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LETTERS OF CREDIT

A Letter of Credit is a special contract designed to answer two concerns:


Seller’s refusal to part with his goods before being paid coupled with the Buyer’s want
What are LETTERS OF CREDIT? of ownership over the goods before paying.
Those issued by one merchant to another for the purpose of attending to a commercial
transaction. Note: The opening of a LC does not involve specific appropriation of money in favor of
the beneficiary. The correspondent bank does not receive in advance the money form
Kinds: the buyer or issuing bank but pays the amount out of its own funds and then later on
seek reimbursement from the issuing bank. It does not convey the notion that a
Common Letter of Credit—an instrument by which a bank, for the account of a buyer particular sum of money has been specifically reserved or has been held in trust.
of merchandise, gives formal evidence to a seller, of its willingness to permit the seller
to draw bills against it, and stipulates in legal form that all such bills will be honored. Note: An LC is not a negotiable instrument. It does Not conform w/ Section 1 of the
Negotiable Instruments Law. This is because it does not contain an unconditional
Traveler’s Letter of Credit—a letter from a bank addressed to its correspondents promise to pay a sum certain in money. The LC is conditioned to the submission of
stating that drafts up to a certain sum drawn by the beneficiary will be honored by the certain documents. Moreover, the LC is issued in favor of a definite person and not to
bank. order. Therefore, it also lacks the words of negotiability required.

Essential Conditions: LC is conditioned on –


1.) Issued in favor of a definite person and not to order; and 1. Submission of stipulated documents
2.) Amount is fixed and specified. 2. Compliance with the terms of the LC

Duration: Is LC a commercial transaction?


1.) Upon a period fixed by the parties; YES. Because it is governed by the Code of Commerce.
2.) If none is fixed, 6 months from its date if used in the Philippines or 1 year if used
abroad.
PARTIES TO THE TRANSACTION:
Basic parties to a letter of credit:
Letter of credit – an arrangement by a bank or other person made at the request of a 1. Applicant/buyer/importer – the one who procures the letter of credit and
customer that the issuer will honor drafts or other demands for payment upon obliges himself to reimburse the Issuing Bank (IB) upon the receipt of the
compliance w/ the conditions specified in the credit. documents of title. He is the party who initiates the operation of the Letter of
Credit transaction as the buyer of the merchandise and also of the credit
Internationally accepted definition of a LC as provided in the Uniform Customs instrument.
and Practices for Documentary Credit (UCPDC):
2. Issuing Bank – is usually the buyer’s bank; it issues the letter of credit and
Letter of Credit – any arrangement, however named or described, whereby a bank undertakes to pay the seller upon receipt of the draft and proper documents
also known as the issuing bank, acting upon the request or instruction of to the buyer upon reimbursement.
another(applicant or customer) or on its own behalf, binds itself to:
1. Pay to the order of a 3rd person known as beneficiary OR 3. Seller/beneficiary – is the one who in compliance w/ the contract of sale
2. Accepts and pay any draft that may be drawn by the beneficiary, OR ships the goods to the buyer and delivers the documents of title and drafts
3. Authorize another bank to: to the issuing bank to recover payment. He is the beneficiary of the
• Pay to the order of a 3rd person known as the beneficiary. instrument because the instrument is addressed to him and in his favor.
• Accept and pay any draft by the beneficiary, OR
4. Authorize another bank to negotiate against the stipulated documents. Additional party/parties to the LC:
4. Correspondent Bank
Note: We are bound by the UCPDC issued by the International Chamber of
Commerce. Sec. 2 of the Code of Commerce states that in the absence of any TYPES OF CORRESPONDENT BANK:
particular provision in the code of Commerce, commercial transactions shall be
governed by the usages and customs generally observed (BPI vs. Nery).
1. Advising/Notifying Bank – does not have any contractual relations w/ the DOCTRINE OF STRICT COMPLIANCE-
buyer but merely serves as an agent of the issuing bank. Its only The document tendered by the seller must strictly conform to the terms of the LC . The
responsibility is to transmit the LC. Thus, it could validly refuse to negotiate correspondent bank which departs from what has been stipulated under the LC, as
or accept, even if the seller tenders all the documents required under the LC when it accepts a faulty tender , acts on his own risk and may not thereafter recover
and it does not become liable as the beneficiary has no cause of action from the buyer or issuing bank , the money paid to the benefic
against the bank. In short, the documents presented must comply w/ those stipulated on. In a LC, the
banks only deals w/ documents and not w/ goods.
2. Confirming Bank – lends credence to the LC issued by a lesser known
bank. It assumes direct obligation to the seller/beneficiary and becomes Can a breach of contract be invoked against the Issuing Bank?
principally liable. NO. Because if all the documents stipulated have been submitted and the IB finds that
they conform w/t the LC requires, then the IB must pay the seller. In a LC transaction
A notifying bank, who also assumes the role of a negotiating bank does not include the banks deal only w/ documents not goods, so banks pays if the documents are OK
assuming the role of a confirming bank and is therefore not liable to the beneficiary. To and gets reimbursed by the buyer. This relationship is independent so if ever the goods
be liable, there must be an absolute assurance that it will undertake the issuing bank’s are in bad condition, the applicant still pays the bank.
obligation as its own. If it does confirm, the beneficiary become entitled to proceed
against either or both banks in case of breach. Note: A loan transaction may give rise to LC. An LC does not arise only because of
sale or importation. Example: Standby LC.
3. Paying Bank – the bank w/c pays the beneficiary. It may either be the
opening/issuing bank or any other bank in the place of the beneficiary. Standby Letter of Credit (SLC) – it is a bank issued option on loan involving 3
parties: the bank issuing the credit, the party requesting for such issuance (otherwise
4. Negotiating Bank – any bank in the place of the beneficiary w/c buys or known as the account party) and the beneficiary.
discounts the seller’s draft. Its liability depends on the stage of Under the terms of a SLC, the beneficiary has the right to trigger the loan option
negotiation. If BEFORE negotiation, such that it suggests its willingness to (referred to as TAKING DOWN THE LOAN) if the account party fails to meet its
negotiate, it has no liability w/ respect to the seller. But if AFTER negotiation, commitment, in w/c case the issuing bank disburses a specified sum to the beneficiary
a contractual relationship will then prevail between them. and books an equivalent loan to its customer.
SLC’s may support non-financial obligations such as those of bidders, or financial
Note: A bank does not become a negotiating bank unless he pays the draft and obligations such as those of borrowers. In the latter case, the borrower purchases an
becomes the holder of said document. SLC and names the lender as beneficiary. Should the borrower default, the beneficiary
As such, the IB may notify the seller of the opening of the LC either directly or through has the right to take down the SLC and receive the principal balance from the issuing
a correspondent bank, w/c may either be a mere advising bank or a Confirming Bank. bank. The borrower’s loan obligation is then passed to the bank.

Note: The IB has the option to tap a correspondent bank or not. When the Notifying Bank (NB) may be held liable:
The liability of a Correspondent Bank depends on what kind of function it plays in the The NB is liable if:
LC transaction. 1. It did not notify the seller of the opening of the LC, or
2. It did not determine the apparent authenticity of the required documents.
RELATIONSHIP OF THE PARTIES is governed by-
1. Issuing bank and applicant – the relationship is governed by the terms of the Note: Only the APPARENT AUTHENTICITY is to be determined. The NB does not
application and agreement for the issuance of the LC by the bank. warrant the authenticity of the LC but only its apparent authenticity. So if the LC turns
2. Issuing bank and the Beneficiary – the relationship is governed by the terms out to be spurious, NB is not liable for damages unless obvious that it is not authentic.
of the LC issued by the bank
3. Applicant and beneficiary – the relationship is governed by the contract they Therefore, Notifying Bank/Advising Bank is liable if it acts beyond the scope of its
entered into. ex. Sales authority.

