Special Commercial Laws

notes
Trust Receipts Law
Governing Law
v Presidential   Decree   115   governs   the   trust   receipts   system,   including  
the  criminal  penalty  for  violation  of  the  trust.  
 
PD  115  does  not  violate  the  constitution  
v It  is  a  declaration  by  the  legislative  authority  that,  as  a  matter  of  public  
policy,  the  failure  of  a  person  to  turn  over  the  proceeds  of  the  sale  of  
goods  covered  by  a  trust  receipt  or  to  return  said  goods  if  not  sold  is  a  
public   nuisance   to   be   abated   by   the   imposition   of   penal   sanctions.  
(Tiomico  v.  CA)  
v There   is   a   contention   that   a   violation   of   a   trust   receipt   agreement  
should   result   only   in   a   civil   action   for   collection.   However,   TRL   is   a  
valid   exercise   of   police   power   as   it   punishes   an   offense   malum  
prohibitum   and   enacted   to   punish   the   dishonesty   and   abuse   of  
confidence  in  handling  of  money  or  goods  to  the  prejudice  of  the  bank.  
(People  v.  Nitafan)  
 
Not  the  payment  of  the  loan,  but  as  punishment  for  dishonesty  
v TRL   does   not   seek   to   enforce   payment   of   loan,   rather   it   punishes  
dishonesty   and   abuse   of   confidence   in   handling   of   money   or   goods   to  
the  prejudice  of  another  regardless  of  whether  the  latter  is  the  owner.  
v In   a   pure   trust   receipts   transaction,   the   goods   are   owned   by   bank   and  
only  released  to  importer  in  trust  subsequent  to  the  grant  of  the  loan  
–   the   bank   acquires   a   security   interest   in   the   goods   as     holder   of   a  
security  title  for  the  advances  it  had  mad  to  the  entrustee.  In  a  certain  
manner,   trust   receipts   partake   of   the   nature   of   a   conditional   sale  
where   the   importer   becomes   absolute   owner   of   the   imported  
merchandise  as  soon  as  he  had  paid  its  price.  (Colinares  v.  CA)  
 
Where  transaction  is  not  a  TRA  but  merely  a  loan  
v Where   debtor   received   goods   subject   of   trust   receipt   before   trust  
receipt  itself  was  entered  into,  the  transaction  in  question  is  a  simple  
loan  and  not  a  trust  receipt  agreement.  (Consolidated  Bank  v.  CA)  
 
Definition  and  Nature  of  Trust  Receipt  
v A  trust  receipt  is  a  commercial  document  whereby  the  bank  releases  
the   goods   in   the   possession   of   the   entrustee   but   retains   ownership  
thereof   while   the   entrustee   shall   sell   the   goods   and   apply   the  
proceeds   for   the   full   payment   of   his   liability   with   the   bank.   It   is   a  
security   arrangement   to   which   a   bank   acquires   ownership   of   the  
imported  personal  property.  (Garcia  v.  CA)  
 
True  nature  of  a  trust  receipt  transaction  
v It   is   a   convenient   business   device   to   assist   importers   and   merchants  
solve  their  financing  problems.  The  State  in  enacting  the  law,  sought  
to   find   a   way   to   assist   importers   and   merchants   in   their   financing   in  
order  to  encourage  commerce  in  the  PH.  (Ng  v.  People)  
 
Obligations  of  the  entrustee  
  In  Gonzalez  v.  Hongkong  &  Shanghai  Banking  Corp.,  the  Court  held  that  
a  TRA  imposes  upon  the  entrustee  the  obligation  to:  
(a) Deliver  to  the  entruster  the  price  of  the  sale;  OR  
(b) If  the  merchandise  is  not  sold,  to  return  the  same  to  the  entruster.  

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 1
 
    

Special Commercial Laws

  notes
A  violation  of  any  of  these  undertakings  constitute  estafa.  
 
What  is  a  trust  receipt?  
v It   is   a   document   which   expresses   a   security   transaction   where   the  
lender,   having   no   prior   title   to   the   goods   on   which   the   lien   is   to   be  
constituted,   and   not   having   possession   over   the   same   since  
possession   thereof   remains   in   the   borrower,   lends   his   money   to   the  
borrower  on  security  of  the  goods  which  borrower  is  privileged  to  sell,  
clear   of   the   lien,   with   an   agreement   to   pay   all   or   part   of   the   sale  
proceeds  to  the  lender.  (Metropolitan  Bank  v.  Go)  
 
[Bance]  Essential  elements:  
 
1. It  is  a  DOCUMENT  which  express  a  security  transaction.    
While  the  PD  115  provides  that  a  trust  receipt  need  not  be  in  
any   particular   form   (Sec.   5,   PD   115),   the   same   provision   of   law   also  
provides  that  it  must  contain  (a)  a  description  of  the  goods,  (b)  total  
invoice  value  and  (c)  the  undertaking  or  commitment  of  the  entrustee.  
Hence,   while   the   law   does   not   provide   that   a   TR   must   be   in   writing,  
there   can   be   no   other   way   to   interpret   the   provision   that   would  
comply   with   its   requirements   other   than   that   the   TR   must   be   in  
writing.  
 
2. Entruster   has   NO   PRIOR   TITLE   to   the   goods   subject   of   the   lien   and   NOT  
HAVING  POSSESSION    
This   is   in   keeping   with   the   spirit   and   intention   of   the   law  
which  makes  the  TRA  a  unique  tool.  It  is  to  be  remembered  that  a  TRA  
is  a  business  device  to  allow  a  person  without  capital  to  acquire  goods  
he   requires.   The   fact   that   the   entruster   “owns”   these   goods   is   merely  
legal  fiction,  a  device  to  guard  the  rights  of  the  entruster  but  in  reality,  
these  goods  were  acquired  by  the  entrustee  using  the  capital  lent  by  
the   entruster.   The   essence   of   a   TRA   is   that   the   money   lent   by   the  
entruster  is  to  be  used  as  capital  to  buy  the  goods.  If  these  goods  are  
already   owned   by   the   entrustee,   then   it   would   contravene   with   the  
purpose   of   the   law.   (Plus,   wouldn’t   it   be   a   violation   of,   if   not   the  
banking   law   then,   the   corporation   law,   if   a   bank   may   hold   title   to   goods  
which  may  have  no  relation  at  all  to  the  functions  of  a  bank?)  
 
