KOPPEL v.

MAKATI ROTARY CLUB

The Donation

Fedders Koppel, Incorporated (FKI), a manufacturer of air-conditioning products, was the registered
owner of a parcel of land located at Km. 16, South Superhighway, Parañaque City (subject land). 3 Within
the subject land are buildings and other improvements dedicated to the business of FKI. 4

In 1975, FKI5 bequeathed the subject land (exclusive of the improvements thereon) in favor of herein
respondent Makati Rotary Club Foundation, Incorporated by way of a conditional donation. 6 The
respondent accepted the donation with all of its conditions. 7 On 26 May1975, FKI and the respondent
executed a Deed of Donation8evidencing their consensus.

The Lease and the Amended Deed of Donation

One of the conditions of the donation required the Makati Rotary to lease the subject land back to FKI
under terms specified in their Deed of Donation. 9 With the Makati Rotary’s acceptance of the donation, a
lease agreement between FKI and the respondent was, therefore, effectively incorporated in the Deed of
Donation.

Pertinent terms of such lease agreement, as provided in the Deed of Donation , were as follows:

1. The period of the lease is for twenty-five (25) years, 10 or until the 25th of May 2000;

2. The amount of rent to be paid by FKI for the first twenty-five (25) years is ₱40,126.00 per
annum .11

The Deed of Donation also stipulated that the lease over the subject property is renewable for another
period of twenty-five (25) years " upon mutual agreement" of FKI and Makati Rotary.12 In which case, the
amount of rent shall be determined in accordance with item 2(g) of the Deed of Donation, viz:

g. The rental for the second 25 years shall be the subject of mutual agreement and in case of
disagreement the matter shall be referred to a Board of three Arbitrators appointed and with
powers in accordance with the Arbitration Law of the Philippines, Republic Act 878, whose
function shall be to decide the current fair market value of the land excluding the improvements,
provided, that, any increase in the fair market value of the land shall not exceed twenty five
percent (25%) of the original value of the land donated as stated in paragraph 2(c) of this Deed.
The rental for the second 25 years shall not exceed three percent (3%) of the fair market value of
the land excluding the improvements as determined by the Board of Arbitrators.13

In October 1976, FKI and the respondent executed an Amended Deed of Donation 14 that reiterated the
provisions of the Deed of Donation , including those relating to the lease of the subject land.

Verily, by virtue of the lease agreement contained in the Deed of Donation and Amended Deed of
Donation , FKI was able to continue in its possession and use of the subject land.

2000 Lease Contract

Two (2) days before the lease incorporated in the Deed of Donation and Amended Deed of Donation was
set to expire, or on 23 May 2000, FKI and Makati Rotary executed another contract of lease ( 2000
Lease Contract )15covering the subject land. In this 2000 Lease Contract, FKI and Makati Rotary agreed
on a new five-year lease to take effect on the 26th of May 2000, with annual rents ranging from
₱4,000,000 for the first year up to ₱4,900,000 for the fifth year. 16 The 2000 Lease Contract also
contained an arbitration clause enforceable in the event the parties come to disagreement about
the" interpretation, application and execution" of the lease, viz :

19. Governing Law – The provisions of this 2000 Lease Contract shall be governed, interpreted
and construed in all aspects in accordance with the laws of the Republic of the Philippines.

Any disagreement as to the interpretation, application or execution of this 2000 Lease Contract
shall be submitted to a board of three (3) arbitrators constituted in accordance with the arbitration
law of the Philippines. The decision of the majority of the arbitrators shall be binding upon FKI
and respondent.17 (Emphasis supplied)

2005 Lease Contract

After the 2000 Lease Contract expired, FKI and Makati Rotary agreed to renew their lease for another
five (5) years. This new lease (2005 Lease Contract ) 18 required FKI to pay a fixed annual rent of
₱4,200,000.19 In addition to paying the fixed rent, however, the 2005 Lease Contract also obligated FKI to
make a yearly " donation " of money to the respondent. 20 Such donations ranged from ₱3,000,000 for the
first year up to ₱3,900,000for the fifth year.21Notably, the 2005 Lease Contract contained an arbitration
clause similar to that in the 2000 Lease Contract, to wit:

19. Governing Law – The provisions of this 2005 Lease Contract shall be governed, interpreted and
construed in all aspects in accordance with the laws of the Republic of the Philippines.

Any disagreement as to the interpretation, application or execution of this 2005 Lease Contract shall be
submitted to a board of three (3) arbitrators constituted in accordance with the arbitration law of the
Philippines. The decision of the majority of the arbitrators shall be binding upon FKI and
respondent.22 (Emphasis supplied)

The Assignment and Petitioner’s Refusal to Pay

From 2005 to 2008, FKI faithfully paid the rentals and " donations "due it per the 2005 Lease
Contract.23 But in June of 2008, FKI sold all its rights and properties relative to its business in
favor of herein petitioner Koppel, Incorporated.24 On 29 August 2008, FKI and petitioner executed
an Assignment and Assumption of Lease and Donation 25 —wherein FKI, with the conformity of the
respondent, formally assigned all of its interests and obligations under the Amended Deed of
Donation and the 2005 Lease Contract in favor of petitioner.

The following year, petitioner discontinued the payment of the rent and " donation " under the 2005 Lease
Contract.

Petitioner’s refusal to pay such rent and "donation " emanated from its belief that the rental
stipulations of the 2005 Lease Contract, and even of the 2000 Lease Contract, cannot be given
effect because they violated one of the" material conditions " of the donation of the subject land,
as stated in the Deed of Donation and Amended Deed of Donation. 26

According to petitioner, the Deed of Donation and Amended Deed of Donation actually
established not only one but two (2) lease agreements between FKI and respondent, i.e. , one
lease for the first twenty-five (25)years or from 1975 to 2000, and another lease for the next twenty-
five (25)years thereafter or from 2000 to 2025. 27 Both leases are material conditions of the
donation of the subject land.

Petitioner points out that while a definite amount of rent for the second twenty-five (25) year lease
was not fixed in the Deed of Donation and Amended Deed of Donation , both deeds nevertheless
prescribed rules and limitations by which the same may be determined. Such rules and limitations
ought to be observed in any succeeding lease agreements between petitioner and respondent for
they are, in themselves, material conditions of the donation of the subject land.28

In this connection, petitioner cites item 2(g) of the Deed of Donation and Amended Deed of
Donation that supposedly limits the amount of rent for the lease over the second twenty-five (25)
years to only " three percent (3%) of the fair market value of the subject land excluding the
improvements.29

For petitioner then, the rental stipulations of both the 2000 Lease Contract and 2005 Lease Contract
cannot be enforced as they are clearly, in view of their exorbitant exactions, in violation of the
aforementioned threshold in item 2(g) of the Deed of Donation and Amended Deed of Donation .
Consequently, petitioner insists that the amount of rent it has to pay thereon is and must still be governed
by the limitations prescribed in the Deed of Donation and Amended Deed of Donation. 30

The Demand Letters

On 1 June 2009, respondent sent a letter (First Demand Letter) 31 to petitioner notifying the latter of its
default " per Section 12 of the 2005 Lease Contract " and demanding for the settlement of the rent and "
donation " due for the year 2009. Respondent, in the same letter, further intimated of canceling the 2005
Lease Contract should petitioner fail to settle the said obligations. 32 Petitioner received the First Demand
Letter on2 June 2009.33

On 22 September 2009, petitioner sent a reply 34 to respondent expressing its disagreement over the
rental stipulations of the 2005 Lease Contract — calling them " severely disproportionate,"
"unconscionable" and "in clear violation to the nominal rentals mandated by the Amended Deed of
Donation." In lieu of the amount demanded by the respondent, which purportedly totaled to
₱8,394,000.00, exclusive of interests, petitioner offered to pay only ₱80,502.79, 35 in accordance with the
rental provisions of the Deed of Donation and Amended Deed of Donation. 36Respondent refused this
offer.37

On 25 September 2009, respondent sent another letter (Second Demand Letter) 38 to petitioner, reiterating
its demand for the payment of the obligations already due under the 2005 Lease Contract. The Second
Demand Letter also contained a demand for petitioner to " immediately vacate the leased premises "
should it fail to pay such obligations within seven (7) days from its receipt of the letter. 39 The respondent
warned of taking " legal steps " in the event that petitioner failed to comply with any of the said
demands.40 Petitioner received the Second Demand Letter on 26September 2009. 41

Petitioner refused to comply with the demands of the respondent. Instead, on 30 September 2009,
petitioner filed with the Regional Trial Court (RTC) of Parañaque City a complaint 42 for the rescission or
cancellation of the Deed of Donation and Amended Deed of Donation against the respondent. This case
is currently pending before Branch 257 of the RTC, docketed as Civil Case No. CV 09-0346.

The Ejectment Suit

On 5 October 2009, respondent filed an unlawful detainer case 43 against the petitioner before the
Metropolitan Trial Court (MeTC) of Parañaque City. The ejectment case was raffled to Branch 77 and was
docketed as Civil Case No. 2009-307.

