Case Digest: Security Bank and Trust Company, Inc. v. Cuenca, G.R. No. 138544, October 3, 2000

Commercial Law | Novation

Facts: 

• Sta. Ines Melale Corporation (Sta. Ines) is engaged in logging operations with a Timber License Agreement from DENR.
• On November 10, 1980, Security Bank and Trust Co. granted Sta. Ines a ₱8 million credit line for logging operations.
• The Credit Approval Memorandum specified terms and joint  conditions, valid until November 30, 1981.
• Sta. Ines and Rodolfo M. Cuenca, President and Chairman of the Board of Directors, executed Chattel Mortgage and Indemnity Agreement to secure the loan.
• The Agreement states that:
• Rodolfo M. Cuenca binds himself  jointly and severally with the client (SIMC) in favor of the bank for the payment, upon demand and without the benefit of excussion of whatever amount the client may be indebted to the bank by virtue of aforesaid credit accommodation(s) including the substitutions, renewals, extensions, increases, amendments, conversions and revivals of the aforesaid credit accommodation(s).
• On November 26, 1981, Sta. Ines drew ₱6.1 million from the credit line.
• Sta. Ines duly executed a promissory note for said amount.
• In 1985, Cuenca resigned from Sta. Ines and his shares were sold to Adolfo Angala in a public auction.
• Sta. Ines obtained six additional loans totaling ₱6,369,019.50 from Security Bank.
• Sta. Ines also executed a promissory notes to cover said amount.
• However, Sta. Ines encountered difficulty in making the amortization payments on its loans and requested Security Bank. for a complete restructuring of its indebtedness
• In February 1988, Security Bank approved a restructuring of Sta. Ines' debts without Cuenca's notice or consent.
• Sta. Ines executed promissory notes totaling to ₱12.2 million dated March 9, 1988.
• ₱8.8 million + ₱3.4 million
• A Loan Agreement dated October 31, 1989, formalized the restructuring.
• Sta. Ines defaulted on restructured loans despite demands from Security Bank upon Sta. Ines and Cuenca.
• Sta. Ines was able to pay ₱1.757 million.
• Security Bank filed a complaint for sum of money.

RTC-Makati: Ordered Sta. Ines Melale Corporation and Rodolfo M. Cuenca to pay, jointly and severally, Security Bank & Trust Company the sum of ₱39,129,124.73.

CA: Modified the decision of RTC, Ruled that the 1989 Loan Agreement novated the 1980 credit accommodation, extinguishing Cuenca's liability.

• Cuenca held liable only for loans obtained before November 30, 1981, up to ₱8 million.
• Restructuring without Cuenca's consent was tantamount to a grant of an extension of time to the debtor without the consent of the surety and extinguished the surety agreement under Article 2079 of the Civil Code.

Issue: 

• Whether the 1989 Loan Agreement novated the original credit accommodation and Cuenca’s liability under the Indemnity Agreement. YES 

Held:

First Issue: Original Obligation Extinguished by Novation

An obligation may be extinguished by novation, pursuant to Article 1292 of the Civil Code, which reads as follows:

"ART. 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."

Novation of a contract is never presumed. It has been held that "[i]n the absence of an express agreement, novation takes place only when the old and the new obligations are incompatible on every point."

Indeed, the following requisites must be established:

1. there is a previous valid obligation;
2. the parties concerned agree to a new contract;
3. the old contract is extinguished; and
4. there is a valid new contract. 

Petitioner contends that there was no absolute incompatibility between the old and the new obligations, and that the latter did not extinguish the earlier one. It further argues that the 1989 Agreement did not change the original loan in respect to the parties involved or the obligations incurred. It adds that the terms of the 1989 Contract were "not more onerous."  Since the original credit accomodation was not extinguished, it concludes that Cuenca is still liable under the Indemnity Agreement.

We reject these contentions. Clearly, the requisites of novation are present in this case. The 1989 Loan Agreement extinguished the obligation obtained under the 1980 credit accomodation. This is evident from its explicit provision to "liquidate" the principal and the interest of the earlier indebtedness, as the following shows:

"1.02. Purpose. The First Loan shall be applied to liquidate the principal portion of the Borrower’s present total outstanding Indebtedness to the Lender (the "Indebtedness") while the Second Loan shall be applied to liquidate the past due interest and penalty portion of the Indebtedness."

The testimony of an officer of the bank that the proceeds of the 1989 Loan Agreement were used "to pay-off" the original indebtedness serves to strengthen this ruling.

