Letters of Credit A.

Definition/Concept Letters of credit are those issued by one merchant to another for the purpose of attending to a commercial transaction. (Art. 567 Code of Commerce) Any arrangement, however named or described, whereby a bank (issuing bank), acting upon the request or instruction of another (applicant or customer) or on its own behalf, bind itself to: 1. Pay to the order of, or accept and pay drafts brawn by a third person (beneficiary), or 2. Authorize another bank to pay or to accept and pay such drafts, or 3. Authorize another bank to negotiate against stipulated documents. Provide, the terms and conditions of the credit are complied with. (Art. 2 Uniform Custom & Practice for Documentary Credits UCP 500) The kind of Letters of Credit; Commercial Letters of Credit used in the payment of money under a contract of sale. It becomes payable upon presentation of the seller of documents that show he has performed/complied with the contract. Standby Letters of Credit used in non-sale transactions. It becomes payable upon certification of the beneficiary that the applicant has not performed the contract. Revocable Letter of Credit may be revoked or changed without the consent of the seller/exporter up to the time the documents are presented. Irrevocable Letter of Credit may not be revoked or changed without the consent of the parties, including the seller/exporter. Unless otherwise stipulated, all Letters of Credit are irrevocable. B. Governing Laws Articles 567 to 572 of the Code of Commerce are now considered obsolete, considering our adherence to the Uniform Customs and Practice for Documentary Credits of the International Chamber of Commerce. The latest revision of the UCP is UCP 600, which became effective July, 2007. It followed UCP 500 which became effective 1994. Letters of Credits have long been and are still governed by the provisions of the Uniform Customs and Practice for Documentary Credits of the

International Chamber of Commerce. .We have accepted, in Feati Bank and Trust Company v. Court of Appeals and Bank of America NT & SA v. Court of Appeals, to the extent that they are pertinent, the application in our jurisdiction of the international credit regulatory set of rules known as the Uniform Customs and Practice for Documentary Credits (U.C.P) issued by the International Chamber of Commerce, which we said in Bank of the Philippine Islands v. Nery was justified under Art. 2 of the Code of Commerce, which states: Acts of commerce, whether those who execute them be merchants or not and whether specified in this Code or not should be governed by the provisions contained in it; in their absence, by the usages of commerce generally observed in each place; and in the absence of both rules, by those of the civil law. (MWSS vs. Daway GR.160732) C. Nature Letters of credit were historically developed to facilitate the sale of goods between distant and unfamiliar buyers and sellers. It was not usually made by natural persons but involve bank to bank transactions. (De Leon) It was an answer to two concerns, the seemingly irreconcilable interest 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. CA 228 SCRA 357 Letters of credit were developed for the purpose of insuring to a seller payment of a definite amount upon the presentation of documents (Prudential vs. IAC 216 SCRA 257) The primary purpose of a letter of credit is to substitute and therefore support the agreement of the buyer-important to pay money under a contract or arrangement; but it does not necessarily constitute a condition for the perfection of such arrangement. A commitment by the issuer that the party in whose favor it is issued and who can collect upon it will have his credit against the applicant of the letter, duly paid in the amount specified in the letter. (Climaco vs. CBP 63 OG No. 6) They are in effect absolute undertakings to pay the money advanced or the amount for which credit is given on the faith of the instrument. They are primary obligations and not accessory contracts and while they are security arrangements, they are not converted thereby into contracts of guaranty. (Insular Bank of America vs. IAC 167 SCRA 450) Unlike in a guarantee, the settlement of a dispute between the parties is not a prerequisite for the release of funds under a letter of credit. ( Transfield vs. Luzon Hydro 443 SCRA 307)

D. Parties to a Letter of Credit 1. Buyer/Importer/Applicant the one who procures the letter of credit, purchases the goods and obliges himself to reimburse the issuing bank upon receipt of the documents of title e.g. bill of lading. 2. Seller/Beneficiary the one in whose favor the instrument is executed. The one who delivers the documents of title and draft to the issuing bank to recover payment. 3. Opening/Issuing Bank the 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. 4. Advising/Notifying Bank the correspondent bank of the issuing bank which advises the beneficiary of the letter of credit. 5. Confirming Bank bank which, upon request of the beneficiary, confirms the Letter of Credit issued. 6. Paying Bank 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 bank in the city of the beneficiary which buys or discounts the drafts. Step by step of a typical Letter of Credit Transaction I. A buyer/importer and seller/exporter agree on the purchase and sale of goods where payments is made by Letter of Credit. II. The importer completes an application requesting its bank to issue a Letter of Credit in favor of the exporter. The bank now becomes the issuing bank. III. The issuing bank issues the Letter of Credit and sends it to the advising bank by telecommunications or registered mail. A request may be included for the advising bank to add its confirmation. The advising bank may be the exporter's bank but it does not have to be. IV. The advising bank will verify the Letter of Credit for authenticity and send a copy to the exporter. V. The exporter examines the Letter of Credit to ensure that it corresponds to the terms and conditions of the sales agreement; that he can produce the documents stipulated, that he can fulfill the terms and conditions. VI. The exporter arranges for shipment of goods, prepares to obtain the specified documents and makes demand under the Letter of Credit by presenting the

documents to the paying bank. This may be the advising/confirming bank. The bank checks the documents and exported is paid. VII. The documents are sent to the issuing bank and obtain payment from the importer for the payment it made available to the paying bank. The importer received the documents to allow them to take possession of the goods from the shipping company.

1. Rights and Obligations of Parties In a letter of credit arrangement there are three distinct and independent contracts...to be maintained in a state of perpetual separation. ( Keng Hua Paper vs. CA 286 SCRA257) a. Between the buyer and seller

The buyer is the one who procure the Letter of Credit while the seller is one who in compliance with the contract of sale ships the goods to the buyer and delivers the document of title and draft to the bank to recover payment for the goods. b. Between the issuing bank and the seller The bank issues the Letter of Credit and undertakes to pay the seller upon receipt of the draft and the proper documents of title. The seller must surrender the documents of title to the bank in compliance with the terms of the Letters of Credit. c. Between the issuing bank and the buyer The buyer obliges himself to reimburse the issuing bank upon receipt of the documents of title under the terms of the application for the issuance of the Letters of Credit The relationship between the beneficiary seller and the issuer is not strictly contractual, because privity of contracts and meeting of the minds are lacking, yet strict compliance with its terms is an enforceable right. Letter of credit is not a third beneficiary contract because the issuer must honor the drafts drawn against the letter of credit regardless of problems subsequently arising in the underlying contract.

E. Basic Principles of Letter of Credit 1. Doctrine of Independence The relationship of the buyer and the bank is separate and distinct from the relationship of the buyer and the seller in the main contract. In BPI vs. De Reny Fabric Inc (L-2481) De Reny had refused to pay BPI for goods which were found to be colored chalk instead of dyestuffs. Said goods were covered by LOC issued by BPI applied for by De Reny. De Reny was found liable to BPI. Banks do not deal with the property exported or shipped to the importer but deal only with documents

2.

Fraud Exception Principle Most writers agree that fraud is an exception to the independence principle. Professor Dolan opines that 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. ( Transfield vs. Luzon Hydro GR. 146717) 3. Doctrine of Strict Compliance 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 tender of documents by the beneficiary (seller) 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 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 Thus the rule of strict compliance. (Feati Bank vs. CA GR. 94209)