G.R. No. L-13307; February 3, 1919
LA INSULAR, plaintiff-appellee, vs. RAFAEL MACHUCA GO-TAUCO and MANUEL NUBLA CO-SIONG, defendants-appellants.

FACTS:
La Insular, a manufacturer, entered into a contract with Manuel Nubla Co-Siong (principal) and Rafael Machuca Go-Tauco (surety) for the daily supply of cigarettes at P172 per box. The surety bound himself jointly and severally for Nubla’s obligations up to P25,000. Subsequently, the Philippine Legislature increased the specific tax on cigarettes via Act No. 2432 , and Act No. 2445 provided that for existing contracts of future delivery, the burden of the increase should fall on the purchaser unless otherwise agreed. La Insular continued to pay the tax but added P10 per box to the price to cover the increase, which was reflected in its monthly statements to Nubla. Nubla made payments credited to his account. For cigarettes delivered in August and September 1916, valued at P10,192 (including the tax increase), Nubla failed to pay. La Insular sued both defendants. The trial court held Nubla liable for the full amount but limited the surety’s liability to the original contract price of P172 per box, absolving him from the P560 representing the tax increase. Both defendants appealed.

ISSUE:
1. Whether the principal debtor, Nubla, is liable for the increased tax.
2. Whether the surety, Go-Tauco, is released from his obligation because:
a. The legislative increase in tax constituted a material alteration of the contract without his consent; or
b. The payments made by Nubla should be reapplied exclusively to the original contract price, thereby fully extinguishing the debt secured by the surety.

RULING:
The Supreme Court affirmed the trial court’s judgment.
1. As to the principal debtor (Nubla): Following its precedent in Mitsui Bussan Kaisaha vs. Manila Electric Railroad and Light Company, the Court held that under Act No. 2445, the burden of the increased tax properly fell on the purchaser, Nubla. Therefore, he was liable for the full amount, including the tax increase.
2. As to the surety (Go-Tauco):
a. On material alteration: The increase in tax imposed by law did not constitute a material alteration of the contract that would release the surety. Contracts are made subject to the valid exercise of the state’s taxing power. The legislative act did not impair the obligation of contracts in a constitutional sense, nor did it effect a change by the immediate parties to the contract. The alteration was by operation of law, not by agreement between La Insular and Nubla.
b. On application of payments: The surety is bound by the application of payments made by the creditor with the principal debtor’s assent. Nubla, by paying the bills that included the increased tax, assented to the application of his payments to cover both the original price and the tax. The form of the account statements did not alter the fundamental rights of the parties. Therefore, the payments could not be reapplied to discharge only the original price and release the surety.

The surety remained liable for the unpaid balance based on the original contract price (P172 per box), as held by the trial court. The decision was affirmed with costs against the appellants.