is one that is required by the government or any of its agencies to guarantee compliance with the terms and condition to operate a certain business. Examples of which are as follows:
- Importer's Bond
- Fishery Bond
- Forestry Bond
- School Bond as required by the Department of Education
- Real Estate Brokers' Bond as required by the Philippine Regulation Commission
A Permit Bond, on the other hand, guarantees compliance in exchange for the exercise of a privilege like to own or carry a firearm or stay in the country. Examples of which are the following:
- Firearm Bond
- Immigration Bond
UNDERWRITING BONDS
Bond is not an insurance contract because there is no transfer of risk from the insured to the insurer. In the event the insured or Principal defaults, the Principal must reimburse the Surety for whatever cost it will incur.
Bonding is akin to banking. It is imperative for the Surety underwriter to determine the financial capacity of the principal to complete the project or the ability to reimburse whatever the Surety shall advance to the Obligee in case the Principal defaults.
It is for this reason, bonds are considered an accommodation business only.
It important to determine the three C’s in the underwriting which are as follows:
Discuss the process for underwriting bond applications?
The steps are as follows:
I. Gather all underwriting information submitted by the applicant as listed in the bond application form. For purposes of underwriting, the Surety bonds may be classified into five (5) categories which are as follows:
Contractor’s Bond (Surety Payment of Wages, Surety for Supply and Delivery, Surety for Downpayment, Performance, Bidders, Warranty, etc)
* Republic Act No. 4566 or otherwise known as Contractors’ License law paved the way for the creation of PCAB. Under the said law, it is mandatory for all contractors in the country to first secure a license before engaging in construction contracting in the country. This is to ensure that only qualified and reliable contractors are allowed to undertake construction in the country.Section 35 of the Act provides that “any contractor who, for a price, commission, fee or wage, submits or attempts to submit a bid to construct, or contracts to or undertakes to construct, or assumes charge in a supervisory capacity of a construction work within the purview of this Act, without first securing a license to engage in the business of contracting in this country; or who shall present or file the license certificate of another, give false evidence of any kind to the Board, or any member thereof in obtaining a certificate or license, impersonate another, or use an expired or revoked certificate, or license, shall be deemed guilty of misdemeanor, and shall, upon conviction, be sentenced to pay a fine of not less than five hundred pesos but not more than five thousand pesos.”
Currently, PCAB is under the Construction Industry Authority of the Philippines under the Department of Trade and Industry pursuant to Presidential Decree No. 1746 or otherwise known as “Act Creating Construction Industry Authority of the Philippines”. It was created with the purpose to promote, accelerate, and regulate the growth and development of the construction industry.
Non Construction-related Bonds (Bonds which guaranty Services and Security Agreement or any undertaking not related to construction
Heirs’ Bond - Inheritance-related
Heirs' Bond - Loan-related
Other Judicial Bonds (Supersedeas, Replevin, Attachment, Guardian’s, etc)
Indemnity Bond for Lost Checks
General Surety Bond for Lost Stock Certificate
Performance Bond for HLURB
II. Evaluate the underwriting information to determine the risk factors and degree of risk to be assumed. For reference, refer to PIRA's classification of bonds according to degree of risks.
III. Based on the risk involved, decide on the following matters:
IV. If the decision is to provide cover, refer to the PIRA Tariff Manual for the application of appropriate rates.
V. Determine how much of the total risk assumed should be retained and how much will be reinsured taking into account the nature of risk and current accumulation as of date of issuance.
Discuss and explain the purpose of each documentary requirement mentioned in the preceding item.
When is collateral needed?
The submission of collateral is required in case of high risk accounts such as guaranty payment and judicial bonds. Surety Bond is supposed to be a “no loss” contract.
If the Principal submits collateral, the Surety may provide a 50% discount in the premium rate. (Circular Letter of the Insurance Commission (1995), Rule 3(a)
Bonding is akin to banking. It is imperative for the Surety underwriter to determine the financial capacity of the principal to complete the project or the ability to reimburse whatever the Surety shall advance to the Obligee in case the Principal defaults.
It is for this reason, bonds are considered an accommodation business only.
It important to determine the three C’s in the underwriting which are as follows:
- Character - this has to do with the moral hazard involved in considering a bond applicant. Pertinent information included in this is the applicant's past dealings and his reputation. The contractor must also be registered with Philippine Contractors Accreditation Board (PCAB) and must not be in their list of blacklisted contractors.
- Capacity - this refers to the experience of the applicant, the facilities, and resources available to them to accomplish the work. Included in this is the list of contracts completed as well as those in progress to help gauge the capacity of the contractor. For construction projects, one can refer to the PCAB's License Category.
- Capital - this has to do with the contractor's financial capacity to accomplish the project. The following data would serve as the gauge to measure the company's financial capability;
Discuss the process for underwriting bond applications?
