Mejia, Melanie

Negotiable Instruments Law

LETTERS OF CREDIT I. Concept A. Definition A letter of credit is any arrangement, however named or described, whereby a bank (issuing bank), acting at the request and on the instructions of a customer (applicant) or on its own behalf, binds itself to: 1. Pay to the order of, or accept and pay drafts drawn by a third party (Beneficiary); 2. Authorize another bank to pay or to accept and pay such drafts 3. Authorizes another bank to negotiate, against stipulated document/s Provided, the terms and conditions of the credit are complied with (Art 2, UCP 500) It is an engagement by a bank or other person made at the request of a customer (applicant) that the issuer will honor drafts or other demands for payment upon compliance with the conditions specified in the credit (Prudential Bank v. IAC, G.R. no 74886, December 8, 1992) The bank merely substitutes its own promise to pay for the promise to pay of one of its customers who in return, promises to pay the bank the amount of funds mentioned in the letter of credit plus credit or commitment fees mutually agreed upon. B. Nature and Purpose It is a commercial document and an entity unto itself Purpose: 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 It serves to reduce the risk of non-payment of the purchase price (in a contract of sale) or non-performance of obligation COMMERCIAL LETTERS OF CREDIT Involve contracts of sale Payable upon presentation by the sellerbeneficiary of the documents that show the he has performed his contract STANDBY LETTERS OF CREDIT Involve non-sale transactions Payable upon certification by the beneficiary of the applicants non-performance of the agreement

C. Essential Conditions of Letters of Credit 1. Issued in favor of a definite person and not to order. NOTE: The Uniform Commercial Practice for Documentary Credits allows letters of credit to be payable to order 2. Limited to a fixed or specified amount, or to one or more amounts, but with a maximum stated limit. NOTE: If any of these essential conditions is not present, the instrument is merely considered as a letter of recommendation. II. Governing Laws The provisions of the Code of Commerce on Letters of Credit were not repealed by the New Civil Code or any other special law. Its provisions were already rendered obsolete by the present customs on Letters of Credit embodied in the Uniform Customs and Practice for Documentary Credits (UCP), which was adopted by the International Chamber of Commerce. The latest revision (UCP 600) took effect on July 1, 2007. However, UCP 600 must be adopted in the Letter of Credit to be Applicable. Parties of a Letter of Credit 1. Applicant/Buyer/Importer The one who procures the letter of credit, purchases the goods and obliges himself to reimburse the issuing bank when the latter complies with the terms of the letter 2. Issuing bank One which, whether a paying bank or not, issues the letter of credit and undertakes to pay the seller upon receipt of the draft and proper documents of title from the seller and to surrender them to the buyer upon reimbursement 3. Beneficiary/Seller/Exporter The one in whose favor the instrument is executed. The beneficiary/seller is the one who delivers the documents of title and draft to the issuing bank to recover payment

III.

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Negotiable Instruments Law

4. Notifying or Advising bank The notifying bank is a correspondent bank (agent) of the issuing bank through which it advises the beneficiary of the letter of credit 5. Confirming bank The confirming bank not only notifies the beneficiary but it also assumes the direct obligation to the seller 6. Paying bank The bank on which the drafts are to be drawn, which may be the issuing bank or another bank not in the city of the beneficiary 7. Negotiating bank A negotiating bank is a correspondent bank which buys or discounts a draft under the letter of credit, if such draft is to be drawn on the opening bank not in the city of the beneficiary IV. Stages in 1. 2. 3. 4. 5. 6. 7. a Letter of Credit Contract of sale between buyer and seller Application for Letter of Credit by the buyer with the issuing bank Issuance of Letter of Credit by the bank Shipping of goods by the seller Execution of draft and tender of documents by the seller Redemption of draft (payment) and obtaining of documents by the issuing bank Reimbursement to the bank and obtaining of documents by the buyer

V.

Rights and Obligations of the Parties A. Contracts involved in a Letter of Credit 1. Between the Applicant/Buyer/Importer and the Beneficiary/Seller/Exporter The applicant/buyer/importer is the one who procures the letter of credit while the beneficiary/seller/exporter is the 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 for the goods. Their relationship is governed by the contract of sale. 2. Between the Issuing Bank and the Beneficiary/Seller/Exporter The issuing bank is the one that issues the letter of credit and undertakes to pay the seller upon receipt of the draft and proper documents of title. On the other hand, the beneficiary/seller/exporter surrenders the documents of title to the bank in compliance with the terms of the letter of credit. Their relationship is governed by the terms of the Letter of Credit. 3. Between the Issuing Bank and the Applicant/Buyer/Importer The applicant/buyer/importer obliges himself to reimburse the issuing bank upon receipt of the documents of title. Their relationship is governed by the terms of the application for the issuance of the letter of credit by the bank (loan agreement). B. Roles and Liabilities of Parties involved