On 4 November 2009, petitioner filed an Answer with Compulsory Counterclaim. 44 In it, petitioner
reiterated its objection over the rental stipulations of the 2005 Lease Contract for being violative of the
material conditions of the Deed of Donation and Amended Deed of Donation. 45 In addition to the
foregoing, however, petitioner also interposed the following defenses:
 1. The MeTC was not able to validly acquire jurisdiction over the instant unlawful detainer case in
view of the insufficiency of respondent’s demand. 46 The First Demand Letter did not contain an
actual demand to vacate the premises and, therefore, the refusal to comply there with does not
give rise to an action for unlawful detainer.47

2. Assuming that the MeTC was able to acquire jurisdiction, it may not exercise the same until the
disagreement between the parties is first referred to arbitration pursuant to the arbitration clause
of the 2005 Lease Contract.48

3. Assuming further that the MeTC has jurisdiction that it can exercise, ejectment still would not
lie as the 2005 Lease Contract is void abinitio. 49 The stipulation in the 2005 Lease Contract
requiring petitioner to give yearly " donations " to respondent is a simulation, for they are, in fact,
parts of the rent. 50 Such grants were only denominated as " donations " in the contract so that
the respondent—anon-stock and non-profit corporation—could evade payment of the taxes
otherwise due thereon.51

In due course, petitioner and respondent both submitted their position papers, together with their other
documentary evidence.52 Remarkably, however, respondent failed to submit the Second Demand Letter
as part of its documentary evidence.

Rulings of the MeTC, RTC and Court of Appeals

On 27 April 2010, the MeTC rendered judgment 53 in favor of the petitioner. While the MeTC refused to
dismiss the action on the ground that the dispute is subject to arbitration, it nonetheless sided with the
petitioner with respect to the issues regarding the insufficiency of the respondent’s demand and the nullity
of the 2005 Lease Contract.54 The MeTC thus disposed:

WHEREFORE, judgment is hereby rendered dismissing the case x x x, without pronouncement as to

costs.

SO ORDERED.55

The respondent appealed to the Regional Trial Court (RTC). This appeal was assigned to Branch 274 of
the RTC of Parañaque City and was docketed as Civil Case No. 10-0255.

On 29 October 2010, the RTC reversed 56 the MeTC and ordered the eviction of the petitioner from the
subject land:

WHEREFORE, all the foregoing duly considered, the appealed Decision of the Metropolitan Trial Court,
Branch 77, Parañaque City, is hereby reversed, judgment is thus rendered in favor of the plaintiff-
appellant and against the defendant-appellee, and ordering the latter –

(1) to vacate the lease[d] premises made subject of the case and to restore the possession
thereof to the plaintiff-appellant;

(2) to pay to the plaintiff-appellant the amount of Nine Million Three Hundred Sixty Two Thousand
Four Hundred Thirty Six Pesos (₱9,362,436.00), penalties and net of 5% withholding tax, for the
lease period from May 25, 2009 to May 25, 2010 and such monthly rental as will accrue during
the pendency of this case;

(3) to pay attorney’s fees in the sum of ₱100,000.00 plus appearance fee of ₱3,000.00;

(4) and costs of suit.

As to the existing improvements belonging to the defendant-appellee, as these were built in good faith,
the provisions of Art. 1678of the Civil Code shall apply.

SO ORDERED.57

The ruling of the RTC is premised on the following ratiocinations:

1. The respondent had adequately complied with the requirement of demand as a jurisdictional
precursor to an unlawful detainer action. 58 The First Demand Letter, in substance, contains a
demand for petitioner to vacate when it mentioned that it was a notice " per Section12 of the 2005
Lease Contract."59 Moreover, the issue of sufficiency of the respondent’s demand ought to have
been laid to rest by the Second Demand Letter which, though not submitted in evidence, was
nonetheless admitted by petitioner as containing a" demand to eject " in its Answer with
Compulsory Counterclaim.60

2. The petitioner cannot validly invoke the arbitration clause of the 2005 Lease Contract while, at
the same time, impugn such contract’s validity.61 Even assuming that it can, petitioner still did not
file a formal application before the MeTC so as to render such arbitration clause operational. 62 At
any rate, the MeTC would not be precluded from exercising its jurisdiction over an action for
unlawful detainer, over which, it has exclusive original jurisdiction. 63

3. The 2005 Lease Contract must be sustained as a valid contract since petitioner was not able to
adduce any evidence to support its allegation that the same is void. 64 There was, in this case, no
evidence that respondent is guilty of any tax evasion. 65

Aggrieved, the petitioner appealed to the Court of Appeals.

On 19 August 2011, the Court of Appeals affirmed 66 the decision of the RTC:

WHEREFORE , the petition is DENIED . The assailed Decision of the Regional Trial Court of Parañaque
City, Branch 274, in Civil Case No. 10-0255 is AFFIRMED.

xxxx

SO ORDERED.67

Hence, this appeal.

On 5 September 2011, this Court granted petitioner’s prayer for the issuance of a Temporary Restraining
Order68staying the immediate implementation of the decisions adverse to it.

OUR RULING

Independently of the merits of the case, the MeTC, RTC and Court of Appeals all erred in overlooking the
significance of the arbitration clause incorporated in the 2005 Lease Contract . As the Court sees it, that is
a fatal mistake.

For this reason, We grant the petition.

Present Dispute is Arbitrable Under the

Arbitration Clause of the 2005 Lease
Agreement Contract
Going back to the records of this case, it is discernable that the dispute between the petitioner and
respondent emanates from the rental stipulations of the 2005 Lease Contract. The respondent insists
upon the enforce ability and validity of such stipulations, whereas, petitioner, in substance, repudiates
them. It is from petitioner’s apparent breach of the 2005 Lease Contract that Makati Rotary filed the
instant unlawful detainer action.

One cannot escape the conclusion that, under the foregoing premises, the dispute between the
petitioner and respondent arose from the application or execution of the 2005 Lease Contract .
Undoubtedly, such kinds of dispute are covered by the arbitration clause of the 2005 Lease
Contract to wit:

19. Governing Law – The provisions of this 2005 Lease Contract shall be governed, interpreted
and construed in all aspects in accordance with the laws of the Republic of the Philippines.

Any disagreement as to the interpretation, application or execution of this 2005 Lease Contract
shall be submitted to a board of three (3) arbitrators constituted in accordance with the arbitration
law of the Philippines. The decision of the majority of the arbitrators shall be binding upon FKI
and respondent.69 (Emphasis supplied)

The arbitration clause of the 2005 Lease Contract stipulates that "any disagreement" as to the "
interpretation, application or execution " of the 2005 Lease Contract ought to be submitted to
arbitration.70 To the mind of this Court, such stipulation is clear and is comprehensive enough so as to
include virtually any kind of conflict or dispute that may arise from the 2005 Lease Contract including the
one that presently besets petitioner and respondent.

The application of the arbitration clause of the 2005 Lease Contract in this case carries with it certain
legal effects. However, before discussing what these legal effects are, We shall first deal with the
challenges posed against the application of such arbitration clause.

Challenges Against the Application of the

Arbitration Clause of the 2005 Lease
Contract

Curiously, despite the lucidity of the arbitration clause of the 2005 Lease Contract, the petitioner, as well
as the MeTC, RTC and the Court of Appeals, vouched for the non-application of the same in the instant
case. A plethora of arguments was hurled in favor of bypassing arbitration. We now address them.

At different points in the proceedings of this case, the following arguments were offered against the
application of the arbitration clause of the 2005 Lease Contract:

1. The disagreement between the petitioner and respondent is non-arbitrable as it will inevitably
touch upon the issue of the validity of the 2005 Lease Contract. 71 It was submitted that one of the
reasons offered by the petitioner in justifying its failure to pay under the 2005 Lease Contract was
the nullity of such contract for being contrary to law and public policy. 72 The Supreme Court, in
Gonzales v. Climax Mining, Ltd., 73 held that " the validity of contract cannot be subject of
arbitration proceedings " as such questions are " legal in nature and require the application and
interpretation of laws and jurisprudence which is necessarily a judicial function ." 74

2. The petitioner cannot validly invoke the arbitration clause of the 2005 Lease Contract while, at
the same time, impugn such contract’s validity.75

3. Even assuming that it can invoke the arbitration clause whilst denying the validity of the 2005
Lease Contract , petitioner still did not file a formal application before the MeTC so as to render
 such arbitration clause operational.76 Section 24 of Republic Act No. 9285 requires the party
seeking arbitration to first file a " request " or an application therefor with the court not later than
the preliminary conference.77

4. Petitioner and respondent already underwent Judicial Dispute Resolution (JDR) proceedings
before the RTC.78 Hence, a further referral of the dispute to arbitration would only be
circuitous.79 Moreover, an ejectment case, in view of its summary nature, already fulfills the prime
purpose of arbitration, i.e. , to provide parties in conflict with an expedient method for the
resolution of their dispute.80 Arbitration then would no longer be necessary in this case. 81

None of the arguments have any merit.

First. As highlighted in the previous discussion, the disagreement between the petitioner and
respondent falls within the all-encompassing terms of the arbitration clause of the 2005 Lease
Contract. While it may be conceded that in the arbitration of such disagreement, the validity of the
2005 Lease Contract, or at least, of such contract’s rental stipulations would have to be
determined, the same would not render such disagreement non-arbitrable. The quotation from
Gonzales that was used to justify the contrary position was taken out of context. A rereading of Gonzales
would fix its relevance to this case.

