KUWAIT AIRWAYS, CORPORATION, vs. PHILIPPINE AIRLINES, INC., G.R. No. 156087, May 8, 2009

Facts:

1935 – Philippine Airlines is the grantee of a legislative franchise authorizing it to provide domestic and international air services. Its initial franchise was granted in 1935 through Act No. 4271.

1952 – Republic Act (R.A.) No. 776, or the Civil Aeronautics Act of the Philippines, which grants the Civil Aeronautics Board (CAB) has the power to regulate the economic aspect of air transportation, [its] general supervision and regulation of, and jurisdiction and control over, air carriers as well as their property, property rights, equipment, facilities, and franchise.” R.A. No. 776 also mandates that the CAB “shall take into consideration the obligation assumed by the Republic of the Philippines in any treaty, convention or agreement with foreign countries on matters affecting civil aviation.”

1959 – The Franchise of Philippine Airlines underwent Substantial amendments through Republic Act No. 2360.

1979 – Philippine Airlines was granted a new franchise in 1979 through Presidential Decree No. 1590, wherein statutory recognition was accorded to Philippine Airlines as the “national flag carrier.” P.D. No. 1590 also recognized that the “ownership, control, and management” of Philippine Airlines had been reacquired by the Government.

Section 19 of P.D. No. 1590 authorized Philippine Airlines to contract loans, credits and indebtedness from foreign sources, including foreign governments, with the unconditional guarantee of the Republic of the Philippines. It is well known that the Philippine Airlines was controlled by the Philippine government, with the Government Service Insurance System (GSIS) holding the majority of shares.

1981 – Kuwait Airways and Philippine Airlines entered into a Commercial Agreement. The Commercial Agreement covered a twice weekly Kuwait Airways flight on the route Kuwait-Bangkok-Manila and vice versa.6 The agreement stipulated that “only 3rd and 4th freedom traffic rights between Kuwait and Manila and vice versa will be exercised. No 5th freedom traffic rights will be exercised between Manila on the one hand and Bangkok on the other.”

Kuwait Airways sectors, special prorates for use by Philippine Airlines to specified Kuwait Airways sectors, joint advertising by both carriers in each other’s timetables and other general advertising, and mutual assistance to each other with respect to the development of traffic on the route.

Most pertinently of the Commercial Agreement, Kuwait Airways obligated itself to “share with Philippine Airlines revenue earned from the uplift of passengers between Kuwait and Manila and vice versa.”

April of 1992 – Philippine Airlines was privatized, with a private consortium acquiring 67% of the shares of the carrier.28 Thus, at the time of the signing of the CMU, Philippine Airlines was a private corporation no longer controlled by the Government.

April of 1995 – delegations from the Philippines and Kuwait (Philippine Panel and Kuwait Panel) met in Kuwait. The talks culminated in a Confidential Memorandum of Understanding (CMU) entered into in Kuwait on 12 April 1995. Among the members of the Philippine Panel were officials of the Civil Aeronautics Board (CAB), the Department of Foreign Affairs (DFA), and four officials of Philippine Airlines: namely its Vice-President for Marketing, Director for International Relations, Legal Counsel, and a Senior International Relations Specialist. Dr. Victor S. Linlingan, the Head of the Delegation and Executive Director of the CAB, signed the CMU in behalf of the Government of the Republic of the Philippines.

The two delegations agreed that the unilateral operation and the exercise of third and fourth freedom traffic rights shall not be subject to any royalty payment or commercial arrangements, as from the date of signing of this [CMU].

May of 1995 – Philippine Airlines received a letter from Dawoud M. Al-Dawoud, the Deputy Marketing & Sales Director for International Affairs of Kuwait Airways, addressed to Ms. Socorro Gonzaga, the Director for International Relations of Philippine Airlines. Both Al-Dawoud and Gonzaga were members of their country’s respective delegations that had met in Kuwait the previous month. The letter stated the Commercial Agreement, pursuant to item 4 of the new MOU concerning royalty for 3rd/4th freedom traffic will be terminated effective April 12, 1995.