Applicant/Buyer/Importer

ROLE Applies for Letter of Credit Reimburses the Issuing Bank when the bank complies with the terms of the Letter of Credit Issues the Letter of Credit obligating itself to pay the seller Serves as an agent of the Issuing Bank Warrants the apparent (on its face) authenticity of the LC

LIABILITY Solidary liability with the Issuing Bank

Issuing Bank

Notifying/Advising Bank

Solidary liability with the applicant (Exception: contrary stipulation) Does not incur any obligation more than notifying the beneficiary of the opening of the LC after it has determined its apparent authority Not liable for damages unless the document on its face is manifestly fake Direct (primary) obligation, as if it is the one who issued the LC Depends on the stage of

Confirming Bank Negotiating Bank

Lends credence to the LC issued by the lesser-known bank Buys the sellers draft and later

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Negotiable Instruments Law

on sells the draft to the issuing bank

Paying Bank

May either be the issuing bank or any other bank in the place of the beneficiary

negotiation: 1. Before negotiation No liability with respect to the seller. Merely suggests its willingness sot negotiate 2. After negotiation A contractual relationship will then arise, making the bank liable Direct obligation

NOTES: The applicant/buyer is obliged to reimburse the issuing bank once the issuing bank shall have paid the beneficiary after the latters compliance with the terms of the Letter of Credit. Presentment for acceptance to the customer/applicant is not a condition sine qua non for reimbursement (Prudential Bank v. IAC, G.R. no 74886, December 8, 1992) An issuing bank which paid the beneficiary of an expired letter of credit can recover the payment from the applicant which obtained the goods from the beneficiary to prevent unjust enrichment (Rodzssen Supply Co v. Far East Bank & Trust Co, G.R. no 109087, May 9, 2001) VI. Basic Principles A. Independence Principle The relationship of the buyer and the bank is separate and distinct from the relationship of the buyer and seller in the main contract; the bank is not required to investigate if the contract underlying the LC has been fulfilled or not because in transactions involving LC, banks deal only with documents and not goods. In effect, the buyer has no course of action against the issuing bank. The Letter of Credit is independent from the contract of sale. Failure of the buyer to open the Letter of Credit does not prevent the birth of the Sales Contract. (Reliance Commodities, Inc. v. Daewoo Industrial Co. Ltd., G.R. No. 100831, December 17, 1993) The opening of the Letter of Credit is only a mode of payment. The Letter of Credit is not an essential requisite to the contract of sale. Ratio: The independence principle assures the beneficiary/seller 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. The independent nature of the Letter of Credit may be: a. Independence in toto where the credit is independent from the justification aspect and is a separate obligation from the underlying agreement, e.g. a typical standby; or b. Independence may be only 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 In both cases, the payment may be enjoined if in the light of the B. Fraud Exception Principle It provides that the untruthfulness of a certificate accompanying a demand for payment under a standby letter of credit may qualify as fraud sufficient to support an injunction against payment. (Transfield v. Luzon Hydro, G.R. No. 146717, November 22, 2004) The Fraud Exception provides a reasonable balance between the interests of offering minimal protection to bank customers and of assuring reasonable certainty in the execution of international transactions. Remedy for fraud in Letter of Credit: Injunction REQUIREMENTS FOR INJUNCTION UNDER THE FRAUD EXCEPTION (1) There is clear proof of fraud (2) The fraud constitutes fraudulent abuse of the independent purpose of the letter of credit and not only fraud under the main agreement; and (3) Irreparable injury might follow if injunction is not granted or the recovery of damages would be seriously impaired