INDEPENDENCE PRINCIPLE- When may the Advising Bank (AB) be equally liable with the Issuing Bank (IB)?
The bank in determining compliance with the terms of the LC is required only to Ordinarily, an AB, whose obligation is merely to advise the seller/beneficiary of
examine the shipping document presented by the seller and is precluded from the opening of a LC has no liability. The opening of a LC does not make the IB liable
determining whether the main contract is accomplished or not at once because there is no liability. The liability is conditioned and dependent on the
tender or submission of the documents stipulated upon by the parties. If the beneficiary
requires that the obligation of the IB shall also be made the obligation of the AB to him, NO. As long as the documents submitted by the seller are complete and in conformity
there is what is known as a CONFIRMED COMMERCIAL CREDIT and the AB shall w/ what the LC requires, the IB is bound to pay the seller. This is true even if the goods
become a Confirming Bank. In this situation, the liability of the CB is primary and it is turned out to be defective.
as if the credit were issued by the IB and the CB jointly, thus giving the beneficiary or
holder for value of the drafts drawn under the credit, the right to proceed against either How about the buyer, is he still bound to reimburse the IB despite the defective goods
or both banks, the moment the credit instrument has been breached. received by him?
The CB is liable only when the documents are submitted and gets reimbursed YES. The buyer has no course of action against the IB. The buyer has a COA
by the IB because there is no privity of contract with the applicant. against the seller.
Thus, an AB becomes a CB when the above mentioned conditions occur. In If the documents submitted by the seller are incomplete and the IB still pays the seller,
such a case, the CB acquires the same liabilities as the Issuing Bank and is bound by is the buyer still bound to pay the IB?
the same conditions as an IB. NO. Because the IB should not have paid the seller knowing the documents to be
incomplete. The IB deals only w/ documents.
Function of a Negotiating Bank (NB):
It accepts or gives value to the draft and w/c later on sells the draft to the IB. The IB Can the beneficiary demand payment form the CB?
then reimburses the NB. What happens is that the NB buys the draft at a discounted YES. Since the CB is equally liable w/ the IB.
price and then sells it to the IB for its face value. If the beneficiary proceeds against the CB, the CB may ask reimbursement from the
IB. But if the beneficiary proceeds directly against the CB; it has no right to collect from
If LC is disowned by the IB, can the Negotiating Bank ask reimbursement from the the IB. The beneficiary may compel the CB to accept drafts it has drawn.
seller? Under what principle?
YES. Seller is a drawer of the draft accepted and paid by the Negotiating How is payment made by the Issuing Bank?
Bank. Therefore, the seller has contingent liability on such draft. Payment by the IB is done through:
1. Direct payment or wire transfer or credit in the account of the beneficiary
Can a Confirming Bank become a Notifying Bank? 2. Drawing of a draft by the beneficiary against the IB – pay to my order
NEVER, because they have different liabilities. The CB’s liability is primary while the 3. IB may authorize the Confirming Bank to pay
NB’s liability comes only after negotiation (Before negotiation, there is no liability). 4. Authorize Correspondent Bank to accept and pay any draft drawn
• It is the application for the opening of a LC w/c governs the relationship 5. Authorize the negotiation of any draft drawn by the beneficiary.
between the buyer and the IB. This implies that the buyer/applicant is not
concerned w/ the terms of the LC between the IB and the seller/beneficiary. Note: If the drawee doesn’t pay, go to the drawer who is secondarily liable.
• As to the IB, it is not a guarantor because its liability is not subsidiary since Apart form the bill of lading, what additional documents may be needed as a condition
the condition of the submission of the document is determinative of the of the LC for honoring a draft?
liability not the nonpayment of the buyer.
• The IB opens a LC for a consideration w/c comes in the form of a 1. Commercial invoice – it is a document signed and issued by the seller and
commission. contains a precise description of the merchandise and the terms of the sale
such as unit prices, amount due form the buyer and shipping conditions
If the IB does not advance the payment in favor of the seller/beneficiary, may the related to charges such as FOB (Free on Board), FAS (Free Alongside), C
buyer/applicant recover the commission paid? and F (Cost and Freight) or CIF (Cost, Insurance, Freight).
No More because this is the consideration. But he may recover the margin fee.
2. Consular invoice – document issued by the consulate of the importing
What among other things, should be stipulated upon the application for a LC? country to provide customs information and statistics for that country and to
The documents w/c the seller should submit to the IB. help prevent false declaration of value.
In LC transactions, the IB deals only w/ the documents, not w/ goods. The IB is not
bound or required to examine the goods. For as long as the required documents are 3. Certificate of analysis – may be required to ascertain that certain
submitted by the seller, the IB pays the seller. specifications of weight, purity, sanitation, etc., have been met. These
specifications may be required by health or other officials of the importing
If the goods turned out to be defective, is this a valid defense to avoid payment by the country, or they may be insisted by the importer as assurance that it is
IB to the seller? receiving what it ordered.
4. Export declaration – it is a document prepared by the exporter to assist the documents of title over the goods while the buyer acquires the said
government to prepare export statistics. documents and control over the goods only after reimbursing the bank.

Note: Documents to be passed are not unilaterally determined by the bank but agreed
upon by the buyer and seller.

Document of Title (Bill of Lading) – given to the seller upon shipment of goods. This is INDEPENDENCE PRINCIPLE
to be given to the IB to be able for the seller to get payment. > What characterizes letters of credit, as distinguished from other
accessory contract, is the ENGAGEMENT OF THE ISSUING BANK TO
PAY THE SELLER ONCE THE DRAFT AND THE REQUIRED SHIPPING
Is there a scheme where the IB may release the documents of title to the buyer w/o DOCUMENTS ARE PRESENTED TO IT. In turn, this arrangement
being reimbursed first by the buyer? ASSURES THE SELLER OF PROMPT PAYMENT, INDEPENDENT OF ANY
YES. By the IB letting the buyer execute a trust receipt. BREACH OF THE MAIN SALES CONTRACT.