3. LENDS  his  money  to  the  borrower  on  security  of  the  goods    
 
4. Borrower  (Entrustee)  is  privileged  to  SELL  CLEAR  OF  THE  LIEN  
This  means  that  the  entruster,  while  technically  the  owner  of  
the   goods,   have   no   claim/lien   to   the   same   when   the   goods   are   sold   to  
a  third  person  by  the  entrustee.  The  recourse  of  the  entruster  is  with  
the   entrustee.   In   the   same   manner,   a   third   person   has   no   cause   of  
action  against  the  entruster  (bank)  on  matters  concerning  the  goods.  
His  remedy  is  with  the  entrustee.  
This  then  emphasizes  the  fact  that  the  entruster’s  ownership  
of  the  goods  is  merely  legal  fiction.  Whatever  transactions  are  entered  
into   by   the   entrustee   with   third   persons   concerning   the   goods   are  
between   them   and   does   not   concern   the   bank.   (Why   do   I   love   “legal  
fiction?”)  
  Furthermore,   it   must   be   emphasized   that   this   transaction   is  
for   the   sale   or   for   purposes   substantially   equivalent   to   the   sale   of  
goods.   Hence,   if   the   goods   were   never   meant   for   sale   but   for   the  

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 2
 
    

Special Commercial Laws

consumption  of  the  borrower,  then  the  same  is  not  a  TRA.  Read  State   notes
Investment  House  v.  CA.  
 
5. AGREEMENT  to  pay  all  or  part  of  the  sale  proceeds  to  the  lender.  
This  is  essential.  There  must  be  an  agreement  or  undertaking  
on  the  part  of  the  entrustee  to:  (a)  deliver  the  price  of  the  sale  or  (b)  
return   the   goods   if   not   sold   to   the   entruster.   Without   these  
stipulations,   the   agreement   can’t   well   be   called   a   TRA   regardless   of  
the  nomenclature  used  by  the  parties.  
 
 
Two-­‐fold  obligation  imposed  on  the  entrustee  
(a) To   hold   the   goods,   documents   or   instruments   in   trust   for   the   purpose  
of  selling  or  otherwise  disposing  of  them;  and  
(b) To   turn   over   to   entruster   either   proceeds   thereof   to   the   extent   of  
amount   owing   to   the   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   terms   and  
conditions  specified  in  the  trust  receipts.    
 
[Bance]  The  fancy  terms  for  these  obligations  are  entregarla  and  devolvera  
which  will  be  discussed  in  a  latter  part.  
 
Other  transactions  covered  by  TRA/Transactions  equivalent  to  sale  of  goods  
  A   TR   is   essentially   for   the   purpose   of   the   sale   of   goods   or   for   other  
purposes  substantially  equivalent  to  their:  
(a) sale  or  the  procurement  of  their  sale;  
(b) manufacture  or  processing  with  the  purpose  of  ultimate  sale,   in  which  
case  the  entruster  retains  his  title  over  the  said  goods  whether  in  their  
original  or  processed  form  until  the  entrustee  has  complied  fully  with  
his  obligation  under  the  trust  receipt;  or  
(c) loading,   unloading,   shipment   or   transshipment   or   otherwise   dealing  
with  them  in  a  manner  preliminary  or  necessary  to  their  sale.  
 
Trust  receipt  agreement  is  not  a  simple  loan  
v A  TRA  does  not  involve  a  simple  loan  transaction  between  a  creditor  
and   debtor-­‐importer.   The   law   warrants   the   validity   of   entruster’s  
security   interest   as   against   creditors   of   the   trust   receipt   agreement.  
Consequently,  the  goods  covered  by  the  trust  receipt  cannot  be  levied  
upon  by  entrustee’s  creditors.  (Prudential  Bank  v.  NLRC)  
 
TRA  is  a  collateral  agreement  
v A   trust   receipt   agreement   is   merely   a   collateral   agreement,   the  
purpose  of  which  is  to  serve  as  security  for  a  loan.  TRL  was  enacted  to  
safeguard  commercial  transactions  and  to  offer  an  additional  layer  of  
security   to   the   lending   bank   –   trust   receipts   are   indispensable  
contracts  in  international  and  domestic  business  transactions.  (Landl  &  
Company  v.  Metropolitan  Bank)  
 
Does   PD   115   apply   if   the   loan   proceeds   were   not   used   to   acquire   goods  
destined  for  sale?  
  Yes,   PD   115   would   apply   even   when   the   trust   receipt   issued   covers  
goods   or   items   not   destined   for   sale   or   for   use   in   manufacture,   and   would  
include   items   obtained   under   a   trust   receipt   used   to   repair   and   maintain  
equipment   used   in   business.   If   the   beneficiary   is   not   paid   under   such   trust  
receipt,  the  trustee  is  liable  under  the  law.  (Allied  Banking  v.  Ordonez)  

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 3
 
    

Special Commercial Laws

  notes
When  transaction  is  not  a  TRA  
v There  is  a  line  of  SC  decision  that  views  the  trust  receipt  institution  as  
the   means   by   which   the   importation   of   goods   can   be   effected   by  
importers  using  the  credit  facilities  of  the  banking  system.    
v Such   that   if   the   TR   were   not   employed   as   the   means   by   which  
importation  was  effected,  but  merely  resorted  to  as  collateral  for  the  
loan   taken   AFTER   the   fact   of   importation,   then   the   relationship   is  
governed   by   the   primary   contract   of   loan   and   not   the   trust   receipt  
institution   under   PD   115,   especially   so   when   it   comes   to   the   criminal  
penalty  of  estafa  imposed  on  violation  of  the  trust.  (Check  cases.)  
 