The steps are as follows:
I. Gather all underwriting information submitted by the applicant as listed in the bond application form. For purposes of underwriting, the Surety bonds may be classified into five (5) categories which are as follows:
Contractor’s Bond (Surety Payment of Wages, Surety for Supply and Delivery, Surety for Downpayment, Performance, Bidders, Warranty, etc)
- Principal Contract which may be any of the following: a. Construction Agreement or Purchase Order for Performance Bond and Downpayment Bond, b. Notice or Invitation to Bid for Bidder’s Bond, c. Certificate of Completion for Warranty Bond
- Contractor’s License as issued by the Philippine Contractors Accreditation Board, if a constructor only.*
- Audited Financial Statement for the last two (2) years.
- Company Profile which includes the management team, completed and present projects, to name a few
- Duly-accomplished bond application form.
- Duly-accomplished bond co-signer statement. Must at least be two (2).
- Duly-signed Indemnity Agreement.
- Two (2) valid IDs of the authorized signatory and his co-indemnitors.
- Articles of Incorporation and By-Laws, if the applicant is a corporation or Accreditation with the Department of Trade and Industry, if the applicant is a single proprietor or Articles of Partnership, if the applicant is a partnership.
- Secretary’s Certificate, if the applicant is a corporation.
* Republic Act No. 4566 or otherwise known as Contractors’ License law paved the way for the creation of PCAB. Under the said law, it is mandatory for all contractors in the country to first secure a license before engaging in construction contracting in the country. This is to ensure that only qualified and reliable contractors are allowed to undertake construction in the country.Section 35 of the Act provides that “any contractor who, for a price, commission, fee or wage, submits or attempts to submit a bid to construct, or contracts to or undertakes to construct, or assumes charge in a supervisory capacity of a construction work within the purview of this Act, without first securing a license to engage in the business of contracting in this country; or who shall present or file the license certificate of another, give false evidence of any kind to the Board, or any member thereof in obtaining a certificate or license, impersonate another, or use an expired or revoked certificate, or license, shall be deemed guilty of misdemeanor, and shall, upon conviction, be sentenced to pay a fine of not less than five hundred pesos but not more than five thousand pesos.”
Currently, PCAB is under the Construction Industry Authority of the Philippines under the Department of Trade and Industry pursuant to Presidential Decree No. 1746 or otherwise known as “Act Creating Construction Industry Authority of the Philippines”. It was created with the purpose to promote, accelerate, and regulate the growth and development of the construction industry.
Non Construction-related Bonds (Bonds which guaranty Services and Security Agreement or any undertaking not related to construction
- Principal Contract
- Audited Financial Statement for the last two (2) years.
- Company Profile which includes the management team, completed and present projects, to name a few
- Duly-accomplished bond application form.
- Duly-accomplished bond co-signer statement. Must at least be two (2).
- Duly-signed Indemnity Agreement.
- Two (2) valid IDs of the authorized signatory and his co-indemnitors.
- Articles of Incorporation and By-Laws, if the applicant is a corporation or Accreditation with the Department of Trade and Industry, if the applicant is a single proprietor or Articles of Partnership, if the applicant is a partnership.
- Secretary’s Certificate, if the applicant is a corporation.
Heirs’ Bond - Inheritance-related
- Deed of Extra-judicial Settlement / Self-Adjudication / Partition, as the case may be.
- Copy of the property/ies of listed in the preceding item which shall include, but is not limited, to the following: a. Stock Certificates, b. Bank Deposits, c. TCTs, d. CCTs, e. Life Insurance policy/ies
- Publisher's Affidavit of Publication of the Deed of Extra-judicial Settlement / Self-Adjudication / Partition, as the case may be.
- Death Certificate of the owner of the properties to be distributed
- Proof of Filiation by the applicant/s (Birth or Marriage Certificate).
- Duly-accomplished bond application form.
- Duly-accomplished bond co-indemnitors statement. Must at least be two (2).
- Duly-signed Indemnity Agreement.
- Audited Financial Statement for the last two (2) years.
- Copy of a least two (2) valid IDs of the Principal and his/her co-indemnitors.
- Special Power of Attorney, if applicable
Heirs' Bond - Loan-related
- Deed of Extra-judicial Settlement or Partition or Affidavit of Self-Adjudication, as the case may be, from either the seller or heirs, whichever is applicable
- Proof of Publication of Deed of Extra-judicial Settlement or Partition or Affidavit of Self-Adjudication, as the case may be, or Publisher's Affidavit of Publication
- Proof of loan approval
- Copy of the TCT or CCT to be mortgaged to the Obligee bank. It should be under the name of the mortgagor already.
- Deed of Sale, if the property to be mortgaged was acquired by the Principal from the heirs of the decedent.
- Duly-accomplished bond application form.
- Duly-accomplished bond co-indemnitors statement. Must at least be two (2).
- Duly-signed Indemnity Agreement.
- Audited Financial Statement for the last two (2) years.
