LETTERS OF CREDIT

A.

DEFINITION
1. A letter of credit is a letter from a merchant or bank or
banker in one place, addressed to another, in another
place or country, requesting the addressee to pay money
or deliver goods to a third party named, therein the writer
of the letter undertaking to provide him money for the
goods or to repay him.
2. It is a letter requesting one person to make advances to a
third person on the credit of the writer.

B.

CONTRACTS INVOLVED
1. In a letters of credit, there are three distinct and
independent contracts:
i.
The contract of sale between the buyer and the
seller;
ii.
The contract of the buyer with the issuing bank; and
iii.
The letter of credit proper in which the bank
promises to pay the seller pursuant to the terms and
conditions stated therein.
2. Apart from the letter of credit, it also involves a contract
of transportation specially when the seller and the buyer
are not in the same locale or country, and the goods
purchased have to be transported to the letter.

C.

PARTIES TO THE LETTER OF CREDIT

1. The buyer or the importer:
a. He is the one who procures the letter of credit and
obliges himself to reimburse the issuing bank upon
the receipt of the documents of title.
b. He is the one initiating the operation of the
transaction as buyer of the merchandise and also of
the credit instrument. His contract with the bank
which is to issue the instrument and is represented
by the Commercial Credit Agreement for which he
signs, supported by the mutually made promises
contained in the agreement.
2. The seller or the beneficiary:
a. 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.
b.
He is also 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 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 is made
within the terms of the instrument, even though he
hasnt given the bank any direct consideration for
the banks promises contained in the instrument.
3. The issuing or opening bank 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.
4. Correspondent banks:
a. The notifying or advising bank:
i. The corresponding bank of the issuing bank
through which advises the beneficiary of the
letter of credit.
ii. Whenever the instrument is not delivered to the
buyer a d by him mailed to the beneficiary, the
issuing bank will advise the existence of the credit
to the beneficiary through the notifying bank
operating in the same locality as the seller.
iii. RULE: Whenever the facilities of the opening
bank are used, the beneficiary is supposed to
present his drafts to the notifying bank for
negotiation.
b. The paying bank:
i. Buys or discounts the drafts contemplated by the
letter of credit, if such draft is to be drawn on the
issuing bank or on another designated bank not in
the city of the beneficiary.
ii. Undertakes to encash the draft drawn by the
exporter.

c.

The confirming bank:

i. Confirms the letter of credit issued by the
opening bank, upon the request of the
beneficiary.
ii. Lends the credence to the letter of credit issued
by a lesser known issuing bank.
d. The negotiating bank instead of going to the
place of issuing bank to claim payment, the buyer
approaches another bank, termed as a negotiating
bank, to have the draft discounted.
D.

NATURE
1. It is nothing more than 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 stated therein.
2. It is in a nature of guaranty but not itself a contract of
guaranty;
3. Under the Code of Commerce, the letters are not
negotiable instruments being issued in favor of a
specified person and not to order;
4. The bearer of the letter is not considered bound to
receive money, he may only use the letter as he pleases,
and the contracts an obligation only by receiving the
money.

E.

PURPOSE
Its purpose is to insure to a seller they payment of a
definite amount upon the presentation of documents and
is thus a commitment by the issuer that the party in
whose favor it is issued and who can collect upon will
have his credit against the applicant of the letter, duly
paid in the amount specified in the letter. They are
absolute undertakings to pay the money in advanced.
They are primary obligations and not accessory contracts.

F.

KINDS OF LETTER OF CREDIT

1. Commercial Letters of Credit Used as a method of
payment in a contract of sale of goods.
2. Standby Letters of Credit:
a. In non-sale transactions, it is used to guaranty or
secure, either a monetary or nonmonetary
obligation, whereby the issuer agrees to pay the
creditor if the debtor defaults the obligation.
b. It is used to reduce the risk of non-performance.
3. Differences:
a. Commercial credits involve the payment of
money under a contract of sale. Such credit
becomes payable upon the presentation by the
seller-beneficiary of documents that show he has
taken affirmative steps to comply with the sales
agreement. In standby credits, the credit is
payable upon certification of a partys
nonperformance
of
the
agreement.
The
documents accompany the beneficiarys draft
tend to show that the applicant has not
performed.
b. The beneficiary of a commercial credit must
demon-strate by documents that he has
performed his contract. The beneficiary of a
standby credit must certify that his obligor has
not performed the contract.