[Bance]  This  is  again  a  recognition  of  the  TR  as  a  convenient  business  
tool   to   allow   a   person   without   the   sufficient   means   to   acquire   the  
necessary   goods.   The   basic   idea   is   that   the   TRA   is   used   to   acquire   the  
goods   such   that,   if   the   goods   were   already   acquired   (even   with   money  
lent  by  the  bank)  before  the  execution  of  a  TRA,  then  it  is  not  at  all  a  TRA  
and  the  borrower  is  not  liable  for  estafa.  The  transaction  is  merely  a  loan.  
This   is   to   curb   the   usual   practice   of   banks   of   lending   money   and   using   a  
TRA  as  an  additional  security.  
 
Who  are  parties  to  a  TRA?  
(1) Entrustee   –   to   whom   goods   are   delivered   for   sale   or   processing   and  
who  bears  the  risk  of  loss.  
(2) Entrustor/Entruster   –   the   one   entitled   to   the   proceeds   from   the   sale  
of  the  goods  to  the  extent  of  the  amount  owing  to  the  entruster  or  as  
appears   in   the   trust   receipt,   or   to   the   return   of   the   goods,   documents  
or  instruments  in  case  of  non-­‐sale,  and  to  the  enforcement  of  all  other  
rights  conferred  on  him  in  thr  trust  receipts.  
 
Obligations  of  the  entrustee  
(a) hold   goods,   documents   or   instruments   in   trust   for   entruster   and  
dispose  of  them  strictly  in  accordance  with  the  terms  of  trust  receipt;  
(b) receive   proceeds   in   trust   for   entruster   and   turn   over   same   to  
entruster   to   the   extent   of   amount   owing   to   the   entruster   or   as  
appears  on  TR;  
(c) insure   goods   for   their   total   value   against   loss   from   fire,   theft,  
pilferage  or  other  casualties;  
(d) keep  said  goods  or  proceeds  thereof  whether  in  money  or  whatever  
form,  separate  and  capable  of  identification  as  property  of  entruster;  
(e) return  goods,  documents  or  instruments  in  event  of  non-­‐sale  or  upon  
demand  of  entruster;  and  
(f) observe  all  other  terms  and  conditions  of  trust  receipt  not  contrary  to  
provisions  of  PD  115.  (Ching  v.  Secretary  of  Justice)  
 
Two  obligations  in  a  trust  receipt  transaction  
(a) Entregarla  –  the  obligation  to  deliver  to  the  owner  (the  entruster)  of  
the  merchandise  sold  the  money  received;  and  
(b) Devolvera   –   the   obligation   to   return   to   the   owner   the   merchandise  
received.    
 
[Bance]  A  violation  of  any  of  these  undertakings  constitute  estafa,  and  the  
mere   failure   to   return   the   undisposed   goods   is   the   gravamen   of   the  
offense  and  thus,  there  is  no  need  to  prove  intent  to  defraud.  
 

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 4
 
    

Special Commercial Laws

Is  previous  demand  by  the  entrustor  to  the  entrustee  essential  to  set  up  any   notes
of  the  remedies  under  the  trust  receipts?  (Meaning,  should  there  be  demand  
before  the  entrustee  is  considered  in  default)  
v No.   In   case   of   default   by   entrustee   on   his   obligation   under   TRA,   it   is  
not   absolutely   necessary   that   entruster   cancel   the   trust   and   take  
possession  of  the  goods  to  be  able  to  enforce  his  rights  thereunder.    
v The   entruster   has   the   discretion   to   avail   to   cancel   the   trust   and   take  
possession   of   the   goods   or   to   avail   of   any   alternative   action,   such   as   a  
third   party   claim   or   a   separate   civil   action   which   it   deems   best   to  
protect  its  rights,  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  v.  BA  Finance  Corp.)  
 
Entrustee  always  bound  to  pay  the  loan  
v An   entruster   who   has   taken   actual   and   juridical   possession   of   the  
goods  may  subsequently  avail  of  the  right  to  demand  from  entrustee  
the  deficiency  of  the  amount  covered  by  the  TR.  The  TR  being  only  a  
security   for   the   loan   agreement,   the   full   turn-­‐over   of   the   goods  
subject   of   the   TR   does   not   suffice   to   divest   debtors   of   their  
obligations   to   repay   principal   amount   of   their   loan.   Sec.   7   of   PD   115  
expressly   provides   that   entrustee   shall   be   liable   to   entruster   for   any  
deficiency.  (Landl  Company  v.  Metropolitan  Bank)  
[Bance]   It   must   be   emphasized   that   the   TR   is   merely   a  
collateral   agreement,   the   principal   contract   being   that   of   a  
loan.   Hence,   the   mere   return   of   the   goods   subject   to   a   TRA  
does  not  extinguish  the  loan  –  there  is  still  then  the  obligation  
to   pay   off   the   same.   The   only   effect   of   the   return   of   the  
goods   is   that   no   criminal   liability   may   arise   from   the   failure   to  
do  so.  
v The  entrustee-­‐borrower  cannot  be  relieved  of  his  obligation  to  pay  the  
loan  simply  by  abandoning  property  with  the  bank.    
 
