Breach of contract + moral damages?

Under Article 2220 of the Civil Code, moral damages may be awarded in case of breach of contract where the breach is due to fraud or bad faith:

Art. 2220. Willful injury to property may be a legal ground for awarding moral damages if the court should find that, under the circumstances, such damages are justly due. The same rule applies to breaches of contract where the defendant acted fraudulently or in bad faith.Moral damages are not awarded as a matter of right but only after the party claiming it proved that the breach was due to fraud or bad faith. Moral damages are not recoverable simply because a contract has been breached. They are recoverable only if the party from whom it is claimed acted fraudulently or in bad faith or in wanton disregard of his contractual obligations. The breach must be wanton, reckless, malicious or in bad faith, and oppressive or abusive.

Further, the following requisites must be proven for the recovery of moral damages:

[1] There must be an INJURY, whether physical, mental or psychological, clearly sustained by the claimant;
[2] There must be culpable act or omission FACTUALLY established;
[3] The wrongful act or omission of the defendant is the PROXIMATE CAUSE of the injury sustained by the claimant; and
[4] The award of damages is predicated on any of the cases stated in ARTICLE 2219 of the Civil Code.

In Arco Pulp v. Lim, the injury suffered by respondent (Lim) is the loss of ₱7,220,968.31 from his business. This has remained unpaid since 2007. This injury undoubtedly was caused by petitioner Arco Pulp and Paper's act of refusing to pay its obligations.

When the obligation became due and demandable, petitioner Arco Pulp and Paper not only issued an unfunded check but also entered into a contract with a third person in an effort to evade its liability. This proves the third requirement.

As to the fourth requisite, Article 2219 of the Civil Code provides that moral damages may be awarded in the following instances:

Article 2219. Moral damages may be recovered in the following and analogous cases: [1] a criminal offense resulting in physical injuries; [2] quasi-delicts causing physical injuries; [3] seduction, abduction, rape, or other lascivious acts; [4] adultery or concubinage; [5] illegal or arbitrary detention or arrest; [6] illegal search; [7] libel, slander or any other form of defamation; [8] malicious prosecution; [9] acts mentioned in Article 309; and [10] acts and actions referred to in Articles 21, 26, 27, 28, 29, 30, 32, 34, and 35.

Breaches of contract done in BAD FAITH, however, are not specified within this enumeration. When a party breaches a contract, he or she goes against Article 19 of the Civil Code, which states: Article 19. Every person must, in the exercise of his rights and in the performance of his duties, act with justice, give everyone his due, and observe honesty and good faith.

Persons who have the right to enter into contractual relations must exercise that right with honesty and good faith. Failure to do so results in an abuse of that right, which may become the basis of an action for damages. Article 19, however, cannot be its sole basis.

Article 19 is the general rule which governs the conduct of human relations. By itself, it is not the basis of an actionable tort. Article 19 describes the degree of care required so that an actionable tort may arise when it is alleged together with Article 20 or Article 21. Article 20 and 21 of the Civil Code are as follows:

Article 20. Every person who, contrary to law, wilfully or negligently causes damage to another, shall indemnify the latter for the same.

Article 21.Any person who wilfully causes loss or injury to another in a manner that is contrary to morals, good customs or public policy shall compensate the latter for the damage.

To be actionable, Article 20 requires a violation of law, while Article 21 only concerns with lawful acts that are contrary to morals, good customs, and public policy:

Article 20 concerns violations of existing law as basis for an injury. It allows recovery should the act have been willful or negligent. Willful may refer to the intention to do the act and the desire to achieve the outcome which is considered by the plaintiff in tort action as injurious. Negligence may refer to a situation where the act was consciously done but without intending the result which the plaintiff considers as injurious.

Article 21, on the other hand, concerns injuries that may be caused by acts which are not necessarily proscribed by law. This article requires that the act be willful, that is, that there was an intention to do the act and a desire to achieve the outcome. In cases under Article 21, the legal issues revolve around whether such outcome should be considered a legal injury on the part of the plaintiff or whether the commission of the act was done in violation of the standards of care required in Article 19.

When parties act in bad faith and do not faithfully comply with their obligations under contract, they run the risk of violating Article 1159 of the Civil Code:

Article 1159. Obligations arising from contracts have the force of law between the contracting parties and should be complied with in good faith.

Article 2219, therefore, is not an exhaustive list of the instances where moral damages may be recovered since it only specifies, among others, Article 21. When a party reneges on his or her obligations arising from contracts in bad faith, the act is not only contrary to morals, good customs, and public policy; it is also a violation of Article 1159. Breaches of contract become the basis of moral damages, not only under Article 2220, but also under Articles 19 and 20 in relation to Article 1159.