In Gonzales, a complaint for arbitration was filed before the Panel of Arbitrators of the Mines and
Geosciences Bureau (PA-MGB) seeking the nullification of a Financial Technical Assistance Agreement
and other mining related agreements entered into by private parties. 82

Grounds invoked for the nullification of such agreements include fraud and unconstitutionality. 83 The
pivotal issue that confronted the Court then was whether the PA-MGB has jurisdiction over that particular
arbitration complaint. Stated otherwise, the question was whether the complaint for arbitration raises
arbitrable issues that the PA-MGB can take cognizance of.

Gonzales decided the issue in the negative. In holding that the PA-MGB was devoid of any jurisdiction to
take cognizance of the complaint for arbitration, this Court pointed out to the provisions of R.A. No. 7942,
or the Mining Act of 1995, which granted the PA-MGB with exclusive original jurisdiction only over mining
disputes, i.e., disputes involving " rights to mining areas," "mineral agreements or permits," and " surface
owners, occupants, claim holders or concessionaires" requiring the technical knowledge and experience
of mining authorities in order to be resolved. 84 Accordingly, since the complaint for arbitration in Gonzales
did not raise mining disputes as contemplated under R.A. No. 7942 but only issues relating to the validity
of certain mining related agreements, this Court held that such complaint could not be arbitrated before
the PA-MGB.85 It is in this context that we made the pronouncement now in discussion:

Arbitration before the Panel of Arbitrators is proper only when there is a disagreement between
the parties as to some provisions of the contract between them, which needs the interpretation
and the application of that particular knowledge and expertise possessed by members of that
Panel. It is not proper when one of the parties repudiates the existence or validity of such contract
or agreement on the ground of fraud or oppression as in this case. The validity of the contract
cannot be subject of arbitration proceedings. Allegations of fraud and duress in the execution of a
contract are matters within the jurisdiction of the ordinary courts of law. These questions are legal
in nature and require the application and interpretation of laws and jurisprudence which is
necessarily a judicial function.86(Emphasis supplied)

The Court in Gonzales did not simply base its rejection of the complaint for arbitration on the ground that
the issue raised therein, i.e. , the validity of contracts, is per se non-arbitrable. The real consideration
behind the ruling was the limitation that was placed by R.A. No. 7942 upon the jurisdiction of the PA-MGB
as an arbitral body . Gonzales rejected the complaint for arbitration because the issue raised therein is
not a mining dispute per R.A. No. 7942 and it is for this reason, and only for this reason, that such issue is
rendered non-arbitrable before the PA-MGB. As stated beforehand, R.A. No. 7942 clearly limited the
jurisdiction of the PA-MGB only to mining disputes.87

Much more instructive for our purposes, on the other hand, is the recent case of Cargill Philippines, Inc. v.
San Fernando Regal Trading, Inc.88 In Cargill , this Court answered the question of whether issues
involving the rescission of a contract are arbitrable. The respondent in Cargill argued against arbitrability,
also citing therein Gonzales . After dissecting Gonzales , this Court ruled in favor of arbitrability. 89 Thus,
We held:

Respondent contends that assuming that the existence of the contract and the arbitration clause is
conceded, the CA's decision declining referral of the parties' dispute to arbitration is still correct. It claims
that its complaint in the RTC presents the issue of whether under the facts alleged, it is entitled to rescind
the contract with damages; and that issue constitutes a judicial question or one that requires the exercise
of judicial function and cannot be the subject of an arbitration proceeding. Respondent cites our ruling in
Gonzales, wherein we held that a panel of arbitrator is bereft of jurisdiction over the complaint for
declaration of nullity/or termination of the subject contracts on the grounds of fraud and oppression
attendant to the execution of the addendum contract and the other contracts emanating from it, and that
the complaint should have been filed with the regular courts as it involved issues which are judicial in
nature.

Such argument is misplaced and respondent cannot rely on the Gonzales case to support its
argument.90(Emphasis ours)

Second. Petitioner may still invoke the arbitration clause of the 2005 Lease Contract notwithstanding the
fact that it assails the validity of such contract. This is due to the doctrine of separability. 91

Under the doctrine of separability, an arbitration agreement is considered as independent of the

main contract.92Being a separate contract in itself, the arbitration agreement may thus be invoked
regardless of the possible nullity or invalidity of the main contract. 93

Once again instructive is Cargill, wherein this Court held that, as a further consequence of the doctrine of
separability, even the very party who repudiates the main contract may invoke its arbitration clause. 94

Third . The operation of the arbitration clause in this case is not at all defeated by the failure of the
petitioner to file a formal "request" or application therefor with the MeTC. We find that the filing of
a "request" pursuant to Section 24 of R.A. No. 9285 is not the sole means by which an arbitration
clause may be validly invoked in a pending suit.

Section 24 of R.A. No. 9285 reads:

SEC. 24. Referral to Arbitration . - A court before which an action is brought in a matter which is
the subject matter of an arbitration agreement shall, if at least one party so requests not later that
the pre-trial conference, or upon the request of both parties thereafter, refer the parties to
arbitration unless it finds that the arbitration agreement is null and void, inoperative or incapable
of being performed. [Emphasis ours; italics original]

The " request " referred to in the above provision is, in turn, implemented by Rules 4.1 to 4.3 of
A.M. No. 07-11-08-SC or the Special Rules of Court on Alternative Dispute Resolution (Special
ADR Rules):

RULE 4: REFERRAL TO ADR

Rule 4.1. Who makes the request. - A party to a pending action filed in violation of the arbitration
agreement, whether contained in an arbitration clause or in a submission agreement, may request
the court to refer the parties to arbitration in accordance with such agreement.

Rule 4.2. When to make request. - (A) Where the arbitration agreement exists before the action is
filed . - The request for referral shall be made not later than the pre-trial conference. After the pre-
trial conference, the court will only act upon the request for referral if it is made with the
agreement of all parties to the case.

(B) Submission agreement . - If there is no existing arbitration agreement at the time the case is
filed but the parties subsequently enter into an arbitration agreement, they may request the court
to refer their dispute to arbitration at any time during the proceedings.

Rule 4.3. Contents of request. - The request for referral shall be in the form of a motion, which
shall state that the dispute is covered by an arbitration agreement.

A part from other submissions, the movant shall attach to his motion an authentic copy of the
arbitration agreement.

The request shall contain a notice of hearing addressed to all parties specifying the date and time
when it would be heard. The party making the request shall serve it upon the respondent to give
him the opportunity to file a comment or opposition as provided in the immediately succeeding
Rule before the hearing. [Emphasis ours; italics original]

Attention must be paid, however, to the salient wordings of Rule 4.1.It reads: "a party to a pending action
filed in violation of the arbitration agreement x x x may request the court to refer the parties to arbitration
in accordance with such agreement."

In using the word " may " to qualify the act of filing a " request " under Section 24 of R.A. No. 9285, the
Special ADR Rules clearly did not intend to limit the invocation of an arbitration agreement in a pending
suit solely via such "request." After all, non-compliance with an arbitration agreement is a valid defense to
any offending suit and, as such, may even be raised in an answer as provided in our ordinary rules of
procedure.95

In this case, it is conceded that petitioner was not able to file a separate " request " of arbitration
before the MeTC. However, it is equally conceded that the petitioner, as early as in its Answer with
Counterclaim ,had already apprised the MeTC of the existence of the arbitration clause in the 2005
Lease Contract96 and, more significantly, of its desire to have the same enforced in this
case.97 This act of petitioner is enough valid invocation of his right to arbitrate. Fourth . The fact
that the petitioner and respondent already under went through JDR proceedings before the RTC,
will not make the subsequent conduct of arbitration between the parties unnecessary or
circuitous. The JDR system is substantially different from arbitration proceedings.

The JDR framework is based on the processes of mediation, conciliation or early neutral
evaluation which entails the submission of a dispute before a " JDR judge " who shall merely "
facilitate settlement " between the parties in conflict or make a " non-binding evaluation or
assessment of the chances of each party’s case." 98 Thus in JDR, the JDR judge lacks the authority
to render a resolution of the dispute that is binding upon the parties in conflict. In arbitration, on
the other hand, the dispute is submitted to an arbitrator/s —a neutral third person or a group of
thereof— who shall have the authority to render a resolution binding upon the parties. 99

Clearly, the mere submission of a dispute to JDR proceedings would not necessarily render the
subsequent conduct of arbitration a mere surplusage. The failure of the parties in conflict to reach an
amicable settlement before the JDR may, in fact, be supplemented by their resort to arbitration where a
binding resolution to the dispute could finally be achieved. This situation precisely finds application to the
case at bench.

Neither would the summary nature of ejectment cases be a valid reason to disregard the enforcement of
the arbitration clause of the 2005 Lease Contract . Notwithstanding the summary nature of ejectment
cases, arbitration still remains relevant as it aims not only to afford the parties an expeditious method of
resolving their dispute.

A pivotal feature of arbitration as an alternative mode of dispute resolution is that it is, first and
foremost, a product of party autonomy or the freedom of the parties to " make their own
arrangements to resolve their own disputes." 100Arbitration agreements manifest not only the
desire of the parties in conflict for an expeditious resolution of their dispute. They also represent,
if not more so, the parties’ mutual aspiration to achieve such resolution outside of judicial
auspices, in a more informal and less antagonistic environment under the terms of their choosing.
Needless to state, this critical feature can never be satisfied in an ejectment case no matter how
summary it may be.