Furthermore, several incompatibilities between the 1989 Agreement and the 1980 original obligation demonstrate that the two cannot coexist. While the 1980 credit accommodation had stipulated that the amount of loan was not to exceed ₱8 million, the 1989 Agreement provided that the loan was ₱12.2 million. The periods for payment were also different.

Likewise, the later contract contained conditions, "positive covenants" and "negative covenants" not found in the earlier obligation. As an example of a positive covenant, Sta. Ines undertook "from time to time and upon request by the Lender, [to] perform such further acts and/or execute and deliver such additional documents and writings as may be necessary or proper to effectively carry out the provisions and purposes of this Loan Agreement."  Likewise, SIMC agreed that it would not create any mortgage or encumbrance on any asset owned or hereafter acquired, nor would it participate in any merger or consolidation. 

Since the 1989 Loan Agreement had extinguished the original credit accommodation, the Indemnity Agreement, an accessory obligation, was necessarily extinguished also, pursuant to Article 1296 of the Civil Code, which provides:

"ART. 1296. When the principal obligation is extinguished in consequence of a novation, accessory obligations may subsist only insofar as they may benefit third persons who did not give their consent."

Alleged Extension

Petitioner insists that the 1989 Loan Agreement was a mere renewal or extension of the ₱8 million original accommodation; it was not a novation. 

This argument must be rejected. To begin with, the 1989 Loan Agreement expressly stipulated that its purpose was to "liquidate," not to renew or extend, the outstanding indebtedness. Moreover, respondent did not sign or consent to the 1989 Loan Agreement, which had allegedly extended the original ₱8 million credit facility. Hence, his obligation as a surety should be deemed extinguished, pursuant to Article 2079 of the Civil Code, which specifically states that "[a]n extension granted to the debtor by the creditor without the consent of the guarantor extinguishes the guaranty. x x x." In an earlier case,26 the Court explained the rationale of this provision in this wise:

"The theory behind Article 2079 is that an extension of time given to the principal debtor by the creditor without the surety’s consent would deprive the surety of his right to pay the creditor and to be immediately subrogated to the creditor’s remedies against the principal debtor upon the maturity date. The surety is said to be entitled to protect himself against the contingency of the principal debtor or the indemnitors becoming insolvent during the extended period."

Binding Nature of the Credit Approval Memorandum

As noted earlier, the appellate court relied on the provisions of the Credit Approval Memorandum in holding that the credit accommodation was only for ₱8 million, and that it was for a period of one year ending on November 30, 1981. Petitioner objects to the appellate court’s reliance on that document, contending that it was not a binding agreement because it was not signed by the parties. It adds that it was merely for its internal use.

We disagree. It was petitioner itself which presented the said document to prove the accommodation. Attached to the Complaint as Annex A was a copy thereof "evidencing the accommodation."  Moreover, in its Petition before this Court, it alluded to the Credit Approval Memorandum in this wise:

"4.1 On 10 November 1980, Sta. Ines Melale Corporation ("SIMC") was granted by the Bank a credit line in the aggregate amount of Eight Million Pesos (P8,000,000.00) to assist SIMC in meeting the additional capitalization requirements for its logging operations. For this purpose, the Bank issued a Credit Approval Memorandum dated 10 November 1980."

Clearly, respondent is estopped from denying the terms and conditions of the ₱8 million credit accommodation as contained in the very document it presented to the courts. Indeed, it cannot take advantage of that document by agreeing to be bound only by those portions that are favorable to it, while denying those that are disadvantageous.

Second Issue: Alleged Waiver of Consent

Pursuing another course, petitioner contends that Respondent Cuenca "impliedly gave his consent to any modification of the credit accommodation or otherwise waived his right to be notified of, or to give consent to, the same." Respondent’s consent or waiver thereof is allegedly found in the Indemnity Agreement, in which he held himself liable for the "credit accommodation including [its] substitutions, renewals, extensions, increases, amendments, conversions and revival." It explains that the novation of the original credit accommodation by the 1989 Loan Agreement is merely its "renewal," which "connotes cessation of an old contract and birth of another one x x x."

At the outset, we should emphasize that an essential alteration in the terms of the Loan Agreement without the consent of the surety extinguishes the latter’s obligation. As the Court held in National Bank v. Veraguth, "[i]t is fundamental in the law of suretyship that any agreement between the creditor and the principal debtor which essentially varies the terms of the principal contract, without the consent of the surety, will release the surety from liability."

