I.

LETTERS OF CREDIT

A. Definition and Nature of Letter of Credit

DEFINITION

1. Transfield Philippines, Inc. v. Luzon hydro A letter of credit is a written instrument

Corp., 443 SCRA 307 (2004) whereby the writer requests or authorizes the
addressee to pay money or deliver goods to a
third person and assumes responsibility for
payment of debt therefor to the addressee

2. Prudential Bank v. Intermediate Appellate A letter of credit is an engagement by a bank

Court, 216 SCRA 257 (1992); Bank of or other person made at the request of a
Commerce v. Serrano 451 SCRA 484 (2005) customer that the issuer will honor a draft or
other demands for payments or other
complaints with the conditions

3. Art. 2, Uniform Customs & Practice for It is any arrangement, however named or
Documentary Credits described, whereby a bank (issuing bank),
acting at the request and on the instructions of
a customer (applicant) or on its own behalf,
binds itself to:

1. Pay to the order of, or accept and pay

drafts drawn by a third party
(Beneficiary), or
2. Authorize another bank to pay or to
accept and pay such drafts, or
3. Authorizes another bank to negotiate,
against stipulated documents(s),
Provided, the terms and conditions of the
credit are complied with.

NATURE

1. Transfield Philippines, Inc. v. Luzon Hydro
Corp., 443 SCRA 307 (2004); Land bank of the
Philippines v. Monets Export and
Manufacturing Corp., 453 SCRA 173 (2005)
A letter of credit is a financial device developed
by merchants as a convenient and relatively
safe mode of dealing with sale of goods to
satisfy the seemingly irreconcilable interest of
a seller, who refuses to part with his goods
before he is paid, and a buyer, who wants to
 have control of the goods before paying. The
use of credits in commercial transactions
serves to reduce the risk of nonpayment of the
purchase price under the contract for the sale
of goods. However, letters of credits are also
used in non-sale settings where they serve to
reduce the risk of non-performance. Generally
credits in the non-sale settings have come to
be known as standby credits

- The relationship between the

beneficiary and the issuer of a letter of
credit is not strictly contractual,
because both privity and a meeting of
the minds are lacking, yet strict
compliance with its terms is an
enforceable right.
- Nor is it a third-party beneficiary
contract, because the issuer must
honor drafts drawn against a letter
regardless of problems subsequently
arising in the underlying contract.
- Since the banks customer cannot draw
on the letter, it does not function as an
assignment by the customer to the
beneficiary.
- Nor, if properly used, is it a contract of
suretyship or guarantee, because it
entails a primary liability following a
default.
- Finally, it is not in itself a negotiable
instrument, because it is not payable
to order or bearer and is generally
conditional, yet the draft presented
under it is often negotiable.

B. Parties to a Letter of Credit

1. Bank of America, NT & SA v. Court of a. Buyer/Applicant/Importer procures
Appeals, G.R. No. 105395, 228 SCRA 357 the letter of credit and obliges himself
(1993) to reimburse Issuing Bank upon receipt
of the documents of title
b. Issuing Bank undertakes to pay Seller
upon receipt of the draft and proper
documents if titles and to surrender the
documents to Buyer upon
reimbursement
c. Seller/Beneficiary/Exporter who in
compliance with the contract of sale
ships the goods to Buyer and delivers
the documents of title and draft to the
Issuing Bank to recover payment

The parties may be increased. Modern letters

of credit usually involve bank-to-bank
transactions
a. Advising/notifying bank the
correspondent bank (agent) of the
issuing bank through which it advises
the beneficiary of the LC
b. Confirming bank bank which, upon
the request of the beneficiary,
confirms the LC issued.
c. Paying bank bank on which the drafts
are to be drawn, which may be the
issuing bank or another bank not in the
city of the beneficiary
d. Negotiating Bank bank in the city of
the beneficiary which buys or
discounts the drafts contemplated by
the LC, if such draft is to be drawn on
the opening bank not in the city of the
beneficiary

1. Rights and Obligations of Parties

BAR QUESTION 2002: Explain the three (3) distinct but intertwined contract relationship
that are indispensable in a letter of credit transaction
 1.Between
applicant/buyer/importer
beneficiary/seller/importer
The buyer is the one who Their relationship is
and procures the letter of governed by the
credit while the seller is contract of sale
the one who in
compliance with the
contract of sale ships the
goods to the buyer and
delivers the documents of
title and draft to the
issuing bank to recover
payment for the goods.

