Metropolitan Waterworks and Sewerage System vs. Court of Appeals

A possessor in bad faith is not entitled to either reimbursement for or removal of useful improvements introduced on the property of another. The right of removal under the Civil Code is limited to improvements for pure luxury or mere pleasure, provided the thing suffers no injury and the lawful possessor does not prefer to retain them by paying their value at the time of entry.

The City of Dagupan sought to recover ownership and possession of its local waterworks system from NAWASA, which claimed ownership under Republic Act No. 1383. Prior Supreme Court decisions had already declared unconstitutional the taking of patrimonial waterworks systems of cities, municipalities, and provinces without just compensation. After the complaint was filed and despite those rulings, NAWASA introduced useful improvements to the system using loan proceeds, and later counterclaimed for reimbursement of the expenses incurred.

• Nature of the Action: The City of Dagupan filed a complaint against NAWASA for recovery of ownership and possession of the Dagupan Waterworks System. NAWASA interposed a special defense based on Republic Act No. 1383, which purportedly vested it with ownership, possession, and control of all waterworks systems in the Philippines.
• NAWASA’s Counterclaim: NAWASA counterclaimed for reimbursement of approximately P255,000 in expenses it had incurred for necessary and useful improvements introduced to the waterworks system.
• Stipulated Facts and Trial Court Decision: The case was decided by the trial court on the basis of a stipulation of facts. The trial court found that NAWASA was a possessor in bad faith because the useful improvements were instituted after the complaint was filed and after numerous Supreme Court decisions had declared unconstitutional the taking of local patrimonial waterworks without just compensation. Consequently, the trial court declared the City the lawful owner and held that NAWASA was not entitled to reimbursement.
• Court of Appeals Affirmance: The Court of Appeals affirmed, characterizing the useful expenses as having been made in “utter bad faith.” It invoked Article 546 of the Civil Code and the ruling in Santos vs. Mojica to conclude that a builder or possessor in bad faith is not entitled to indemnity for useful improvements.
• MWSS’s New Theory on Appeal: Before the Supreme Court, MWSS no longer sought reimbursement but instead claimed the right to remove all the useful improvements it had introduced, contending that the Civil Code did not definitively settle whether a possessor in bad faith could remove such improvements.
• Procedural Context: The issue of removal was never pleaded as an alternative counterclaim in the trial court. No evidence was presented on the removability of the improvements because the case was decided on a stipulation of facts. The City objected to the belated raising of the issue.
• City’s Alternative Arguments: The City argued that even if removal were theoretically available, the improvements were not specifically identified, and any removal would cause substantial injury or damage to the Dagupan Waterworks System.

• Right to Remove Useful Improvements: Petitioner MWSS maintained that Articles 546, 547, and 549 of the Civil Code do not definitively preclude a possessor in bad faith from removing useful improvements, and that the decisions in Mindanao Academy, Inc. vs. Yap and Carbonell vs. Court of Appeals supported a right of removal.
• Implied Consent to Try the Unpleaded Issue: Petitioner argued that although the issue of removal was not pleaded as a counterclaim, it was tried with the implied consent of the City because the City never objected to petitioner’s manifestation that the improvements were separable from the system. It invoked Section 5 of Rule 10 of the Rules of Court, which permits amendment of pleadings to conform to evidence on issues tried with implied consent.

• Procedural Bar: Respondent City of Dagupan countered that the issue of removal of useful improvements was raised for the first time before the Supreme Court, not having been pleaded in the trial court or assigned as error before the Court of Appeals; therefore, it could not be entertained.
• Absolute Denial of Rights to a Possessor in Bad Faith: Respondent argued that a possessor in bad faith has absolutely no right to useful improvements under the Civil Code, and that the rulings in Mindanao Academy and Carbonell were inapplicable to the case.
• Impossibility of Removal Without Damage: Even assuming a right to remove existed, respondent maintained that the useful improvements were not identified and could not be separated from the waterworks system without causing substantial injury or damage, making a rehearing necessary—a course improper at that stage of the proceedings.

• Procedural Propriety: Whether the issue of the right to remove useful improvements, raised for the first time on appeal and not pleaded in the trial court, could properly be considered by the Supreme Court.
• Substantive Right of a Possessor in Bad Faith: Whether a possessor in bad faith has the right to remove useful improvements introduced on the land of another under the Civil Code.

