TRANSFIELD PHILIPPINES, INC. vs.
LUZON HYDRO would constrain it to hold respondent banks liable for
CORPORATION, AUSTRALIA and NEW ZEALAND
BANKING GROUP LIMITED and SECURITY BANK
CORPORATION
G.R. No. 146717 November 22, 2004
FACTS:
Petitioner and respondent Luzon Hydro Corporation
(LHC) entered into a Turnkey Contract whereby
petitioner, as Turnkey Contractor, undertook to
construct, on a turnkey basis, a seventy (70)-
Megawatt hydro-electric power station at the Bakun
River in the provinces of Benguet and Ilocos Sur.
Petitioner was given the sole responsibility for the
design, construction, commissioning, testing and
completion of the Project.
To secure performance of petitioner's obligation on
or before the target completion date, petitioner
opened in favor of LHC two (2) standby letters of
credit (Securities), to wit: Standby Letter of Credit
No. E001126/8400 with the local branch of
respondent Australia and New Zealand Banking
Group Limited (ANZ Bank) and Standby Letter of
Credit No. IBDIDSB-00/4 with respondent Security
Bank Corporation (SBC) each in the amount of
US$8,988,907.00.
In the course of the construction of the project,
petitioner sought various extensions of time (EOT) to
complete the Project. The extensions were
requested allegedly due to several factors such as
force majeure occasioned by typhoon Zeb,
barricades and demonstrations. LHC denied the
requests, however. This gave rise to a series of legal
actions between the parties which culminated in the
instant petition.
The first of the actions was a Request for Arbitration
which LHC filed before the Construction
Industry Arbitration Commission (CIAC). This was
followed by another Request for Arbitration, this time
filed by petitioner before the International Chamber
of Commerce (ICC). In both arbitration proceedings,
the common issues presented were: [1) whether
typhoon Zeb and any of its associated events
constituted force majeure to justify the extension of
time sought by petitioner; and [2) whether LHC had
the right to terminate the Turnkey Contract for failure
of petitioner to complete the Project on target date.
Foreseeing that LHC would call on the Securities
pursuant to the pertinent provisions of the Turnkey
Contract, petitionerin two separate letters
advised respondent banks of the arbitration
proceedings already pending before the CIAC and
ICC in connection with its alleged default in the
performance of its obligations. Asserting that LHC
had no right to call on the Securities until the
resolution of disputes before the arbitral tribunals,
petitioner warned respondent banks that any
transfer, release, or disposition of the Securities in
favor of LHC or any person claiming under LHC
liquidated damages.
Petitioner as plaintiff filed a Complaint for Injunction,
with prayer for temporary restraining order and writ
of preliminary injunction, against herein respondents
as defendants before the Regional Trial Court
(RTC). Petitioner sought to restrain respondent LHC
from calling on the Securities and respondent banks
from transferring, paying on, or in any manner
disposing of the Securities or any renewals or
substitutes thereof.
The RTC denied petitioner's application for a writ of
preliminary injunction. It ruled that petitioner had no
legal right and suffered no irreparable injury to justify
the issuance of the writ. Employing the principle of
"independent contract" in letters of credit, the trial
court ruled that LHC should be allowed to draw on
the Securities for liquidated damages. It debunked
petitioner's contention that the principle of
"independent contract" could be invoked only by
respondent banks since according to it respondent
LHC is the ultimate beneficiary of the Securities. The
trial court further ruled that the banks were mere
custodians of the funds and as such they were
obligated to transfer the same to the beneficiary for
as long as the latter could submit the required
certification of its claims.
Dissatisfied with the trial court's denial of its
application for a writ of preliminary injunction,
petitioner elevated the case to the Court of Appeals
via a Petition for Certiorari under Rule 65, with
prayer for the issuance of a temporary restraining
order and writ of preliminary injunction. Petitioner
submitted to the appellate court that LHC's call on
the Securities was premature considering that the
issue of its default had not yet been resolved with
finality by the CIAC and/or the ICC. It asserted that
until the fact of delay could be established, LHC had
no right to draw on the Securities for liquidated
damages.
The Court of Appeals issued a temporary restraining
order, enjoining LHC from calling on the Securities or
any renewals or substitutes thereof and ordering
respondent banks to cease and desist from
transferring, paying or in any manner disposing of
the Securities.
The appellate court dismissed the petition for
certiorari. The appellate court expressed conformity
with the trial court's decision that LHC could call on
the Securities pursuant to the first principle in credit
law that the credit itself is independent of the
underlying transaction and that as long as the
beneficiary complied with the credit, it was of no
moment that he had not complied with the
underlying contract. Further, the appellate court held
that even assuming that the trial court's denial of
petitioner's application for a writ of preliminary
injunction was erroneous, it constituted only an error
of judgment which is not correctible by certiorari,
unlike error of jurisdiction.