In this case, petitioner’s assertion - that respondent consented to the alterations in the credit accommodation -- finds no support in the text of the Indemnity Agreement, which is reproduced hereunder:

"Rodolfo M. Cuenca of legal age, with postal address c/o Sta. Ines Malale Forest Products Corp., Alco Bldg., 391 Buendia Avenue Ext., Makati Metro Manila for and in consideration of the credit accommodation in the total amount of eight million pesos (₱8,000,000.00) granted by the SECURITY BANK AND TRUST COMPANY, a commercial bank duly organized and existing under and by virtue of the laws of the Philippine, 6778 Ayala Avenue, Makati, Metro Manila hereinafter referred to as the BANK in favor of STA. INES MELALE FOREST PRODUCTS CORP., x x x ---- hereinafter referred to as the CLIENT, with the stipulated interests and charges thereon, evidenced by that/those certain PROMISSORY NOTE[(S)], made, executed and delivered by the CLIENT in favor of the BANK hereby bind(s) himself/themselves jointly and severally with the CLIENT in favor of the BANK for the payment , upon demand and without benefit of excussion of whatever amount or amounts the CLIENT may be indebted to the BANK under and by virtue of aforesaid credit accommodation(s) including the substitutions, renewals, extensions, increases, amendment, conversions and revivals of the aforesaid credit accommodation(s), as well as of the amount or amounts of such other obligations that the CLIENT may owe the BANK, whether direct or indirect, principal or secondary, as appears in the accounts, books and records of the BANK, plus interest and expenses arising from any agreement or agreements that may have heretofore been made, or may hereafter be executed by and between the parties thereto, including the substitutions, renewals, extensions, increases, amendments, conversions and revivals of the aforesaid credit accommodation(s), and further bind(s) himself/themselves with the CLIENT in favor of the BANK for the faithful compliance of all the terms and conditions contained in the aforesaid credit accommodation(s), all of which are incorporated herein and made part hereof by reference."

While respondent held himself liable for the credit accommodation or any modification thereof, such clause should be understood in the context of the ₱8 million limit and the November 30, 1981 term. It did not give the bank or Sta. Ines any license to modify the nature and scope of the original credit accommodation, without informing or getting the consent of respondent who was solidarily liable. Taking the bank’s submission to the extreme, respondent (or his successors) would be liable for loans even amounting to, say, ₱100 billion obtained 100 years after the expiration of the credit accommodation, on the ground that he consented to all alterations and extensions thereof.

Indeed, it has been held that a contract of surety "cannot extend to more than what is stipulated. It is strictly construed against the creditor, every doubt being resolved against enlarging the liability of the surety."  Likewise, the Court has ruled that "it is a well-settled legal principle that if there is any doubt on the terms and conditions of the surety agreement, the doubt should be resolved in favor of the surety x x x. Ambiguous contracts are construed against the party who caused the ambiguity."  In the absence of an unequivocal provision that respondent waived his right to be notified of or to give consent to any alteration of the credit accommodation, we cannot sustain petitioner’s view that there was such a waiver.

It should also be observed that the Credit Approval Memorandum clearly shows that the bank did not have absolute authority to unilaterally change the terms of the loan accommodation. Indeed, it may do so only upon notice to the borrower, pursuant to this condition:

"5. The Bank reserves the right to amend any of the aforementioned terms and conditions upon written notice to the Borrower." 

We reject petitioner’s submission that only Sta. Ines as the borrower, not respondent, was entitled to be notified of any modification in the original loan accommodation.  Following the bank’s reasoning, such modification would not be valid as to Sta. Ines if no notice were given; but would still be valid as to respondent to whom no notice need be given. The latter’s liability would thus be more burdensome than that of the former. Such untenable theory is contrary to the principle that a surety cannot assume an obligation more onerous than that of the principal. 

The present controversy must be distinguished from Philamgen v. Mutuc, in which the Court sustained a stipulation whereby the surety consented to be bound not only for the specified period, "but to any extension thereafter made, an extension x x x that could be had without his having to be notified."

In that case, the surety agreement contained this unequivocal stipulation: "It is hereby further agreed that in case of any extension of renewal of the bond, we equally bind ourselves to the Company under the same terms and conditions as herein provided without the necessity of executing another indemnity agreement for the purpose and that we hereby equally waive our right to be notified of any renewal or extension of the bond which may be granted under this indemnity agreement."