Having hurdled all the challenges against the application of the arbitration clause of the 2005 Lease
Agreement in this case, We shall now proceed with the discussion of its legal effects.

Legal Effect of the Application of the

Arbitration Clause

Since there really are no legal impediments to the application of the arbitration clause of the 2005
Contract of Lease in this case, We find that the instant unlawful detainer action was instituted in violation
of such clause. The Law, therefore, should have governed the fate of the parties and this suit:

R.A. No. 876 Section 7. Stay of civil action. - If any suit or proceeding be brought upon an issue arising
out of an agreement providing for the arbitration thereof, the court in which such suit or proceeding is
pending, upon being satisfied that the issue involved in such suit or proceeding is referable to arbitration,
shall stay the action or proceeding until an arbitration has been had in accordance with the terms of the
agreement: Provided, That the applicant for the stay is not in default in proceeding with such arbitration.
[Emphasis supplied]

R.A. No. 9285

Section 24. Referral to Arbitration. - A court before which an action is brought in a matter which is the
subject matter of an arbitration agreement shall, if at least one party so requests not later that the pre-trial
conference, or upon the request of both parties thereafter, refer the parties to arbitration unless it finds
that the arbitration agreement is null and void, in operative or incapable of being performed. [Emphasis
supplied]

It is clear that under the law, the instant unlawful detainer action should have been stayed; 101 the
petitioner and the respondent should have been referred to arbitration pursuant to the arbitration clause of
the 2005 Lease Contract . The MeTC, however, did not do so in violation of the law—which violation was,
in turn, affirmed by the RTC and Court of Appeals on appeal.

The violation by the MeTC of the clear directives under R.A. Nos.876 and 9285 renders invalid all
proceedings it undertook in the ejectment case after the filing by petitioner of its Answer with
Counterclaim —the point when the petitioner and the respondent should have been referred to arbitration.
This case must, therefore, be remanded to the MeTC and be suspended at said point. Inevitably, the
decisions of the MeTC, RTC and the Court of Appeals must all be vacated and set aside.
The petitioner and the respondent must then be referred to arbitration pursuant to the arbitration clause of
the 2005 Lease Contract.

This Court is not unaware of the apparent harshness of the Decision that it is about to make.
Nonetheless, this Court must make the same if only to stress the point that, in our jurisdiction, bona fide
arbitration agreements are recognized as valid; 102 and that laws,103 rules and regulations104 do exist
protecting and ensuring their enforcement as a matter of state policy. Gone should be the days when
courts treat otherwise valid arbitration agreements with disdain and hostility, if not outright "
jealousy,"105 and then get away with it. Courts should instead learn to treat alternative means of dispute
resolution as effective partners in the administration of justice and, in the case of arbitration agreements,
to afford them judicial restraint.106 Today, this Court only performs its part in upholding a once disregarded
state policy.

Civil Case No. CV 09-0346

This Court notes that, on 30 September 2009, petitioner filed with the RTC of Parañaque City, a
complaint107 for the rescission or cancellation of the Deed of Donation and Amended Deed of Donation
against the respondent. The case is currently pending before Branch 257 of the RTC, docketed as Civil
Case No. CV 09-0346.

This Court recognizes the great possibility that issues raised in Civil Case No. CV 09-0346 may involve
matters that are rightfully arbitrable per the arbitration clause of the 2005 Lease Contract. However, since
the records of Civil Case No. CV 09-0346 are not before this Court, We can never know with true
certainty and only speculate. In this light, let a copy of this Decision be also served to Branch 257of the
RTC of Parañaque for its consideration and, possible, application to Civil Case No. CV 09-0346.
J PLUS ASIA DEVELOPMENT v. UTILITY INSURANCE CORP.

The Facts

On December 24, 2007, petitioner J Plus Asia Development Corporation represented by its Chairman,
Joo Han Lee, and Martin E. Mabunay, doing business under the name and style of Seven Shades of
Blue Trading and Services, entered into a Construction Agreement 3 whereby the latter undertook to build
the former’s 72-room condominium/hotel (Condotel Building 25) located at the Fairways & Bluewaters
Golf & Resort in Boracay Island, Malay, Aklan. The project, costing P42,000,000.00, was to be completed
within one year or 365 days reckoned from the first calendar day after signing of the Notice of Award and
Notice to Proceed and receipt of down payment (20% of contract price). The P8,400,000.00 down
payment was fully paid on January 14, 2008. 4 Payment of the balance of the contract price will be based
on actual work finished within 15 days from receipt of the monthly progress billings. Per the agreed work
schedule, the completion date of the project was December 2008. 5 Mabunay also submitted the required
Performance Bond6 issued by respondent Utility Assurance Corporation (UTASSCO) in the amount
equivalent to 20% down payment or P8.4 million.

Mabunay commenced work at the project site on January 7, 2008. Petitioner paid up to the 7 th monthly
progress billing sent by Mabunay. As of September 16, 2008, petitioner had paid the total amount of
P15,979,472.03 inclusive of the 20% down payment. However, as of said date, Mabunay had
accomplished only 27.5% of the project. 7

In the Joint Construction Evaluation Result and Status Report 8 signed by Mabunay assisted by Arch.
Elwin Olavario, and Joo Han Lee assisted by Roy V. Movido, the following findings were accepted as
true, accurate and correct:cralavvonlinelawlibrary

III] STATUS OF PROJECT AS OF 14 NOVEMBER 2008

1)  After conducting a joint inspection and evaluation of the project to determine the actual
percentage of accomplishment, the contracting parties, assisted by their respective technical
groups, SSB assisted by Arch. Elwin Olavario and JPLUS assisted by Engrs. Joey Rojas and Shiela
Botardo, concluded and agreed that as of 14 November 2008, the project is only Thirty One
point Thirty Nine Percent (31.39%) complete.
2) Furthermore, the value of construction materials allocated for the completion of the project and
currently on site has been determined and agreed to be ONE MILLION FORTY NINE THOUSAND
THREE HUNDRED SIXTY FOUR PESOS AND FORTY FIVE CENTAVOS (P1,049,364.45)
3)  The additional accomplishment of SSB, reflected in its reconciled and consolidated 8th and 9th
billings, is Three point Eighty Five Percent (3.85%) with a gross value of P1,563,553.34 amount
creditable to SSB after deducting the withholding tax is P1,538,424.84
4) The unrecouped amount of the down payment is P2,379,441.53 after deducting the cost of materials
on site and the net billable amount reflected in the reconciled and consolidated 8th and 9th billings.
The uncompleted portion of the project is 68.61% with an estimated value per construction
agreement signed is P27,880,419.52.9 (Emphasis supplied.)

On November 19, 2008, petitioner terminated the contract and sent demand letters to Mabunay
and respondent surety. As its demands went unheeded, petitioner filed a Request for
Arbitration10 before the Construction Industry Arbitration Commission (CIAC). Petitioner prayed that
Mabunay and respondent be ordered to pay the sums of P8,980,575.89 as liquidated damages and
P2,379,441.53 corresponding to the unrecouped down payment or overpayment petitioner made to
Mabunay.11
In his Answer,12 Mabunay claimed that the delay was caused by retrofitting and other revision
works ordered by Joo Han Lee. He asserted that he actually had until April 30, 2009 to finish the
project since the 365 days period of completion started only on May 2, 2008 after clearing the
retrofitted old structure. Hence, the termination of the contract by petitioner was premature and
the filing of the complaint against him was baseless, malicious and in bad faith.

Respondent, on the other hand, filed a motion to dismiss on the ground that petitioner has no
cause of action and the complaint states no cause of action against it. The CIAC denied the motion
to dismiss. Respondent’s motion for reconsideration was likewise denied. 13

In its Answer Ex Abundante Ad Cautelam With Compulsory Counterclaims and Cross-claims, 14 Utility
Insurance Corp. argued that the performance bond merely guaranteed the 20% down payment and
not the entire obligation of Mabunay under the Construction Agreement. Since the value of the
project’s accomplishment already exceeded the said amount, Utility Insurance’s obligation under
the performance bond had been fully extinguished. As to the claim for alleged overpayment to
Mabunay, respondent contended that it should not be credited against the 20% down payment
which was already exhausted and such application by petitioner is tantamount to reviving an
obligation that had been legally extinguished by payment. Respondent also set up a cross-claim
against Mabunay who executed in its favor an Indemnity Agreement whereby Mabunay undertook to
indemnify respondent for whatever amounts it may be adjudged liable to pay petitioner under the surety
bond.

Both petitioner and respondent submitted their respective documentary and testimonial evidence.
Mabunay failed to appear in the scheduled hearings and to present his evidence despite due
notice to his counsel of record. The CIAC thus declared that Mabunay is deemed to have waived
his right to present evidence. 15

On February 2, 2010, the CIAC rendered its Decision 16 and made the following
award:cralavvonlinelawlibrary

Accordingly, in view of our foregoing discussions and dispositions, the Tribunal hereby adjudges, orders
and directs:cralavvonlinelawlibrary

1. Respondents Mabunay and Utassco to jointly and severally pay claimant the
following:cralavvonlinelawlibrary

a) P4,469,969.90, as liquidated damages, plus legal interest thereon at the rate of 6% per annum
computed from the date of this decision up to the time this decision becomes final, and 12% per annum
computed from the date this decision becomes final until fully paid, and

b) P2,379,441.53 as unrecouped down payment plus interest thereon at the rate of 6% per annum
computed from the date of this decision up to the time this decision becomes final, and 12% per annum
computed from the date this decision becomes final until fully paid[.]