ISSUES:
1. Whether the "independence principle" on letters of
credit may be invoked by a beneficiary thereof where
the beneficiary's call thereon is wrongful or
fraudulent.
2. Whether LHC has the right to call and draw on the
securities before the resolution of petitioner's and
LHC's disputes by the appropriate tribunal.
3. Whether ANZ bank and security bank are justified in
releasing the amounts due under the securities
despite being notified that LHC's call thereon is
wrongful.
RULING:
1. In a letter of credit transaction, such as in this case,
where the credit is stipulated as irrevocable, there is
a definite undertaking by the issuing bank to pay the
beneficiary provided that the stipulated documents
are presented and the conditions of the credit are
complied with.41 Precisely, the independence
principle liberates the issuing bank from the duty of
ascertaining compliance by the parties in the main
contract. As the principle's nomenclature clearly
suggests, the obligation under the letter of credit is
independent of the related and originating contract.
In brief, the letter of credit is separate and distinct
from the underlying transaction.
Given the nature of letters of credit, petitioner's
argumentthat it is only the issuing bank that may
invoke the independence principle on letters of credit
does not impress this Court. To say that the
independence principle may only be invoked by the
issuing banks would render nugatory the purpose for
which the letters of credit are used in commercial
transactions. As it is, the independence doctrine
works to the benefit of both the issuing bank and the
beneficiary.
Letters of credit are employed by the parties desiring
to enter into commercial transactions, not for the
benefit of the issuing bank but mainly for the benefit
of the parties to the original transactions. With the
letter of credit from the issuing bank, the party who
applied for and obtained it may confidently present
the letter of credit to the beneficiary as a security to
convince the beneficiary to enter into the business
transaction. On the other hand, the other party to the
business transaction, i.e., the beneficiary of the letter
of credit, can be rest assured of being empowered to
call on the letter of credit as a security in case the
commercial transaction does not push through, or
the applicant fails to perform his part of the
transaction. It is for this reason that the party who is
entitled to the proceeds of the letter of credit is
appropriately called "beneficiary."
Petitioner's argument that any dispute must first be
resolved by the parties, whether through
negotiations or arbitration, before the beneficiary is
entitled to call on the letter of credit in essence
would convert the letter of credit into a mere
guarantee. Jurisprudence has laid down a clear
distinction between a letter of credit and a guarantee
in that the settlement of a dispute between the
parties is not a pre-requisite for the release of funds
under a letter of credit. In other words, the argument
is incompatible with the very nature of the letter of
credit. If a letter of credit is drawable only after
settlement of the dispute on the contract entered into
by the applicant and the beneficiary, there would be
no practical and beneficial use for letters of credit in
commercial transactions.
While it is the bank which is bound to honor the
credit, it is the beneficiary who has the right to ask
the bank to honor the credit by allowing him to draw
thereon. The situation itself emasculates petitioner's
posture that LHC cannot invoke the independence
principle and highlights its puerility, more so in this
case where the banks concerned were impleaded as
parties by petitioner itself.
Respondent banks had squarely raised the
independence principle to justify their releases of the
amounts due under the Securities. Owing to the
nature and purpose of the standby letters of credit,
this Court rules that the respondent banks were left
with little or no alternative but to honor the credit and
both of them in fact submitted that it was "ministerial"
for them to honor the call for payment.
2. In the instant case, petitioner failed to show that it
has a clear and unmistakable right to restrain LHC's
call on the Securities which would justify the
issuance of preliminary injunction. By petitioner's
own admission, the right of LHC to call on the
Securities was contractually rooted and subject to
the express stipulations in the Turnkey Contract.
Indeed, the Turnkey Contract is plain and
unequivocal in that it conferred upon LHC the right to
draw upon the Securities in case of default.
The pendency of the arbitration proceedings would
not per se make LHC's draws on the Securities
wrongful or fraudulent for there was nothing in the
Contract which would indicate that the parties
intended that all disputes regarding delay should first
be settled through arbitration before LHC would be
allowed to call upon the Securities. It is therefore
premature and absurd to conclude that the draws on
the Securities were outright fraudulent given the fact
that the ICC and CIAC have not ruled with finality on
the existence of default.
3. With respect to the issue of whether the petitioner's declaration that LHC's call thereon was
respondent banks were justified in releasing the wrongful. To repeat, respondent banks' undertaking
amounts due under the Securities, this Court was simply to pay once the required documents are
reiterates that pursuant to the independence presented by the beneficiary.
principle the banks were under no obligation to
determine the veracity of LHC's certification that
default has occurred. Neither were they bound by