G.

DURATION
1. Upon a period fixed by the parties;
2. If none is fixed, 6 months from its date of used in the
Philippines or 1 year if used abroad.

H.

FAILURE TO OPEN A LETTER OF CREDIT WITHIN THE

PERIOD AGREED UPON
Suffices to prevent a binding juridical tie from being created.
To bind the offeror, the offeree must comply with the
obligations of the offer.

I.

PRINCIPLES/DOCTRINES
a. INDEPENDENCE PRINCIPLE OR THE DOCTRINE OF
INDEPENDENCE
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1.

b.

c.

J.

The bank in determining compliance with the terms

of the letter of credit is required to examine the
shipping presented by the seller and is precluded
from determining whether the main contract is
accomplished or not.
2. A letter accommodation is an entirely distinct and
separate agreement. It is not supposed to be
affected by the main contract upon which it rests.
3. Purposes:
a. It assures the seller/beneficiary of prompt
payment independent of any breach of the
main contract.
b. It precludes the issuing bank from determining
whether the main contract is actually
accomplished.
4. Independence nature of letter of credit may be:
a. Independence in toto where the credit is
independent from the justification aspect and is
a separate obligation form the underlying
agreement (e.g. a typical standby); or
b. Independence as only to the justification aspect
identical with the same obligations under the
underlying agreement (e.g. commercial letter
of credit or repayment standby).
5. NOTE: This principle liberates the issuing bank from
the duty of ascertaining compliance by the parties in
the main contract.
a. The obligation under the letter of credit is
independent of the related and originating
contract (it is separate and distinct from the
underlying transaction).
6. Who may invoke this principle?
a. Beneficiary and the seller; or
b. Issuing bank
FRAUD EXCEPTION PRINCIPLE
1. 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.
2. Injunction as remedy when:
a. There is clear proof of fraud;
b. Fraudulent abuse of the independent purpose of
the letter of credit and not only fraud in the main
agreement.
3. Pursuant to the Independence principle, irreparable
injury might follow if injunction is not granted or the
recovery of damages would be seriously damaged
(Transfield Phil. v. Luzon Hydro Corp.).
DOCTRINE OF STRICT COMPLIANCE
1. The document tendered by the seller must strictly
conform to the terms of the letter of credit.
2. The correspondent bank which departs from what
has been stipulated in the letter of credit (e.g. when
it accepts a faulty tender) acts on his own risk and
may not thereafter recover from the buyer or issuing
bank, the money paid to the beneficiary.
3. The documents presented must comply with those
stipulated (in a letter of credit, the banks only deals
with documents and not with the goods).

RESPONSIBILITIES OF BANKS IN COMMERCIAL CREDIT

TRANSACTIONS
a. If the beneficiary is to be advised by the issuing bank by
cable, the services of an ADVISING OR NOTIFYING BANK
must always be utilized.
b. 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 the 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 case, the liability of
the confirming bank is primary and it is as if the credit
were issued by the issuing and confirming banks jointly,

c.

d.

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.
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 HAS 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 issuing
bank doesnt concern him.
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 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 becomes an
endorser and bona fide holder of the drafts and within the
protection of the credit instrument. It is also protected by
the drawers signature, as the drawers contingent
liability, as drawer, continues until discharged by the
actual payment of the bills of exchange.

K.

LIABILITY IN COMMERCIAL CREDIT TRANSACTIONS

a. A commercial 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 issuing
bank, as the case may be, the money thus paid to the
beneficiary.
b. 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 has 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.

