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LETTERS OF CREDIT AND TRUST RECEIPTS

I. LETTERS OF CREDIT AND TRUST RECEIPTS 1993, by which commercial banks sell foreign exchange to
service payments for, e.g., commodity imports (Reliance
Definition and Nature Commodities v. Daewoo, 1993).

Letters of credit (L/C) are those issued by one merchant to (2) Composite of three distinct contracts – An L/C
another, or for the purpose of attending to a commercial transaction involves three distinct but intertwined
transaction. (Art. 567, Code of Commerce) relationships:

A letter of credit is one whereby one person requests some (a) First Contract between the party applying for the
other person to advance money or give credit to a third L/C (buyer/importer/account party) and the party
person, and promises that he will repay the same to the for whose benefit the L/C is issued
person making the advancement, or accept the bills drawn (seller/exporter/beneficiary).
upon himself for the like amount. (Campos, Notes and (b) Second Contract between the buyer and the
Selected Cases on Negotiable Instruments Law) issuing bank. This contract is sometimes called
the "Application and Agreement" or the
A written instrument whereby the writer requests or "Reimbursement Agreement".
authorizes the addressee to pay money or deliver goods to (c) Third Contract between the issuing bank and the
a third person and assumes responsibility for payment of seller, in order to support the contract, under (a)
debt therefor to the addressee (Transfield Philippines v. above (Reliance Commodities v. Daewoo, 1993).
Luzon Hydro, 2004).
TYPES OF LETTERS OF CREDIT AS TO THE TYPE OF THE
An engagement by a bank or other person made at the MAIN CONTRACT:
request of a customer that the issuer shall honor drafts or
other demands of payment upon compliance with the (1) Commercial L/C – The main transaction involves a
conditions specified in the credit (Prudential Bank v. contract of sale. The credit is payable upon the presentation
Intermediate Appellate Court, 1992). by the seller of documents that show he has taken
affirmative steps to comply with the sales agreement. The
PURPOSE: Its purpose is to substitute for, and support, the beneficiary of a commercial credit must demonstrate by
agreement of the buyer-importer to pay money under a documents that he has performed his contract (Transfield
contract or other arrangement, but does not necessarily Philippines v. Luzon Hydro, 2004).
constitute as a condition for the perfection of such
arrangement (Reliance Commodities, Inc. v. Daewoo (2) Standby L/C – Used in non-sale settings. The credit is
Industrial Co., Ltd., 1993) payable upon certification of a party's nonperformance of
the agreement. The creditor-beneficiary of the standby
ESSENTIAL REQUISITES OF LETTERS OF CREDIT: credit must certify that the debtor-applicant has not
(1) Issued in favor of a definite person and not to performed the principal obligation. (Transfield Philippines v.
order. Luzon Hydro, 2004).
(2) Limited to a fixed and specified amount, or to one
or more undetermined amounts, but within a AS TO REVOCABILITY:
maximum the limits of which has to be stated
exactly. (1) Revocable L/C – One which can be revoked by the
issuing bank without the consent of the buyer and
Those which do not have one of these conditions shall be seller
mere letters of recommendation. (Art. 568, Code of (2) Irrevocable L/C – One which the issuing bank
Commerce) cannot revoke without the consent of the buyer
and seller (Feati Bank and Trust Co. v. CA, 1991)
NATURE
AS TO THE OBLIGATION ASSUMED BY CORRESPONDENT
(1) Financial device – L/Cs are developed by merchants as a BANK:
convenient and relatively safe mode of dealing with sales of
goods to satisfy the seemingly irreconcilable interests of a (1) Unconfirmed L/C – One which continues to be the
seller, who refuses to part with his goods before he is paid, obligation of the issuing bank
and a buyer, who wants to have control of the goods before (2) Confirmed L/C – One which is supported by the
paying. (Bank of America, NT&SA v. Court of Appeals, 1993) absolute assurance to the beneficiary that the
confirming bank will undertake the issuing bank's
A letter of credit is one of the modes of payment, set out in obligation as its own according to the terms and
Sec. 8, Central Bank Circular No. 1389, "Consolidated conditions of the credit (Feati Bank and Trust Co.
Foreign Exchange Rules and Regulations," dated 13 April v. CA, 1991)

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LETTERS OF CREDIT AND TRUST RECEIPTS