- Copy of a least two (2) valid IDs of the Principal and his/her co-indemnitors.
- Articles of Incorporation and By-Laws, if the applicant is a corporation or Accreditation with the Department of Trade and Industry, if the applicant is a single proprietor or Articles of Partnership, if the applicant is a partnership.
- Special Power of Attorney, if applicable
Other Judicial Bonds (Supersedeas, Replevin, Attachment, Guardian’s, etc)
- Copy of the Complaint / Order of the Court / Copy of the Petition indicating the type of bond required.
- Duly-accomplished bond application form.
- Duly-accomplished bond co-indemnitor’s statement. Must at least be two (2). However, it may be waived if an acceptable collateral will be submitted by the applicant.
- Duly-signed Indemnity Agreement.
- Audited Financial Statement for the last two (2) years.
- Copy of a least two (2) valid IDs of the Principal and his/her co-indemnitors.
- Articles of Incorporation and By-Laws, if the applicant is a corporation.
- Accreditation with the Department of Trade and Industry, if the applicant is a single proprietor or Articles of Partnership, if the applicant is a partnership. or Individual Income Tax Return, if individual
- Secretary’s Certificate, if the applicant is a corporation.
- Articles of Incorporation and By-Laws, if the applicant is a corporation or Accreditation with the Department of Trade and Industry, if the applicant is a single proprietor or Articles of Partnership, if the applicant is a partnership.
Indemnity Bond for Lost Checks
- Affidavit of Loss.
- Stop Order Payment duly certified or received by the bank.
- Audited Financial Statement for the last two (2) years.
- Copy of a least two (2) valid IDs of the Principal and his/her co-indemnitors.
- Duly-accomplished bond application form.
- Duly-accomplished bond cosigner statement. Must at least be two (2).
- Duly-signed Indemnity Agreement.
- Articles of Incorporation and By-Laws, if the applicant is a corporation, accreditation with the Department of Trade and Industry, if the applicant is a single proprietor or Articles of Partnership, if the applicant is a partnership. or Individual Income Tax Return, if individual
- Copy of a least two (2) valid IDs of the authorized signatory and co-indemnitors.
General Surety Bond for Lost Stock Certificate
- Affidavit of Loss.
- Publisher's Affidavit of Publication as required by Republic Act No. 201
- Audited Financial Statement for the last two (2) years.
- Copy of a least two (2) valid IDs of the Principal and his/her co-indemnitors.
- Duly-accomplished bond application form.
- Duly-accomplished bond cosigner statement. Must at least be two (2).
- Duly-signed Indemnity Agreement.
- Articles of Incorporation and By-Laws, if the applicant is a corporation, accreditation with the Department of Trade and Industry, if the applicant is a single proprietor or Articles of Partnership, if the applicant is a partnership. or Individual Income Tax Return, if individual
- Copy of a least two (2) valid IDs of the authorized signatory and co-indemnitors.
Performance Bond for HLURB
- Registration Certificate and License to Sell issued by HLURB as required by Presidential Decree No. 957
- Audited Financial Statement for the last two (2) years.
- Copy of a least two (2) valid IDs of the Principal and his/her co-indemnitors.
- Company Profile which includes the management team, completed and present projects, to name a few
- Duly-accomplished bond application form.
- Duly-accomplished bond cosigner statement. Must at least be two (2).
- Duly-signed Indemnity Agreement.
- Articles of Incorporation and By-Laws, if the applicant is a corporation, accreditation with the Department of Trade and Industry, if the applicant is a single proprietor or Articles of Partnership, if the applicant is a partnership. or Individual Income Tax Return, if individual
- Copy of a least two (2) valid IDs of the authorized signatory and co-indemnitors.
II. Evaluate the underwriting information to determine the risk factors and degree of risk to be assumed. For reference, refer to PIRA's classification of bonds according to degree of risks.
III. Based on the risk involved, decide on the following matters:
- Whether to accept or not the risk.
- Whether to require collateral or not, if the decision is to accept the application. In case a collateral is required, the following additional documents are must be submitted: a. Deed of Assignment. b. Original Copy of the TCT or CCT or c. Original copy of the Certificate of Deposit or Original copy of the Stock Certificate.
IV. If the decision is to provide cover, refer to the PIRA Tariff Manual for the application of appropriate rates.
V. Determine how much of the total risk assumed should be retained and how much will be reinsured taking into account the nature of risk and current accumulation as of date of issuance.
Discuss and explain the purpose of each documentary requirement mentioned in the preceding item.
- Articles of Incorporation – To show the corporate status of the applicant and its corporate powers, particularly if the transaction of the applicant for whom the bond is required is within its corporate powers, the identities of the incorporators, and the capitalization of the corporation.
- Board Resolution of the Corporation or Secretary’s Certificate attesting to the adoption of such resolution – To show if the signatory has the authority to sign the bond and the indemnity agreement, thereby binding the corporation.