In the present case, there is no such express stipulation. At most, the alleged basis of respondent’s waiver is vague and uncertain. It confers no clear authorization on the bank or Sta. Ines to modify or extend the original obligation without the consent of the surety or notice thereto.

Continuing Surety

Contending that the Indemnity Agreement was in the nature of a continuing surety, petitioner maintains that there was no need for respondent to execute another surety contract to secure the 1989 Loan Agreement.

This argument is incorrect. That the Indemnity Agreement is a continuing surety does not authorize the bank to extend the scope of the principal obligation inordinately.

In Dino v. CA, the Court held that "a continuing guaranty is one which covers all transactions, including those arising in the future, which are within the description or contemplation of the contract of guaranty, until the expiration or termination thereof."

To repeat, in the present case, the Indemnity Agreement was subject to the two limitations of the credit accommodation: (1) that the obligation should not exceed ₱8 million, and (2) that the accommodation should expire not later than November 30, 1981. Hence, it was a continuing surety only in regard to loans obtained on or before the aforementioned expiry date and not exceeding the total of ₱8 million.

Accordingly, the surety of Cuenca secured only the first loan of ₱6.1 million obtained on November 26, 1991. It did not secure the subsequent loans, purportedly under the 1980 credit accommodation, that were obtained in 1986. Certainly, he could not have guaranteed the 1989 Loan Agreement, which was executed after November 30, 1981 and which exceeded the stipulated P8 million ceiling.

Petitioner, however, cites the Dino ruling in which the Court found the surety liable for the loan obtained after the payment of the original one, which was covered by a continuing surety agreement. At the risk of being repetitious, we hold that in Dino, the surety Agreement specifically provided that "each suretyship is a continuing one which shall remain in full force and effect until this bank is notified of its revocation." Since the bank had not been notified of such revocation, the surety was held liable even for the subsequent obligations of the principal borrower.

No similar provision is found in the present case. On the contrary, respondent’s liability was confined to the 1980 credit accommodation, the amount and the expiry date of which were set down in the Credit Approval Memorandum.

Special Nature of the JSS

It is a common banking practice to require the JSS ("joint and solidary signature") of a major stockholder or corporate officer, as an additional security for loans granted to corporations. There are at least two reasons for this. 

1. First, in case of default, the creditor’s recourse, which is normally limited to the corporate properties under the veil of separate corporate personality, would extend to the personal assets of the surety. 
2. Second, such surety would be compelled to ensure that the loan would be used for the purpose agreed upon, and that it would be paid by the corporation.

Following this practice, it was therefore logical and reasonable for the bank to have required the JSS of respondent, who was the chairman and president of Sta. Ines in 1980 when the credit accommodation was granted. There was no reason or logic, however, for the bank or Sta. Ines to assume that he would still agree to act as surety in the 1989 Loan Agreement, because at that time, he was no longer an officer or a stockholder of the debtor-corporation. Verily, he was not in a position then to ensure the payment of the obligation. Neither did he have any reason to bind himself further to a bigger and more onerous obligation.

Indeed, the stipulation in the 1989 Loan Agreement providing for the surety of respondent, without even informing him, smacks of negligence on the part of the bank and bad faith on that of the principal debtor. Since that Loan Agreement constituted a new indebtedness, the old loan having been already liquidated, the spirit of fair play should have impelled Sta. Ines to ask somebody else to act as a surety for the new loan.

In the same vein, a little prudence should have impelled the bank to insist on the JSS of one who was in a position to ensure the payment of the loan. Even a perfunctory attempt at credit investigation would have revealed that respondent was no longer connected with the corporation at the time. As it is, the bank is now relying on an unclear Indemnity Agreement in order to collect an obligation that could have been secured by a fairly obtained surety. For its defeat in this litigation, the bank has only itself to blame.

In sum, we hold that the 1989 Loan Agreement extinguished by novation the obligation under the 1980 ₱8 million credit accommodation. Hence, the Indemnity Agreement, which had been an accessory to the 1980 credit accommodation, was also extinguished. Furthermore, we reject petitioner’s submission that respondent waived his right to be notified of, or to give consent to, any modification or extension of the 1980 credit accommodation.

In this light, we find no more need to resolve the issue of whether the loan obtained before the expiry date of the credit accommodation has been paid.

WHEREFORE, the Petition is DENIED and the assailed Decision AFFIRMED. Costs against petitioner.

SO ORDERED.