Failure of the buyer to open the Letter of Contract does not prevent the birth of the LAWS GOVERNING A LETTER OF CREDIT TRANSACTION
Sales Contract. > Uniform Customs and Practice for Documentary Credits (UCP) issued by the
International Chamber of Commerce
The opening of the letter of credit is only a mode of payment. The letter of the credit is
not an essential requisite to the contract of sale. PARTIES TO A LETTER OF CREDIT TRANSACTION
1. Buyer—procures the letter of credit and obliges himself to reimburse the
———————————— OTHER NOTES ———————————- issuing bank upon receipt of the documents of title. He is the one initiating the operation
of the transaction as buyer of
NATURE AND IMPORTANCE the merchandise and also of the credit instrument. His contract with the bank
> A letter of credit is a financial device developed by merchants as a convenient which is to issue the instrument and is represented
and relatively safe mode of dealing with sales of goods to satisfy the seemingly by the Commercial Credit Agreement form which he signs,
irreconcilable interests of the seller, who refuses supported by the mutually made promises contained in the agreement
to part with his goods before he is paid, and a buyer, who wants to have control
of the goods before paying 2. Opening bank—usually the buyer’s bank which issues the letter of
credit and undertakes to pay the seller upon receipt of the draft and proper
> To break the impasse, the buyer may be required to contract a bank to documents of titles to surrender the documents to the
issue a letter of credit, the issuing bank can authorize the seller to buyer upon reimbursement. As it is the one issuing the
raw drafts and engage to pay them upon their presentment simultaneously instrument, it should be a strong bank, well known and well regarded in
with the tender of documents required by the letter of international trading circles.
credit. The buyer and seller agree on what documents are to be
presented for payment, but ordinarily they are documents of title evidencing or 3. Seller—in compliance with the contract of sale, ships the goods to
attesting to the shipment of the goods to the buyer the buyer and delivers the documents of title and draft to the issuing bank to
recover payment. He is also the beneficiary of the credit instrument because the
> Once the letter of credit is established, the seller ships the goods to the buyer instrument is addressed to him and
and in the process secures the required shipping documents is in his favor. While the bank cannot compel the seller to ship the goods and
and documents of title. To get paid, the seller executes a draft and presents it avail of the benefits of the instruments, however, the seller may recover from the bank
together with the required documents to the issuing bank the value of his shipment is made within the terms of the instrument, even though he
hasn’t given the bank any direct consideration for the bank’s promises contained
> The issuing bank redeems the draft and pays cash to the seller if it in the instrument
finds that the documents submitted by the seller conform with what the letter of
credit requires. The bank then obtains possession of the documents upon paying the 4. Correspondent bank/advising bank—to convey to the seller the
seller. The transaction is completed when existence of the credit or a confirming bank which will lend credence to the letter
the buyer reimburses the issuing bank and acquires the documents entitling him of credit issued by the lesser known issuing bank or paying bank which undertakes to
to the goods. The seller gets paid only if he delivers the encash the drafts drawn
by the exporter. Furthermore, another bank known as the risk, and it may not thereafter be able to recover from the buyer or
negotiating bank may be approached by the buyer to have the draft discounted issuing bank, as the case may be, the money thus paid to the beneficiary
instead of going to the place of the issuing bank to claim payment
> In the case of a discounting arrangement, wherein a negotiating bank pays the draft
RESPONSIBILITIES OF BANKS IN COMMERCIAL CREDIT TRANSACTIONS of a beneficiary of a letter of credit in order to save such beneficiary from the hardship
> If the beneficiary is to be advised by the issuing bank by cable, the services of presenting the documents directly to
of an ADVISING OR NOTIFYING BANK must always be utilized the issuing bank, the negotiating bank can seek reimbursement of
what has been paid to the beneficiary who as drawer of the draft
> The responsibility of the NOTIFYING BANK is merely to convey or continues to assume a contingent liability thereon. Thus, the negotiating bank
transmit to the seller or beneficiary the existence of the credit. However, if the has the ordinary right of recourse against the seller or beneficiary in the event of
beneficiary requires that the obligation of the issuing bank shall also be made the dishonor by the issuing bank.
obligation of the bank to himself, there is
what is known as a CONFIRMED COMMERCIAL CREDIT and the bank PROTOTYPE EXPORT TRANSACTION
notifying the beneficiary of the credit shall become a CONFIRMING BANK. In 1. PROFORMA INVOICE—all the particulars for the proposed shipment
this case, the liability of the confirming bank is primary and it is as if the credit were which are then known to the buyer
issued by the issuing and confirming banks jointly, thus giving the beneficiary or a
holder for value of drafts drawn under the credit, the right to proceed against either or 2. PRICE QUOTATION FAS AND CIF—FAS stands for “free along side”
both banks, the moment the credit instrument has been breached. which means that the seller will be responsible for the cost and
risks of the goods “along side” an overseas vessel at the stated location: the
> The paying bank on which the drafts are to be drawn it may be the buyer bears the costs and risks from that point. CIF
issuing bank or the advising bank. If the beneficiary is to draw and on the other hand means “cost, freight and insurance”, that in
receive payment in his own currency, the advising bank may be indicated as the exchange for this stated price, the seller undertakes not only to
paying bank also. When the draft is to be paid in this supply the goods but also to obtain and pay for insurance and bear the freight
manner, the paying bank assumes no responsibility but merely pays charges to the stated pointy.
the beneficiary and debits the payment immediately to the account
which the issuing bank has with it. IF THE ISSUING BANK HAS NO 3. BUYER’S PURCHASE ORDER
ACCOUNT WITH THE PAYING BANK, the paying bank reimburses itself by drawing a
bill of exchange on the issuing bank, in dollars, for the equivalent of the local currency 4. LETTER OF CREDIT
paid to the beneficiary, at the buyeing a. One way for a seller to be assured of payment is to ship goods under a negotiable
rate for dollar exchange. The beneficiary is entirely out of the transaction bill of lading and arrange for a
because his draft is completely discharged by the payment, and the credit arrangement bank in buyer’s city to hold the bill of lading until the
between the paying bank and issuing bank doesn’t concern him. buyer pays the draft in the usual foreign sale this
arrangement for securing payment of the price is not adequate
> If the draft contemplated by the credit instrument, is to be drawn on
the issuing bank or on other designated banks not in the city of the b. In some situations, sellers may need assurance of payment even before the
seller, any bank in the city of the seller which buys or discounts the time of payment. This problem
draft of the beneficiary becomes a negotiating bank. As a rule, whenever, the arises in contracts which call for the manufacture of goods to the buyer’s
facilities of an advising or notifying bank are used, the specifications.
beneficiary is apt to offer his drafts to the advising bank for
negotiation, thus giving the advising bank the character of a c. Although the proforma invoice may not specify, the seller
negotiating bank becomes an endorser and bona fide holder of the will expect the letter of credit to be confirmed by the
drafts and within the protection of the credit instrument. It is also local bank in its location. But why does a local bank
protected by the drawer’s signature, as the drawer’s contingent liability, as drawer, confirm rather than issue a letter of credit? The bank that issues the letter of
continues until discharged by the actual payment of the bills of exchange. credit needs assurance that it will be reimbursed by the buyer, on whose behalf it pays
the seller. The buyer’s bank can take steps to minimize or remove the
LIABILITY IN COMMERCIAL CREDIT TRANSACTIONS hazards. It will receive the negotiable bill of
> A commercial bank which departs from what has been stipulated under the letter of lading controlling the goods which will provide security
credit, as when it accepts a faulty tender, acts on its own for the customer’s obligation to reimburse the bank; in addition, the buyer’s own
bank can judge in the light of its knowledge of his financial standing whether added goods are loaded on board, the steamship line issues a bill of lading which, to comply
security is needed and can insist on such security before it issues the letter of credit with the letter of credit, is CONSIGNED TO ORDER OF THE ISSUING BANK. The bill
of lading is initially prepared by the forwarder on
d. To meet the seller’s letter of credit requirements, the buyer will request its a form supplied by the ocean carrier, it sets forth the
bank to arrange for the issuance of a letter of credit which will comply with the terms of markings and numbers of the packages, description of the goods, and the number
the proforma invoice. The buyer will then sign a detailed and weight of the packages. On its dorsal side, it will state that the goods are received
application and agreement for commercial credit prepared by the bank. The for shipment, but a statement FREIGHT PREPAID ON
issuing bank, after approving the buyer’s credit standing transmits a letter of credit by BOARD is initiated by a representative of the steamship line after loading. The
cable to the confirming bank. This confirming bank will then deliver to seller a forwarder then delivers the bill of lading and the commercial invoice to the seller.
document advising the latter that the issuing bank opened a letter of credit in its favor
and adding the confirming bank’s confirmation. In this arrangement, the seller is 6. INSURANCE
assured of payment of its sight drafts drawn on the confirming bank in the amount of
the total amount of the sale, provided it presents the 7. PAYMENT; THE DRAFT.
documents called for in the letter of credit. An examination of the letter of a. The confirming bank stated in their letter that the estimated CIF price
credit will also reveal that the bill of lading is to be consigned to the order of the buyer’s would be “available by your drafts on us at sight” when accompanied by the listed
bank, thereby giving the bank control over the goods, documents
with the consequent security for its claim against the buyer. b. Seller accordingly draws a sight draft on the confirming
bank. The sight draft together with the commercial
5. ACCEPTANCE; SHIPMENT invoice, insurance certificate, full set of bills of lading,
a. On the receipt of the confirmed letter of credit, the seller will send the and the packing list are presented to the confirming
order acknowledgment. This document will repeat the bank. When the bank receives these documents, it
description and price of the goods which has issues its bank draft to seller’s order and transmits the
also appeared on the proforma invoice and states the number and expiration date documents by air mail to issuing bank, which will
of the letter of credit. reimburse the confirming bank.
b. Further, the arrival of the letter of credit is the go-signal for the seller to c. The documents, sent by airmail, will reach the buyer’s
send the goods. The seller then prepares bank well ahead of the ocean shipment. The time for release of the documents
the COMMERCIAL INVOICE which provides a complete to buyer and reimbursement to
record of the transaction and is an important source of the bank will depend upon the arrangement which was
information to such interested parties as a bank made between the bank and buyer when the letter of
discounting a draft or an underwriting extending issuance. credit was initially established.
c. As the time of shipment approaches, the seller will contact its d. If the buyer plans to resell the goods, he may not be able
forwarder and give its shipping instructions. It to reimburse the bank until the goods arrive and he
will inform that to comply with the requirements of the resells the goods. In this event, the issuing bank may need to take further steps
letter of credit, the bill of lading must be made to the order of the issuing bank. It to secure its claim against the buyer.
will also send copies of the commercial invoice, a packing list, and a Shipper’s export
declaration. When the forwarder receives these
documents, he takes over all further documentation as
the agent of the shipper, the latter merely has to
dispatch the goods from the factory in accordance with the forwarder’s
instructions.
d. The seller will then send the truck to the pier where they STANDBY LETTERS OF CREDIT OR GUARANTEES
are delivered to the ocean carrier’s receiving clerk who
signs the dock receipt. The dock receipt is a form supplied by the ocean carrier HISTORY AND PURPOSE
which contains information relevant to the shipping of the bearings such as the > Sometime ago, it is common in international dealings to require the
number of the pier, and the name of the ship. The dock receipt is NON- furnishing of a cash deposit as security, but with the expansion of
NEGOTIABLE and serves as a temporary receipt for the goods until they are loaded international trade this became prohibitively expensive for the
on board. counterparty and in due course gave way to a more convenient safeguard, the
e. The ocean carrier is soon ready to receive the cargo. When the
provision of a written undertaking by a bank in favor of the buyer or employer payable 1. Tender or bid guarantee
on demand a. Where tenders are invited it is often a condition of consideration of
the tender that the tenderer undertakes to sign the contract if its awarded to him, to
> Demand guarantees as substitute for cash are designed to provide the procure the issue of any performance or other guarantee required by the guarantee
beneficiary with a speedy monetary remedy against the counterparty and not to modify or withdraw his tender in the meantime
to the underlying contract and to that end are primary in form and documentary b. Purpose—safeguard the beneficiary against breach of such an
in character. undertaking
c. If the tenderer is successful and fails to sign the contract
> The demand guarantee is expressed to be payable solely on presentation and to furnish the requisite performance or other guarantee, or withdraws his
of a written demand and any other specified documents. Accordingly, any demand tender before its expiry, the beneficiary can call upon the guarantor to pay a specified
within the maximum amount stated must in principle be paid by the guarantor, sum designed to compensate him for the trouble and
regardless whether the underlying expense he suffered in reawarding the contract, as well as any additional cost of
contract has in fact been broken and regardless of the loss actually suffered by the contract
the beneficiary
2. Performance guarantee
A CONCISE DEFINITION: DEMAND GUARANTEES a. Guarantee of the central performance of the contract from
> Undertaking given for payment of a stated or maximum sum of money commencement to completion
on presentation to the party giving the undertaking of a demand or b. Given for a specified percentage of the contract sum
payment and such other documents as may be specified in the c. But there are stages in the relationship between the
guarantee within the period and in conformity with the other conditions of parties which precede and follow the central
the guarantee performance, and there may be distinct segments of liability to be covered within
> Procured by the seller in favor of the buyer for the latter to be paid in case the seller that performance
doesn’t comply with contract provisions. The economic burder is upon the party who
breaches the contract 3. Advance payment or repayment guarantee
a. Underlying contract may entitle the principal to payment of stated sums
> Employed typically in construction contracts and contracts for international in advance of performance
sale of goods b. The advance payment guarantee is designed to secure the
beneficiary’s right to repayment of the advance if the performance to which it relates is
> Demand guarantees are intended to safeguard the other party against non- not furnished
performance or late or defective performance by the supplier or contractor
4. Retention guarantee
GUARANTEE STRUCTURES AND TERMINOLOGY: DIRECT (3RD PARTY) a. Construction contracts usually provide for stage payments
GUARANTEES against architect’s or engineer’s certificate and for a specified percentage of the amount
> Involves a minimum of three parties certified in each certificate to be retained by the employer for a specified period of time
1. Account party/principal—party to the underlying contract as safeguard against defects
whose performance is required to be covered by the guarantee and who b. The employer may be willing to release such retention
gives instruction for its moneys against a retention guarantee securing
2. Issuer/guarantor—the bank or other party issuing the guarantee on behalf repayment of the released retention moneys if defects are later found or if the
of the customer the principal contractor fails to complete the contract
3. The beneficiary—the other party to the underlying contract, in whose favor the
guarantee is issued 5. Maintenance or warranty guarantee
> Usually the guarantee in the 3-party structure is the principal’s bank and carries a. Construction contracts usually provide that on completion
on business in the same country as the principal, whilst the beneficiary carries on part of the retention moneys are to be retained for a specified period to cover
business in a foreign country the cost of any defects or malfunction which become manifest during that period
> Known as direct guarantees because the guarantee is issued to directly
by the principal’s bank, not by the local bank in the beneficiary’s country GUARANTEES NOT GUARANTEED BY UNDERLYING CONTRACT
> Not all guarantees are meant to be in favor of a party in the underlying contract
PRINCIPAL TYPES OF DEMAND GUARANTEES > For example are customs guarantees which are issued to the customs to cover any
duty that may become payable when imported goods which would be exempt from duty > Undertaking primary in form but intended to be used only as a fallback in
if reexported within a specified time are not in fact reexported within that time the event of default by the principal under the underlying contract
> Standby credit in legal perspective is simply another term for demand
THE LEGAL NATURE OF A DEMAND GUARANTEE guarantees
> A demand guarantee is an abstract payment undertaking that is, a > The standby credit has developed into an all-purpose financial support
promise of payment which, though intended to preserve the instrument embracing a much wider range of uses than the normal
beneficiary from loss in connection with the underlying transaction is demand guarantee. Thus, standby credits are used to support
detached from the underlying contract between principal and financial and non-financial obligations of the principal and to provide credit
beneficiary and is in form a primary undertaking between the guarantor and enhancement for the primary financial undertaking
beneficiary which becomes binding solely by virtue of its issue
KEY ELEMENTS IN A DEMAND GUARANTEE
> A secondary guarantee is both secondary in form and intent. The intention of 1. The parties
the parties is that the guarantor will be called upon to pay 2. A reference to the underlying contract
only if the principal defaults in performance, and then only to the extent of the 3. The amount or maximum amount of the guarantee and any agreement for
principal’s liability and subject to any defenses available to the principal reduction or increase
4. The currency of payment
> A documentary credit is both primary in intent and form. The parties to the underlying 5. The documents, if any, to be presented for the purpose of a demand or of
contract intend that the bank issuing the credit is a reduction or expiry
to be the first port of call for payment, and this is the effect of the 6. The expiry date or other expiry provisions as well as any agreement for
agreement between them. Whereas in the case of a suretyship extension
guarantee, the beneficiary cannot look to the guarantor without
establishing default by the principal, the reverse is true of the > Where it is intended that the guarantee shall not commence until presentation
documentary credit. The parties have designated payment by the bank as the of a particular document, this fact should be specified
primary payment method and only if it fails without fault on the part of the beneficiary is
entitled to > Direct guarantee: principal, guarantor, and beneficiary should be identified