L.

PROTOTYPE EXPORT TRANSACTION

1. PRO FORMA INVOICEall the particulars for the
proposed shipment which are then known to the buyer.
2. PRICE QUOTATION FAS AND CIFFAS stands for
free along side which means that the seller will be
responsible for the cost and risks of the goods along
side an overseas vessel at the stated location: the buyer
bears the costs and risks from that point. CIF on the
other hand means cost, freight and insurance,
that in exchange for this stated price, the seller
undertakes not only to supply the goods but also to
obtain and pay for insurance and bear the freight charges
to the stated pointy.
3. BUYERS PURCHASE ORDER
4. LETTER OF CREDIT
a. One way for a seller to be assured of payment is to
ship goods under a negotiable bill of lading and
arrange for a bank in buyers city to hold the bill of
lading until the buyer pays the draft in the usual
foreign sale this arrangement for securing payment
of the price is not adequate.
b. In some situations, sellers may need assurance of
payment even before the time of payment. This
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problem arises in contracts which call for the

manufacture of goods to the buyers specifications.
c. Although the pro forma invoice may not specify, the
seller will expect the letter of credit to be confirmed
by the local bank in its location. But why does a local
bank confirm rather than issue a letter of credit? The
bank that issues the letter of credit needs assurance
that it will be reimbursed by the buyer, on whose
behalf it pays the seller. The buyers bank can take
steps to minimize or remove the hazards. It will
receive the negotiable bill of lading controlling the
goods which will provide security for the customers
obligation to reimburse the bank; in addition, the
buyers own bank can judge in the light of its
knowledge of his financial standing whether added
security is needed and can insist on such security
before it issues the letter of credit.
d. To meet the sellers letter of credit requirements, the
buyer will request its bank to arrange for the
issuance of a letter of credit which will comply with
the terms of the pro forma invoice. The buyer will
then sign a detailed application and agreement for
commercial credit prepared by the bank. The issuing
bank, after approving the buyers credit standing
transmits a letter of credit by cable to the confirming
bank. This confirming bank will then deliver to seller
a document advising the latter that the issuing bank
opened a letter of credit in its favor and adding the
confirming banks confirmation. In this arrangement,
the seller is assured of payment of its sight drafts
drawn on the confirming bank in the amount of the
total amount of the sale, provided it presents the
documents called for in the letter of credit. An
examination of the letter of credit will also reveal
that the bill of lading is to be consigned to the order
of the buyers bank, thereby giving the bank control
over the goods, with the consequent security for its
claim against the buyer.
ACCEPTANCE; SHIPMENT
a. On the receipt of the confirmed letter of credit, the
seller will send the order acknowledgment. This
document will repeat the description and price of the
goods which has also appeared on the pro forma
invoice and states the number and expiration date of
the letter of credit.
b. Further, the arrival of the letter of credit is the gosignal for the seller to send the goods. The seller
then prepares the COMMERCIAL INVOICE which
provides a complete record of the transaction and is
an important source of information to such interested
parties as a bank discounting a draft or an
underwriting extending issuance.
c. As the time of shipment approaches, the seller will
contact its forwarder and give its shipping
instructions. It will inform that to comply with the
requirements of the letter of credit, the bill of lading
must be made to the order of the issuing bank. It will
also send copies of the commercial invoice, a
packing list, and a Shippers export declaration.
When the forwarder receives these documents, he
takes over all further documentation as the agent of
the shipper, the latter merely has to dispatch the
goods from the factory in accordance with the
forwarders instructions.
d. The seller will then send the truck to the pier where
they are delivered to the ocean carriers receiving
clerk who signs the dock receipt. The dock receipt is
a form supplied by the ocean carrier which contains
information relevant to the shipping of the bearings
such as the number of the pier, and the name of the
ship. The dock receipt is NON-NEGOTIABLE and
serves as a temporary receipt for the goods until
they are loaded on board.
e. The ocean carrier is soon ready to receive the cargo.
When the goods are loaded on board, the steamship
line issues a bill of lading which, to comply with the
letter of credit, is CONSIGNED TO ORDER OF THE
ISSUING BANK. The bill of lading is initially prepared