It being understood that respondent Utassco’s liability shall in no case exceed P8.4 million.

2. Respondent Mabunay to pay to claimant the amount of P98,435.89, which is respondent [Mabunay’s]
share in the arbitration cost claimant had advanced, with legal interest thereon from January 8, 2010 until
fully paid.

3. Respondent Mabunay to indemnify respondent Utassco of the amounts respondent Utassco will have
paid to claimant under this decision, plus interest thereon at the rate of 12% per annum computed from
the date he is notified of such payment made by respondent Utassco to claimant until fully paid, and to
pay Utassco P100,000.00 as attorney’s fees.
SO ORDERED.17

Dissatisfied, respondent filed in the CA a petition for review under Rule 43 of the 1997 Rules of Civil
Procedure, as amended.

In the assailed decision, the CA agreed with the CIAC that the specific condition in the Performance Bond
did not clearly state the limitation of the surety’s liability. Pursuant to Article 137718 of the Civil Code, the
CA said that the provision should be construed in favor of petitioner considering that the obscurely
phrased provision was drawn up by respondent and Mabunay. Further, the appellate court stated that
respondent could not possibly guarantee the down payment because it is not Mabunay who owed the
down payment to petitioner but the other way around. Consequently, the completion by Mabunay of
31.39% of the construction would not lead to the extinguishment of respondent’s liability. The P8.4 million
was a limit on the amount of respondent’s liability and not a limitation as to the obligation or undertaking it
guaranteed.

However, the CA reversed the CIAC’s ruling that Mabunay had incurred delay which entitled petitioner to
the stipulated liquidated damages and unrecouped down payment. Citing Aerospace Chemical Industries,
Inc. v. Court of Appeals,19 the appellate court said that not all requisites in order to consider the obligor or
debtor in default were present in this case. It held that it is only from December 24, 2008 (completion
date) that we should reckon default because the Construction Agreement provided only for delay in the
completion of the project and not delay on a monthly basis using the work schedule approved by
petitioner as the reference point. Hence, petitioner’s termination of the contract was premature since the
delay in this case was merely speculative; the obligation was not yet demandable.

The dispositive portion of the CA Decision reads:cralavvonlinelawlibrary

WHEREFORE, premises considered, the instant petition for review is GRANTED. The assailed Decision
dated 13 January 2010 rendered by the CIAC Arbitral Tribunal in CIAC Case No. 03-2009 is
hereby REVERSED and SET ASIDE. Accordingly, the Writ of Execution dated 24 November 2010 issued
by the same tribunal is hereby ANNULLED and SET ASIDE.

SO ORDERED.20

Petitioner moved for reconsideration of the CA decision while respondent filed a motion for partial
reconsideration. Both motions were denied.

The Issues

Before this Court petitioner seeks to reverse the CA insofar as it denied petitioner’s claims under the
Performance Bond and to reinstate in its entirety the February 2, 2010 CIAC Decision. Specifically,
petitioner alleged that –

A. THE COURT OF APPEALS SERIOUSLY ERRED IN NOT HOLDING THAT THE

ALTERNATIVE DISPUTE RESOLUTION ACT AND THE SPECIAL RULES ON
ALTERNATIVE DISPUTE RESOLUTION HAVE STRIPPED THE COURT OF APPEALS
OF JURISDICTION TO REVIEW ARBITRAL AWARDS.

B. THE COURT OF APPEALS SERIOUSLY ERRED IN REVERSING THE ARBITRAL

AWARD ON AN ISSUE THAT WAS NOT RAISED IN THE ANSWER. NOT IDENTIFIED
 IN THE TERMS OF REFERENCE, NOT ASSIGNED AS AN ERROR, AND NOT
ARGUED IN ANY OF THE PLEADINGS FILED BEFORE THE COURT.

C. THE COURT OF APPEALS SERIOUSLY ERRED IN RELYING ON THE CASE

OF AEROSPACE CHEMICAL INDUSTRIES, INC. v. COURT OF APPEALS, 315 SCRA
94, WHICH HAS NOTHING TO DO WITH CONSTRUCTION AGREEMENTS.21

Our Ruling

On the procedural issues raised, we find no merit in petitioner’s contention that with the
institutionalization of alternative dispute resolution under Republic Act (R.A.) No.
9285,22 otherwise known as the Alternative Dispute Resolution Act of 2004, the CA was divested of
jurisdiction to review the decisions or awards of the CIAC. Petitioner erroneously relied on the
provision in said law allowing any party to a domestic arbitration to file in the Regional Trial Court (RTC) a
petition either to confirm, correct or vacate a domestic arbitral award.

We hold that R.A. No. 9285 did not confer on regional trial courts jurisdiction to review awards or
decisions of the CIAC in construction disputes. On the contrary, Section 40 thereof expressly
declares that confirmation by the RTC is not required, thus:cralavvonlinelawlibrary

SEC. 40. Confirmation of Award. – The confirmation of a domestic arbitral award shall be governed by
Section 23 of R.A. 876.

A domestic arbitral award when confirmed shall be enforced in the same manner as final and executory
decisions of the Regional Trial Court.

The confirmation of a domestic award shall be made by the regional trial court in accordance with the
Rules of Procedure to be promulgated by the Supreme Court.

A CIAC arbitral award need not be confirmed by the regional trial court to be executory as
provided under E.O. No. 1008. (Emphasis supplied.)

Executive Order (EO) No. 1008 vests upon the CIAC 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. By express provision of Section 19 thereof,
the arbitral award of the CIAC is final and unappealable, except on questions of law, which are
appealable to the Supreme Court. With the amendments introduced by R.A. No. 7902 and promulgation
of the 1997 Rules of Civil Procedure, as amended, the CIAC was included in the enumeration of quasi-
judicial agencies whose decisions or awards may be appealed to the CA in a petition for review
under Rule 43. Such review of the CIAC award may involve either questions of fact, of law, or of fact and
law.23

Petitioner misread the provisions of A.M. No. 07-11-08-SC (Special ADR Rules) promulgated by this
Court and which took effect on October 30, 2009. Since R.A. No. 9285 explicitly excluded CIAC awards
from domestic arbitration awards that need to be confirmed to be executory, said awards are therefore not
covered by Rule 11 of the Special ADR Rules, 24 as they continue to be governed by EO No. 1008, as
amended and the rules of procedure of the CIAC. The CIAC Revised Rules of Procedure Governing
Construction Arbitration25 provide for the manner and mode of appeal from CIAC decisions or awards in
Section 18 thereof, which reads:cralavvonlinelawlibrary
SECTION 18.2 Petition for review. – A petition for review from a final award may be taken by any of the
parties within fifteen (15) days from receipt thereof in accordance with the provisions of Rule 43 of the
Rules of Court.

As to the alleged error committed by the CA in deciding the case upon an issue not raised or litigated
before the CIAC, this assertion has no basis. Whether or not Mabunay had incurred delay in the
performance of his obligations under the Construction Agreement was the very first issue stipulated in the
Terms of Reference26(TOR), which is distinct from the issue of the extent of respondent’s liability under
the Performance Bond.

Indeed, resolution of the issue of delay was crucial upon which depends petitioner’s right to the liquidated
damages pursuant to the Construction Agreement. Contrary to the CIAC’s findings, the CA opined that
delay should be reckoned only after the lapse of the one-year contract period, and consequently
Mabunay’s liability for liquidated damages arises only upon the happening of such condition.

We reverse the CA.

Default or mora on the part of the debtor is the delay in the fulfillment of the prestation by reason of a
cause imputable to the former. It is the non-fulfillment of an obligation with respect to time. 27

Article 1169 of the Civil Code provides:cralavvonlinelawlibrary

ART. 1169. Those obliged to deliver or to do something incur in delay from the time the obligee judicially
or extrajudicially demands from them the fulfillment of their obligation.

xxxx

It is a general rule that one who contracts to complete certain work within a certain time is liable for the
damage for not completing it within such time, unless the delay is excused or waived. 28

The Construction Agreement provides in Article 10 thereof the following conditions as to completion time
for the project

1. The CONTRACTOR shall complete the works called for under this Agreement within
ONE (1) YEAR or 365 Days reckoned from the 1st calendar day after signing of the
Notice of Award and Notice to Proceed and receipt of down payment.

2. In this regard the CONTRACTOR shall submit a detailed work schedule for approval by
OWNER within Seven (7) days after signing of this Agreement and full payment of 20%
of the agreed contract price. Said detailed work schedule shall follow the general
schedule of activities and shall serve as basis for the evaluation of the progress of work
by CONTRACTOR.29

In this jurisdiction, the following requisites must be present in order that the debtor may be in default: (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 extrajudicially. 30

In holding that Mabunay has not at all incurred delay, the CA pointed out that the obligation to perform or
complete the project was not yet demandable as of November 19, 2008 when petitioner terminated the
contract, because the agreed completion date was still more than one month away (December 24, 2008).
Since the parties contemplated delay in the completion of the entire project, the CA concluded that the
failure of the contractor to catch up with schedule of work activities did not constitute delay giving rise to
the contractor’s liability for damages.