> DEMAND GUARANTEE STANDS BETWEEN THE SURETYSHIP > Indirect guarantee: principal, instructing party, beneficiary, and counter-
GUARANTEE AND THE DOCUMENTARY CREDIT—SECONDARY IN guarantee
INTENT AND PRIMARY IN FORM. Performance is due in the first
instance from the principal, and the guarantee is intended to be resorted to only > Central to the demand guarantee is its documentary character: the rights and
if the principal has failed to perform. But though this is the intent of the parties, the obligations it creates are to be determined solely from the
guarantee isn’t in form linked to default terms of the guarantee and from any document presented in accordance
under the underlying contract, nor there is any question of with the guarantee, without the need to ascertain external facts
performance to hold the beneficiary harmless up to the agreed maximum; and the
sole condition of the guarantors payment liability is
the presentation of a demand and other documents specified in the guarantee in
the manner of and within the period of the guarantee

> THE GUARANTOR HAS NO CONCERN WITH THE UNDERLYING


CONTRACT AND IF DEMAND IS DULY PRESENTED, PAYMENT MUST BE
MADE DESPITE ALLEGATIONS BY THE PRINCIPAL HAS FULLY
PERFORMED THE CONTRACT—IN THE ABSENCE OF ESTABLISHED
FRAUD OR OTHER EVENT CONSTITUTING GROUND FOR NON-
PAYMENT

STANDBY LETTERS OF CREDIT


its date in any point of the Philippines, and within twelve months outside thereof, it shall be
void in fact and in law.