6.
7.

by the forwarder on a form supplied by the ocean

carrier, it sets forth the markings and numbers of the
packages, description of the goods, and the number
and weight of the packages. On its dorsal side, it will
state that the goods are received for shipment, but a
statement FREIGHT PREPAID ON BOARD is initiated
by a representative of the steamship line after
loading. The forwarder then delivers the bill of lading
and the commercial invoice to the seller.
INSURANCE
PAYMENT; THE DRAFT.
a. The confirming bank stated in their letter that
the estimated CIF price would be available by
your drafts on us at sight when accompanied by
the listed documents.
b. Seller accordingly draws a sight draft on the
confirming bank. The sight draft together with
the commercial invoice, insurance certificate, full
set of bills of lading, and the packing list are
presented to the confirming bank. When the
bank receives these documents, it issues its
bank draft to sellers order and transmits the
documents by air mail to issuing bank, which will
reimburse the confirming bank.
c. The documents, sent by airmail, will reach the
buyers bank well ahead of the ocean shipment.
The time for release of the documents to buyer
and reimbursement to the bank will depend
upon the arrangement which was made between
the bank and buyer when the letter of credit was
initially established.
d. If the buyer plans to resell the goods, he may
not be able to reimburse the bank until the
goods arrive and he resells the goods. In this
event, the issuing bank may need to take further
steps to secure its claim against the buyer.

M. QUESTIONS
1. Q:
Can a breach of contract be invoked against
the issuing bank?
A: No, a breach of contract cannot be invoked against
the issuing bank. This is because if all the documents
stipulated have been submitted and the issuing bank
finds that they conform to what the letters of credit
requires, then the issuing bank must pay the seller. In a
letter of credit transaction, the bank deals only with
documents and not with goods, so the bank pays as if the
documents are in good condition and gets reimbursed by
the buyer. This relationship is independent; so if ever the
goods are in bad condition, the applicant still pays the
bank.
2. Q: When can a notifying bank be held liable?
A: A notifying bank is liable if it did not notify the seller
of the opening of the letters of credit or it did not
determine the apparent authenticity of the required
documents. Note that only the apparent authenticity is
determined. The notifying bank does not warrant the
authenticity of the letters of credit but only its apparent
authenticity. So, if the letters of credit turns out to be
spurious, the notifying bank is not liable for damages
unless it is obvious that it is not authentic. Therefore, the
notifying bank is liable if it acts beyond the scope of its
authority.
3. Q: When may the advising bank be equally liable
with the issuing bank?
A:
Ordinarily, an advising bank, whose obligation is
merely to advise the seller or beneficiary of the opening
of the letters of credit, has no liability. The opening of a
letter of credit does not make the issuing bank liable at
once because there is no liability. The liability is
conditioned and dependent on the tender of submission
of the documents stipulated upon by the parties.
4. Q: What are the functions of a negotiating bank?
A: It accepts or gives value to the draft and which later
on sells the draft to the issuing bank. The issuing bank
then reimburses the negotiating bank. What happens is
that the negotiating bank buys the draft at a discounted
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price and then sells it to the issuing bank for its face
value.
5. Q: If the letter of credit is disowned by the issuing
bank, can the negotiating bank ask reimbursement
from the seller? Under what principle?
A:
Yes, the negotiating bank can ask reimbursement
from the seller in case when the letter of credits is
disowned by the issuing bank. Seller is a drawer of the
draft accepted and paid by the negotiating bank.
Therefore, the seller has contingent liability on such draft.
6. Q:
If the issuing bank does not advance the
payment in favor of the seller or beneficiary, may
the buyer or applicant recover the commission
paid?
A: No, it cannot recover the commission paid because
this is the consideration; however, he may recover the
margin fee.
7. Q: What among other things should be stipulated
upon the application for a letter of credit?
A: The documents which the seller should submit to the
issuing bank. In letter of credit transactions, the issuing
bank deals only with the documents, not with goods; the
same is not bound or required to examine the goods. For
as long as the required documents are submitted by the
seller, the issuing bank pays the seller.
8. Q: If the goods turned out to be defective, is this
a valid defense to avoid payment by the issuing
bank to the seller?
A: No. As long as the documents submitted by the seller
are complete and in conformity with what the letter of
credit requires, the issuing bank is bound to pay the
seller. This is true even if the goods turned out to be
defective.
9. Q:
Is the buyer still bound to reimburse the
issuing bank despite the defective goods received
by him?
A: The buyer has no course of action against the issuing
bank, but only to the seller.
10. Q:
If the documents submitted by the seller are
incomplete and the issuing bank still pays the
seller, is the buyer still bound to pay the issuing
bank?
A: No, because the issuing bank should not have paid
the seller knowing the documents are said to be
incomplete.
11. Q: Can the beneficiary demand payment from the
confirming bank?
A: Yes, since the confirming bank is equally liable with
the issuing bank. If the beneficiary proceeds against the
confirming bank, the latter may ask reimbursement from
the issuing bank. But if the beneficiary proceeds directly
against the confirming bank, it has no right to collect
from the issuing bank. The beneficiary may compel the
confirming bank to accept drafts it has drawn.

