Commercial Law Review

Letters of Credit
Maria Zarah Villanueva - Castro

LETTERS OF CREDIT

Definition:

Q: What is a letter of credit?

A: Letters of Credit is an engagement by a bank or other person made at the request of a customer
that the issuer will honor drafts or other demands for payment upon compliance with the conditions
specified in the credit.
Example: importation of purchase of goods
Q: Are you applying a loan when you open a letter of credit?
A: YES.
Reasons why businessmen open letter of credit:
1. Lack of funds
2. Security purposes
3. Don’t want to part his money until the goods are received
Q: What are the relationships may arise in a letter of credit?
A: General Rule: Three relationships they are: 1. Buyer-seller (contract of sale); 2. Issuing bank-
beneficiary; and 3. Issuing bank-buyer (contract of loan)
Usual conditions imposed by the bank: 1. Financial capacity; 2. collateral

Applicable Laws:

1. Code of Commerce of Letters of Credit

Article 568 of the Code of Commerce provides that: “A letter of credit shall: 1. Be issued in
favor of a definite person and not to orders; and 2. Be limited to a fixed and specified
amount or to one or more undetermined amount but with maximum limit stated exactly.”
*Letter of credit is not a negotiable instrument.
2. Customs, primarily those embodied in the Uniform Customs and Practice for Documentary
Credits which was adopted by the International Chamber of Commerce

Parties to a Letter of Credit:

1. Buyer – one who procures the letter of credit and obliges himself to reimburse the issuing
bank upon receipt of the document of title.
2. Issuing Bank – one which undertakes to pay the seller upon receipt of the draft and proper
documents of titles and to surrender the documents to the buyer upon reimbursement.
3. Seller – one who in compliance with the contract of sale ships the goods to the buyer and
delivers the documents of title and draft to the issuing bank to recover payment.
4. Advising (notifying) Bank – may be utilized to convey to the seller the existence of the credit.
5. Confirming Bank – which will lend credence to the letter of credit issued by a lesser known
issuing bank; the confirming bank is directly liable to pay the seller-beneficiary.
6. Paying Bank – which undertakes to encash the drafts drawn by the exporter/seller.
7. Negotiating Bank

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 Commercial Law Review
Letters of Credit
Maria Zarah Villanueva - Castro

*Most common parties are the buyer, seller and issuing bank.

Transactions involved in a Letter of Credit:

a. Independence Principle
This principle provides that the three contracts entered into in this transaction, the
contracts are: 1. Contract of sale between the buyer and seller; 2. Contract of the buyer with
the issuing bank; and 3. Letter of Credit proper, are separate from each other thus any
infirmity from one contract does not affect the other contracts.
A direct consequence of this principle is the rule that banks only deal with documents and
not with goods, services or obligations to which they relate.
*In BPI v De Reny, the SC held that the bank has no obligation to inquire the specifications
of the goods.
b. Fraud Exception Principle
c. Rule of Strict Compliance
This rule provides that the documentary requirements imposed by the issuing bank must be
strictly complied with by the beneficiary otherwise the issuing bank cannot ask for
reimbursement.
Usual documents submitted to the bank:
1. Vouchers;
2. Contract of sale; and
3. Purchase orders

Types of Letters of Credit:

a. Irrevocable Letter of Credit – is a definite undertaking on the part of the issuing bank and
constitutes the engagement of that bank to the beneficiary and bona fide holders of drafts
drawn and or documents presented thereunder, that the provisions for payment,
acceptance or negotiation contained in the credit will be duly fulfilled, provided that all the
terms and conditions of the credit are complied with.
b. Confirmed Letter of Credit – whenever the beneficiary stipulates that the obligation of the
opening bank shall also be made the obligation of another bank (also bank that notifies) to
himself.
c. Standby Letter of Credit – a security arrangement for the performance of certain
obligations. It can be drawn against only if another business transaction is not performed. It
may also be issued in lieu of a performance bond.
*This type of letter of credit involves an obligation to do.
*In Transfield v Luzon, the SC held that Luzon can ran after the Letter of Credit despite the
pending arbitration of before the Commission because of the independence principle.
*Upon default, the bank pay the beneficiary.

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Letters of Credit
Maria Zarah Villanueva - Castro

d. Revolving Letter of Credit – one that provides for renewed credit to become available as
soon as the opening bank has advised that the negotiating or paying bank that the drafts
already drawn by the beneficiary have been reimbursed to the opening bank by the buyer.
e. Back-to-Back Letter of Credit – a credit with identical documentary requirements and
covering the same merchandise as another letter of credit, except for a difference in the
price of the merchandise as shown by the invoice and the draft. The second letter of credit
can be negotiated only after the first is negotiated.