CODE OF COMMERCE

Title XIII Letters of Credit


PRESIDENTIAL DECREE No. 115 January 29, 1973
ART. 567. Letters of Credit are those issued by one merchant to another, or for the purpose of
attending to a commercial transaction. PROVIDING FOR THE REGULATION OF TRUST RECEIPTS TRANSACTIONS

ART. 568. The essential conditions of letters of credit shall be : WHEREAS, the utilization of trust receipts, as a convenient business device to assist
importers and merchants solve their financing problems, had gained popular
1. To be issued in favor of a determined person and not to order. acceptance in international and domestic business practices, particularly in commercial
banking transactions;
2. To be limited to a fixed and specified amount, or to one or more
indeterminate amounts, but all within a maximum sum the limit of which
WHEREAS, there is no specific law in the Philippines that governs trust receipt
must exactly stated.
transactions, especially the rights and obligations of the parties involved therein and
the enforcement of the said rights in case of default or violation of the terms of the trust
Letters of credit which do not have one of these conditions shall be considered receipt agreement;
simply as letters of recommendation.

ART. 569. One who issues a letter of credit shall be liable to the person on whom it was issued WHEREAS, the recommendations contained in the report on the financial system which
for the amount paid by virtue of the same within the maximum fixed therein. have been accepted, with certain modifications by the monetary authorities included,
among others, the enactment of a law regulating the trust receipt transactions;
Letters of credit cannot be protested, even when not paid, nor can the holder thereof
acquire any right of action for said non-payment against the person who issue it.
The payor shall have a right to demand the proof of identity of the person in whose NOW, THEREFORE, I, FERDINAND E. MARCOS, President of the Philippines, by
favor the letter of credit was issued. virtue of the powers vested in me by the Constitution, as Commander-in-Chief of all the
Armed Forces of the Philippines, and pursuant to Proclamation No. 1081, dated
ART. 570. The drawer of a letter of credit may annul it, informing the bearer and the person to September 21, 1972, and General Order No. 1, dated September 22, 1972, as
whom it is addressed of said revocation. amended, and in order to effect the desired changes and reforms in the social,
economic, and political structure of our society, do hereby order and decree and make
as part of the law of the land the following:
ART. 571. The holder of a letter of credit shall pay the drawer the amount received without
delay.
Should he not do so, an action including attachment may be brought to recover the Section 1. Short Title. This Decree shall be known as the Trust Receipts Law.
said amount with the legal interest and the current exchange in the place where the payment
was made on the place where it was repaid. Section 2. Declaration of Policy. It is hereby declared to be the policy of the state (a)
to encourage and promote the use of trust receipts as an additional and convenient aid
ART. 572. If the holder of a letter of credit does not make use thereof within the period agreed to commerce and trade; (b) to provide for the regulation of trust receipts transactions in
upon with the drawer of the same, or, in the absence of a fixed period, within six months from order to assure the protection of the rights and enforcement of obligations of the parties
involved therein; and (c) to declare the misuse and/or misappropriation of goods or
proceeds realized from the sale of goods, documents or instruments released under (j) "Trust Receipt" shall refer to the written or printed document signed by the entrustee
trust receipts as a criminal offense punishable under Article Three hundred and fifteen in favor of the entruster containing terms and conditions substantially complying with
of the Revised Penal Code. the provisions of this Decree. No further formality of execution or authentication shall
be necessary to the validity of a trust receipt.
Section 3. Definition of terms. As used in this Decree, unless the context otherwise
requires, the term (k) "Value" means any consideration sufficient to support a simple contract.

(a) "Document" shall mean written or printed evidence of title to goods. Section 4. What constitutes a trust receipt transaction. A trust receipt transaction,
within the meaning of this Decree, is any transaction by and between a person referred
(b) "Entrustee" shall refer to the person having or taking possession of goods, to in this Decree as the entruster, and another person referred to in this Decree as
documents or instruments under a trust receipt transaction, and any successor in entrustee, whereby the entruster, who owns or holds absolute title or security interests
interest of such person for the purpose or purposes specified in the trust receipt over certain specified goods, documents or instruments, releases the same to the
agreement. possession of the entrustee upon the latter's execution and delivery to the entruster of
a signed document called a "trust receipt" wherein the entrustee binds himself to hold
the designated goods, documents or instruments in trust for the entruster and to sell or
(c) "Entruster" shall refer to the person holding title over the goods, documents, or otherwise dispose of the goods, documents or instruments with the obligation to turn
instruments subject of a trust receipt transaction, and any successor in interest of such over to the entruster the proceeds thereof to the extent of the amount owing to the
person. entruster or as appears in the trust receipt or the goods, documents or instruments
themselves if they are unsold or not otherwise disposed of, in accordance with the
(d) "Goods" shall include chattels and personal property other than: money, things in terms and conditions specified in the trust receipt, or for other purposes substantially
action, or things so affixed to land as to become a part thereof. equivalent to any of the following:

(e) "Instrument" means any negotiable instrument as defined in the Negotiable 1. In the case of goods or documents, (a) to sell the goods or procure their sale; or (b)
Instrument Law; any certificate of stock, or bond or debenture for the payment of money to manufacture or process the goods with the purpose of ultimate sale: Provided, That,
issued by a public or private corporation, or any certificate of deposit, participation in the case of goods delivered under trust receipt for the purpose of manufacturing or
certificate or receipt, any credit or investment instrument of a sort marketed in the processing before its ultimate sale, the entruster shall retain its title over the goods
ordinary course of business or finance, whereby the entrustee, after the issuance of the whether in its original or processed form until the entrustee has complied fully with his
trust receipt, appears by virtue of possession and the face of the instrument to be the obligation under the trust receipt; or (c) to load, unload, ship or tranship or otherwise
owner. "Instrument" shall not include a document as defined in this Decree. deal with them in a manner preliminary or necessary to their sale; or

