G.R. No. 160600 - Gonzalo vs. Tarnate, Jr.

Case Summary (G.R. No. 160600)

Factual Background

The Department of Public Works and Highways awarded on July 22, 1997 a contract for the improvement of the Sadsadan-Maba-ay Section of the Mountain Province-Benguet Road to Gonzalo Construction in the amount of P7,014,963.33. Petitioner Domingo Gonzalo, as the contractor, subcontracted on October 15, 1997 to respondent John Tarnate, Jr. under Tarnate’s business JNT Aggregates for the supply of materials and labor. The subcontract provided that Tarnate would pay Gonzalo eight percent and four percent of the contract price upon his first and second billings. On April 6, 1999 Gonzalo executed a deed whereby he assigned to Tarnate ten percent of the total collection from the DPWH for the project, representing rental for Tarnate’s equipment and amounting to P233,526.13, and authorized Tarnate to use Gonzalo Construction’s official receipt to process and encash the retention payment. The deed was submitted to the DPWH on April 15, 1999, but Gonzalo filed an affidavit of cancellation dated April 19, 1999 which was recorded with the DPWH on April 22, 1999, after which the 10% retention was disbursed to Gonzalo.

Procedural History in the Trial Court

After Gonzalo refused Tarnate’s demand for the retention fee, Tarnate instituted suit in the RTC on September 13, 1999 seeking recovery of P233,526.13, moral and exemplary damages for breach of contract, and attorneys’ fees. Gonzalo admitted the deed of assignment and the authority granted thereunder but asserted that the project had not been fully implemented because of cancellation by the DPWH and that he had revoked the deed; he contended the assignment was derivative of and dependent on the subcontract and that Tarnate, aware of the illegality, could not seek relief with unclean hands. The RTC, viewing the deed of assignment as valid and binding, rendered judgment on January 26, 2001 in favor of Tarnate, awarding the principal amount of P233,526.13, attorneys’ fees of P30,000, litigation expenses of P15,000, moral damages of P20,000, and costs.

Court of Appeals Decision

On February 18, 2003 the Court of Appeals affirmed the RTC decision but characterized the subcontract as illegal under Section 6 of Presidential Decree No. 1594 because it lacked DPWH approval, and held that the deed of assignment, as a product of that subcontract, was likewise illegal and unenforceable. The CA declined to apply the doctrine of in pari delicto because it considered Gonzalo more culpable than Tarnate; it found that Gonzalo’s crediting of the 10% retention to his account unjustly enriched him and ordered reimbursement to Tarnate in the amount of P233,526.13.

Issues Presented on Appeal

Petitioner Gonzalo challenged the CA ruling on three principal grounds: (1) that the parties stood in in pari delicto and therefore neither could obtain affirmative relief; (2) that the deed of assignment was void and unenforceable; and (3) that the arbitration clause in the subcontract was not complied with. Gonzalo argued that both the subcontract and deed of assignment were specifically prohibited by law and that the courts should leave the parties where they stood rather than afford relief.

Parties’ Contentions at Supreme Court

Petitioner reiterated that the subcontract and the deed of assignment were illegal under Section 6 of Presidential Decree No. 1594, rendering them void and unenforceable; petitioner urged application of the doctrine of in pari delicto to deny relief. Respondent Tarnate maintained entitlement to the 10% retention fee for equipment rental and invoked the public policy against unjust enrichment to justify recovery despite the illegality of the subcontract and deed.

Ruling of the Supreme Court

The Supreme Court denied the petition for review but modified the relief awarded. The Court affirmed the CA’s judgment insofar as it held Gonzalo liable to pay Tarnate P233,526.13, but deleted the awards of moral damages, attorneys’ fees, and litigation expenses. The Court imposed legal interest of six percent per annum on the principal amount from September 13, 1999, and directed petitioner to pay the costs of suit.