- List of Current Officers / Directors of corporate applicant certified by the Corporate Secretary – To identify the people currently managing the affairs of the bond applicant / co-signer.
- Articles of Partnership – To show the identity of the partners, the managing partner to sign and bind the partnership, and the capitalization of the partnership.
- Bond Application duly accomplished by the applicant – To show the bonafide intention of the applicant to secure the bond from the Surety company, other pertinent corporate information, and, if an individual applicant, to show his personal circumstances.
- Co-indemnitors – persons who agree to bind solidarily himself with the Principal in the faithful compliance with the principal contract.
- Co-indemnitor’s Information Sheet - To show the bonafide intention of the proposed cosigner to bind solidarily himself with the bond applicant and to disclose pertinent corporate information or the personal circumstances of the individual cosigner.
- Latest Audited Financial Statements – To determine if the applicant and/or his co-indemnitors has the financial capacity to undertake the proposed project and comply with the undertaking of the bond.
- Certificate of Registration of Business Name – if the applicant is an individual or the co-indemnitor – To show if the applicant is an enterprise duly registered wit the Bureau of Domestic Trade.
- Certificate of Employment and Annual Income – to determine the employment status and financial capability of the applicant / cosigner
When is collateral needed?
The submission of collateral is required in case of high risk accounts such as guaranty payment and judicial bonds. Surety Bond is supposed to be a “no loss” contract.
If the Principal submits collateral, the Surety may provide a 50% discount in the premium rate. (Circular Letter of the Insurance Commission (1995), Rule 3(a)
FINANCIAL RATIOS
What are the important financial ratios that need to be determined in order to determine the financial health of a bond applicant?
Profitability Ratio – measures the firm’s ability to generate income. It measures the ability of a firm to generate returns on its stockholders’ and owners’ investment.
Return on Assets Ratio – Measures profit per peso of assets
Formula : Net Income/Average Total Assets
Return on Equity Ratio – measures profits per peso of stockholders’ investment in the firm.
Formula : Net Income/Average Total Equity
Liquidity Ratio – Measures the applicant’s ability to convert assets into liquid assets.
Net Working Capital – measures the ability of the firm to function after settling maturing obligations.
Formula : Current Assets – Current Liabilities
Current Ratio – refers to the ability of a firm to meet current obligations.
Formula : Current Assets/Current Liabilities
Acid Test Ratio – shows the ability of a firm to meet its short term maturing obligations without relying on the sale of its inventories
Formula : (Current Asset – Inventories)/Current Liabilities
Leverage Ratio measures to what extent the firm is financed by debt.
Debt-to-Asset Ratio – measures to what extent the firm is financed by debt.
Formula : Total Debts/Total Assets
CLAIMS
What is the nature of Surety's undertaking?
- Its liability is accessory but direct. The Surety's obligation is not an original and direct one. It is merely accessory to the obligation contracted by the Principal. Surety is directly, primarily, and equally bound with the Principal although he possesses no direct or personal interest over the latter's obligations nor does he receive any benefits therefrom. (Garcia Jr vs Court of Appeals, 191 SCRA 493 [1990])
- It is conditional. Its liability arises only if the Principal is held liable.
- Is not entitled to benefit of exhaustion.
How is a contract of suretyship interpreted?
The “complementary-contracts-construed-together’ doctrine shall apply to a contract of suretyship. According to this doctrine, the accessory contract must be construed with the principal agreement.
If there had been any doubt on the terms and conditions of the surety agreement, the doubt should be resolved in favor of the surety. As concretely put in Article 2055 of the Civil Code, "A guaranty is not presumed, it must be expressed and cannot extend to more than what is stipulated therein." The extent of the surety's liability is determined only by the clause of the contract of suretyship as well as the conditions of the bond. It cannot be extended by implication beyond the terms of the contract. (Philippine Commercial and Industrial Bank vs Court of Appeals, 159 SCRA 24 [1988]), Umali vs Court of Appeals, 198 SCRA 529 [1990]), Philippine National Bank vs Court of Appeals 198 SCRA 767 [1991])
Does the Surety have the right to intervene in the Principal Contract?
The acceptance does not give the Surety the right to intervene in the Principal Contract because it is not a party to the Principal Contract. The Surety’s role arises only upon the Principal’s default, at which time, it can be directly held liable by the Obligee for payment as a solidary obligor. (Stronghold Insurance Co. Inc. v. Tokyu Construction Co. Ltd, G.R. Nos. 158820-21, [5 June 2009])
What is time-bar provision?
It is the deadline within which the Obligee should file a claim against the Surety and, it is counted either from the default of the Principal and or the expiration of the bond.