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Negotiable Instruments Law

WHEN COURTS MAY ENJOIN PAYMENT (1) Where the circumstances plainly show that the underlying contract forbids the beneficiary to call a letter of credit; (2) Where the circumstances show that the contract deprives the beneficiary of even a colorable right to call on a letter of credit (3) Where the contract and the circumstances reveal that the beneficiarys demand for payment has absolutely no basis in fact; and (4) Where the beneficiarys conduct has so vitiated the transaction that the legitimate purposes of the independence of the issuers obligation would no longer be served PROTECTION OF INNOCENT PARTY (1) The issuer shall honor the presentation, if honor is demanded by: (a) A nominated person who has given value in good faith and without notice of forgery or material fraud (b) A confirmer who has honored its confirmation in good faith (c) A holder in due course of a daft drawn under the letter of credit which was taken after acceptance by the issuer or nominated person (d) An assignee of the issuers or nominated persons deferred obligation that was taken for value and without notice of forgery or material fraud after the obligation was incurred by the issuer or nominated person; and (2) The issuer, acting in good faith, may honor or dishonor the presentation in any other case C. Doctrine of Strict Compliance The documents tendered by the seller/beneficiary must strictly conform to the terms of the letter of credit. The tender of documents must include all documents required by the letter. Thus, a correspondent bank which departs from what has been stipulated under the LC acts on its own risk and 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. (Feati Bank and Trust Company v. CA, G.R. No. 940209, Apr. 30, 1991) VII. Kinds of Letters of Credit 1. Confirmed Letter of Credit There is a confirmed letter of credit whenever the beneficiary stipulates that the obligation of the opening bank shall also be made the obligation of a bank to himself. o The correspondent bank gives an absolute assurance to the beneficiary that it will undertake the issuing banks obligation as its own according to the terms and condition of the credit. o Pertains to the kind of obligation assumed by the correspondent bank 2. Irrevocable Letter of Credit 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 o In a Irrevocable Letter of Credit, the issuing bank, may not, without the consent of the beneficiary and applicant, revoke its undertaking under the Letter of Credit o Refers the duration of the Letter of Credit 3. Revolving Letter of Credit A credit that provides for renewed credit to become available as soon as the opening bank has advised the negotiating or paying bank that the drafts already drawn by the beneficiary have been reimbursed to the opening bank by the buyer 4. Back-to-Back Letter of Credit A credit with identical documentary requirements and covering ht 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 5. Standby Letter of Credit A security arrangement for the performance of certain obligations. It can be drawn only if another business transaction is not performed. It may be issued in lieu of a performance bond 6. General Letter of Credit One addressed to any and all persons without naming anyone in particular. It does not restrict the beneficiarys right to transfer his interest thereunder

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Negotiable Instruments Law

7. Special Letter of Credit One addressed to a particular individual, firm or corporation by name. There is a limit to permissible transfer 8. Straight Letter of Credit One that does not run in favor of purchasers of drafts drawn thereunder 9. Fixed Letter of Credit Can be exhausted either when drafts for payment have been drawn by the beneficiary for the full amount of the credit or when the time or period for drawing upon the letter has expired 10. Sight Letter of Credit Payable on demand as distinguished from a Time Letter of Credit, which is payable within a certain period VIII. Cases BPI V. CIR, 496 SCRA 601 (2006) FACTS: Between February and October 1986, petitioner BPI sold to Banko Sentral ng Pilipinas (BSP) US dollars for P1,608,541,900. BPI instructed its correspondent bank in New York to transfer US dollars deposited in BPIs account therein to the Federal Reserve Bank in New York for credit to BSPs account therein. Thereafter, the Federal Reserve Bank sent a confirmation to BSP that such funds had been credited to its account and BSP then transferred to BPIs account in the Philippines the corresponding amount in Pesos. Subsequently, CIR ordered an investigation on BPIs sale of foreign currency. As a result thereof, CIR issued a pre-assessment notice (PAN) holding BPI liable for documentary stamp tax (DST). BPI protested the assessment but said protest was denied. On appeal, CTA held that BPI was liable for DST in connection with the sale of foreign exchange to BSP from July to October 1986 only. CTA ruled that BPIs instructions to its correspondent bank to pay the Federal Reserve Bank falls within Sec 51 of the Revised Documentary Stamp Tax Regulations. ISSUE: WON BPI is liable for DST in connection with its sale of foreign exchange to BSP HELD: Yes. Under Sec 182 NIRC, DST is imposed on: (1) foreign bills of exchange; (2) letters of credit; and (3) orders, by telegraph or otherwise, for the payment of money issued by express or steamship companies or by any person/s. This enumeration is further limited by the qualification that they should be drawn in the Philippines and payable outside of the Philippines. The Code of Commerce defines a letter of credit by providing its essential conditions, thus: Art. 567. Letters of credit are those issued by one merchant to another or for the purpose of attending to a commercial transaction. Art 568. The essential conditions of letters of credit shall be: 1. To be issued in favor of a definite person and not to order. 2. To be limited to a fixed and specified amount, or to one or more undetermined amounts, but within a maximum the limits of which has to be stated exactly. A letter of credit is one whereby one person requests some other person to advance money or give credit to a third person, and promises that he will repay the same to the person making the advancement, or accept the bills drawn upon himself for the like amount. A bill of exchange and a letter of credit may differ as to their negotiability, and as to who owns the funds used for the payment at the time payment is made. However, in both bills of exchange and letters of credit, a person orders another to pay money to a third person. CAB: BPI ordered its correspondent bank in the U.S. to pay the Federal Reserve Bank in New York a sum of money, which is to be credited to the account of the Central Bank. These are the same acts described under Sec 51 of Regulations No. 26, interpreting the documentary stamp tax provision in the Administrative Code of 1917, which is substantially identical to Sec 195 (now Sec 182) NIRC. These acts performed by BPI incidental to its sale of foreign exchange to the Central Bank are included among those taxed under Sec 195 (now Sec 182) NIRC. TRANSFIELD PHIL INC V. LUZON HYDRO CORP, 443 SCRA 307 (2004) FACTS: Transfield entered into a turn-key contract with Luzon Hydro Corp (LHC) for the construction of a 70-megawatt hdyro-electric power station in Bakun River in the provinces of

