10/21/2019 SUPREME COURT REPORTS ANNOTATED VOLUME 228

378 SUPREME COURT REPORTS ANNOTATED

Letters of Credit in Banking Transactions

ANNOTATION

LETTERS OF CREDIT IN BANKING TRANSACTIONS

By
SEVERIANO S. TABIOS

—————

§ I. Introduction, p. 378
§ II. Nature and Importance of Letters of Credit, p.
379
§ III. Laws Governing A Letter of Credit
Transaction, p. 380
§ IV. Parties To A Letter of Credit Transaction, p.
381
§ V. Responsibilities of Banks in Commercial
Credit Transactions, p. 382
§ VI. Liability in Commercial Credit Transactions,
p. 384

——————

§ I. Introduction

The decision of the Supreme Court in Bank of America vs.

Court of Appeals, G.R. No. 105395, December 10, 1993,
gives bankers and their clients very instructive guidelines
on the use of letters of credit in banking transactions in
international trade. In that case, which involves an
interpretation of the rights of parties to a letter of credit,
whereby Bank of America sought reimbursement of the
amount it had paid to Inter-Resin Industrial Corporation
on a letter of credit received by the bank by registered mail,
which turned out to be spurious, the Supreme Court after
giving a very instructive discourse on the nature of letters
of credit in international trade declared that the bank could
www.central.com.ph/sfsreader/session/0000016deeb0aff713ea4ed2003600fb002c009e/t/?o=False 1/8
10/21/2019 SUPREME COURT REPORTS ANNOTATED VOLUME 228

recover from Inter-Resin Industrial Corporation on the

latter’s partial availment as beneficiary of the letter of
credit, because on the basis of evidence the bank did not
assume the
379

VOL. 228, DECEMBER 10, 1993 379

Letters of Credit in Banking Transactions

responsibility of a confirming bank.

Because of the importance of letters of credit in banking
transactions involving international trade, this brief study
is presented to guide advocates in handling letters of credit
for their clients.

§ II. Nature and Importance of Letters of Credit

A letter of credit is a financial device developed by

merchants as a convenient and relatively safe mode of
dealing with sales of goods to satisfy the seemingly
irreconcilable interests of a seller, who refuses to part with
his goods before he is paid, and a buyer, who wants to have
control of the goods before paying. (Bank of America vs.
Court of Appeals, supra, citing William S. Shaterian,
Export-Import Banking: The Instruments and Operations
Utilized by American Exporters and Importers and their
Banks in Financing Foreign Trade [The Ronald Press
Company: New York, 1947, pp. 284-374], James J. White &
Robert S. Summers (eds), Uniform Commercial Code [West
Publishing Co.: St. Paul, 1988] pp. 806-883, and John H.
Jacson and William J. Davey, Legal Problems of
International Economic Relations: Cases, Materials and
Text on the National and International Economic
Relations, 2nd Ed., [West Publishing Co.: St. Paul] pp. 52-
63). To break the impasse, the buyer may be required to
contract a bank to issue a letter of credit in favor of the
seller so that, by virtue of the letter of credit, the issuing
bank can authorize the seller to draw drafts and engage to
pay them upon their presentment simultaneously with the
tender of documents required by the letter of credit. The
buyer and the seller agree on what documents are to be
presented for payment, but ordinarily they are documents
of title evidencing or attesting to the shipment of the goods
to the buyer. (Bank of America vs. Court of Appeals, et al.,
supra.)

www.central.com.ph/sfsreader/session/0000016deeb0aff713ea4ed2003600fb002c009e/t/?o=False 2/8
10/21/2019 SUPREME COURT REPORTS ANNOTATED VOLUME 228

Once the letter of credit is established, the seller ships

the goods to the buyer and in the process secures the
required shipping documents or documents of title. To get
paid, the seller executes a draft and presents it together
with the required documents to the issuing bank. The
issuing bank redeems the draft and pays cash to the seller
if it finds that the documents submitted by the seller
conform with what the letter of credit

380

380 SUPREME COURT REPORTS ANNOTATED

Letters of Credit in Banking Transactions

requires. The bank then obtains possession of the

documents upon paying the seller. The transaction is
completed when the buyer reimburses the issuing bank and
acquires the documents entitling him to the goods. Under
this arrangement, the seller gets paid only if he delivers
the documents of title over the goods, while the buyer
acquires the said documents and control over the goods
only after reimbursing the bank. (Bank of America vs.
Court of Appeals, et al., supra.)
What characterizes letters of credit, as distinguished
from other accessory contracts, is the engagement of the
issuing bank to pay the seller once the draft and the
required shipping documents are presented to it. In turn,
this arrangement assures the seller of prompt payment,
independent of any breach of the main sales contract. By
this so-called “independence principle”, the bank
determines compliance with the letter of credit only by
examining the shipping documents presented; it is
precluded from determining whether the main contract is
actually accomplished or not. (Bank of America vs. Court of
Appeals, et. al., supra.)