The purpose of this provision in the performance bond is to give the Principal, notice of the claim at the earliest possible time and to afford the Surety sufficient time to evaluate, and examine the validity of the claim while the evidence or indicators of breach are fresh. In the construction industry, time is precious, delay costs money and postponement in making a claim could cause additional expenses. (Prudential Guarantee and Assurance Inc vs. Anscor Land Inc. G.R. No. 177240 [September 8, 2010])
Liability on a bond is contractual in nature and is ordinarily restricted to the obligation expressly assumed therein. The Supreme Court have repeatedly held that the extent of a Surety's liability is determined only by the clause of the contract of suretyship and by the conditions stated in the bond. It cannot be extended by implication beyond the terms of the contract. Equally basic is the principle that obligations arising from contracts have the force of law between the parties and should be complied with in good faith. Nothing can stop the parties from establishing stipulations, clauses, terms and conditions as they may deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy. Here, nothing in the records shows the invalidity of the written claim provision; therefore, the parties must strictly and in good faith comply with this requirement. (Philippine Charter Insurance Corporation vs Philippine National Construction Corporation G.R. No. 185066 [October 2, 2009])
What are the 3 kinds of default?
- Mora solvendi – it is a default on the part of the Principal. In this case, the bond will respond to the claim of the Obligee.
- Mora accipiendi – it is a default on the part of the Obligee. In this case, the bond will not respond because default is not attributable to the Principal.
- Compensatio morae – it is a default on the part of both the Principal and Obligee in reciprocal obligations. In this case, offsetting will apply. The liability of the Surety is mitigated if the Obligee is partly to be blamed in the delay to the project.
What are the requisites for default?
- Obligation must be due, demandable, and liquidated
- Principal fails to perform his positive obligation on the date agreed upon
- A judicial or extra-‐judicial demand made by the Obligee upon the Principal to fulfill, perform or comply with his obligation
- Failure of the Principal to comply with such demand from the Obligee.
When is the Principal deemed in default?
Delay arises from the time the Obligee judicially or extra-judicially demands from the Principal the performance of the obligation, and the latter fails to comply. (Social Security System vs. Moonwalk Development & Housing Corp., G.R. No. 73345, [7 April 1993]).
Delay, as used in Article 1169, is synonymous with default or mora, which means delay in the fulfilment of obligations. It is the non-fulfillment of an obligation with respect to time. In order for the debtor (in this case, the Surety) to be in default, it is necessary that the following requisites be present: (1) that the obligation be demandable and already liquidated; (2) that the debtor delays performance; and (3) that the creditor requires the performance judicially or extra-judicially. (Santos Ventura Hocorma Foundation, Inc. v. Santos, 484 Phil. 447 [2004], citing IV Arturo M. Tolentino, Civil Code of the Philippines, 101-102 (1987 ed.)
The civil law concept of delay or default commences from the time the obligor demands, judicially or extrajudicially, the fulfillment of the obligation from the Obligee. In legal parlance, demand is the assertion of a legal or procedural right. Hence, Principal incurred delay from the time Obligee called its attention that it had breached the contract and extrajudicially demanded the fulfillment of its commitment against the bonds. It is the Principal's culpable delay, not merely the time element, which gives the Obligee the right to seek the performance of the obligation. As such, Obligee's cause of action accrued from the time that Principal became in culpable delay as contemplated in the surety and performance bonds. (Philippine Charter Insurance Corporation vs. Central Colleges of the Philippines and Dynamic Planners and Construction Corporation, G.R. No. 180631-33 [February 22, 2012])
What are the causes of extinguishment of a Contract of Suretyship?
- Payment or performance:
- By the loss of the thing due:
- By the condonation or remission of the debt;
- By the confusion or merger of the rights of creditor and debtor;
- By compensation;
- By novation.
What is novation?
A Surety is released from its obligation when there is a material alteration of the contract in connection with which the bond is given, such as a change which imposes a new obligation on the promising party, or which takes away some obligation already imposed, or one which changes the legal effect of the original contract and not merely its form. A Surety, however, is not released by a change in the contract which does not have the effect of making its obligation more onerous. (Intra-Strata Assurance Corporation v. Republic, 579 Phil. 631, 644 (2008) [Per J. Brion, Second Division], citing NASSCO v. Torrento, G.R. No. L-21109, June 26, 1967, 20 SCRA 427 [Per J. Makalintal, En Banc]
Novation is defined as the extinguishment of an obligation by the substitution or change of the obligation by a subsequent one which terminates the first, either by changing the object or principal conditions, or by substituting the person of the debtor, or subrogating a third person in the rights of the creditor.
The Civil Code further provides: Article 1292. In order that an obligation may be extinguished by another which substitute the same, it is imperative that it be so declared in unequivocal terms, or that the old and the new obligations be on every point incompatible with each other.
The cancellation of the old obligation by the new one is a necessary element of novation which may be effected either expressly or impliedly. While there is really no hard and fast rule to determine what might constitute sufficient change resulting in novation, the touchstone, however, is irreconcilable incompatibility between the old and the new obligations. (Reyes v. BPI Family Savings Bank, Inc., 520 Phil. 801, 806-807 [2006])
What is material alteration and its effects?