Moral damages, however, are not recoverable on the mere breach of the contract. Article 2220 requires that the breach be done fraudulently or in bad faith. As Adriano v. Lasala dictates, to recover moral damages in an action for breach of contract, the breach must be palpably wanton, reckless and malicious, in bad faith, oppressive, or abusive. Hence, the person claiming bad faith must prove its existence by clear and convincing evidence for the law always presumes good faith.

What does bad faith mean? Bad faith does not simply connote bad judgment or negligence. It imports a dishonest purpose or some moral obliquity and conscious doing of a wrong, a breach of known duty through some motive or interest or ill will that partakes of the nature of fraud. It is, therefore, a question of intention, which can be inferred from one’s conduct and/or contemporaneous statements.

This is a question of fact. Since a finding of bad faith is generally premised on the intent of the doer, it requires an examination of the circumstances in each case.

When petitioner Arco Pulp and Paper issued a check in partial payment of its obligation to respondent, it was presumably with the knowledge that it was being drawn against a closed account. Worse, it attempted to shift their obligations to a third person without the consent of respondent.

Petitioner Arco Pulp and Paper’s actions clearly show a dishonest purpose or some moral obliquity and conscious doing of a wrong, a breach of known duty through some motive or interest or ill will that partakes of the nature of fraud. Moral damages may, therefore, be awarded.

Are there other forms of damages that may be awarded? Yes, exemplary damages may also be awarded. Under the Civil Code, exemplary damages are due in the following circumstances:

Article 2232. In contracts and quasi-contracts, the court may award exemplary damages if the defendant acted in a wanton, fraudulent, reckless, oppressive, or malevolent manner.

Article 2233. Exemplary damages cannot be recovered as a matter of right; the court will decide whether or not they should be adjudicated.

Article 2234. While the amount of the exemplary damages need not be proven, the plaintiff must show that he is entitled to moral, temperate or compensatory damages before the court may consider the question of whether or not exemplary damages should be awarded.

In Tankeh v. Development Bank of the Philippines, the Supreme Court stated that the purpose of exemplary damages is to serve as a deterrent to future and subsequent parties from the commission of a similar offense.

The case of People v. Ranteciting People v. Dalisay is instructive:

Also known as 'punitive' or 'vindictive' damages, exemplary or corrective damages are intended to serve as a deterrent to serious wrong doings, and as a vindication of undue sufferings and wanton invasion of the rights of an injured or a punishment for those guilty of outrageous conduct. These terms are generally, but not always, used interchangeably. In common law, there is preference in the use of exemplary damages when the award is to account for injury to feelings and for the sense of indignity and humiliation suffered by a person as a result of an injury that has been maliciously and wantonly inflicted, the theory being that there should be compensation for the hurt caused by the highly reprehensible conduct of the defendant—associated with such circumstances as willfulness, wantonness, malice, gross negligence or recklessness, oppression, insult or fraud or gross fraud—that intensifies the injury. The terms punitive or vindictive damages are often used to refer to those species of damages that may be awarded against a person to punish him for his outrageous conduct. In either case, these damages are intended in good measure to deter the wrongdoer and others like him from similar conduct in the future.

The requisites for the award of exemplary damages are as follows:

[1] TO SET AN EXAMPLE IF CLAIMANT HAS RIGHT. They may be imposed by way of example in addition to compensatory damages, and only after the claimant's right to them has been established;
[2] NOT A MATTER OF RIGHT AND RECOVERY DEPENDS ON ACTUAL DAMAGES. That they cannot be recovered as a matter of right, their determination depending upon the amount of compensatory damages that may be awarded to the claimant; and
[3] THERE MUST BE BAD FAITH. The act must be accompanied by bad faith or done in a wanton, fraudulent, oppressive or malevolent manner.

Business owners must always be forthright in their dealings. They cannot be allowed to renege on their obligations, considering that these obligations were freely entered into by them. Exemplary damages may also be awarded in this case to serve as a deterrent to those who use fraudulent means to evade their liabilities.

Since the award of exemplary damages is proper, attorney's fees and cost of the suit may also be recovered. Article 2208 provides that, in the absence of stipulation, attorney's fees and expenses of litigation, other than judicial costs, cannot be recovered, except: "(1) When exemplary damages are awarded; [xxx]." (Arco Pulp v. Lim. G.R. No. 206806. June 25, 2014. Justice Leonen)