§ III. Laws Governing A Letter of Credit Transaction

According to the Supreme Court, since the impact of

commercial credit instruments transcends national
boundaries, it being a product of international commerce, it
is thus not uncommon to find a dearth of national law that
can adequately provide for its governance. Our own Code of
Commerce basically introduces only its concept under
Articles 567 to 572, It is no wonder then why great reliance
has been placed on commercial usage and practice, which,
in any case, can be justified by the universal acceptance of

www.central.com.ph/sfsreader/session/0000016deeb0aff713ea4ed2003600fb002c009e/t/?o=False 3/8
10/21/2019 SUPREME COURT REPORTS ANNOTATED VOLUME 228

the autonomy of contracts rule. The rules were later

developed into what is now known as the Uniform Customs
and Practice for Documentary Credits (“U.C.P.”) issued by
the International Chamber of Commerce. It is by no means
a complete text by itself, for, to be sure, there are other
principles, which, although part of lex mercatoria, are not
dealt with in the U.C.P. (Bank of America vs. Court of
Appeals, et, al., supra.)
The Uniform Customs and Practices for documentary
credits were first published in 1933. The current version
was adopted by the International Chamber of Commerce
Council in 1983 and

381

VOL. 228, DECEMBER 10, 1993 381

Letters of Credit in Banking Transactions

published as Publication No. 400 in July of that year. This

current version has the blessing of the United Nations
Commission on International Trade Law (UNCITRAL).
The Uniform Customs and Practices are not “law” because
of the act of any legislative or court, but because they have
been explicitly and implicitly made part of the contract of
letters of credit. Many of the letters of credit in the United
States are governed by the Uniform Customs and Practices
and not by the UCC (Uniform Commercial Code). (White &
Summers, Op. Cit., pp. 881-883).
In the case of Bank of P.I. vs. De Nery, 35 SCRA 256
(1970), the Supreme Court declared that the observance of
the U.C.P. is justified by Article 2 of the Code of Commerce
which expresses that, in the absence of any particular
provision in the Code of Commerce, commercial
transactions shall be governed by usages and customs
generally observed. It further observed that there being no
specific provisions which govern the legal complexities
arising from transactions involving letters of credit not only
between or among banks themselves but also between
banks and the seller or the buyer, as the case may be, the
applicability of the U.C.P. is undeniable. Furthermore, in
the case of FEATI Bank and Trust Co. vs. Court of Appeals,
196 SCRA 576 (1991), the Supreme Court accepted the
application of the international commercial credit
regulatory set of rules in our jurisdiction to the extent of
their pertinency.

§ IV. Parties to A Letter of Credit Transaction

www.central.com.ph/sfsreader/session/0000016deeb0aff713ea4ed2003600fb002c009e/t/?o=False 4/8
10/21/2019 SUPREME COURT REPORTS ANNOTATED VOLUME 228

There are several parties to a letter of credit transaction.

These parties are the following:

1. The Buyer who procures the letter of credit and

obliges himself to reimburse the issuing bank upon
receipt of the documents of title. He is the party
who initiates the operation of the letter of credit
transaction as buyer of the merchandise and also of
the credit instrument. His contract is with the bank
which is to issue the instrument and is represented
by the Commercial Credit of Agreement form which
he signs, supported by the mutually made promises
contained in the Agreement. (Shaterian, Op. Cit.,
pp. 291-292).
2. The Opening Bank which is usually the buyer’s
bank which issues the letter of credit and
undertakes to pay the seller

382

382 SUPREME COURT REPORTS ANNOTATED

Letters of Credit in Banking Transactions

upon receipt of the draft and proper documents of

titles and to surrender the documents to the buyer
upon reimbursement. Also known as the Issuing
Bank, because it actually issues the instrument, it
should be a strong bank, well known and well
regarded in international trading circles. In this
connection, the purposes of commercial credit may
not be readily accomplished unless the opening
bank is well known and well regarded. (Shaterian,
Op. Cit., p. 292)
3. The Seller 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. He is also called the beneficiary of
the credit instrument, because the instrument is
addressed to him and is in his favor. While the
bank cannot compel the seller as beneficiary of the
letter of credit to ship the goods and avail of the
benefits of the instruments, however, the seller may
recover from the bank the value of his shipment if
made within the terms of the instrument, even
though he has not given the bank any direct
consideration for the bank’s promises contained in
the instrument. In this regard, in order to support
www.central.com.ph/sfsreader/session/0000016deeb0aff713ea4ed2003600fb002c009e/t/?o=False 5/8
10/21/2019 SUPREME COURT REPORTS ANNOTATED VOLUME 228

the instrument as a two-sided contract, supported

by mutually given considerations, the courts seem
to hold that the commission paid or to be paid by
the buyer to the bank is also the consideration
flowing from the seller to the bank. (Shaterian, Op.
Cit., p. 292).
4. The Correspondent Bank which may be an Advising
Bank to convey to the seller the existence of the
credit or a Confirming Bank which will lend
credence to the letter of credit issued by a lesser
known issuing bank or a Paying Bank which
undertakes to encash the drafts drawn by the
exporter. Furthermore, another bank known as
Negotiating Bank may be approached by the buyer
to have the draft discounted instead of going to the
place of the issuing bank to claim payment.