For  conviction  to  lie  under  PD  115,  it  must  be  shown  that  the  goods  covered  by  
the  TR  were  received  from  either  the  bank  or  the  supplier.  (Ramos  v.  CA)  
 
Who  may  be  held  criminally  liable?  
v The   directors,   officers,   employees   or   other   officials   or   persons   in   the  
corporation,  partnership,  association  or  other  juridical  entities  may  be  
held   criminally   liable   for   the   offense,   without   prejudice   to   the   civil  
liabilities   arising   from   the   criminal   offense.   The   rationale   being   that  
these   officers   and   employers   are   vested   with   the   authority   and  
responsibility   to   devise   means   necessary   to   ensure   compliance   with  
the   law,   and   if   they   fail   to   do   so,   are   held   criminally   accountable.  
(Gonzalez  v.  HSBC)  
v In   Ching   v.   Secretary   of   Justice,   the   accused   signed   the   TR   merely   as  
senior   VP   and   had   no   physical   possession   of   the   good.   However,   the  
Court  held  that  he  cannot  escape  prosecution  for  violation  of  PD  115.  
Though   the   entrustee   is   a   corporation,   nevertheless,   the   law  
specifically   makes   the   officers,   employees,   etc   or   other   persons  
responsible   as   they   have   the   authority   and   responsibility   to   ensure  
compliance  with  the  law.    
v There  is  no  need  to  allege  in  the  information  in  what  capacity  an  agent  
(meaning   the   officer   or   director   of   the   corporation)   participated   to  
hold   him   responsible   for   the   offense.   It   is   sufficient   to   allege   and  
establish  the  failure  of  the  corporation,  who  the  agent  represented,  to  
remit  the  proceeds  or  to  return  the  goods  to  the  bank-­‐entruster.    

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 5
 
    

Special Commercial Laws

  notes
Should  damage  be  proved?  
v No  necessarily.  Damage  to  the  entrustor  need  not  be  proven  because  
the   nature   of   the   TRA   and   the   damage   caused   to   trade   circles   and   the  
banking   community   in   case   of   violation   thereof   is   the   basis   for   the  
criminal  offense.    
 
Acquittal  does  not  extinguish  civil  liability  on  the  underlying  loan  
v A   TRA   does   not   make   the   bank   an   investor   in   the   venture   as   to  
extinguish   the   creditor-­‐debtor   relationship,   and   the   acquittal   of   the  
entrustee   in   the   criminal   charge   of   estafa   does   not   dissolve   the   civil  
liability   arising   from   the   TRA.   The   trustee   cannot   extinguish   his   civil  
obligation  under  the  TR  by  surrendering  the  goods  if  the  lender  is  not  
willing  to  accept  them.  (Vintola  v.  Insular  Bank)  
 
Innovations  of  PD  115  on  Civil  Law  Concepts  
a. Exception   to   “Nemo   Dat   Quod   Non   Habet”   –   Under   Art.   1505   of   the  
Civil,  the  buyer  only  acquires  whatever  title  the  seller  had  at  the  time  
the  sale  was  perfected.  However,  in  a  TRA,  the  third  person  acquires  
good  title  over  the  goods    even  though  the  entrustee  is  not  the  owner  
of  the  same  (as  ownership  is  with  the  bank/entruster).  
b. Exception  to  Rule  “Res  Perit  Domino”  –  Contrary  to  civil  law  principle  
that  the  owner  bears  the  risk,  under  a  TRA,  although  the  entrustee  is  
not   the   owner   of   the   goods,   should   the   goods   be   lost   while   in   his  
possession,  entrustee  will  bear  the  risk  of  loss.  
[Bance]   Hence,   the   reason   why   the   obligation   to   insure   the  
goods  is  with  the  entrustee.    

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 6
 
    

Special Commercial Laws

notes
Letters of Credit
Letter  of  Credit  
v Instrument  issued  by  a  bank  that  guarantees  its  client’s  ability  to  pay  
for   imported   goods   or   services,   authorizing   an   individual   or   a   firm   to  
draw  drafts  on  the  bank  or  on  its  correspondents  for  bank’s  account  
under  certain  conditions  of  the  credit.  
v Engagement   by   a   bank   or   other   person   made   at   the   request   of   a  
customer  that  the  issuer  will  honor  a  draft  or  other  demands  or  other  
complaints  with  the  condition  specified  in  the  credit.  (Prudential  Bank  
v.  IAC)  
v Written   instrument   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.  
A   letter   of   credit,   however,   changes   its   nature   as   different  
transactions   occur   and   if   carried   to   completion   ends   up   as   a   binding  
contract  between  the  issuing  and  honoring  banks  without  any  regard  
or   relation   to   the   underlying   contract   or   disputes   between   the   parties  
thereto.  
 
Primary  purpose  
v The   primary   purpose   of   a   letter   of   creidt   is   to   substitute   for,   and  
therefore  support,  the  agreement  of  the  buyer-­‐importer  to  pay  money  
under  a  contract  or  other  arrangement;  
v But   it   does   not   necessarily   constitute   as   a   condition   for   the   perfection  
of  such  arrangement.  
 
Other  uses  
v 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  credit  are  also  used  in  non-­‐sale  settings  
where   they   serve   to   reduce   the   risk   of   nonperformance.   Generally,  
credits   in   the   non-­‐sale   settings   have   come   to   be   known   as   standby  
credits.  
 
Three  Contracts  in  Letter  of  Credit  
  In   a   letter   of   credit   arrangement,   there   are   three   distinct   and  
independent  contracts  which  are:  
(1) Contract  of  sale  between  buyer  and  seller  
(2) Contract  of  buyer  with  issuing  bank  
(3) Letter   of   credit   proper,   in   which   the   bank   promises   to   pay   seller  
pursuant  to  the  terms  and  conditions  indicated  therein.    
 