(f) "Purchase" means taking by sale, conditional sale, lease, mortgage, or pledge, legal 2. In the case of instruments,
or equitable.
a) to sell or procure their sale or exchange; or
(g) "Purchaser" means any person taking by purchase.
b) to deliver them to a principal; or
(h) "Security Interest" means a property interest in goods, documents or instruments to
secure performance of some obligations of the entrustee or of some third persons to c) to effect the consummation of some transactions involving delivery to a depository
the entruster and includes title, whether or not expressed to be absolute, whenever or register; or
such title is in substance taken or retained for security only.
d) to effect their presentation, collection or renewal
(i) "Person" means, as the case may be, an individual, trustee, receiver, or other
fiduciary, partnership, corporation, business trust or other association, and two more
persons having a joint or common interest. The sale of goods, documents or instruments by a person in the business of selling
goods, documents or instruments for profit who, at the outset of the transaction, has,
as against the buyer, general property rights in such goods, documents or instruments,
or who sells the same to the buyer on credit, retaining title or other interest as security
for the payment of the purchase price, does not constitute a trust receipt transaction keeping and storing the goods, documents or instruments; (c) to the satisfaction of the
and is outside the purview and coverage of this Decree. entrustee's indebtedness to the entruster. The entrustee shall receive any surplus but
shall be liable to the entruster for any deficiency. Notice of sale shall be deemed
Section 5. Form of trust receipts; contents. A trust receipt need not be in any particular sufficiently given if in writing, and either personally served on the entrustee or sent by
form, but every such receipt must substantially contain (a) a description of the goods, post-paid ordinary mail to the entrustee's last known business address.
documents or instruments subject of the trust receipt; (2) the total invoice value of the
goods and the amount of the draft to be paid by the entrustee; (3) an undertaking or a Section 8. Entruster not responsible on sale by entrustee. The entruster holding a
commitment of the entrustee (a) to hold in trust for the entruster the goods, documents security interest shall not, merely by virtue of such interest or having given the entrustee
or instruments therein described; (b) to dispose of them in the manner provided for in liberty of sale or other disposition of the goods, documents or instruments under the
the trust receipt; and (c) to turn over the proceeds of the sale of the goods, documents terms of the trust receipt transaction be responsible as principal or as vendor under any
or instruments to the entruster to the extent of the amount owing to the entruster or as sale or contract to sell made by the entrustee.
appears in the trust receipt or to return the goods, documents or instruments in the
event of their non-sale within the period specified therein. Section 9. Obligations of the entrustee. The entrustee shall (1) hold the goods,
documents or instruments in trust for the entruster and shall dispose of them strictly in
The trust receipt may contain other terms and conditions agreed upon by the parties in accordance with the terms and conditions of the trust receipt; (2) receive the proceeds
addition to those hereinabove enumerated provided that such terms and conditions in trust for the entruster and turn over the same to the entruster to the extent of the
shall not be contrary to the provisions of this Decree, any existing laws, public policy or amount owing to the entruster or as appears on the trust receipt; (3) insure the goods
morals, public order or good customs. for their total value against loss from fire, theft, pilferage or other casualties; (4) keep
said goods or proceeds thereof whether in money or whatever form, separate and
Section 6. Currency in which a trust receipt may be denominated. A trust receipt may capable of identification as property of the entruster; (5) return the goods, documents
be denominated in the Philippine currency or any foreign currency acceptable and or instruments in the event of non-sale or upon demand of the entruster; and (6)
eligible as part of international reserves of the Philippines, the provisions of existing observe all other terms and conditions of the trust receipt not contrary to the provisions
law, executive orders, rules and regulations to the contrary notwithstanding: Provided, of this Decree.
however, That in the case of trust receipts denominated in foreign currency, payment
shall be made in its equivalent in Philippine currency computed at the prevailing Section 10. Liability of entrustee for loss. The risk of loss shall be borne by the
exchange rate on the date the proceeds of sale of the goods, documents or instruments entrustee. Loss of goods, documents or instruments which are the subject of a trust
held in trust by the entrustee are turned over to the entruster or on such other date as receipt, pending their disposition, irrespective of whether or not it was due to the fault
may be stipulated in the trust receipt or other agreements executed between the or negligence of the entrustee, shall not extinguish his obligation to the entruster for the
entruster and the entrustee. value thereof.

Section 7. Rights of the entruster. The entruster shall be entitled to the proceeds from Section 11. Rights of purchaser for value and in good faith. Any purchaser of goods
the sale of the goods, documents or instruments released under a trust receipt to the from an entrustee with right to sell, or of documents or instruments through their
entrustee to the extent of the amount owing to the entruster or as appears in the trust customary form of transfer, who buys the goods, documents, or instruments for value
receipt, or to the return of the goods, documents or instruments in case of non-sale, and in good faith from the entrustee, acquires said goods, documents or instruments
and to the enforcement of all other rights conferred on him in the trust receipt provided free from the entruster's security interest.
such are not contrary to the provisions of this Decree.
Section 12. Validity of entruster's security interest as against creditors. The entruster's
The entruster may cancel the trust and take possession of the goods, documents or security interest in goods, documents, or instruments pursuant to the written terms of
instruments subject of the trust or of the proceeds realized therefrom at any time upon a trust receipt shall be valid as against all creditors of the entrustee for the duration of
default or failure of the entrustee to comply with any of the terms and conditions of the the trust receipt agreement.
trust receipt or any other agreement between the entruster and the entrustee, and the
entruster in possession of the goods, documents or instruments may, on or after Section 13. Penalty clause. The failure of an entrustee to turn over the proceeds of the
default, give notice to the entrustee of the intention to sell, and may, not less than five sale of the goods, documents or instruments covered by a trust receipt to the extent of
days after serving or sending of such notice, sell the goods, documents or instruments the amount owing to the entruster or as appears in the trust receipt or to return said
at public or private sale, and the entruster may, at a public sale, become a purchaser. goods, documents or instruments if they were not sold or disposed of in accordance
The proceeds of any such sale, whether public or private, shall be applied (a) to the with the terms of the trust receipt shall constitute the crime of estafa, punishable under
payment of the expenses thereof; (b) to the payment of the expenses of re-taking,
the provisions of Article Three hundred and fifteen, paragraph one (b) of Act Numbered
Three thousand eight hundred and fifteen, as amended, otherwise known as the
Revised Penal Code. If the violation or offense is committed by a corporation,
partnership, association or other juridical entities, the penalty provided for in this Decree
shall be imposed upon the directors, officers, employees or other officials or persons
therein responsible for the offense, without prejudice to the civil liabilities arising from
the criminal offense.

Section 14. Cases not covered by this Decree. Cases not provided for in this Decree
shall be governed by the applicable provisions of existing laws.

Section 15. Separability clause. If any provision or section of this Decree or the
application thereof to any person or circumstance is held invalid, the other provisions
or sections hereof and the application of such provisions or sections to other persons
or circumstances shall not be affected thereby.

Section 16. Repealing clause. All Acts inconsistent with this Decree are hereby
repealed. What are the purposes of Trust Receipt Law (PD 115)?

The following are the purposes of the Trust Receipt Law:


Section 17. This Decree shall take effect immediately. 1. To encourage and promote the use of the trust receipts as an additional and
convenient aid to commerce and trade;
2. To regulate trust receipt transactions in order to assure the protection of the
rights and the enforcement of the obligations of the parties involved therein;
and
3. To declare the misuse and/or misappropriation of goods or proceeds realized
from the sale, goods, documents or instruments released under trust receipts
as a criminal offense punishable under Art 315 of the Revised Penal Code
(swindling or estafa).

What is a trust receipt transaction?

Trust Receipt Transaction is a transaction between an entruster and an entrustee


whereby the entruster, who owns or holds absolute title or security in interest over
certain specified goods, documents or instruments, releases the same to the
possession of the entrustee upon the latter's execution and delivery to the entruster of
a trust receipt wherein the entrustee binds himself to hold the designated goods,
documents or instruments in trust for the entruster and to sell or otherwise dispose of
the goods, documents or instruments, with the obligation to turn over to the entruster
the proceeds thereof to the extent of the amount owing to the entruster or the goods,
documents or instruments themselves if they are unsold or not otherwise disposed
of (Sec. 4, PD No. 115).

Who are the parties in a trust receipt transaction?


2. To have possession of the goods as a condition for his liability under the trust
1. Entruster - the person holding title over the goods, documents or instruments receipt law.
subject of a trust transaction, or any successor in interest of such person. He is not the
owner of the goods but merely a holder of security interest.
What are the obligations of the entrustee?
2. Entrustee - the person having or taking possession of goods, documents or
1. Hold the goods, documents or instruments in trust for the entruster and shall
instruments under a trust receipt transaction, and any successor in interest of such
dispose of them strictly in accordance with, the terms and conditions of the
person for the purpose or purposes specified in the trust receipt agreement. He is the
trust receipt;
owner of the goods purchased. In fact, the law imposes on him the risk of loss of the
goods (res perit domino) 2. Receive the proceeds in trust for the entruster and turn over the same to the
enstruster to the extent of the amount owing to the entruster or, as appears
3. Seller of the goods – not strictly and actually a party to the trust receipt transaction; on the trust receipt;
but a party to the contract of sale with the buyer/importer (entrustee).
3. Insure the goods for their total value against the loss from fire, theft, pilferage
or other casualties;
4. Keep the goods or proceeds separate and identifiable as property of the
entruster;
5. Return the goods, documents or instruments in the event of non-sale or upon
demand of the entruster; and
What are the rights of the entruster? 6. Observe all other terms and conditions of the trust receipt not contrary to the
provisions of PD 115
The rights of the entruster are the following:
1. To receive the proceeds of the sale of the goods, documents or instruments Distinguished from:
released under the trust receipt to the entrustee to the extent of the amount
owing to the entruster or as appears in the trust receipt; Pledge – In a pledge, the financer possesses the property; in a trust receipt, the person
2. To the return of the goods, documents or instruments in case of non-sale; financed possesses the property
3. To the enforcement of all other rights conferred on him in the trust receipt; Conditional Sale – In a conditional sale, there is a sale of the property from the seller
4. To cancel the trust in case the entrustee defaults and to take possession of to the buyer; in a trust receipt, there is no sale of the property from the entruster to
the goods; entrustee
5. To sell, after proper notice to the entrustee, of the goods, documents or Chattel Mortgage – A chattel mortgage involves the creation of a lien upon the
instruments at public or private sale and apply the proceeds to his claims and
property; a trust receipt does not involve the creation of a lien
charges
Consignment – In a consignment, the consignor retains title to the property to secure
the indebtedness due from the consignee [bipartite]; in a trust receipt, the seller does
What are the obligations of the entruster? not retain title to the property but transfers such title to the entruster (not to the
1. To give possession of the goods to the entrustee; entrustee) [tripartite]
2. To give at least 5 days notice to the entrustee of the intention to sell the goods
at public sale
What is the required form of trust receipt?