§ IV. Responsibilities of Banks in Commercial Credit

Transactions

The responsibilities of the different banks involved in

commercial credit transactions vary, depending on their
respective roles in the transactions. Thus, if the beneficiary
is to be advised by the issuing bank by cable, the services of
an Advising or Notifying

383

VOL. 228, DECEMBER 10, 1993 383

Letters of Credit in Banking Transactions

Bank must always be utilized. The responsibility of the

Notifying Bank is merely to convey or transmit to the seller
or beneficiary the existence of the credit. However, if the
beneficiary requires that the obligation of the issuing bank
shall also be made the obligation of a bank to himself, there
is what is known as a confirmed commercial credit and the
bank notifying the beneficiary of the credit shall become a
Confirming Bank. In this situation, the liability of the
Confirming Bank is primary and it is as if the credit were
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 both
banks, the moment the credit instrument has been
breached. In other words, the Confirming Bank assumes
primary liability to the seller as if it had issued the letter of

www.central.com.ph/sfsreader/session/0000016deeb0aff713ea4ed2003600fb002c009e/t/?o=False 6/8
10/21/2019 SUPREME COURT REPORTS ANNOTATED VOLUME 228

credit. (FEATI Bank & Trust Co. vs. Court of Appeals, 196
SCRA 576 (1991). In this regard, the Confirming Bank
receives a commission for its confirmation from the Issuing
Bank which the Issuing Bank, in turn, passes on to the
buyer of the merchandise. (Shaterian, Op. Cit., pp. 294-
295).
Moreover, the Paying Bank on which the drafts are to be
drawn it may be the Issuing Bank or the Advising Bank. If
the beneficiary is to draw and receive payment in his own
currency, the Advising Bank may be indicated as the
Paying Bank also. When the draft is to be paid in this
manner, the Paying Bank assumes no responsibility but
merely pays the beneficiary and debits the payment
immediately to the account which the Issuing Bank has
with it. If the Issuing Bank maintains no 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 paid to the
beneficiary, at the buying rate for dollar exchange. The
beneficiary is entirely out of the transaction because his
draft is completely discharged by the payment, and the
credit arrangement between the Paying Bank and the
Issuing Bank does not concern him. (Shaterian, Op. Cit.,
pp. 293-294).
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 seller, any bank in the city of the
seller which buys or discounts the draft of the beneficiary
becomes a Negotiating Bank. As a rule, whenever, the
facilities of an Advising or
384

384 SUPREME COURT REPORTS ANNOTATED

Letters of Credit in Banking Transactions

Notifying Bank are used, the beneficiary is apt to offer his

drafts to the Advising Bank for negotiation, thus giving the
Advising Bank the character of a Negotiating Bank also.
By negotiating the beneficiary’s drafts, the Negotiating
Bank becomes “an endorser and bona fide holder” of the
drafts and within the protection of the credit instrument. It
is also protected by the drawer’s signature, as the drawer’s
contingent liability, as drawer, continues until discharged
by the actual payment of the bills of exchange. (Shaterian,
Op. Cit., p. 293).

www.central.com.ph/sfsreader/session/0000016deeb0aff713ea4ed2003600fb002c009e/t/?o=False 7/8
10/21/2019 SUPREME COURT REPORTS ANNOTATED VOLUME 228

§ VI. Liability in Commercial Credit Transactions

It is a settled rule in commercial transactions involving

letters of credit that the documents tendered must strictly
conform to the terms of the letter of credit. The documents
tendered by the beneficiary must include all documents
required by the letter. 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 risk 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. Thus, the rule of strict compliance where
no discretion to waive any requirements is allowed should
be followed. (FEATI Bank & Trust Co. vs. Court of Appeals,
196 SCRA 576 (1991).
However, in the case of a discounting arrangement,
wherein a Negotiating Bank pays the draft of a beneficiary
of a letter of credit in order to save such beneficiary from
the hardship of presenting the documents directly to the
Issuing Bank, the Negotiating Bank can seek
reimbursement of what had been paid to the beneficiary
who as drawer of the draft continues to assume a
contingent liability thereon. Thus, the Negotiating Bank
has the ordinary right of recourse against the seller or
beneficiary in the event of dishonor by the Issuing Bank.
(Bank of America vs. Court of Appeals, et al., supra.)

——o0o——

385

© Copyright 2019 Central Book Supply, Inc. All rights reserved.

www.central.com.ph/sfsreader/session/0000016deeb0aff713ea4ed2003600fb002c009e/t/?o=False 8/8