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Negotiable Instruments Law

Benguet and Ilocos Sur. The contract provides for a period for which the project is to be completed and also allows for the extension of the period provided that the extension is based on justified grounds, e.g. fortuitous event. To secure the performance by Transfield, two standby letters of credit were required to be opened by LHC. During the construction of the plant, Transfield requested for extension of time citing fortuitous events (typhoon, barricades and demonstration). LHC did not give due course to the extension of the period prayed for but referred the matter to the arbitration committee. Due to the delay in the construction of the plant, LHC called on the standby letters of credit because of default. However, the demand was objected by Transfield on the ground that there is still pending arbitration on their request for extension of time. LHC invoked the independence principle on letters of credit. On the other hand, Transfield claimed fraud on the part of LHC for calling on the standby letters of credit. ISSUE: WON fraud exception rule applies in the case at bar HELD: No. Art 3 UCP provides that credits, by their nature, are separate transactions from the sales or other contract(s) on which they may be based and banks are in no way concerned with or bound by such contract/s, even if any reference whatsoever to such contract/s is included in the credit. Consequently, the undertaking of a bank to pay, accept and pay draft/s or negotiate and/or fulfill any other obligation under the credit is not subject to claims or defenses by the applicant resulting from his relationships with the issuing bank or the beneficiary. A beneficiary can in no case avail himself of the contractual relationships existing between the banks or between the applicant and the issuing bank. In a letter of credit transaction, such as in this case, where the credit is stipulated as irrevocable, there is a definite undertaking by the issuing bank to pay the beneficiary provided that the stipulated documents are presented and the conditions of the credit are complied with. Precisely, the independence principle liberates the issuing bank from the duty of ascertaining compliance by the parties in the main contract. As the principle's nomenclature clearly suggests, the obligation under the letter of credit is independent of the related and originating contract. In short, the letter of credit is separate and distinct from the underlying transaction. To say 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. As it is, the independence doctrine works to the benefit of both the issuing bank and the beneficiary. Letters of credit are employed by the parties desiring to enter into commercial transactions, not for the benefit of the issuing bank but mainly for the benefit of the parties to the original transactions. With the letter of credit from the issuing bank, the party who applied for and obtained it may confidently present the letter of credit to the beneficiary as a security to convince the beneficiary to enter into the business transaction. On the other hand, the other party to the business transaction, i.e., the beneficiary of the letter of credit, can be rest assured of being empowered to call on the letter of credit as a security in case the commercial transaction does not push through, or the applicant fails to perform his part of the transaction. It is for this reason that the party who is entitled to the proceeds of the letter of credit is appropriately called "beneficiary." Fraud is an exception to the independence principle on letters of credit. The fraud exception rule refers to 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. The remedy for fraudulent abuse is an injunction. However, injunction should not be granted unless: (a) there is clear proof of fraud; (b) the fraud constitutes fraudulent abuse of the independent purpose of the letter of credit and not only fraud under the main agreement; and (c) irreparable injury might follow if injunction is not granted or the recovery of damages would be seriously damaged.

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CAB: petitioner failed to show that it has a clear and unmistakable right to restrain LHC's call on the Securities which would justify the issuance of preliminary injunction. By petitioner's own admission, the right of LHC to call on the Securities was contractually rooted and subject to the express stipulations in the Turnkey Contract. The Turnkey Contract is plain and unequivocal in that it conferred upon LHC the right to draw upon the Securities in case of default.

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