Case Digest: Country Bankers Insurance Corp. v. Lagman, G.R. No. 165487, July 13, 2011

Commercial Law | Novation

Facts: 

• Nelson Santos applied for a license with the National Food Authority (NFA) to store not more than 30,000 sacks of palay in his warehouse in Tarlac.
• Under General Bonded Warehouse Act, the approval for said license was conditioned upon posting of a cash bond secured by real estate signed by a duly authorized bonding company, the amount of which shall be fixed by the NFA Administrator at not less than thirty-three and one third percent (33 1/3%) of the market value of the maximum quantity of rice to be received. 
• In 1989, Country Bankers Insurance Corporation issued Warehouse Bonds for Santos, secured by an indemnity agreements.
• Value:
• Warehouse Bond No. 033044 — ₱1,749,825.00
• Warehouse Bond No. 023555 —₱749,925.00
• Parties:
• Nelson Santos — bond principal
• Antonio Lagman, agent of Country Bankers — surety 
• Republic of the Philippines, through the NFA  —  obligee
• Indemnity Agreements:
• Executed by Santos, as bond principal, together with Ban Lee Lim Santos, Rhosemelita Reguine and Antonio Lagman, as co-signors binding themselves jointly and severally liable to Country Bankers.
• In 1990, Santos alleged that Country Bankers issued another warehouse bond which was also valid for one year without Indemnity Agreement.
• Santos then secured a loan using his warehouse receipts as collateral. Santos defaulted in his payment. The sacks of palay covered by the warehouse receipts were no longer found in the bonded warehouse.
• By virtue of the surety bonds, Country Bankers was compelled to pay ₱1,166,750.37.
• Santos defaulted on a loan, and the palay covered by the bonds was missing, leading Country Bankers to pay ₱1,166,750.37.
• Country Bankers filed a complaint for sum of money against Lagman and Reguine, seeking reimbursement.
• Lagman claimed that the bonds expired after a year and the 1990 Bond superseded them.
• RTC-Manila: Held Lagman and Reguine jointly and severally liable based on the indemnity agreement.
• The bonds remained in force unless cancelled by the NFA Administrator.
• CA: Reversed the decision of the RTC, ordering the dismissal of the complaint filed against Lagman.
• The 1990 Bond superseded the 1989 Bonds. 
• The 1990 Bond covers 33.3% of the market value of the palay, thereby manifesting the intention of the parties to make the latter bond more comprehensive.

Issue: 

• Whether the subject surety bonds were superseded by a subsequent bond notwithstanding the non-cancellation thereof by the bond obligee. YES 

Held:

Country Bankers maintains that by the express terms of the 1989 Bonds, they shall remain in full force until cancelled by the Administrator of the NFA. As continuing bonds, Country Bankers avers that Section 177 of the Insurance Code applies, in that the bond may only be cancelled by the obligee, by the Insurance Commissioner or by a competent court.

Country Bankers questions the existence of a third bond, the 1990 Bond, which allegedly cancelled the 1989 Bonds on the following grounds: First, Lagman failed to produce the original of the 1990 Bond and no basis has been laid for the presentation of secondary evidence; Second, the issuance of the 1990 Bond was not approved and processed by Country Bankers; Third, the NFA as bond obligee was not in possession of the 1990 Bond. Country Bankers stresses that the cancellation of the 1989 Bonds requires the participation of the bond obligee. Ergo, the bonds remain subsisting until cancelled by the bond obligee. Country Bankers further assert that Lagman also failed to prove that the NFA accepted the 1990 Bond in replacement of the 1989 Bonds.

Country Bankers notes that the receipts issued for the 1989 Bonds are mere evidence of premium payments and should not be relied on to determine the period of effectivity of the bonds. Country Bankers explains that the receipts only represent the transactions between the bond principal and the surety, and does not involve the NFA as bond obligee.

Country Bankers calls this Court’s attention to the incontestability clause contained in the Indemnity Agreements which prohibits Lagman from questioning his liability therein.