2. Between the issuing bank and The issuing bank is the Their relationship is
the beneficiary/seller/exporter one that issues the letter governed by the
of credit and undertakes terms of the LC
to pay the seller upon
receipt of the draft and
proper documents of
title. On the other hand,
the seller surrenders the
document of title to the
bank in compliance with
the terms of the LC.

3. Between the issuing bank and The buyer obliges himself Their relationship is
the applicant/buyer/importer to reimburse the issuing governed by the
bank upon receipt of the terms of the
documents of title. application for the
issuance of the
letter of credit by
the bank

Liabilites of Correspondent Banks (Feati bank & Trust Company v. Court of Appeals, G.R.
No. 94209, 196 SCRA 576 [1991])

Notifying/Advising Bank - Serves as an agent - Does not incur any

of the issuing bank obligation more than
- Warrants the just notifying the
apparent seller/beneficiary of
authenticity of the the opening of the LC
LC after it has
 determined its
apparent authority
- Not liable for
damages unless the
document on its face
is manifestly fake

Confirming Bank Lends credence to the LC Direct obligation, as if it is the

issued by a lesser-known one which issued the LC
bank

Negotiating Bank Buys the sellers draft and Depends on the stage of the
later on sells the draft to negotiation:
the issuing bank
- Before negotiation
no liability with
respect to the seller.
Merely suggest its
willingness to
negotiate
- After negotiation a
contractual
relationship will
arise, making the
bank liable

Paying Bank May either be the issuing Direct obligation

bank or any other bank in
the place of the
beneficiary

RELATED JURISPRUDENCE

Feati bank & Trust Company v. Court of
Appeals, G.R. No. 94209, 196 SCRA 576
(1991)
- Since a bank deals only with
documents, it is not in apposition
to determine whether the
documents required by the letter
of credit re material or superfluous.
The mere fact that the documents
was specified therein readily
means that the documents is of
vital importance to the buyer
 - The absence of any documents
required in the documentary credit
justifies the refusal by the
correspondent bank to negotiate,
accept or pay the beneficiary, as it
is not its obligation to look beyond
the document.

Transfield Philippines, Inc. v. Luzon While the bank is bound to honor the
Hydro Corp., 443 SCRA 307 (2004) credit, it is the beneficiary who has the right
to ask the bank to honor the credit by
allowing him to draw thereon, and not the
buyer

Metropolitan Waterworks v. Daway, - Obligation of the banks issuing the

432 SCRA 559 (2004) letters of credit is solidary with that
of the person or entity requesting
for its issuance, the same being a
direct primary, absolute and
definite undertaking to pay the
beneficiary upon the presentation
of the set of documents required
therein
- Is an issuing bank a guarantor?
No, the concept of guarantee vis--
vis the concept of irrevocable LC is
inconsistent with each other. LCs
are primary obligations and not
security contracts and while they
are security arrangements, they
are not converted thereby into
contracts of guaranty

Prudential Bank v. Intermediate When is the bank entitled to

Appellate Court, G.R. No. 74886, Dec. 8, reimbursement? Once the issuing bank
1992 shall have paid the beneficiary after the
latters compliance with the terms of the
LC. Presentment for acceptance to the
customer/applicant is not a condition sine
qua non for reimbursement
 Rodzssen Supply Co. v. Far East Bank What is the consequence of payment upon
and Trust Co., G.R. No. 109087, May 9, an expired LC? An issuing bank which paid
2001 the beneficiary of an expired letter of credit
can recover the payment from the
applicant which obtained the goods from
the beneficiary to prevent unjust
enrichment

C. Basic Principles of Letter of Credit

1. Doctrine of Independence

BPI v. De Reny Fabric Industries, Inc., L- The relationship of the buyer and the bank
2481, Oct. 16, 1970 is separate and distinct from the
relationship of the buyer and the seller in
the main contract; the bank is not
required to investigate if the contract
underlying the LC has been fulfilled or not
because in transactions involving LC,
banks deal only with documents and not
goods

The buyer has no course of action against

the issuing bank

Reliance Commodities, Inc. v. Daewoo What is the effect of the buyers failure to
Industrial Co. Ltd., G.R. No. 100831, Dec procure an LC to the main contract? the
17, 1993 LC is independent from the contract of
sale. Failure of the buyer to open the LC
does not prevent the birth of the Sales
Contract

