G.R. No. 173575 ; February 2, 2011
IMMACULATE CONCEPTION ACADEMY and the late DR. PAULO C. CAMPOS substituted by his heirs, Petitioners, vs. AMA COMPUTER COLLEGE, INCORPORATED, Respondent.

FACTS

Immaculate Conception Academy (ICA) owned a three-storey building in Dasmariñas, Cavite. After an unsuccessful attempt to purchase it, AMA Computer College, Inc. (AMA) inspected the building and subsequently entered into a 10-year lease contract with ICA. AMA paid earnest money, advance rentals, and a security deposit. After signing, AMA officials re-inspected and began renovations but then noticed significant cracks on the second floor. AMA applied for an occupancy permit, and the Municipal Engineer, after inspection, issued a letter dated September 29, 1997, stating the building had multiple cracks, deflections beyond allowable limits, unusual vibrations, and was structurally unsafe for human occupancy. On the same day, AMA demanded a refund from ICA, rescinded the lease, and leased another property.
AMA filed a complaint for breach of contract and damages before the RTC, alleging fraudulent representation, breach of implied warranty against hidden defects, and ICA’s failure to produce a certificate of occupancy. The RTC ruled in favor of AMA, ordering restitution of payments with interest, exemplary damages, and attorney’s fees. The Court of Appeals affirmed the order for restitution but deleted the damages, holding that while ICA did not violate an implied warranty or act in bad faith, AMA was justified in rescinding due to ICA’s default in making necessary repairs upon demand.

ISSUE

Whether AMA was justified in rescinding the contract of lease.

RULING

Yes, AMA was justified in rescinding the contract, but not on the grounds of fraudulent representation or breach of implied warranty against hidden defects. The Supreme Court agreed with the CA that no fraud or violation of warranty existed because AMA inspected the building before leasing and the cracks were patent, not hidden. The legal justification for rescission arose from ICA’s failure to comply with its contractual obligation to make the premises suitable for the lessee’s intended use. The lease contract contained a stipulation that the lessor would bear the cost of major repairs to the main building structure. The Municipal Engineer’s finding that the building was structurally unsafe constituted a major defect requiring repair by the lessor. Upon AMA’s demand via its request for an occupancy permit, which the Court construed as a demand for repairs, ICA was obligated to rectify the defects to make the building safe for use as a school. ICA’s failure to do so constituted a breach of contract that justified rescission under Article 1191 of the Civil Code. Consequently, the parties must be restored to their original positions. The Court affirmed the CA’s decision ordering ICA to return AMA’s security deposit and advance rentals totaling ₱4,072,150.00 with legal interest. However, the Supreme Court reversed the CA on the award of damages, finding AMA’s rescission justified and not in bad faith; therefore, it reinstated the RTC’s award of exemplary damages and attorney’s fees to ICA, holding that AMA’s abrupt abandonment and filing of an unfounded suit for fraud warranted such an award against it.