In his Comment, Lagman raises the issue of novation by asserting that the 1989 Bonds were superseded by the 1990 Bond, which did not include Lagman as party. Therefore, Lagman argues, Country Bankers has no cause of action against him. Lagman also reiterates that because of novation, the 1989 bonds are neither perpetual nor continuing.

Lagman anchors his defense on two (2) arguments: 1) the 1989 Bonds have expired and 2) the 1990 Bond novates the 1989 Bonds.

The Court of Appeals held that the 1989 bonds were effective only for one (1) year, as evidenced by the receipts on the payment of premiums.

We do not agree.

The official receipts in question serve as proof of payment of the premium for one year on each surety bond. It does not, however, automatically mean that the surety bond is effective for only one (1) year. In fact, the effectivity of the bond is not wholly dependent on the payment of premium. Section 177 of the Insurance Code expresses:

Sec. 177. The surety is entitled to payment of the premium as soon as the contract of suretyship or bond is perfected and delivered to the obligor. No contract of suretyship or bonding shall be valid and binding unless and until the premium therefor has been paid, except where the obligee has accepted the bond, in which case the bond becomes valid and enforceable irrespective of whether or not the premium has been paid by the obligor to the surety: Provided, That if the contract of suretyship or bond is not accepted by, or filed with the obligee, the surety shall collect only reasonable amount, not exceeding fifty per centum of the premium due thereon as service fee plus the cost of stamps or other taxes imposed for the issuance of the contract or bond: Provided, however, That if the non-acceptance of the bond be due to the fault or negligence of the surety, no such service fee, stamps or taxes shall be collected. (Emphasis supplied)

The 1989 Bonds have identical provisions and they state in very clear terms the effectivity of these bonds, viz:

NOW, THEREFORE, if the above-bounded Principal shall well and truly deliver to the depositors PALAY received by him for STORAGE at any time that demand therefore is made, or shall pay the market value therefore in case he is unable to return the same, then this obligation shall be null and void; otherwise it shall remain in full force and effect and may be enforced in the manner provided by said Act No. 3893 as amended by Republic Act No. 247 and P.D. No. 4. This bond shall remain in force until cancelled by the Administrator of National Food Authority. 

This provision in the bonds is but in compliance with the second paragraph of Section 177 of the Insurance Code, which specifies that a continuing bond, as in this case where there is no fixed expiration date, may be cancelled only by the obligee, which is the NFA, by the Insurance Commissioner, and by the court. Thus:

In case of a continuing bond, the obligor 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.

By law and by the specific contract involved in this case, the effectivity of the bond required for the obtention of a license to engage in the business of receiving rice for storage is determined not alone by the payment of premiums but principally by the Administrator of the NFA. From beginning to end, the Administrator’s brief is the enabling or disabling document.

The clear import of these provisions is that the surety bonds in question cannot be unilaterally cancelled by Lagman. The same conclusion was reached by the trial court and we quote:

As there appears no record of cancellation of the Warehouse Bonds No. 03304 and No. 02355 either by the administrator of the NFA or by the Insurance Commissioner or by the Court, the Warehouse Bonds are valid and binding and cannot be unilaterally cancelled by defendant Lagman as general agent of the plaintiff. 

While the trial court did not directly rule on the existence and validity of the 1990 Bond, it upheld the 1989 Bonds as valid and binding, which could not be unilaterally cancelled by Lagman. The Court of Appeals, on the other hand, acknowledged the 1990 Bond as having cancelled the two previous bonds by novation. Both courts however failed to discuss their basis for rejecting or admitting the 1990 Bond, which, as we indicated, is bone to pick in this case.

Lagman’s insistence on novation depends on the validity, nay, existence of the allegedly novating 1990 Bond. Country Bankers understandably impugns both. We see the point. Lagman presented a mere photocopy of the 1990 Bond. We rule as inadmissible such copy.