Legal Basis and Reasoning

The Court affirmed that the subcontract contravened Section 6 of Presidential Decree No. 1594, which bars assignment, transfer, pledge, subcontract, or other disposition of a government contract except with the approval of the proper minister, and that a deed of assignment that springs from an illegal subcontract is likewise void. The Court invoked Article 1409 (1) of the Civil Code to confirm that a contract whose cause, object or purpose is contrary to law is inexistent, and Article 1422 of the Civil Code to hold that a contract directly resulting from an illegal contract is also void. The Court rejected the CA’s conclusion that Tarnate was less guilty, finding that Tarnate voluntarily entered into the illegal agreements, participated in the arrangement despite knowing he was not authorized to contract with the DPWH, and thus was not less culpable than Gonzalo. Under Article 1412 (1) of the Civil Code, the guilty parties to an illegal contract ordinarily cannot recover from one another because they are in in pari delicto. The Court observed, however, that the doctrine admits exceptions where its rigid application would contravene well-established public policy. The Court identified the prevention of unjust enrichment as such a public policy, citing Article 22 of the Civil Code and prior decisions including Hulst v. PR Builders, Inc. The Court found that Tarnate had in fact furnished equipment, labor and materials and that Gonzalo had received the retention payment and refused to deliver it to Tarnate. To deny recovery would permit Gonzalo to retain an unjust enrichment at Tarnate’s expense, contrary to Article 22 and the aims of justice, equity and good conscience. Accordingly, the Court applied the unjust enrichment exception and sustained Tarnate’s recovery of the retention amount.

Treatment of Ancillary Claims and Defenses

The Court rejected Gonzalo’s claim that the retention fee could be withheld because of an alleged P200,000 debt to Congressman Victor Do

Case Syllabus (G.R. No. 160600)

Parties and Procedural Posture

DOMINGO GONZALO was the main contractor awarded the DPWH contract for the Sadsadan-Maba-ay Section of the Mountain Province-Benguet Road and appealed after adverse rulings.
JOHN TARNATE, JR. contracted as subcontractor under the business name JNT Aggregates to supply labor and materials and sued to recover a 10% retention fee.
The Regional Trial Court rendered judgment in favor of JOHN TARNATE, JR. on January 26, 2001, awarding P233,526.13 and various damages.
The Court of Appeals affirmed the RTC decision on February 18, 2003 while declaring the subcontract and deed of assignment illegal but awarding restitution for unjust enrichment.
The petitioner brought the case to the Supreme Court by petition for review, which denied the petition in part and modified monetary awards.

Key Factual Allegations

DOMINGO GONZALO was awarded the DPWH contract dated July 22, 1997 for P7,014,963.33 and subcontracted portions of the work to JOHN TARNATE, JR. on October 15, 1997.
The subcontract provided that JOHN TARNATE, JR. would pay Gonzalo eight percent and four percent of the contract price upon the first and second billings respectively.
On April 6, 1999, DOMINGO GONZALO executed a deed of assignment assigning to JOHN TARNATE, JR. ten percent of total DPWH collections as equipment rental, equivalent to P233,526.13.
The deed authorized JOHN TARNATE, JR. to use Gonzalo Construction’s official receipt and to process and encash the DPWH check for the retention fee.
Gonzalo filed an affidavit canceling the deed of assignment on April 19, 1999, the DPWH released the retention fee to Gonzalo, and Tarnate’s demand for payment was refused.

Statutory Framework

Section 6 of Presidential Decree No. 1594 proscribes assignment, transfer, pledge, subcontract or other disposition of a public works contract without approval of the appropriate Minister or Secretary.
Article 1409 (1) of the Civil Code provides that a contract whose cause, object or purpose is contrary to law is void or inexistent.
Article 1422 of the Civil Code declares that a contract which is the direct result of a previous illegal contract is likewise void and inexistent.
Article 1412 (1) of the Civil Code embodies the in pari delicto rule that guilty parties to an illegal contract cannot recover from one another.
Article 22 of the Civil Code mandates restitution where a person acquires or comes into possession of something at the expense of another without just or legal ground.

Rulings Below

The RTC held the deed of assignment valid and ordered DOMINGO GONZALO to pay P233,526.13, P30,000.00 in attorneys fees, P15,000.00 in litigation expenses, P20,000.00 in moral damages, and costs.
The Court of Appeals found the subcontract and deed of assignment illegal under Sectio