A Surety is released from its obligation when there is a material alteration of the principal contract in connection with which the bond is given, such as a change which imposes a new obligation on the promising party, or which takes away some obligation already imposed, or one which changes the legal effect of the original contract and not merely its form. However, a surety is not released by a change in the contract, which does not have the effect of making its obligation more onerous. (CCC Insurance Corporation vs Kawasaki Steel Corporation and FF Manacop Construction Co., Inc, et al G.R. No. 156162 [June 22, 2015]
What is liquidated damages?
Liquidated damages are agreed upon by the contracting parties, either by way of penalty or in order to avoid controversy on the determination of amount of damages.
Liability for liquidated damages is governed by Articles 2226 to 2228 of the Civil Code, which provide:
ART. 2226. Liquidated damages are those agreed upon by the parties to a contract, to be paid in case of breach thereof.
ART. 2227. Liquidated damages, whether intended as an indemnity or a penalty, shall be equitably reduced if they are iniquitous or unconscionable.
ART. 2228. When the breach of the contract committed by the defendant is not the one contemplated by the parties in agreeing upon the liquidated damages, the law shall determine the measure of damages, and not the stipulation.
A stipulation for liquidated damages is attached to an obligation in order to ensure performance and has a double function: (1) to provide for liquidated damages, and (2) to strengthen the coercive force of the obligation by the threat of greater responsibility in the event of breach. The amount agreed upon answers for damages suffered by the owner due to delays in the completion of the project. As a precondition to such award, however, there must be proof of the fact of delay in the performance of the obligation. (J Plus Asia Development Corporation vs Utility Assurance Corporation, G.R. No. 199650 [June 26, 2013])
The principal would then be bound to pay the stipulated indemnity without the necessity of proof on the existence and on the measure of damages caused by the breach. It is well-settled that so long as such stipulation does not contravene law, morals, or public order, it is strictly binding upon the principal. (Suatengco v. Reyes, G.R. No. 162729, December 17, 2008, 574 SCRA 187, 194, citing Ligutan v. Court of Appeals, G.R. No. 138677 [February 12, 2002, 376 SCRA 560, 567-568])
Cite an example wherein liquidated damages was deemed iniquitous or unconscionable.
In Filinvest Land Inc. vs. Court of Appeals, Philippine American General Insurance Company, and Pacific Equipment Corporation [G.R. No.138980 September 20, 2005]), the trial court ruled that the penalty charge for delay – pegged at P15,000.00 per day of delay in the aggregate amount of P3,990,000.00 was excessive and accordingly reduced it to P1,881,867.66 "considering the amount of work already performed and the fact that [Filinvest] consented to three (3) prior extensions."
The Supreme Court agreed with the trial court that a penalty interest of P15,000.00 per day of delay as liquidated damages or P3,990,000.00 (representing 32% penalty of the P12,470,000.00 contract price) is unconscionable considering that the construction was already not far from completion at 94.53%. Moreover, Filinvest did agree to extend the period for completion of the project, which extensions Filinvest included in computing the amount of the penalty, the reduction thereof is clearly warranted.
The judge shall equitably reduce the penalty when the principal obligation has been partly or irregularly complied with by the debtor. Even if there has been no performance, the penalty may also be reduced by the courts if it is iniquitous or unconscionable (Art. 1229, New Civil Code).
What is the industry practice on liquidated damages?
The construction industry practice is that liquidated damages do not accrue after the date of substantial completion of the project, as evidenced in CIAP Document No. 102, which provides that:
20.11 SUBSTANTIAL COMPLETION AND ITS EFFECT:
A. [a] There is substantial completion when the Contractor completes 95% of the Work, provided that the remaining work and the performance of the work necessary to complete the Work shall not prevent the normal use of the completed portion.
xxx
D. [a] No liquidated damages for delay beyond the Completion Time shall accrue after the date of substantial completion of the Work.
In Diesel Construction Co., Inc. v. UPSI Property Holdings, Inc. (G.R. No. 154885, March 24, 2008, 549 SCRA 12.), Supreme Court applied Article 1234 of the Civil Code. In determining what is considered substantial compliance, Supreme Court used the CIAP Document No. 102 as evidence of the construction industry practice that substantial compliance is equivalent to 95% accomplishment rate. In that case, the construction agreement requires the contractor "to pay the owner liquidated damages in the amount equivalent to one-fifth (1/5) of one (1) percent of the total Project cost for each calendar day of delay." Supreme Court declared that the contractor cannot be liable for liquidated damages because it already accomplished 97.56% of the project.
This was reiterated Transcept Construction and Management Professionals, Inc. v. Aguilar (G.R. No. 177556, December 8, 2010, 637 SCRA 574) where we ruled that since the contractor accomplished 98.16% of the project, the project owner is not entitled to the 10% liquidated damages.