A trust receipt need not be in any particular form but every such receipt must contain:
What are the rights of the entrustee? 1. Description of the goods, documents or instruments subject of the trust
1. To receive the surplus from the public sale; receipt;
2. The total invoice value of the goods and the amount of the draft to be paid by which are to be sold (retailed, reshipped or stored) but also applies, to goods processed
the entrustee; as a component of a product ultimately sold to the general public.
3. An undertaking or commitment of the entrustee
a. to hold in trust for the entruster the goods, documents or instruments; What are the alternative obligation of the entrustee?
1. To return to the entruster the PROCEEDS of the sale of goods (entregarla)
b. to dispose of them in the manner provided for in the trust receipt;
2. To return the GOODS themselves in case the goods are not sold (devolvera)
c. to turn over the proceeds of the sale of the goods, documents or
instruments to the entruster to the extent of the amount owing to the ● Thus, under the Trust Receipts Law, intent to defraud is presumed when (1) the
entruster or as appears in the trust receipt or to return the goods, entrustee fails to turn over the proceeds of the sale of goods covered by the trust receipt
documents or instruments in the event of their non-sale. to the entruster; or (2) when the entrustee fails to return the goods under trust, if they
are not disposed of in accordance with the terms of the trust receipts.
d.
4. The terms and conditions agreed by the parties
In all trust receipt transactions, both obligations on the part of the trustee exist in the
alternative – the return of the proceeds of the sale or the return or recovery of the goods,
whether raw or processed. When both parties enter into an agreement knowing that
Who shall be liable in case of loss of goods? the return of the goods subject of the trust receipt is not possible even without any fault
on the part of the trustee, it is not a trust receipt transaction penalized under Section
The risk of loss shall be borne by the entrustee. Loss of goods, documents or 13 of P.D. 115; the only obligation actually agreed upon by the parties would be the
instruments which are the subject of a trust receipt, pending their disposition, return of the proceeds of the sale transaction. This transaction becomes a mere loan,
irrespective of whether or not it was due to the fault or negligence of the entrustee, shall where the borrower is obligated to pay the bank the amount spent for the purchase of
not extinguish his obligation to the entruster for the value thereof. the goods. (Landbank vs. Perez, G.R. No. 166884, June 13, 2012)

What is the right of the purchaser for value and in good faith? What is the effect of non-compliance of the said obligation?
1. Criminal liability under both the TRL and RPC;
Any purchaser of goods from an entrustee with right to sell, or of documents or
2. Civil liability for damages under Art. 33 of the Civil Code without need of
instruments through their customary form of transfer, who buys the goods, documents,
proving intent to defraud because it is malum prohibitum.
or instruments for value and in good faith from the entrustee, acquires said goods,
documents or instruments free from the entruster's security interest.
What is the effect of compliance of the said obligation?
1. Before criminal charge – no criminal liability
Validity of entruster's security interest as against creditors
2. After charge, before conviction – extinguishment of criminal liability
The entruster's security interest in goods, documents, or instruments pursuant to the The liability of the entrustee accrues on his failure to comply with his obligation to return.
written terms of a trust receipt shall be valid as against all creditors of the entrustee for It is not absolutely necessary that the entruster cancel the trust and take possession of
the duration of the trust receipt agreement. the goods to be able to enforce his rights under the TRL

What is the penalty for breach by the entrustee? 2 innovations of PD 115 on civil law concept:

Under the Trust Receipts Law, the failure of the entrustee to surrender the goods held 1. Exception to the principle of “Nemo Dat Quod Non Habet” – Under Art. 1505 of the
under trust, or to account for the proceeds of the sales thereof, of the entrustor, is Civil Code, where there is a contract of sale, the buyer is to acquire only whatever title
estafa, which can make the entrustee criminally liable under both the Trust Receipts the seller had at time the sale was perfected. Under PD 115, although the entrustee is
Law and the Revised Penal Code, and liable to the payment of damages under Art. 33 not the owner of the goods under a trust receipt (ownership retained by the entrustor),
of the Civil Code. The penal provisions of PD No. 115 encompasses any act violative anyone who acquires the goods from the entrustee acquires good title (ownership) over
of the obligation covered by the trust receipt. It is not limited to transaction in goods the goods
2. Exception to Rule “Res Perit Domino” – Contrary to the civil law principle that civil obligation under the trust receipts by surrendering the goods if the lender is not
generally it is the owner who bear the risk of loss of the object, under a trust receipt willing to accept them.
arrangement, although the entrustee is not the owner of the goods covered by a trust
receipt, should the goods be lost while in his possession, ENTRUSTEE will bear the Is the violation of TRL malum prohibitum?
risk of loss.
The finding that there was no fraud and deceit is likewise misplaced considering that
the offense is punished as a malum prohibitum regardless of the existence of intent or
Jurisprudence: malice. A mere failure to deliver the proceeds of the sale or the goods if not sold,
constitutes a criminal offense that causes prejudice not only to another, but more to the
Does the trust receipt law violate the constitutional guarantee against public interest.
imprisonment for non-payment of debt?

TRL not violative of the guarantee against imprisonment for non-payment of a debt. What is the loan and security feature of the trust receipt transaction?
What is sought to be punished by the law is not the failure of the entrustee to pay the
loan but his failure to comply with his alternative obligation. TRL does not seek to A trust receipt arrangement is endowed with its own distinctive features and
enfoce payment of loan, rather it punishes dishonesty and abuse of confidence in the characteristics. Under that set-up, a bank extends a loan covered by the Letter of
handling of money or goods to the prejudice of another. Credit, with the trust receipt as a security for the loan. In other words, the transaction
involves a loan feature represented by the letter of credit, and a security feature which
is in the covering trust receipt. A trust receipt, therefore, is a security agreement,
What is the nature of a trust receipt? pursuant to which a bank acquires a "security interest" in the goods. It secures an
indebtedness and there can be no such thing as security interest that secures no
A trust receipt is considered as a security transaction intended to aid in financing obligation. (Sps. Vintola vs. Insular Bank of Asia and America, G.R. No. 73271, May
importers and retail dealers who do not have sufficient funds or resources to finance 29, 1987)
the importation or purchase of merchandise, and who may not be able to acquire credit
except through utilization, as collateral of the merchandise imported or purchased." Who is the owner of the articles subject of the TR?
Can the entruster who has taken actual and juridical possession of the goods
subsequently avail of the right to demand from entrustee the deficiency amount The entrustee. A trust receipt has two features, the loan and security features. The loan
covered by the trust receipt? is brought about by the fact that the entruster financed the importation or purchase of
the goods under TR. Until and unless this loan is paid, the obligation to pay subsists. If
Yes. Trust receipt arrangements being only a security for the loan agreement, the full the entrustee is made to appear as the owner, it was but an artificial expedient, more
turn-over of the goods subject of the trust receipts does not suffice to divest debtors of of legal fiction than fact, for if it were really so, it could dispose of the goods in any
their obligations to repay the principal amount of their loan. Section 7 of PD 115 manner that it wants, which it cannot do. To consider the entrustee as the true owner
expressly provides that the entrustee shall be liable to the entruster for any deficiency. from the inception of the transaction would be to disregard the loan feature
thereof. (Rosario Textile Mills Corp. v. Home Bankers Savings and Trust Company,
G.R. No. 137232. June 29, 2005)
May the entrustee abandon the goods to set-off loan?