Under the best evidence rule, the original document must be produced whenever its contents are the subject of inquiry. The rule is encapsulated in Section 3, Rule 130 of the Rules of Court, as follow:

Sec. 3. Original document must be produced; exceptions. — When the subject of inquiry is the contents of a documents, no evidence shall be admissible other than the original document itself, except in the following cases:

(a) When the original has been lost or destroyed, or cannot be produced in court, without bad faith on the part of the offeror;

(b) When the original is in the custody or under the control of the party against whom the evidence is offered, and the latter fails to produce it after reasonable notice;

(c) When the original consists of numerous accounts or other documents which cannot be examined in court without great loss of time and the fact sought to be established from them is only the general result of the whole; and

(d) When the original is a public record in the custody of a public officer or is recorded in a public office.

A photocopy, being a mere secondary evidence, is not admissible unless it is shown that the original is unavailable. Section 5, Rule 130 of the Rules of Court states:

SEC.5 When original document is unavailable. — When the original document has been lost or destroyed, or cannot be produced in court, the offeror, upon proof of its execution or existence and the cause of its unavailability without bad faith on his part, may prove its contents by a copy, or by a recital of its contents in some authentic document, or by the testimony of witnesses in the order stated.

Before a party is allowed to adduce secondary evidence to prove the contents of the original, the offeror must prove the following: 

1. the existence or due execution of the original;
2. the loss and destruction of the original or the reason for its non-production in court; and 
3. on the part of the offeror, the absence of bad faith to which the unavailability of the original can be attributed. 

• The correct order of proof is as follows: 
• existence
• execution
• loss and 
• contents.

In the case at bar, Lagman mentioned during the direct examination that there are actually four (4) duplicate originals of the 1990 Bond: the first is kept by the NFA, the second is with the Loan Officer of the NFA in Tarlac, the third is with Country Bankers and the fourth was in his possession. A party must first present to the court proof of loss or other satisfactory explanation for the non-production of the original instrument.

When more than one original copy exists, it must appear that all of them have been lost, destroyed, or cannot be produced in court before secondary evidence can be given of any one. A photocopy may not be used without accounting for the other originals.

Despite knowledge of the existence and whereabouts of these duplicate originals, Lagman merely presented a photocopy. He admitted that he kept a copy of the 1990 Bond but he could no longer produce it because he had already severed his ties with Country Bankers. However, he did not explain why severance of ties is by itself reason enough for the non-availability of his copy of the bond considering that, as it appears from the 1989 Bonds, Lagman himself is a bondsman. Neither did Lagman explain why he failed to secure the original from any of the three other custodians he mentioned in his testimony. While he apparently was able to find the original with the NFA Loan Officer, he was merely contented with producing its photocopy. Clearly, Lagman failed to exert diligent efforts to produce the original.

Fueling further suspicion regarding the existence of the 1990 Bond is the absence of an Indemnity Agreement. While Lagman argued that a 1990 Bond novates the 1989 Bonds, he raises the defense of "non-existence of an indemnity agreement" which would conveniently exempt him from liability. The trial court deemed this defense as indicia of bad faith, thus:

To the observation of the Court, defendant Lagman contended that being a general agent (which requires a much higher qualification than an ordinary agent), he is expected to have attended seminars and workshops on general insurance wherein he is supposed to have acquired sufficient knowledge of the general principles of insurance which he had fully practised or implemented from experience. It somehow appears to the Court’s assessment of his reneging liability of the bonds in question, that he is still short of having really understood the principle of suretyship with reference to the transaction of indemnity in which he is a signatory. If, as he alleged, that he is well-versed in insurance, the Court finds no excuse for him to stand firm in denying his liability over the claim against the bonds with indemnity provision. If he insists in not recognizing that liability, the more that this Court is convinced that his knowledge that insurance operates under the principle of good faith is inadequate. He missed the exception provided by Section 177 of the Insurance Code, as amended, wherein non-payment of premium would not have the same essence in his mind that the agreements entered into would not have full force or effect. It could be glimpsed, therefore, that the mere fact of cancelling bonds with indemnity agreements and replacing them (absence of the same) to escape liability clearly manifests bad faith on his part.