As expressly stated under Articles 1234 and 1376, and in jurisprudence, the construction industry's prevailing practice may supplement any ambiguities or omissions in the stipulations of the contract.
The Civil Code provides:
Art. 1234. If the obligation has been substantially performed in good faith, the obligor may recover as though there had been a strict and complete fulfillment, less damages suffered by the obligee.
Art. 1376. The usage or custom of the place shall be borne in mind in the interpretation of the ambiguities of a contract, and shall fill the omission of stipulations which are ordinarily established.
Notably, CIAP Document N0. 102, by itself, was intended to have suppletory effect on private construction contracts. This is evident in CIAP Board Resolution No. 1-98 (Implementing Rules and Regulations of Presidential Decree No. 1746 titled "An Act Creating the Construction Industry Authority of the Philippines.") which states:
Sec. 9. Policy-Making Body, - The [CIAP], through the CIAP Executive Office and its various Implementing Agencies, shall continuously monitor and study the operations of the construction industry, both domestic and overseas operations, to identify its needs, problems and opportunities, in order to provide for the pertinent policies and/or executive action and/or legislative agenda necessary to implement plans, programs and measures required to support the sustainable development of the construction industry, such as but not limited to the following:
x x x
9.05 The promulgation and adoption of Standard Conditions of Contract for the public construction and private construction sector which shall have suppletory effect in cases where there is a conflict in the internal documents of a construction contract or in the absence of the general conditions of a construction agreement[.]
As the standard conditions for contract for private construction adopted and promulgated by the CIAP, CIAP Document No. 102 applies suppletorily to private construction contracts to remedy the conflict in the internal documents of, or to fill in the omissions in, the construction agreement. (See Werr Corporation International, Petitioner Vs. Highlands Prime Inc., Respondent (G.R. No. 187543 [February 8, 2017]); Highlands Prime, Inc., Petitioner, Vs. Werr Corporation International, Respondent. G.R. No. 187580 [February 8, 2017])
What is the basis for the Surety's right of reimbursement aside from the Indemnity Agreement?
The rights of a guarantor who pays for the debt of the debtor are governed by the following provisions of the Civil Code:
Art. 2066. The guarantor (or Surety) who pays for a debtor must be indemnified by the latter.
The indemnity comprises:
- The total amount of the debt;
- The legal interests thereon from the time the payment was made known to the debtor, even though it did not earn interest for the creditor;
- The expenses incurred by the guarantor after having notified the debtor that payment had been demanded of him;
- Damages, if they are due.
Art. 2067. The guarantor who pays is subrogated by virtue thereof to all the rights which the creditor had against the debtor.
If the guarantor has compromised with the creditor, he cannot demand of the debtor more than what he has really paid.
Can the surety demand payment against the Principal even though Surety has yet to pay the Obligee?
The stipulation in the indemnity agreement allowing the surety to recover even before it paid the creditor is enforceable. In accordance therewith, the surety may demand from the indemnitors even before paying the creditors. (Security Bank vs Globe Assurance, 58 Off. Gaz. 3708 [April 30, 1962])
In the case of Alto Surety and Insurance Co., Inc. vs. Aguilar, et al., G.R. No. L-5625, March 16, 1954, the Court laid down the following ruling:
The contention of appellants that the action of appellee (surety company) is premature or that complaint fails to state a cause of action because it does not allege that the appellee has paid to the bank the balance of their obligation, cannot be sustained. This is belied not only by the allegations of the complaint but also by the agreement entered into between the appellants and the appellee in favor of the bank. Thus, it appears from the complaint that the renewed promissory note became due and payable on May 27, 1950 without the spouses having paid any amount on the account in spite of the repeated demands, as a consequence of which plaintiff surety became liable to pay the bank the amount of P1,150.00 plus interests, under the terms of the Indemnity Agreement, the liability of the former as surety became immediately demandable upon occurrence of the latter's (spouses) default.
Even after analyzing the provisions of the contract entered into between the parties, we are of the opinion that they do not in any way militate against the public good or that they are contrary to the policy of the law. (The Cosmopolitan Insurance Co., Inc vs Angel B. Reyes, G.R. No. L-20199 [November 23, 1965])
Moreover, Art. 2071 of the New Civil Code provides:
The guarantor, even before having paid, may proceed against the principal debtor:
- When he is sued for the payment;
- In case of insolvency of the principal debtor;
- When the debtor has bound himself to relieve him from the guaranty within a specified period, and this period has expired;
- When the debt has become demandable, by reason of the expiration of the period for payment;
- After the lapse of ten years, when the principal obligation has no fixed period for its maturity, unless it be of such nature that it cannot be extinguished except within a period longer than ten years;
- If there are reasonable grounds to fear that the principal debtor intends to abscond;
- If the principal debtor is in imminent danger of becoming insolvent.