Entrustee-borrower cannot be relieved of his obligation to pay the loan simply by What is the penal sanction if offender is a corporation?
abandoning property with bank.
The Trust Receipts Law recognizes the impossibility of imposing the penalty of
Is the acquittal of the entrustee from criminal charge extinguish civil liability on imprisonment on a corporation. Hence, if the entrustee is a corporation, the law makes
the underlying loan? the officers or employees or other persons responsible for the offense liable to suffer
the penalty of imprisonment. The reason is obvious, corporations, partnerships,
A trust receipt arrangement with a bank for the importation of goods, does not make associations and other juridical entities cannot be put to jail. Hence, the criminal liability
the bank an investor in the venture as to extinguish the lender-creditor relationship, and falls on the human agent responsible for the violation of the Trust Receipts Law. (Ong
the acquittal of the entrustee in the criminal charge of estafa does not dissolve the civil vs. CA, G.R. No. 119858, April 29, 2003)
liability arising from the trust receipt arrangement. The trustee cannot extinguish his
In the event of default by the entrustee on his obligation under the trust receipt 1. for any loss of the goods, documents. or instruments (Sec. 10, PD No. 115).
agreement, is it absolutely necessary for the entruster to cancel the trust and
2. for estafa for failure to turn over the proceeds (Sec. 13, PD No. 115).
take possession of the goods to be able to enforce his right thereunder?

The law uses the word "may" in granting to the entruster the right to cancel the trust Q: X, a dealer in imported textiles, opened with Y Bank an irrevocable letter of credit in
and take possession of the goods. Consequently, the entrustee has the discretion to favor of his American supplier, ABC Textile Inc. in the amount of $50,000.00 covering
avail of such right or seek any alternative action, such as a third party claim or a the full invoice value of 2,000 vales of suiting material. He paid Y Bank a marginal
separate civil action which it deems best to protect its right, at any time upon default or deposit of $40,000.00 and the correspondent bank of Y Bank in the United States paid
failure of the entrustee to comply with any of the terms and conditions of the trust ABC textile the amount of $50,000.00. The clothing materials were subsequently
agreement. (South City Homes, Inc. v. BA Finance Corporation, G.R. No. 135462, Dec. shipped by ABC textiles to Manila, with Y Bank as consignee. Y Bank took delivery of
7, 2001) the shipment and had it stored in its bodega. Thereafter X executed the corresponding
trust receipt, but before X could take possession of the goods, a fire of unknown origin
gutted the bodega of Y Bank , resulting in the total loss of the goods. When sued for
What is the effect of novation of a trust agreement? the balance of $10,000.00 X denied liability, contending that Y Bank, as consignee and
owner of the goods, should bear the loss. Is the contention of X tenable? Reason?
Where the entruster and entrustee entered into an agreement which provides for (BAR Q. 1982).
conditions incompatible with the trust receipt agreement, the obligation under the trust
receipt is extinguished. Hence, the breach in the subsequent agreement does not give A: The contention of X is not tenable.
rise to a criminal liability under P.D. 115 but only civil liability. (Philippine Bank v. Ong,
G.R. No. 133176, Aug. 8, 2002) First, the entrustor in a trust receipt is not the owner of the goods but merely a holder
of a security title. The entrustee merchant (X) is the owner of the goods and its return
or inability to sell the goods does not relieve it of its obligation to pay for the money
borrowed."
Second, under Sec. 30: "Loss of goods, documents, or instruments which are the
subject of a trust receipt, pending their disposition, irrespective of whether or not it was
Can deposits in a savings account opened by the buyer subsequent to the TR due to the fault or negligence of the entrustee, shall not extinguish the obligation tot he
transaction be applied to outstanding obligations under the TR account? entruster for the value therefore. "(Sec. 30, Trust Receipts Law).

No, the receipt of the bank of a sum of money without reference to the trust receipt Q: What is the loan and security feature of the trust receipt transaction?
obligation does not obligate the bank to apply the money received against the trust
receipt obligation. Neither does compensation arise because compensation is not A: A trust receipt arrangement is endowed with its own distinctive features and
proper when one of the debts consists in civil liability arising from criminal. (Metropolitan characteristics. Under that set-up, a bank extends a loan covered by the Letter of
Bank and Trust Co. v. Tonda, G.R. No. 134436, Aug. 16, 2000). Credit, with the trust receipt as a security for the loan. In other words, the transaction
Bar Questions: involves a loan feature represented by the letter of credit, and a security feature which
is in the covering trust receipt. A trust receipt, therefore, is a security agreement,
Q: What is a trust receipt? [BAR Q. 1951, 1959]. pursuant to which a bank acquires a "security interest" in the goods. It secures an
A: Trust receipt refers to: indebtedness and there can be no such thing as security interest that secures no
1. document executed between an entrustor and an enstrustee, under which the obligation. (Sps. Vintola vs. Insular Bank of Asia and America, G.R. No. 73271, May
goods are released to the latter who binds himself to hold the goods in trust 29, 1987)
or to sell or dispose of the goods with an obligation to turn over the proceeds
to the entrustor to the context of the entrustee's obligation to him, if unsold, to
return the goods. Q: Who is the owner of the articles subject of the TR?
2. a security agreement to which a bank acquires a "security interest" in the A: The entrustee. A trust receipt has two features, the loan and security features. The
goods. loan is brought about by the fact that the entruster financed the importation or purchase
of the goods under TR. Until and unless this loan is paid, the obligation to pay subsists.
Q: Explain briefly the general liabilities and obligations of the trustee? ( BAR Q. 1951). If the entrustee is made to appear as the owner, it was but an artificial expedient, more
A: The entrustee is liable: of legal fiction than fact, for if it were really so, it could dispose of the goods in any
manner that it wants, which it cannot do. To consider the entrustee as the true owner proper when one of the debts consists in civil liability arising from criminal. (Metropolitan
from the inception of the transaction would be to disregard the loan feature thereof. Bank and Trust Co. v. Tonda, G.R. No. 134436, Aug. 16, 2000).
(Rosario Textile Mills Corp. v. Home Bankers Savings and Trust Company, G.R. No.
137232. June 29, 2005)

Q: What is the penal sanction if offender is a corporation?

A: The Trust Receipts Law recognizes the impossibility of imposing the penalty of
imprisonment on a corporation. Hence, if the entrustee is a corporation, the law makes
the officers or employees or other persons responsible for the offense liable to suffer
the penalty of imprisonment. The reason is obvious, corporations, partnerships,
associations and other juridical entities cannot be put to jail. Hence, the criminal liability
falls on the human agent responsible for the violation of the Trust Receipts Law. (Ong
vs. CA, G.R. No. 119858, April 29, 2003)

Q: In the event of default by the entrustee on his obligation under the trust receipt
agreement, is it absolutely necessary for the entruster to cancel the trust and take
possession of the goods to be able to enforce his right thereunder?

A: The law uses the word "may" in granting to the entruster the right to cancel the trust
and take possession of the goods. Consequently, the entrustee has the discretion to
avail of such right or seek any alternative action, such as a third party claim or a
separate civil action which it deems best to protect its right, at any time upon default or
failure of the entrustee to comply with any of the terms and conditions of the trust
agreement. (South City Homes, Inc. v. BA Finance Corporation, G.R. No. 135462, Dec.
7, 2001)

Q. What is the effect of novation of a trust agreement?

A. Where the entruster and entrustee entered into an agreement which provides for
conditions incompatible with the trust receipt agreement, the obligation under the trust
receipt is extinguished. Hence, the breach in the subsequent agreement does not give
rise to a criminal liability under P.D. 115 but only civil liability. (Philippine Bank v. Ong,
G.R. No. 133176, Aug. 8, 2002)

Q: Can deposits in a savings account opened by the buyer subsequent to the TR


transaction be applied to outstanding obligations under the TR account?

A: No, the receipt of the bank of a sum of money without reference to the trust receipt
obligation does not obligate the bank to apply the money received against the trust
receipt obligation. Neither does compensation arise because compensation is not