We cannot sustain the appellate court’s interpretation as it is inconsistent with the terms of the
Construction Agreement. Article 1374 of the Civil Code requires that the various stipulations of a contract
shall be interpreted together, attributing to the doubtful ones that sense which may result from all of them
taken jointly. Here, the work schedule approved by petitioner was intended, not only to serve as its basis
for the payment of monthly progress billings, but also for evaluation of the progress of work by the
contractor. Article 13.01 (g) (iii) of the Construction Agreement provides that the contractor shall be
deemed in default if, among others, it had delayed without justifiable cause the completion of the project
“by more than thirty (30) calendar days based on official work schedule duly approved by the OWNER.”31

Records showed that as early as April 2008, or within four months after Mabunay commenced work
activities, the project was already behind schedule for reasons not attributable to petitioner. In the
succeeding months, Mabunay was still unable to catch up with his accomplishment even as petitioner
constantly advised him of the delays, as can be gleaned from the following notices of delay sent by
petitioner’s engineer and construction manager, Engr. Sheila N. Botardo:cralavvonlinelawlibrary

April 30, 2008

Seven Shades of Blue

Boracay Island
Malay, Aklan

Attention :  Mr. Martin Mabunay

General Manager
Thru : Engr. Reynaldo Gapasin
Project :  Villa Beatriz
Subject : Notice of Delay

Dear Mr. Mabunay:cralavvonlinelawlibrary

This is to formalize our discussion with your Engineers during our meeting last April 23, 2008 regarding
the delay in the implementation of major activities based on your submitted construction schedule.
Substantial delay was noted in concreting works that affects your roof framing that should have been 40%
completed as of this date. This delay will create major impact on your over-all schedule as the finishing
works will all be dependent on the enclosure of the building.

In this regard, we recommend that you prepare a catch-up schedule and expedite the delivery of critical
materials on site. We would highly appreciate if you could attend our next regular meeting so we could
immediately address this matter. Thank you.

Very truly yours,

Engr. Sheila N. Botardo

Construction Manager – LMI/FEPI 32

October 15, 2008

x x x x

Dear Mr. Mabunay,

We have noticed continuous absence of all the Engineers that you have assigned on-site to administer
and supervise your contracted work. For the past two (2) weeks[,] your company does not have a
Technical Representative manning the jobsite considering the critical activities that are in progress and
the delays in schedule that you have already incurred. In this regard, we would highly recommend the
immediate replacement of your Project Engineer within the week.

We would highly appreciate your usual attention on this matter.

x x x x33

November 5, 2008

x x x x

Dear Mr. Mabunay,

This is in reference to your discussion during the meeting with Mr. Joohan Lee last October 30, 2008
regarding the construction of the Field Office and Stock Room for Materials intended for Villa Beatriz use
only. We understand that you have committed to complete it November 5, 2008 but as of this date there is
no improvement or any ongoing construction activity on the said field office and stockroom.

We are expecting deliveries of Owner Supplied Materials very soon, therefore, this stockroom is badly
needed. We will highly appreciate if this matter will be given your immediate attention.

Thank you.

x x x x34

November 6, 2008

x x x x

Dear Mr. Mabunay,

We would like to call your attention regarding the decrease in your manpower assigned on site. We have
observed that for the past three (3) weeks instead of increasing your manpower to catch up with the delay
it was reduced to only 8 workers today from an average of 35 workers in the previous months.

Please note that based on your submitted revised schedule you are already delayed by approximately
57% and this will worsen should you not address this matter properly.

We are looking forward for [sic] your cooperation and continuous commitment in delivering this project as
per contract agreement.

x x x x35

Subsequently, a joint inspection and evaluation was conducted with the assistance of the architects and
engineers of petitioner and Mabunay and it was found that as of November 14, 2008, the project was only
31.39% complete and that the uncompleted portion was 68.61% with an estimated value per Construction
Agreement as P27,880,419.52. Instead of doubling his efforts as the scheduled completion date
approached, Mabunay did nothing to remedy the delays and even reduced the deployment of workers at
the project site. Neither did Mabunay, at anytime, ask for an extension to complete the project. Thus, on
November 19, 2008, petitioner advised Mabunay of its decision to terminate the contract on account of
the tremendous delay the latter incurred. This was followed by the claim against the Performance Bond
upon the respondent on December 18, 2008.

Petitioner’s claim against the Performance Bond included the liquidated damages provided in the
Construction Agreement, as follows:cralavvonlinelawlibrary

ARTICLE 12 – LIQUIDATED DAMAGES:

12.01 Time is of the essence in this Agreement. Should the CONTRACTOR fail to complete the
PROJECT within the period stipulated herein or within the period of extension granted by the
OWNER, plus One (1) Week grace period, without any justifiable reason, the CONTRACTOR hereby
agrees –

a. The CONTRACTOR shall pay the OWNER liquidated damages equivalent to One Tenth of One
Percent (1/10 of 1%) of the Contract Amount for each day of delay after any and all extensions and the
One (1) week Grace Period until completed by the CONTRACTOR.

b. The CONTRACTOR, even after paying for the liquidated damages due to unexecuted works and/or
delays shall not relieve it of the obligation to complete and finish the construction.

Any sum which maybe payable to the OWNER for such loss may be deducted from the amounts retained
under Article 9 or retained by the OWNER when the works called for under this Agreement have been
finished and completed.

Liquidated Damage[s] payable to the OWNER shall be automatically deducted from the contractors
collectibles without prior consent and concurrence by the CONTRACTOR.

12.02 To give full force and effect to the foregoing, the CONTRACTOR hereby, without necessity of any
further act and deed, authorizes the OWNER to deduct any amount that may be due under Item (a)
above, from any and all money or amounts due or which will become due to the CONTRACTOR by virtue
of this Agreement and/or to collect such amounts from the Performance Bond filed by the CONTRACTOR
in this Agreement.36 (Emphasis supplied.)

Liability for liquidated damages is governed by Articles 2226 to 2228 of the Civil Code, which
provide:cralavvonlinelawlibrary

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. 37 The amount agreed upon
answers for damages suffered by the owner due to delays in the completion of the project. 38 As a
precondition to such award, however, there must be proof of the fact of delay in the performance of the
obligation.39

Concededly, Article 12.01 of the Construction Agreement mentioned only the failure of the contractor to
complete the project within the stipulated period or the extension granted by the owner. However, this will
not defeat petitioner’s claim for damages nor respondent’s liability under the Performance Bond. Mabunay
was clearly in default considering the dismal percentage of his accomplishment (32.38%) of the work he
contracted on account of delays in executing the scheduled work activities and repeated failure to provide
sufficient manpower to expedite construction works. The events of default and remedies of the Owner are
set forth in Article 13, which reads:cralavvonlinelawlibrary

ARTICLE 13 – DEFAULT OF CONTRACTOR:

13.01 Any of the following shall constitute an Event of Default on the [part] of the CONTRACTOR.

xxxx

g. In case the CONTRACTOR has done any of the following:cralavvonlinelawlibrary

(i.) has abandoned the Project

(ii.) without reasonable cause, has failed to commence the construction or has suspended the progress of
the Project for twenty-eight days

(iii.) without justifiable cause, has delayed the completion of the Project by more than thirty (30)
calendar days based on official work schedule duly approved by the OWNER

(iv.) despite previous written warning by the OWNER, is not executing the construction works in
accordance with the Agreement or is persistently or flagrantly neglecting to carry out its
obligations under the Agreement.

(v.) has, to the detriment of good workmanship or in defiance of the Owner’s instructions to the contrary,
sublet any part of the Agreement.

13.02 If the CONTRACTOR has committed any of the above reasons cited in Item 13.01, the OWNER
may after giving fourteen (14) calendar days notice in writing to the CONTRACTOR, enter upon the site
and expel the CONTRACTOR therefrom without voiding this Agreement, or releasing the CONTRACTOR
from any of its obligations, and liabilities under this Agreement. Also without diminishing or affecting the
rights and powers conferred on the OWNER by this Agreement and the OWNER may himself complete
the work or may employ any other contractor to complete the work. If the OWNER shall enter and expel
the CONTRACTOR under this clause, the OWNER shall be entitled to confiscate the performance
bond of the CONTRACTOR to compensate for all kinds of damages the OWNER may suffer. All
expenses incurred to finish the Project shall be charged to the CONTRACTOR and/or his bond. Further,
the OWNER shall not be liable to pay the CONTRACTOR until the cost of execution, damages for the
delay in the completion, if any, and all; other expenses incurred by the OWNER have been ascertained
which amount shall be deducted from any money due to the CONTRACTOR on account of this
Agreement. The CONTRACTOR will not be compensated for any loss of profit, loss of goodwill, loss of
use of any equipment or property, loss of business opportunity, additional financing cost or overhead or
opportunity losses related to the unaccomplished portions of the work. 40 (Emphasis supplied.)
As already demonstrated, the contractor’s default in this case pertains to his failure to substantially
perform the work on account of tremendous delays in executing the scheduled work activities. Where a
party to a building construction contract fails to comply with the duty imposed by the terms of the contract,
a breach results for which an action may be maintained to recover the damages sustained thereby, and of
course, a breach occurs where the contractor inexcusably fails to perform substantially in accordance with
the terms of the contract.41

The plain and unambiguous terms of the Construction Agreement authorize petitioner to confiscate the
Performance Bond to answer for all kinds of damages it may suffer as a result of the contractor’s failure to
complete the building. Having elected to terminate the contract and expel the contractor from the project
site under Article 13 of the said Agreement, petitioner is clearly entitled to the proceeds of the bond as
indemnification for damages it sustained due to the breach committed by Mabunay. Such stipulation
allowing the confiscation of the contractor’s performance bond partakes of the nature of a penalty clause.
A penalty clause, expressly recognized by law, is an accessory undertaking to assume greater liability on
the part of the obligor in case of breach of an obligation. It functions to strengthen the coercive force of
obligation and to provide, in effect, for what could be the liquidated damages resulting from such a
breach. The obligor 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 obligor. 42

Respondent, however, insists that it is not liable for the breach committed by Mabunay because by the
terms of the surety bond it issued, its liability is limited to the performance by said contractor to the extent
equivalent to 20% of the down payment. It stresses that with the 32.38% completion of the project by
Mabunay, its liability was extinguished because the value of such accomplishment already exceeded the
sum equivalent to 20% down payment (P8.4 million).