• Procedural Propriety: The procedural objection was technically correct. NAWASA should have pleaded its additional counterclaim in the alternative—for reimbursement of expenses or for removal of the useful improvements. No evidence was introduced on the removability of the improvements because the case was decided on a stipulation of facts; thus, the pleadings could not be deemed amended to conform to evidence under Section 5 of Rule 10. Nonetheless, the Supreme Court elected to overlook the procedural defect in order to resolve the substantive issue.
• Substantive Right of a Possessor in Bad Faith: A possessor in bad faith has no right to remove useful improvements. Article 449 of the Civil Code provides that one who builds in bad faith loses what is built without right to indemnity. Articles 546 and 547 grant the right to refund of useful expenses and the right to remove useful improvements exclusively to a possessor in good faith. The only removal right accorded to a possessor in bad faith is found in Article 549, and it is confined to improvements for pure luxury or mere pleasure, subject to the conditions that the thing suffers no injury and that the lawful possessor does not prefer to retain them by paying their value at the time of entry. The cases of Mindanao Academy, Inc. vs. Yap and Carbonell vs. Court of Appeals were distinguished and do not support petitioner’s claim. In Mindanao Academy, the defendant builder in bad faith was allowed to remove only equipment, books, furniture, and fixtures brought in, as they were outside the scope of the judgment. In Carbonell, the decision lacked precedential force because only four justices concurred in treating the respondents as possessors in bad faith and allowing removal on equitable grounds, while two justices held they were possessors in good faith.

• Rights of a possessor in bad faith as to improvements under the Civil Code — A possessor in bad faith: (a) Loses what is built, planted, or sown without right to indemnity (Article 449). (b) Is not entitled to reimbursement for useful expenses; only a possessor in good faith is granted the right to refund of useful expenses with the right of retention until reimbursed (Article 546). (c) May remove improvements only for pure luxury or mere pleasure, provided the thing suffers no injury and the lawful possessor does not prefer to retain them by paying the value they have at the time he enters into possession (Article 549). The right of removal of useful improvements under Article 547 is likewise available solely to a possessor in good faith. In this case, NAWASA was found a possessor in bad faith because the improvements were introduced after the complaint was filed and after the taking of local waterworks systems without just compensation had been declared unconstitutional. Consequently, it lost the useful improvements without any right to indemnity and without any right to remove them.

• “Article 449 of the Civil Code of the Philippines provides that ‘he who builds, plants or sows in bad faith on the land of another, loses what is built, planted or sown without right to indemnity.’ As a builder in bad faith, NAWASA lost whatever useful improvements it had made without right to indemnity…” — This passage encapsulates the primary rule applied to the facts.
• “Moreover, under Article 546 of said code, only a possessor in good faith shall be refunded for useful expenses with the right of retention until reimbursed; and under Article 547 thereof, only a possessor in good faith may remove useful improvements if this can be done without damage to the principal thing and if the person who recovers the possession does not exercise the option of reimbursing the useful expenses. The right given a possessor in bad faith is to remove improvements applies only to improvements for pure luxury or mere pleasure, provided the thing suffers no injury thereby and the lawful possessor does not prefer to retain them by paying the value they have at the time he enters into possession (Article 549, Id.).” — The comprehensive statement of the code provisions delineating the rights of good-faith and bad-faith possessors.

• Santos vs. Mojica, L-25450, Jan. 31, 1969, 26 SCRA 703 — Followed. The Court of Appeals relied on this decision for the rule that a builder in bad faith is not entitled to indemnity for useful improvements; the Supreme Court cited it in affirming.
• Mindanao Academy, Inc. vs. Yap, 13 SCRA 190 — Distinguished. The Court had allowed a defendant builder in bad faith to remove only equipment, books, furniture, and fixtures that were outside the scope of the judgment, not the building itself. The holding did not support removal of useful improvements.
• Carbonell vs. Court of Appeals, 69 SCRA 99 — Distinguished and held not to constitute a precedent on the rights of a possessor in bad faith. Only four members concurred in treating the respondents as possessors in bad faith and granting removal on equitable grounds, while two members held they were possessors in good faith; thus the pronouncement lacked the force of a majority precedent.

• Article 449, Civil Code — Applied as the core provision: a builder in bad faith loses what is built without right to indemnity. NAWASA, as a builder in bad faith, lost the useful improvements it made to the waterworks system.
• Article 546, Civil Code — Construed as granting the right to refund of useful expenses exclusively to a possessor in good faith; a possessor in bad faith has no such right.
• Article 547, Civil Code — Construed as granting the right to remove useful improvements solely to a possessor in good faith, under the condition that removal can be done without damage to the principal thing and the lawful possessor does not opt to reimburse.
• Article 549, Civil Code — Limited to the removal of improvements for pure luxury or mere pleasure by a possessor in bad faith, with safeguards. It did not authorize removal of useful improvements.
• Section 5, Rule 10, Rules of Court — Discussed but found inapplicable because no evidence was introduced on the unpleaded issue of removability; the case was decided on a stipulation of facts, so the pleadings could not be deemed amended to conform to evidence.

Fernan, Gutierrez, Jr., Paras, and Cruz, JJ., concurred. Justice Alampay took no part. No separate concurring opinions were issued.