Parties to a Letter of Credit Basic Principles of Letter of Credit

RIGHTS AND OBLIGATIONS OF THE PARTIES DOCTRINE OF INDEPENDENCE – The principle of


There are at least three parties to a letter of credit: independence assures the seller or the beneficiary of
(1) Buyer/Exporter/Account Party – one who prompt payment independent of any breach of the main
procures the letter of credit and obliges himself contract and precludes the issuing bank from determining
to reimburse the issuing bank upon receipt of whether the main contract is actually accomplished or not.
documents of title.
(2) Issuing Bank – the bank which undertakes: Under this principle, banks assume no liability or
(a) to pay the seller upon receipt of the draft and responsibility for the form, sufficiency, accuracy,
proper documents of title; and genuineness, falsification or legal effect of any documents,
(b) to surrender the documents to the buyer upon or for the general and/or particular conditions stipulated in
reimbursement. the documents or superimposed thereon, nor do they
The obligation of the issuing bank to pay the seller assume any liability or responsibility for the description,
is direct, primary, absolute, definite and solidary quantity, weight, quality, condition, packing, delivery, value
with the buyer, in the absence of stipulation in or existence of the goods represented by any documents,
the letter of credit (MWSS v. Daway, 2004) or for the good faith or acts and/or omissions, solvency,
performance or standing of the consignor, the carriers, or
(3) Seller/Importer/Beneficiary – one who ships the the insurers of the goods, or any other person whomsoever
goods to the buyer in compliance with a contract (Transfield Philippines v. Luzon Hydro, 2004; Bank of
of sale and delivers the documents of title and America, NT&SA v. Court of Appeals, 1993).
draft to the issuing bank to recover payment.
Depending on the transaction, the number of The concept of guarantee vis-a-vis the concept of an
parties to the letter of credit may be increased. irrevocable credit are inconsistent with each other. In the
Thus, the different types of correspondent banks: first place, the guarantee theory destroys the
(4) Advising/Notifying Bank – the bank which independence of the bank's responsibility from the contract
conveys to the seller the existence of the credit. upon which it was opened. In the second place, the nature
The bank assumes no liability except to notify of both contracts is mutually in conflict with each other. In
and/or transmit to the seller the existence of the contracts of guarantee, the guarantor's obligation is merely
letter of credit. collateral and it arises only upon the default of the person
A notifying bank is not a privy to the contract of primarily liable. On the other hand, in an irrevocable credit
sale between the buyer and the seller, its the bank undertakes a primary obligation. (Feati v. CA,
relationship is only with that of the issuing bank 1991)
and not with the beneficiary to whom he assumes
no liability. The bank may suggest to the seller its The independent nature of the letter of credit may be:
willingness to negotiate, but this fact alone does (1) Independent in toto - the credit is independent
not imply that the notifying bank promises to from the justification aspect and is a separate
accept the draft drawn under the documentary obligation from the underlying agreement;
credit (Feati Bank and Trust Co. v. CA, 1991). (2) Only as to the justification aspect like in a
(5) Confirming Bank – the bank which lends credence commercial letter of credit or repayment
to the letter of credit issued by a lesser known standby, which is identical with the same
issuing bank. obligations under the underlying agreement.
The bank assumes a direct obligation to the seller (Transfield Philippines v. Luzon Hydro, 2004; Bank
and its liability is a primary one as if the bank itself of America, NT&SA v. Court of Appeals, 1993).
had issued the letter of credit (Feati Bank and
Trust Co. v. CA, 1991). FRAUD EXCEPTION PRINCIPLE – The principle that limits the
(6) Negotiating Bank – the bank which discounts the application of the independence principle only to instances
draft presented by the seller. where it would serve the commercial function of the credit
The bank buys or discounts a draft under the and not when fraud attends the transaction.
letter of credit. Its liability is dependent upon the
stage of the negotiation. If before negotiation, it In the case of Transfield Philippines v. Luzon Hydro, 2004,
has no liability with respect to the seller but after the petitioner alleged misrepresentation as constituting
negotiation, a contractual relationship will then fraud. The Court, however, made no ruling as to whether
prevail between the negotiating bank and the the same indeed constitutes fraud.
seller (Feati Bank and Trust Co. v. CA, 1991).
(7) Paying Bank – the bank which undertakes to The case asserts that the "fraud exception" exists when the
encash the drafts drawn by the seller. beneficiary, for the purpose of drawing on the credit,
fraudulently presents to the confirming bank, documents

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LETTERS OF CREDIT AND TRUST RECEIPTS