The appellate court correctly rejected this theory of respondent when it ruled that the Performance Bond
guaranteed the full and faithful compliance of Mabunay’s obligations under the Construction Agreement,
and that nowhere in law or jurisprudence does it state that the obligation or undertaking by a surety may
be apportioned.

The pertinent portions of the Performance Bond provide:cralavvonlinelawlibrary

The conditions of this obligation are as follows:

Whereas the JPLUS ASIA, requires the principal SEVEN SHADES OF BLUE CONSTRUCTION AND
DEVELOPMENT, INC. to post a bond of the abovestated sum to guarantee 20% down payment for the
construction of Building 25 (Villa Beatriz) 72-Room Condotel, The Lodgings inside Fairways and
Bluewater, Boracay Island, Malay, Aklan.

Whereas, said contract required said Principal to give a good and sufficient bond in the above-stated
sum to secure the full and faithful performance on his part of said contract.

It is a special provision of this undertaking that the liability of the surety under this bond shall in no case
exceed the sum ofP8,400,000.00 Philippine Currency.

Now, Therefore, if the Principal shall well and truly perform and fulfill all the undertakings, covenants,
terms, conditions and agreements stipulated in said contract, then this obligation shall be null and void;
otherwise to remain in full force and effect.43 (Emphasis supplied.)

While the above condition or specific guarantee is unclear, the rest of the recitals in the bond
unequivocally declare that it secures the full and faithful performance of Mabunay’s obligations under the
Construction Agreement with petitioner. By its nature, a performance bond guarantees that the contractor
will perform the contract, and usually provides that if the contractor defaults and fails to complete the
contract, the surety can itself complete the contract or pay damages up to the limit of the
bond.44 Moreover, the rule is that if the language of the bond is ambiguous or uncertain, it will be
construed most strongly against a compensated surety and in favor of the obligees or beneficiaries under
the bond, in this case petitioner as the Project Owner, for whose benefit it was ostensibly executed. 45

The imposition of interest on the claims of petitioner is likewise in order. As we held in Commonwealth
Insurance Corporation v. Court of Appeals46Petitioner argues that it should not be made to pay interest
because its issuance of the surety bonds was made on the condition that its liability shall in no case
exceed the amount of the said bonds.

We are not persuaded. Petitioner’s argument is misplaced.

Jurisprudence is clear on this matter. As early as Tagawa vs. Aldanese and Union Gurantee Co. and
reiterated in Plaridel Surety & Insurance Co., Inc. vs. P.L. Galang Machinery Co., Inc., and more recently,
in Republic vs. Court of Appeals and R & B Surety and Insurance Company, Inc., we have sustained the
principle that if a surety upon demand fails to pay, he can be held liable for interest, even if in thus
paying, its liability becomes more than the principal obligation. The increased liability is not
because of the contract but because of the default and the necessity of judicial collection.

Petitioner’s liability under the suretyship contract is different from its liability under the law. There is no
question that as a surety, petitioner should not be made to pay more than its assumed obligation under
the surety bonds. However, it is clear from the above-cited jurisprudence that petitioner’s liability for the
payment of interest is not by reason of the suretyship agreement itself but because of the delay in the
payment of its obligation under the said agreement. 47 (Emphasis supplied; citations omitted.)
WHEREFORE, the petition for review on certiorari is GRANTED. The Decision dated January 27, 2011
and Resolution dated December 8, 2011 of the Court of Appeals in CA-G.R. SP No. 112808 are
hereby REVERSED and SET ASIDE.

PUROMINES v. COURT OF APPEALS

FACTS: Culled from the records of this case, the facts show that petitioner, Puromines, Inc. (Puromines
for brevity) and Makati Agro Trading, Inc. (not a party in this case) entered into a contract with private
respondent Philipp Brothers Oceanic, Inc. for the sale of prilled Urea in bulk. The Sales Contract No.
S151.8.01018 provided, among others an arbitration clause which states thus:

"9. Arbitration

"Any disputes arising under this contract shall be settled by arbitration in London in accordance with the
Arbitration Act 1950 and any statutory amendment or modification thereof. Each party is to appoint an
Arbitrator, and should they be unable to agree, the decision of an Umpire appointed by them to be final.
The Arbitrators and Umpire are all to be commercial men and resident in London. This submission may
be made a rule of the High Court of Justice in England by either party." [2]
On or about May 12, 1988, the vessel M/V "Liliana Dimitrova" loaded on board at Yuzhny, USSR a
shipment of 15,500 metric tons prilled Urea in bulk complete and in good order and condition for transport
to Iloilo and Manila, to be delivered to petitioner. Three bills of lading were issued by the ship-agent in the
Philippines, Maritime Factors Inc., namely: Bill of Lading No. 1 dated May 12, 1988 covering 10,000
metric tons for discharge in Manila; Bill of Lading No. 2 of even date covering 4,000 metric tons for
unloading in Iloilo City; and Bill of Lading No. 3, also dated May 12, 1988, covering 1,500 metric tons
likewise for discharge in Manila.

The shipment covered by Bill of Lading No. 2 was discharged in Iloilo City complete and in good order
and condition. However, the shipments covered by Bill of Lading Nos. 1 and 3 were discharged in Manila
in bad order and condition, caked, hardened and lumpy, discolored and contaminated with rust and dirt.
Damages were valued at P683,056.29 including additional discharging expenses.

Consequently, petitioner filed a complaint [3] with the trial court[4] for breach of contract of carriage against
Maritime Factors, Inc. (which was not included as respondent in this petition) as ship-agent in the
Philippines for the owners of the vessel MV "Liliana Dimitrova," while private respondent, Philipp Brothers
Oceanic, Inc., was impleaded as charterer of the said vessel and proper party to accord petitioner
complete relief. Maritime Factors, Inc. filed its Answers[5] to the complaint, while private respondent filed a
motion to dismiss, dated February 9, 1989, on the grounds that the complaint states no cause of action:
that it was prematurely filed; and that petitioner should comply with the arbitration clause in the sales
contract.[6]

The motion to dismiss was opposed by petitioner contending the inapplicability of the arbitration clause
inasmuch as the cause of action did not arise from a violation of the terms of the sales contract but rather
for claims of cargo damages where there is no arbitration agreement. On April 26, 1989, the trial court
denied respondent's motion to dismiss in this wise:

"The sales contract in question states in part:

'Any disputes arising under this contract shall be settled by arbitration . . . ' (emphasis supplied)

"A perusal of the facts alleged in the complaint upon which the question of sufficiency of the cause of
action is to be determined shows quite clearly that the cause of action of the complaint arose from a
breach of contract of carriage by the vessel chartered by the defendant Philipp Brothers Oceanic, Inc.
Thus, the aforementioned arbitration clause cannot apply to the dispute in the present action which
concerns plaintiff's claim for cargo loss/damage arising from breach of contract of carriage.

"That the defendant is not the ship owner or common carrier and therefore plaintiff does not have a legal
right against it since every action must be brought against the real party in interest has no merit either for
by the allegations in the complaint the defendant herein has been impleaded as charterer of the vessel,
hence, a proper party."[7]
Elevating the matter to the Court of Appeals, petitioner's complaint was dismissed. The appellate court
found that the arbitration provision in the sales contract and/or the bills of lading is applicable in the
present case. Said the court:

"An examination of the sales contract No. S151.8.01018 shows that it is broad enough to include the
claim for damages arising from the carriage and delivery of the goods subject matter thereof.

"It is also noted that the bills of lading attached as Annexes 'A', 'B' and 'C' to the complaint state, in part,
'any dispute arising under this Bill of Lading shall be referred to arbitration of the Maritime Arbitration
Commission at the USSR Chamber of Commerce and Industry, 6 Kuibyshevskaia Str.. Moscow, USSR,
in accordance with the rules of procedure of said commission.'

"Considering that the private respondent was one of the signatories to the sales contract. . . all parties are
obliged to respect the terms and conditions of the said sales contract, including the provision thereof on
'arbitration.' "
Hence, this petition.

The issue raised is: Whether the phrase "any dispute arising under this contract" in the arbitration clause
of the sales contract covers a cargo claim against the vessel (owners and/or charterers) for breach of
contract of carriage.