Distinct  and  Separate  Contracts  
v These   three   contracts   which   make   up   letter   of   credit   arrangement   are  
to   be   maintained   in   a   state   of   perpetual   separation;   a   transaction  
involving  the  purchase  of  goods  may  also  require,  apart  from  a  letter  
of  credit,  a  contract  of  transportation  specially  when  the  seller  and  the  
buyer   are   not   in   the   same   locale   or   country,   and   the   goods   purchased  
have  to  be  transported  to  the  latter.  
 
Does   the   mere   opening   of   a   letter   of   credit   create   a   trust   (in   favor   of   the  
beneficiary?)  
  No,  the  mere  opening  of  a  letter  of  credit,  does  not  involve  a  specific    
appropriation   of   money   in   favor   of   the   beneficiary.   It   only   signifies   that   the  

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 7
 
    

Special Commercial Laws

beneficiary   may   be   able   to   draw   funds   upon   the   letter   of   credit   up   to   the   notes
designated   amount   specified   therein.   It   does   not   convey   the   notion   that   a  
particular   sum   of   money   has   been   specifically   reserved   or   has   been   held   in  
trust.  (Feati  Bank  v.  CA)  
 
When  is  a  letter  of  credit  perfected?  
v Perfected   the   moment   when   the   correspondent   bank   pays   to   the  
person  in  whose  favor  the  letter  of  credit  has  been  opened.  
o Ex:  When  Chemical  Bank  of  NY  pays  seller  $10,000  on  October  
15,  1973  and  debits  $10,000  to  the  account  of  Merchant  Bank,  
the  letter  of  credit  is  perfected.  
 
Letter  of  credit,  not  a  requisite  for  perfection  of  sale  
v Opening   of   a   letter   of   credit   in   favor   of   a   vendor   is   only   a   mode   of  
payment,  but  it  is  not  among  the  essential  requirements  of  a  contract  
of  sale.  
 
Parties  to  letter  of  credit  
  There  are  at  least  3  parties:  
(a) Buyer  –  who  procures  the  letter  of  credit  and  obliges  himself  to  
reimburse  Issuing  Bank  upon  receipt  of  the  documents  of  title;  
(b) Bank   issuing   the   letter   of   credit   –   undertakes   to   pay   Seller   upon  
receipt   of   the   draft   and   proper   documents   of   titles   and   to   surrender  
the  documents  to  Buyer  upon  reimbursement;  and  
(c) Seller  –  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.  
 
Other  parties  (mostly  correspondent  banks):  
(d) Advising  bank  –  to  convey  to  Seller  the  existence  of  the  credit;  
(e) Confirming   bank   –   which   will   lend   credence   to   the   letter   of   credit  
issued  by  a  lesser  known  Issuing  Bank;  
(f) Paying  Bank  –  undertakes  to  encash  the  drafts  drawn  by  the  exporter;  
or  
(g) Negotiation  Bank  –  instead  of  going  to  the  place  of  the  issuing  bank  to  
claim   payment,   seller   may   approach   negotiating   bank   to   have   draft  
discounted.  
 
Special  rules  in  letter  of  credit;  relationship  between  parties  
(1) Relationship   between   beneficiary-­‐seller   and   the   Issuer   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.  
v [Bance]  There  is  no  privity  between  the  beneficiary-­‐seller  and  the  
Issuer   because   the   letter   of   credit   is   between   the   Issuer   and   the  
buyer-­‐applicant.    
(2) Nevertheless,   the   letter   of   credit   is   not   a   third-­‐party   beneficiary  
contract  (contract  pour  atrui)  because  Issuer  must  honor  drafts  drawn  
against   the   letter   of   credit   regardless   of   problems   subsequently  
arising  in  the  underlying  contract.  
(3) Since   thebank’s   customer   (applicant-­‐buyer)   cannot   draw   on   the   letter,  
it   does   not   function   as   an   assignment   by   the   customer   to   the  
beneficiary;  
(4) If   properly   used,   letter   of   credit   is   not   a   contract   of   suretyship   or  
guarantee,   because   it   entails   a   primary   liability   on   the   part   of   the  
Issuer  following  a  default;  and  

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 8
 
    

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(5) It  is  not  a  negotiable  instrument  because  it  is  not  payable  to  order  or   notes
bearer  and  is  generally  conditional;  yet,  the  draft  presented  under  it  is  
often  negotiable.    
 
Case:  Feati  Bank  v.  CA  
v It   is   a   fundamental   rule   that   an   irrevocable   credit   is   independent   not  
only   of   the   contract   between   the   buyer-­‐applicant   and   the   seller-­‐
beneficiary,   but   also   of   the   credit   agreement   between   the   issuing  
bank  and  the  buyer-­‐applicant.    
v The   non-­‐compliance   by   buyer   with   its   contract   with   issuing   bank   has  
no   bearing   with   the   agreement   between   the   buyer   and   the   seller.   The  
relationship   between   the   issuingbank   and   the   notifying   bank,   on   the  
other   hand   is   more   similar   to   that   of   an   agency,   and   not   that   of   a  
guarantee   since   the   latter   is   merely   to   follow   the   instruction   of   the  
issuing  bank  which  is  to  notify  or  to  transmit  the  letter  of  credit  to  the  
beneficiary.  
 
The  “Rule  of  Strict  Compliance”  
v In   commercial   transactions   involving   letters   of   credit   that   the  
documents  tendered  must  strictly  conform  to  the  terms  of  the  letter  
of  credit.    
v The   tender   of   documents   by   the   beneficiary-­‐seller   must   include   ALL  
documents   required,   and   that   a   correspondent   bank   which   departs  
from   what   has   been   stipulated   under   the   letter   of   credit,   as   when   it  
accepts  a  faulty  tender,  acts  on  its  own  risks  and  it  may  not  thereafter  
be  able  to  recover  from  the  buyer  or  the  issuing  bank,  as  the  case  may  
be,  the  money  thus  paid  to  the  beneficiary-­‐seller.  
 