To this, Gonzaga replied to Kuwait Airways in behalf of Philippine Airlines in a letter dated 22 June 1995. Philippine Airlines called attention to Section 6.5 of the Commercial Agreement that the agreement may be terminated by either party by giving ninety (90) days notice in writing to the other party and any termination date must be the last day of any traffic period which is the 31st March or 31st October.

Subsequently, Philippine Airlines insisted that Kuwait Airways pay it the principal sum of US$1,092,690.00 as revenue for the uplift of passengers and cargo for the period 13 April 1995 until 28 October 1995. When Kuwait Airways refused to pay, Philippine Airlines filed a Complaint against the foreign airline with the Regional Trial Court (RTC) of Makati City, seeking the payment of the aforementioned sum with interest, attorney’s fees, and costs of suit.

The RTC rendered a Decision in favor of Philippine Airlines. The bulk of the RTC’s discussion centered on the Philippine Airlines’ claim that the execution of the CMU could not prejudice its existing rights under the Commercial Agreement, and that the CMU could only be deemed effective only after 31 October 1995, the purported effectivity date of termination under the Commercial Agreement.

The rationale for this position of Philippine Airlines was that the execution of the CMU could not divest its proprietary rights under the Commercial Agreement.

On this crucial point, the RTC agreed with Philippine Airlines. It asserted the obligatory force of contracts between contracting parties as the source of vested rights which may not be modified or impaired.

After recasting Kuwait Airway’s arguments on this point as being that “the Confidential Memorandum of Understanding is superior to the Commercial Agreement[,] the same having been supposedly executed by virtue of the state’s sovereign power,” the RTC rejected the argument, holding that “[t]he fact that the [CMU] may have been executed by a Philippine Panel consisting of representative [sic] of CAB, DFA, etc. does not necessarily give rise to the conclusion that the [CMU] is a superior contract[,] for the exercise of the State’s sovereign power cannot be arbitrarily and indiscriminately utilized specifically to impair contractual vested rights.

Instead, the RTC held that “[t]he Commercial Agreement and its specific provisions on revenue sharing having been freely and voluntarily agreed upon by the affected parties x x x has the force of law between the parties and they are bound to the fulfillment of what has been expressly stipulated therein.”26 Accordingly, “the provision of the [CMU] must be applied in such a manner that it does not impair the vested rights of the parties.”

From this Decision, Kuwait Airways directly filed with this Court the present Petition for Review, raising pure questions of law.

Issue:

Whether the enforcement of the Confidential Memorandum of Understanding violates the non-impairment clause of the Constitution.

Held:

Yes, especially since Philippine Airlines was already under private ownership at the time the CMU was entered into, we cannot presume that any and all commitments made by the Philippine government are unilaterally binding on the carrier even if this comes at the expense of diplomatic embarrassment. While it may have been, prior to the privatization of Philippine Airlines, that the Philippine Government had the authority to bind the airline in its capacity as owner of the airline, under the post-privatization era, however, whatever authority of the Philippine Government to bind Philippine Airlines can only come in its capacity as regulator.

In 1981, Philippine Airlines was still owned by the Philippine government. In that context, it is evident that the Philippine government, as owner Philippine Airlines, could enter into agreements with the Kuwait government that would supersede the Commercial Agreement entered into by one of its GOCCs, a scenario that changed once Philippine Airlines fell to private ownership.

As with all regulatory subjects of the government, infringement of property rights can only avail with due process of law. Legislative regulation of public utilities must not have the effect of depriving an owner of his property without due process of law, nor of confiscating or appropriating private property without due process of law, nor of confiscating or appropriating private property without just compensation, nor of limiting or prescribing irrevocably vested rights or privileges lawfully acquired under a charter or franchise. The power to regulate is subject to these constitutional limits.

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