- In all these cases, the action of the guarantor is to obtain release from the guaranty, or to demand a security that shall protect him from any proceedings by the creditor and from the danger of insolvency of the debtor.
What is cost overrun?
It also known as a cost increase, underrated or budget overrun, involves unexpected costs incurred in excess of budgeted amounts due to an underestimation of the actual cost during budgeting.
Cost overrun can be described in multiple ways.
- As a percentage of the total expenditure
- As a total percentage including and above the original budget
- As a percentage of the cost overruns to original budget
Cost overrun can be described in multiple ways. For example, consider a bridge with a construction budget of $100 million where the actual cost was $150 million. This scenario could be truthfully represented by the following statement:
- As a percentage of the total expenditure: The cost overruns constituted 33% of the total expense.
- As a total percentage including and above the original budget: The budget for the bridge increased to 150%.
- As a percentage of the cost overruns to original budget: The cost overruns exceeded the original budget by 50% (Wikipedia)
How do you compute cost overrun?
Cost overrun is determined by computing the difference between the original contract cost vs the new contract cost to complete the project.
Discuss the jurisdiction of the Construction Industry Arbitration Commission.
The jurisdiction of the Construction Industry Arbitration Commission (CIAC) is conferred by law. Section 41 of Executive Order (E.O.) No. I 008, otherwise known as the Construction Industry Arbitration Law, "is broad enough to cover any dispute arising from, or connected with construction contracts, whether these involve mere contractual money claims or execution of the works." (LICOMCEN, lncorporated v. Foundation Specialists, Inc., [G.R. Nos. 167022 and 169678. April 4, 2011, 647 SCRA 83, 91])
Section 4 of E.O. No. 1008 provides that:
SEC. 4. Jurisdiction. – The CIAC shall have original and exclusive jurisdiction over disputes arising from, or connected with, contracts entered into by parties involved in construction in the Philippines, whether the dispute arises before or after the completion of the contract, or after the abandonment or breach thereof. These disputes may involve government or private contracts. For the Board to acquire jurisdiction, the parties to a dispute must agree to submit the same to voluntary arbitration.
The jurisdiction of the CIAC may include but is not limited to violation of specifications for materials and workmanship, violation of the terms of agreement, interpretation and/or application of contractual time and delays, maintenance and defects, payment, default of employer or contractor, and changes in contract cost.
Excluded from the coverage of the law are disputes arising from employer-employee relationships which shall continue to be covered by the Labor Code of the Philippines.
Based on the foregoing, in order for the CIAC to acquire jurisdiction two requisites must concur: "first, the dispute must be somehow connected to a construction contract; and second, the parties must have agreed to submit the dispute to arbitration proceedings."
The Supreme Court rejected the argument that the jurisdiction of CIAC is limited to the construction industry, and thus, cannot extend to surety contracts. In that case, we declared that "although not the construction contract itself, the performance bond is deemed as an associate of the main construction contract that it cannot be separated or severed from its principal. The Performance Bond is significantly and substantially connected to the construction contract that there can be no doubt it is the CIAC, under Section 4 of E.O. No. 1008, which has jurisdiction over any dispute arising from or connected with it. (Prudential Guarantee and Assurance, Inc. v. Anscor Land, Inc., [G.R. No. 177240, September 8, 2010, 630 SCRA 368, 376]).
Can the factual finding of CIAC be reviewed by the appellate courts?
As a general rule, no. Factual findings by a quasi-judicial body like the CIAC, which has acquired expertise because its jurisdiction is confined to specific matters, are accorded not only with respect but even finality if they are supported by substantial evidence. The Supreme Court recognize that certain cases require the expertise, specialized skills, and knowledge of the proper administrative bodies because technical matters or intricate questions of facts are involved.
However, there are exceptions. The petitioner must affirmatively prove the following:
- the award was procured by corruption, fraud, or other undue means;
- there was evident partiality or corruption of the arbitrators or any of them;
- the arbitrators were guilty of misconduct in refusing to hear evidence pertinent and material to the controversy;
- one or more of the arbitrators were disqualified to act as such under Section 10 of Republic Act No. 876 and willfully refrained from disclosing such disqualifications or of any other misbehavior by which the rights of any party have been materially prejudiced;
- the arbitrators exceeded their powers, or so imperfectly executed them, that a mutual, final, and definite award upon the subject matter submitted to them was not made;
- when there is a very clear showing of grave abuse of discretion resulting in lack or loss of jurisdiction as when a party was deprived of a fair opportunity to present its position before the arbitral tribunal or when an award is obtained through fraud or the corruption of arbitrators;
- when the findings of the CA are contrary to those of the CIAC; or
- when a party is deprived of administrative due process. (Werr Corporation International, Petitioner Vs. Highlands Prime Inc., Respondent (G.R. No. 187543 [February 8, 2017]); Highlands Prime, Inc., Petitioner, Vs. Werr Corporation International, Respondent. G.R. No. 187580 [February 8, 2017])
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