Petitioner states in its complaint that Philipp Brothers "was the charterer of the vessel MV 'Liliana
Dimitrova' which transported the shipment from Yuzhny USSR to Manila." Petitioner further alleged that
the caking and hardening, wetting and melting, and contamination by rust and dirt of the damaged
portions of the shipment were due to the improper ventilation and inadequate storage facilities of the
vessel; that the wetting of the cargo was attributable to the failure of the crew to close the hatches before
and when it rained while the shipment was being unloaded in the Port of Manila;  and that as a direct and
natural consequence of the unseaworthiness and negligence of the vessel (sic), petitioner suffered
damages in the total amount of P683,056.29 Philippine currency." [8] (underscoring supplied)

Moreover, in its Opposition to the Motion to Dismiss, petitioner said that "[t]he cause of action of the
complaint arose from breach of contract of carriage by the vessel that was chartered by defendant Philipp
Brothers"[9]

In the present petition, petitioner argues that the sales contract does not include the contract of carriage
which is a different contract entered into by the carrier with the cargo owners. That it was an error for the
respondent court to touch upon the arbitration provision of the bills of lading in its decision inasmuch as
the same was not raised as an issue by private respondent who was not a party in the bills of
lading (emphasis Ours). Petitioner contradicts itself.
We agree with the court a quo that the sales contract is comprehensive enough to include claims for
damages arising from carriage and delivery of the goods. As a general rule, the seller has the obligation
to transmit the goods to the buyer, and concomitant thereto, the contracting of a carrier to deliver the
same. Art. 1523 of the Civil Code provides:

"Art. 1523. Where in pursuance of contract of sale, the seller is authorized or required to send the goods
to the buyer, delivery of the goods to a carrier, whether named by the buyer or not, for the purpose of
transmission to the buyer is deemed to be a delivery of the goods to the buyer, except in the cases
provided for in article 1503, first, second and third paragraphs, or unless a contrary intent appears.

"Unless otherwise authorized by the buyer, the seller must make such contract with the carrier on behalf
of the buyer as may be reasonable, having regard to the nature of the goods and the other circumstances
of the case. If the seller omit so to do, and the goods are lost or damaged in course of transit, the buyer
may decline to treat the delivery to the carrier as a delivery to himself, or may hold the seller responsible
in damages."

x        x         x
The disputed sales contract provides for conditions relative to the delivery of goods, such as date of
shipment, demurrage, weight as determined by the bill of lading at load port and more particularly the
following provisions:

"3. Intention is to ship in one bottom, approximately 5,000 metric tons to Puromines and approximately
15,000 metric tons to Makati Agro. However, Sellers to have right to ship material as partial shipment or
co-shipment in addition to above. In the event of co-shipment to a third party within Philippines same to
be discussed with and acceptable to both Puromines and Makati Agro.

"4. Sellers to appoint neutral survey for Seller's account to conduct initial draft survey at first discharge
port and final survey at last discharge port. Surveyor's results to be binding and final. In the event draft
survey results show a quantity less than the combined Bills of Lading quantity for both Puromines and
Makati Agro, Sellers to refund the difference. In the event that draft survey results show a quantity in
excess of combined Bills of Lading quantity of both Puromines and Makati Agro then Buyers to refund the
difference.

"5. It is expressly and mutually agreed that neither Sellers nor vessel's Owners have any liability to
separate cargo or to deliver cargos separately or to deliver minimum/maximum quantities stated on
individual Bills of Lading. At each port vessel is to discharge in accordance with Buyers local
requirements and it is Buyer's responsibility to separate individual quantities required by each of them at
each port during or after discharge."
As argued by respondent on its motion to dismiss, "the (petitioner) derives his right to the cargo from the
bill of lading which is the contract of affreightment together with the sales contract. Consequently, the
(petitioner) is bound by the provisions and terms of said bill of lading and of the arbitration clause
incorporated in the sales contract."

Assuming arguendo that the liability of respondent is not based on the sales contract, but rather on the
contract of carriage, being the charterer of the vessel MV "Liliana Dimitrova," it would, therefore, be
material to show what kind of charter party the respondent had with the shipowner to determine
respondent's liability.

American jurisprudence defines charter party as a contract by which an entire ship or some principal part
thereof is let by the owner to another person for a specified time or use. [10] Charter or charter parties are
of two kinds. Charter of demise or bareboat and contracts of affreigntment.

Under the demise or bareboat charter of the vessel, the charterer will generally be considered as owner
for the voyage or service stipulated. The charterer mans the vessel with his own people and becomes, in
effect, the owner pro hac vice, subject to liability to others for damages caused by negligence. [11] To
create a demise the owner of a vessel must completely and exclusively relinquish possession, command
and navigation thereof to the charterer: anything short of such a complete transfer is a contract of
affreightment (time or voyage charter party) or not a charter party at all.

On the other hand, a contract of affreightment is one in which the owner of the vessel leases part or all of
its space to haul goods for others. It is a contract for a special service to be rendered by the owner of the
vessel[12] and under such contract the general owner retains the possession, command and navigation of
the ship, the charterer or freighter merely having use of the space in the vessel in return for his payment
of the charter hire.[13] If the charter is a contract of affreightment, which leaves the general owner in
possession of the ship as owner for the voyage, the rights, responsibilities of ownership rest on the owner
and the charterer is usually free from liability to third persons in respect of the ship. [14]

Responsibility to third persons for goods shipped on board a vessel follows the vessel's possession and
employment; and if possession is transferred to the charterer by virtue of a demise, the charterer, and not
the owner, is liable as carrier on the contract of affreightment made by himself or by the master with third
persons, and is answerable for loss, damage or nondelivery of goods received for transportation. An
owner who retains possession of the ship, though the hold is the property of the charterer, remains liable
as carrier and must answer for any breach of duty as to the care, loading or unloading of the cargo. [15]

Assuming that in the present case, the charter party is a demise or bareboat charter, then Philipp
Brothers is liable to Puromines, Inc., subject to the terms and conditions of the sales contract. On the
other hand, if the contract between respondent and the owner of the vessel MV "Liliana Dimitrova" was
merely that of affreightment, then it cannot be held liable for the damages caused by the breach of
contract of carriage, the evidence of which is the bills of lading.

In any case, whether the liability of respondent should be based on the sales contract or that of the bill of
lading, the parties are nevertheless obligated to respect the arbitration provisions on the sales contract
and/or the bill of lading. Petitioner being a signatory and party to the sales contract cannot escape from
his obligation under the arbitration clause as stated therein.

Neither can petitioner contend that the arbitration provision in the bills of lading should not have been
discussed as an issue in the decision of the Court of Appeals since it was not raised as a special or
affirmative defense. The three bills of lading were attached to the complaint as Annexes "A," "B," and "C,"
and are therefore parts thereof and may be considered as evidence although not introduced as such.
[16]
 Hence, it was then proper for the court a quo to discuss the contents of the bills of lading, having been
made part of the record.

Going back to the main subject of this case, arbitration has been held valid and constitutional. Even
before the enactment of Republic Act No. 876, this Court has countenanced the settlement of disputes
through arbitration. The rule now is that unless the agreement is such as absolutely to close the doors of
the courts against the parties, which agreement would be void, the courts will look with favor upon such
amicable arrangements and will only interfere with great reluctance to anticipate or nullify the action of the
arbitrator.[17]

As pointed out in the case of Mindanao Portland Cement Corp. v. McDonough Construction Company of
Florida[18] wherein the plaintiff sued defendant for damages arising from a contract, the Court said:

"Since there obtains herein a written provision for arbitration as well as failure on respondent's part to
comply therewith, the court a quo rightly ordered the parties to proceed to their arbitration in accordance
with the terms of their agreement (Sec. 6 Republic Act 876). Respondent's arguments touching upon the
merits of the dispute are improperly raised herein. They should be addressed to the arbitrators. This
proceeding is merely a summary remedy to enforce the agreement to arbitrate. The duty of the court in
this case is not to resolve the merits of the parties' claims but only to determine if they should proceed to
arbitration or not. And although it has been ruled that a frivolous or patently baseless claim should not be
ordered to arbitration, it is also recognized that the mere fact that a defense exists against a claim does
not make it frivolous or baseless."[19]
In the case of Bengson v. Chan,[20] We upheld the provision of a contract which required the parties to
submit their disputes to arbitration and We held as follows:

"The trial court sensibly said that 'all the causes of action alleged in the plaintiff's amended complaint are
based upon the supposed violations committed by the defendants of the 'Contract of Construction of a
Building' ' and that 'the provisions of paragraph 15 hereof leave a very little room for doubt that the said
causes of action are embraced within the phrase 'any and all questions, disputes or differences between
the parties hereto relative to the construction of the building,' which must be determined by arbitration of
two persons and such determination by the arbitrators shall be 'final, conclusive and binding upon both
parties' unless they go to court, in which the case the determination by arbitration is a condition precedent
'for taking any court action.' '

x x x

"We hold that the terms of paragraph 15 clearly express the intention of the parties that all disputes
between them should first be arbitrated before court action can be taken by the aggrieved party." [21]
Premises considered, We uphold the validity and applicability of the arbitration clause as stated in Sales
Contract No. S151.8.01018 to the present dispute.