Confirmed  letter  of  credit  v.  irrevocable  letter  of  credit  
v An   irrevocable   letter   of   credit   refers   to   the   DURATION   of   the   letter   of  
credit   and   simply   means   that   the   issuing   bank   may   not   without   the  
consent  of  the  beneficiary  (seller)  and  the  applicant  (buyer)  revoke  his  
undertaking  under  the  letter,  because  the  bank  does  not  reserve  the  
right  to  revoke  the  credit.  
v A  confirmed  letter  of  credit  pertains  to  the  kind  of  obligation  assumed  
by   the   correspondent   bank,   which   means   that   the   correspondent  
bank   gives   an   absolute   assurance   to   the   beneficiary   that   it   will  
undertake   the   issuing   bank’s   obligation   as   its   own   according   to   the  
terms  and  conditions  of  the  credit.  
v Hence,   the   mere   fact   that   a   letter   of   credit   is   irrevocable   does   not  
necessarily   imply   that   the   correspondent   bank   in   accepting   the  
instruction  of  the  issuing  bank  has  also  confirmed  the  letter  of  credit.    
 
Case:  Bank  of  PI  v.  De  Reny  Fabrics  
v De   Reny   Fabrics   asked   BPI   to   open   a   letter   of   credit   with   its   US  
correspondent  bank   for   the   payment   of   chemical   dyes   ordered   from   a  
US   Factory.   The   LC   required   the   presentation   of   genuine   shipping  
documents   to   allow   the   seller-­‐beneficiary   to   draw   upon   the   LC.  
However,  when  the  shipment  arrived,  it  was  found  that  the  US  factory  
swindled  De  Reny  and  the  same  only  contained  colored  chalk.  De  Reny  
refused  to  pay  BPI,  alleging  that  BPI  was  negligent  in  not  seeing  to  it  
that   the   shipping   document   actually   tallied   with   what   was   loaded  
aboard  the  ship.    
v The   Court   held   that   De   Reny   Fabrics   is   liable   (and   thus   must   pay).   A  
custom  in  international  banking  and  financing  negates  any  duty  on  the  
part   of   a   bank   to   verify   whether   what   is   described   in   the   letters   of  

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 9
 
    

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credit   of   shipping   documents  actually   tally   with   what   is   loaded  aboard   notes
a   ship.   It   is   merely   the   obligation   of   the   bank   to   pay   upon   the  
presentation   of   fenuine   documents.   The   correspondent   bank   is   not  
duty   bound   to   open   and   inspect   the   crates   to   see   whether   the  
contents  thereof  tally  with  the  description  in  the  letter  of  credit.  
 
[Bance]   So   what   this   basically   means   is   that   the   Issuing  
Bank/correspondent  bank  is  only  required  to  check  into  the  authenticity  of  
the   documents   and   that   these   are   in   order.   The   bank   need   not   look  
beyond  the  documents.  
 
Who  has  cause  of  action  under  the  letter  of  credit?  
v While  the  bank  is  bound  to  honor  the  credit,  it  is  the  beneficiary  who  
has  the  right  to  ask  bank  to  honor  the  credit  by  allowing  him  to  draw  
thereon,   and   not   the   buyer-­‐applicant.   (Transfield   Philippines   v.   Luzon  
Hydro  Corp.)  
 
Functions  of  correspondent  banks    
(a) Advising  or  notifying  bank    
v Assumes   no   liability   except   to   notify   and/or   transmit   to   the  
beneficiary  the  existence  of  the  letter  of  credit.  
• A   notifying   bank   is   not   liable   to   pay   the   drafts   drawn  
against  the  letter  of  credit.  
• May  suggest  to  seller  its  willingness  to  negotiate,  but  this  
alone  does  not  imply  that  the  notifying  bank  promises  to  
accept   the   draft   drawn   under   the   documentary   credit.  
(Hence,   the   mere   suggestion   to   negotiate   it   does   not  
make  an  advising  bank  into  a  confirming  bank.)  
• It   has   no   privity   to   the   sale   between   the   buyer   and   the  
seller,  and  its  relationship  is  only  with  that  of  the  issuing  
bank;  
(b) Negotiating  bank    
v Buys  or  discounts  a  draft  under  the  letter  of  credit  and  its  liability  
is  dependent  upon  the  stage  of  the  negotiation:  
• If  before  negotiation:  has  no  liability  with  respect  to  the  
seller;  
• If   after   negotiation:   a   contractual   relationship   will   then  
prevail  between  the  negotiating  bank  and  the  seller.  
(c) Confirming  bank  
v Assumes   a   direct   obligation   to   the   seller   and   its   liability   is   a  
primary   one   as   if   the   correspondent   bank   itself   had   issued   the  
letter  of  credit.  
 
Letter  of  credit  is  a  primary  obligation,  not  an  accessory  contract  
v Letter  of  credit  constitutes  the  primary  obilgation,  and  not  merely  an  
accessory   contract,   of   the   issuing   bank   separate   from   the   underlying  
contract   that   it   may   support.   Consequently,   beneficiary   of   a   letter   of  
credit  issued  to  secure  payment  of  a  loan  may  collect  on  its  entirety,  
even  if  borrower  claims  it  made  partial  payments  already.  (Insular  Bank  
v.  IAC)  
 
Independence  principle  
v Assures  the  seller  or  the  beneficiary  of  prompt  payment  independent  
of   any   breach   of   the   main   contract   and   precludes   the   issuing   bank  
from  determining  whether  the  main  contract  is  actually  accomplished  
or  not.  