that contain, expressly or by implication, material LOAN/SECURITY FEATURE


representations of fact that to his knowledge are untrue. In
such a situation, petitioner insists, injunction is recognized A letter of credit-trust receipt arrangement is endowed
as a remedy available to it. with its own distinctive features and characteristics. Under
that set-up, a bank extends a loan covered by the letter of
Citing Dolan's treatise on letters of credit, petitioner argues credit, with the trust receipt as a security for the loan. In
that the independence principle is not without limits and it other words, the transaction involves a loan feature
is important to fashion those limits in light of the principle's represented by the letter of credit, and a security feature
purpose, which is to serve the commercial function of the which is in the covering trust receipt. A trust receipt,
credit. If it does not serve those functions, application of the therefore, is a security agreement, pursuant to which a
principle is not warranted, and the common law principles bank acquires a "security interest" in the goods (Vintola v.
of contract should apply. (Transfield Phils. v. Luzon Hydro, IBAA, 1987)
2004)
A trust receipt arrangement does not involve a simple loan
DOCTRINE OF STRICT COMPLIANCE – The settled rule in transaction between a creditor and debtor-importer. Apart
commercial transactions involving letters of credit requires from a loan feature, the trust receipt arrangement has a
that the documents tendered by the seller must strictly security feature that is covered by the trust receipt itself.
conform to the terms of the letter of credit.
That second feature is what provides the much needed
Otherwise, the issuing bank or the concerned financial assistance to our traders in the importation or
correspondent bank is not obliged to perform its purchase of goods or merchandise through the use of those
undertaking under the contract. goods or merchandise as collateral for the advancements
made by a bank. The title of the bank to the security is the
The tender of documents by the beneficiary (seller) must one sought to be protected and not the loan which is a
include all documents required by the letter. A separate and distinct agreement (People v. Nitafan, 1992)
correspondent bank which departs from what has been
stipulated under the letter of credit, as when it accepts a OWNERSHIP OF THE GOODS, DOCUMENTS AND
faulty tender, acts on its own risks and it may not thereafter INSTRUMENTS UNDER A TRUST RECEIPT
be able to recover from the buyer or the issuing bank, as
the case may be, the money thus paid to the beneficiary Entrustee is the factual owner of the goods, documents and
(Feati v. CA, 1991). instruments (Prudential Bank v. NLRC). Entruster is the real
owner of the goods, documents and instruments “A trust
Concept of Trust Receipt Transaction receipt transaction, within the meaning of this Decree, is
any transaction…whereby the entruster, who owns or holds
A Trust Receipt Transaction is any transaction by and absolute title or security interests over certain specified
between an entruster and another person as entrustee, goods, documents or instruments...” (Sec. 4)
whereby the entruster, who owns or holds absolute title or
security interests over certain specified goods, documents Note: “Security Interest” means a property interest in
or instruments, releases the same to the possession of the goods, documents or instruments to secure performance of
entrustee upon the latter's execution and delivery to the some obligations of the entrustee or of some third persons
entruster of a signed document called a trust receipt [Sec. to the entruster and includes title, whether or not
4, PD 115 (Trust Receipts Law)]. expressed to be absolute, whenever such title is in
substance taken or retained for security only.
A Trust Receipt is a written or printed document signed by
the entruster wherein the entrustee binds himself: “Accordingly, in order to secure that the banker shall be
repaid at the critical point — that is, when the imported
(1) to hold the designated goods, documents or goods finally reach the hands of the intended vendee — the
instruments in trust for the entruster; and banker takes the full title to the goods at the very beginning;
(2) to sell or otherwise dispose of the goods, he takes it as soon as the goods are bought and settled for
documents or instruments with the obligation to by his payments or acceptances in the foreign country, and
turn over to the entruster the proceeds thereof to he continues to hold that title as his indispensable security
the extent of the amount owing to the entruster until the goods are sold.”
or as appears in the trust receipt or the goods,
documents or instruments themselves if they are “[I]n a certain manner, (trust receipt contracts) partake of
unsold or not otherwise disposed of, in the nature of a conditional sale as provided by the Chattel
accordance with the terms and conditions Mortgage Law, that is, the importer becomes absolute
specified in the trust receipt (Sec. 4) owner of the imported merchandise as soon as he has paid
its price. The ownership of the merchandise continues to be

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LETTERS OF CREDIT AND TRUST RECEIPTS