Having discounted the existence and/or validity of the 1990 Bond, there can be no novation to speak of. Novation is the extinguishment of an obligation by the substitution or change of the obligation by a subsequent one which extinguishes or modifies the first, either by changing the object or principal conditions, or by substituting another in place of the debtor, or by subrogating a third person in the rights of the creditor. 

For novation to take place, the following requisites must concur: 

1. There must be a previous valid obligation;
2. The parties concerned must agree to a new contract;
3. The old contract must be extinguished; and 
4. There must be a valid new contract.

In this case, only the first element of novation exists. 

Indeed, there is a previous valid obligation, i.e., the 1989 Bonds. There is however neither a valid new contract nor a clear agreement between the parties to a new contract since the very existence of the 1990 Bond has been rendered dubious. Without the new contract, the old contract is not extinguished.

Implied novation necessitates a new obligation with which the old is in total incompatibility such that the old obligation is completely superseded by the new one. Quite obviously, neither can there be implied novation. In this case, there is no new obligation.

The liability of Lagman is expressed in Indemnity Agreements executed in consideration of the 1989 Bonds which we have considered as continuing contracts. Under both Indemnity Agreements, Lagman, as co-signor, together with Santos, Ban Lee Lim and Reguine, bound themselves jointly and severally to Country Bankers to indemnify it for any damage or loss sustained on the account of the execution of the bond, among others. The pertinent identical stipulations of the Indemnity Agreements state:

INDEMNITY: ─ To indemnify and make good to the COMPANY jointly and severally, any damages, prejudice, loss, costs, payments advances and expenses of whatever kind and nature, including attorney’s fees and legal costs, which the COMPANY may, at any time, sustain or incur, as well as to reimburse to said COMPANY all sums and amounts of money which the COMPANY or its representatives shall or may pay or cause to be paid or become liable to pay, on account of or arising from the execution of the above-mentioned BOND or any extension, renewal, alteration or substitution thereof made at the instance of the undersigned or anyone of them.

Moreover, the Indemnity Agreements also contained identical Incontestability Clauses which provide:

INCONTESTABILITY OF PAYMENTS MADE BY THE COMPANY: ─ Any payment or disbursement made by the COMPANY on account of the above-mentioned Bond, its renewals, extensions, alterations or substitutions either in the belief that the COMPANY was obligated to make such payment or in the belief that said payment was necessary or expedient in order to avoid greater losses or obligations for which the COMPANY might be liable by virtue of the terms of the above-mentioned Bond, its renewals, extensions, alterations, or substitutions, shall be final and shall not be disputed by the undersigned, who hereby jointly and severally bind themselves to indemnify [Country Bankers] of any and all such payments, as stated in the preceding clauses.

In case the COMPANY shall have paid[,] settled or compromised any liability, loss, costs, damages, attorney’s fees, expenses, claims[,] demands, suits, or judgments as above-stated, arising out of or in connection with said bond, an itemized statement thereof, signed by an officer of the COMPANY and other evidence to show said payment, settlement or compromise, shall be prima facie evidence of said payment, settlement or compromise, as well as the liability of the undersigned in any and all suits and claims against the undersigned arising out of said bond or this bond application.

Lagman is bound by these Indemnity Agreements. Payments made by Country Bankers by virtue of the 1989 Bonds gave rise to Lagman’s obligation to reimburse it under the Indemnity Agreements. Lagman, being a solidary debtor, is liable for the entire obligation.

WHEREFORE, the petition is GRANTED. The assailed Decision and Resolution of the Court of Appeals in CA-G.R. CV No. 61797 are SET ASIDE and the Decision dated 21 September 1998 of the RTC is hereby REINSTATED.

SO ORDERED.