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 10
 
    

Special Commercial Laws

v The  bank  assumes  no  liability  or  responsibility  for  the  form,  sufficiency,   notes
accuracy,   genuineness,   falsification   or   legal   effect   of   any   documents,  
or   for   the   general   and/or   particular   conditions   stipulated   in   the  
documents   or   superimposed   thereon,   nor  do   they   assume   any   liability  
or   responsibility   for   the   description,   quantity,   weight,   quality,  
condition,   packing,   delivery,   value   or   existence   of   the   goods  
represented   by   any   documents,   or   for   the   good   faith   or   acts   and/or  
omissions,   solvency,   performance   or   stnding   of   the   consignor,   the  
carriers,   or   the   insurers   of   the   goods,   or   any   other   person  
whomsoever.  
 
Irrevocable  letter  of  credit,  cannot  be  revoked  except  by  express  permission  
v During  the  lifetime  of  an  irrevocable  letter  of  credit,  it  cannot,  even   by  
court   order,   be   cancelled   nor   modified,   nor   can   the   applicant   be  
released,  without  the  express  permission  of  the  beneficiary  in  whose  
favor   it   is   issued.   Otherwise,   it   would   destroy   its   irrevocability.   (Phil.  
Virginia  Tobacco  Adm.  v.  De  los  Angeles)  
 
Independence  principle,  rationale  
v The  independence  principle  liberates  the  issuing  bank  from  the  duty  of  
ascertaining  compliance  by  the  parties  in  the  main  contract.    
v The  obligation  under  the  letter  of  credit  is  independent  of  the  related  
and   originating   contract.   In   brief,   the   letter   of   credit   is   separate   and  
distinct  from  the  underlying  transaction.  
v The   argument   that   any   dispute   must   first   be   resolved   by   the   parties  
through   negotiations   or   arbitration   before   the   beneficiary   is   entitled  
to   call   on   the   letter   of   credit   in   essence   would   convert   the   letter   of  
credit  into  a  mere  guarantee.  
 
Independence  principle,  may  be  invoked  by  beneficiary  
v To  claim  that  the  independence  principle  may  only  be  invoked  by  the  
issuing   banks   would   render   nugatory   the   purpose   for   which   the  
letters  of  credit  are  used  in  commercial  transactions.    
v As   it   is,   the   independence   doctrine   works   to   the   benefit   both   of   the  
issuing  bank  and  the  beneficiary.  
 
Independent  nature  of  the  letter  of  credit,  2  kinds  
(1) independent   in   toto   –   where   the   credit   is   independent   from   the  
justification   aspect   and   is   a   separate   obligation   from   the   underlying  
agreement  like  for  instance  a  typical  standby;  
(2) independence   may   only   be   as   to   the   justification   aspect   like   in   a  
commercial   letter   of   credit   or   repayment   standby,   which   is   identical  
with  the  same  obligations  under  the  underlying  agreement.  
 
Fraudulent  abuse  of  credit,  defense  against  independent  doctrine  
v The   untruthfulness   of   a   certificate   accompanying   a   demand   for  
payment   under   a   standby   credit   may   qualify   as   fraud   sufficient   to  
support  an  injunction  against  payment.    
 
 
Injunction  as  a  remedy,  when  granted  
The   remedy   for   fraudulent   abuse   is   an   injunction   which   should   not   be  
granted  unless:  
(a) there  is  clear  proof  of  fraud;  
(b) fraud   constitutes   fraudulent   abuse   of   the   independent   purpose   of  
the  letter  of  credit  and  not  only  fraud  under  the  main  agreement;  and  

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 11
 
    

Special Commercial Laws

(c) irreparable   injury   might   follow   if   injunction   is   not   granted   or   the   notes
recovery  of  damages  would  be  seriously  damaged.  
 
Effect  of  applicant  being  under  rehabilitation  proceedings  
v The   effects   of   the   stay   order   issued   in   a   rehabilitation   proceeding  
(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   letter   of   credit   issued   in   behalf   of   the  
debtor-­‐applicant   since   the   obligation   of   the   issuing   banks   under   the  
letter  of  credit  is  primary  and  solidary.  
 
Summary  of  rules  pertaining  to  letters  of  credit  
(1) The   Uniform   Customs   and   Practice   may   apply   in   the   absence   of   any  
particular   provisions   in   the   Code   of   Commerce.   Commercial  
transactions  may  then  be  governed  by  usages  and  customs  generally  
observed.  
(2) An   advising   or   notifying   bank   does   not   incur   any   obligation   by   such  
notification   and   is   only   bound   to   check   the   apparent   authenticity   of  
the  letter  of  credit.  
(3) Negotiating  bank  has  a  right  of  recourse  against  the  issuer  bank  and,  
until   reimbursement   is   obtained,   the   drawer   continues   to   assume   a  
contingent  liability  thereon.  
(4) Between   seller   and   the   negotiating   bank   there   is   the   usual  
relationship   existing   between   a   drawer   and   the   purchaser   of   drafts;  
the   involved   bank   deals   only   with   documents   and   not   on   the   goods  
described  in  those  documents.  
 
Margin  fee  
v Tax  on  the  sale  of  foreign  exchange  and  sale  being  consensual,  it  falls  
due   as   soon   as   the   local   bank   opens   the   letter   of   credit.   (Pacific  
Oxygen  Company  v.  Central  Bank)  
 
Marginal  deposit  must  be  deducted  from  principal  obligation  
v The   marginal   deposit   requirement   is   a   Central   Bank   now   measure   to  
cut   off   excess   currency   liquidity   which   would   create   inflationary  
pressure.  It  is  a  collateral  security  given  by  the  debtor,  and  is  supposed  
to   be   returned   to   him   upon   compliance   with   his   obligation.   The  
applicant  for  a  letter  of  credit  is  entitled  to  have  the  marginal  deposit  
first  deducted  from  the  principal  obligation  under  the  letter  of  credit  
and   for   interest   to   accrue   only   on   the   balance,   and   such   deposit   is  
supposed   to   be   returned   upon   the   buyer’s   compliance   with   his  
obligation,   since   compensation   takes   effect   by   operation   of   law.  
(Abad  v.  Court  of  Appeals)  
 
[Bance]   This   speaks   of   the   practice   of   banks   where   the   applicant,   in  
opening   a   letter   of   credit   is   also   required   to   pay   a   marginal   deposit.   As   the  
deposit   is   owned   by   the   applicant-­‐buyer,   in   cases   where   he   cannot   pay   the  
obligation,  the  same  should  be  deducted  from  the  principal  amount.  