vested in the owner thereof or in the person who has (3) To insure the goods for their total value against
advanced payment, until he has been paid in full, or if the loss from fire, theft, pilferage or other casualties;
merchandise has already been sold, the proceeds of the (4) To keep said goods or proceeds thereof whether
sale should be turned over to him by the importer or by his in money or whatever form, separate and capable
representative or successor in interest.” (Prudential Bank v. of identification as property of the entruster;
NLRC, 1995) (5) To return the goods, documents or instruments in
the event of non-sale or upon demand of the
Note: In the earlier cases of Vintola v. IBAA (1987) and Abad entruster; and
v. Court of Appeals (1990), the Supreme Court held that the (6) To observe all other terms and conditions of the
entrustee becomes the absolute owner of the goods, trust receipt not contrary to the provisions of the
documents and instruments, the entruster being a mere TRL. (Sec. 9)
security holder.
LIABILITIES OF THE ENTRUSTEE
Rights of the Entruster
(1) Liability for Loss - The risk of loss shall be borne by
VALIDITY OF THE SECURITY INTEREST AS AGAINST THE the entrustee. Loss of goods, documents or
CREDITORS OF THE ENTRUSTEE/ INNOCENT PURCHASERS instruments which are the subject of a trust
FOR VALUE receipt, pending their disposition, irrespective of
The entruster shall have the following rights: whether or not it was due to the fault or
negligence of the entrustee, shall not extinguish
(1) Right to the proceeds from the sale of the goods, his obligation to the entruster for the value
documents or instruments released under a trust thereof (Sec. 10)
receipt to the entrustee to the extent of the (2) Liability for failure to turn over proceeds of sale or
amount owing to the entruster or as appears in to return – The failure shall constitute the crime
the trust receipt; OR Right to the return of the of estafa, punishable under Art. 315 (b) of the
goods, documents or instruments in case of non- Revised Penal Code (Sec. 13)
sale; AND Note: Penal sanction if offender is a corporation: If the
(2) Right to the enforcement of all other rights violation or offense is committed by a corporation,
conferred on him in the trust receipt provided partnership, association or other juridical entities, the
such are not contrary to the provisions of the TRL. penalty shall be imposed upon the directors, officers,
(3) Right to cancel the trust and take possession of employees or other officials or persons therein responsible
the goods, documents or instruments subject of for the offense, without prejudice to the civil liabilities
the trust or of the proceeds realized therefrom at arising from the criminal offense (Sec. 13)
any time upon default or failure of the entrustee
to comply with any of the terms and conditions of Remedies Available:
the trust receipt or any other agreement between
the entruster and the entrustee. (1) In case of default or failure of the entrustee to
(4) Right to sell the goods, documents or instruments comply with the trust receipt agreement -
at public or private sale at least five days notice to Entruster may cancel the trust receipt agreement,
the defaulting entrustee of the intention to sell. take possession of the goods, documents,
(5) Right to purchase the goods, documents or instruments, and sell the same at any private or
instruments at a public sale. public sale at least five days from notice of
(6) Right to recover the deficiency from the entrustee intention to sell to the entrustee.
should the proceeds of the sale not be sufficient
(Sec. 7) The proceeds of any such sale, whether public or
private, shall be applied (a) to the payment of the
Obligation and Liability of the Entrustee expenses thereof; (b) to the payment of the
expenses of re-taking, keeping and storing the
OBLIGATIONS OF THE ENTRUSTEE goods, documents or instruments; (c) to the
(1) To hold the goods, documents or instruments in satisfaction of the entrustee's indebtedness to
trust for the entruster and shall dispose of them the entruster (Sec. 7)
strictly in accordance with the terms and
conditions of the trust receipt; (2) In case of loss of the goods, documents,
(2) To receive the proceeds in trust for the entruster instruments - Entruster may claim damages from
and turn over the same to the entruster to the the entrustee (Sec.10)
extent of the amount owing to the entruster or as
appears on the trust receipt; (3) In case of failure to turn over proceeds of the sale
of the goods, documents or instruments or to

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LETTERS OF CREDIT AND TRUST RECEIPTS

return the same in case of non-sale - Entruster


may file a criminal complaint for estafa (Art. 315
(b) of the Revised Penal Code) against the
entrustee (Sec. 13)

Warehouseman’s Lien

A warehouseman shall have a lien on goods deposited or on


the proceeds thereof in his hands:

(1) For all lawful charges for storage and


preservation of the goods;
(2) For all lawful claims for money advanced, interest,
insurance, transportation, labor, weighing,
coopering and other charges and expenses in
relation to such goods;
(3) For all reasonable charges and expenses for
notice, and advertisements of sale; and
(4) For sale of the goods where default had been
made in satisfying the warehouseman's lien (Sec.
27)
Notes:
(1) General rule: A warehouseman shall have lien
only for charges for storage of goods subsequent
to the date of the receipt.
(2) Exception: When the receipt expressly
enumerated other charges provided under Sec.
27 even though the amounts thereof are not
stated in the receipt. (Sec. 30)

However, whether a warehouseman has or has not a lien


upon the goods, he is entitled to all remedies allowed by law
to a creditor against a debtor for the collection from the
depositor of all charges and advances which the depositor
has expressly or impliedly contracted with the
warehouseman to pay (Sec. 32).

(1) Against what property the lien may be enforced:


(a) Against all goods, whenever deposited,
belonging to the person who is liable as debtor for
the claims in regard to which the lien is asserted,
and (b) Against all goods belonging to others
which have been deposited at any time by the
person who is liable as debtor for the claims in
regard to which the lien is asserted if such person
had been so entrusted with the possession of
goods that a pledge of the same by him at the
time of the deposit to one who took the goods in
good faith for value would have been valid (Sec.
28)
(2) Satisfaction of the lien by sale: In accordance with
the terms of a notice so given, a sale of the goods
by auction may be had to satisfy any valid claim
of the warehouseman for which he has a lien on
the goods.