The opening of the LC is only a mode of

payment and is not an essential requisite
of the contract of sale
 Insular Bank of Asia & America v. In a contract of loan secured by standby
Intermediate Appellate Court, Nov. 17, LC, can the partial payments made on the
1988 loan be added in computing the issuing
banks liability under its own standby LC?
No, although these payments could
result in the reduction of the actual
amount, which, could ultimately be
collected from the issuing bank, the
latters separate undertaking under its
letters of credit remain. This is because
the LC is an absolute and primary
undertaking which is separate and distinct
from the contract underlying it

2. Fraud Exception Principle

Transfield Philippines, Inc. v. Luzon - Untruthfulness of a certificate

Hydro Corp., 443 SCRA 307 (2004) accompanying a demand for
payment under a standby LC may
qualify as fraud sufficient to support
an injunction against payment
- Exception to the independence
principle
- Requirements:
a. There is a clear proof of
fraud
b. Fraud constitutes
fraudulent abuse of the
independent purpose of the
LC and not only fraud under
the main agreement
c. Irreparable injury might
follow if injunction is not
granted or the recovery of
damages would be seriously
damaged

3. Doctrine of Strict Compliance

 Feati bank & Trust Company v. Court of The document tendered by the
Appeals, G.R. No. 94209, 196 SCRA 576 seller/beneficiary must strictly conform to
(1991) the terms of the letters of credit. The
tender of documents must include all
documents required by the letter.

Thus, a correspondent bank which departs

from what has been stipulated under the
LC acts on its own risk and may not be
thereafter be able to recover from the
buyer or the issuing bank, as the case may
be, the money thus paid to the beneficiary

OTHER PRINCIPLES

What is the duration of LC 1. Upon the period fixed by the parties; or

2. if none is fixed:

a. 6 months from its date if used in the

Philippines
b. 12 months if used abroad (Art. 572,
Uniform Customs & Practice for
Documentary Credits)

Is irrevocable letter of credit and confirmed No

letter of credit synonymous?
In an irrevocable letter of credit, the issuing
bank may not, without the consent of the
beneficiary and the applicant, revoke its
undertaking under the letter

In a confirmed letter of credit, the

correspondent bank gives an absolute
assurance to the beneficiary that it will
undertake the issuing banks obligation as its
own according to the terms and conditions if
the credit (Prudential Bank and Trust Company
v. IAC, G.R. No. 74886, Dec. 8 1992)

Can a court order the release to the No, it violates the nature of an irrevocable
applicant the proceeds of an irrevocable letter of credit. The terms of an irrevocable
letter of credit cannot be changed without the
letter of credit without the consent of the consent of both parties. (Phil. Virginia Tobacco
beneficiary?
What are the essential conditions of LC?
In case the buyer was not able to pay its
obligation under the LC, can the bank take
possession over the goods covered by the
said LC?
What are the stages of LC?
Effect of Applicant Being under The effect of the stay order under Se. 6(b), Rule
Rehabilitation Proceedings
Administration v. De Los Angeles, G.R. No. L-
27829, Aug. 19, 1988)
1. Issued in favor of a definite person
2. Limited to a fixed or specified amount,
or to one or more amounts, but with a
maximum stated limit (Art. 568,
Uniform Commercial Practice for
Documentary Credits)
If any of these essential conditions is not
present, the instrument is merely considered
as a letter of recommendation
No. The opening of a LC did not vest ownership
of the goods in the bank in the absence of a
trust receipt agreement. (Transfield
Philippines, Inc. v. Luzon Hydro Corp., 443
SCRA 307 [2004])
1. Contract of sale between the buyer
and seller
2. Application for LC by the buyer with
the issuing bank
3. Issuance of LC by the bank
4. Shipping of goods by seller
5. Execution of draft and tender of
documents by the seller
6. Redemption of draft(payment) and
obtaining of documents by the issuing
bank
7. Reimbursement to the bank and
obtaining of documents by the buyer
4 of the Interim Rules of Procedure for
Corporate Rehabilitation which enjoins the
enforcement of all claims against guarantors
and sureties who are not solidarily liable with
the debtor, cannot apply to the LC issued in
behalf of the debtor-applicant since the
obligation of the issuing bans under the letter
 of credit is primary and solidary. (Metropolitan
Waterworks and Sewerage System v. Hon.
Reynaldo B. Daway and Maynilad Water
services, Inc., G.R. No. 160732, June 21, 2004)

Are Letters of Credit and Trust Receipts No. However, drafts issued in connection with
negotiable instruments? a Letter of Credit are negotiable instruments
(Mico Metals Corp. v. Court of Appeals and
Philippine Bank of Communications, G.R. No.
117914, Feb. 1, 2002)