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 12
 
    

Special Commercial Laws

notes
LC-TR Transaction

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 13
 
    

Special Commercial Laws

  notes
 
 
Letter  of  credit  v.  Trust  Receipt  
v A  letter  of  credit  is  a  separate  document  from  a  trust  receipt.  While  the  trust  
receipt   may   have   been   executed   as   security   on   the   letter   of   credit,   still   the  
two  documents  involve  a  different  undertaking  and  obligation.  
v Consequently,   a   claim   in   the   letter   of   credit   making   a   party   solidarily   liable  
therein  cannot  be  extend  to  apply  to  the  trust  receipt.  (Bank  of  Commerce  v.  
Serrano)  
 
[Bance]  Letter  of  Credit  v.  Trust  Receipt  (Bank  v.  Serrano)    
 
  Letter  of  Credit   Trust  Receipt  
Nature   Engagement   of   a   bank   or   other   Entruster   (bank)   who   holds  
persons   made   at   the   request   of   absolute   title   or   security  
the  customer  that  the  issuer  will   interest   over   certain   goods  
honor   draft   or   other   demands   releases   the   same   to   an  
for   payment   upon   compliance   entrustee   who   executes   a  
with   conditions   specified   in   the   trust   receipt   binding   himself  
credit.   to  hold  the  goods  in  trust  and  
to   sell   these   goods   or   return  
the  proceeds.  
Role  of  bank   Substitutes   its   own   promise   to   “Lends”  capital  to  allow  buyer  
pay   for   the   promise   to   pay   of   to   purchase   goods,   and   by  
one  of  its  customers  who  in  turn   legal   fiction,   owns   these  
promises   to   pay   the   bank   the   goods   or   holds   a   security  
amount   of   funds   mentioned   in   interest  over  them.  
the  letter  of  credit  plus  credit  or    
commitment   fees   mutually    
agreed  upon.    
   
[Bance]   Technically   here,   the    
bank   plays   a   middleman   between   [Bance]   Technically   here,   the  
a  seller  who  might  be  reluctant  to   bank   is   a   lender   –   lending  
part   with   his   goods   and   a   buyer   capital   to   the   buyer.   The   TR  
who   might   be   reluctant   to   part   was   merely   created   to   further  
with  his  money  and  may  have  no   protect   the   interest   of   the  
credit   facility   to   send   such   a   huge   bank   by   providing   civil   and  
sum  to  the  seller.     criminal   sanctions   for   its  
violation.    
Persons  involved   3:   Buyer-­‐applicant,   Seller-­‐ 2:   The   entruster   (bank)   and  
beneficiary  and  the  Issuing  Bank   the  entrustee  (buyer).  
 
 
Letter  of  Credit  v.  Guarantee  
v Unlike  in  a  guarantee,  the  settlement  of  a  dispute  between  the  parties  is  not  a  
pre-­‐requisite   for   the   release   of   funds   under   a   letter   of   credit.   (Transfield  
Philippines  v.  Luzon  Hydro  Corp.)  
 
Guarantee   Letter  of  credit  
Contract  of  guaranty  depends  upon  the   Independent   of   the   contract   between   the  
primary  contract   seller  and  buyer.  (Independence  principle)  
Guarantor’s   obligation   is   merely   In   an   irrevocable   credit,   the   bank  
collateral   and   arises   upon   upon   default   undertakes  a  primary  obligation  
of  the  person.  
 
 
 
 
 
 

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 14
 
    

Special Commercial Laws

  notes
Commercial  credits  v.  Standby  Credits  
 
Commercial  Credits   Standby  Credit  
Involve   the   payment   of   money   under   a   The  credit  is  payable  upon  certification  of  
contract   of   sale.   The   credits   become   a   party’s   non-­‐performance   of   the  
payable   upon   the   presentation   by   the   agreement.    
seller-­‐beneficiary  of  documents  that  show    
he   has   taken   affirmative   steps   to   comply  
 
with  the  sales  agreements.    
   
[Bance]   So   this   is   more   like   payment   for  
[Bance]   More   like,   a   fee   to   penalize   a  
goods   conditioned   upon   the   performance   party’s  non-­‐performance  of  an  act  required,  
of   an   act,   i.e.   shipping   the   goods   and  
payable   upon   proof   of   said   non-­‐
presenting   complete   documents   to   performance,   i.e.   failure   to   finish   the  
correspondent  bank.     project   on   time.   This   is   a   good   setup   for  
instead   of   merely   stipulating   a   penalty   in  
the   main   contract   and   taking   years   in  
litigation   to   claim   the   same,   the   standby  
credit   allows   for   a   quicker   procedure   and  
with  no  judicial  interference.  
Third   person   (seller-­‐beneficiary)   must   Third   person   (beneficiary)   must   present  
present   documents   tending   to   show   that   documents   tending   to   show   that   the  
he  has  performed  the  contract.   applicant  has  not  performed.    
  Beneficiary   must   certify   that   his   obligor  
  has  not  performed  the  contract.    
 
 
 
 

Bance, Shayne Amor

Xavier University – Ateneo de Cagayan, Class
  of 2017
Commercial Law 15