TRUST RECEIPTS LAW

(P.D. No. 115)
A.

PURPOSE
1. Enacted to safeguard commercial transactions and to
offer an additional layer of security to the lending bank.
2. Trust receipts are indispensable contracts in international
and domestic business transactions.

B.

MEANING OF TRUST RECEIPTS

1. Trust receipt is defined as a document in which is
expressed a security transaction, where under the lender,
having no prior title in the goods on which remains the
borrower, lends his money to the borrower on security of
goods, which the borrower is privileged to sell clear of the
lien on agreement to pay all or part of the proceeds of the
sale to the seller.
2. The term is specifically applied to a written instrument
whereby a banker having advanced money for purchase
of imported merchandise and having taken title in his
own name, delivers possession to an importer on

agreement in writing to hold the merchandise in trust for

the banker till he is paid.
C.

TERMS
1. Entrustee person having or taking possession of
goods, documents or instruments under a trust receipt
transaction, and any successor in interest of such person
for the purpose or purposes specified in the trust receipt
agreement.
2. Entruster person holding title over the goods,
documents, or instruments subject of a trust receipt
transaction, and any successor in interest of such person.
3. Trust receipt shall refer to the written or printed
document signed by the entrustee in favor of the
entruster
containing
the
terms
and
conditions
substantially complying the provisions of PD 115. No
further formality of execution or authentication shall be
necessary to the validity of the trust receipt.

D.

WHAT CONSTITUTES A TRUST RECEIPT TRANSACTION

Is any transaction by and between an entruster and an
entrustee, whereby the former, who owns or holds absolute
title or security interest over certain specified goods,
documents or instruments, release the same to the
possession of the entrustee upon the latters execution and
delivery to the entruster of a signed document called the trust
receipt.

E.

IMPORTANCE AND CHARACTER OF TRUST RECEIPTS

i. Originally used in importing transactions the device first
came into general use in importing transactions, where
goods were consigned directly to a bank which paid a
draft for the price on the credit of the intended buyer who
engaged to repay the banks advances.
ii. Convenient aid to commerce and trade it is a
convenient business device to assist importers and
merchants solve their financing problems and has gained
popular acceptance in international and domestic
business practice, particularly in commercial banking
transactions.
iii. Full title vested in the entruster in order to secure that
the banker shall be repaid at the critical point that is
when the imported goods finally reached the hands of the
intended vendee the banker takes the full title to the
goods at the very beginning; he takes it as soon as the
goods are brought and settled for by his payments or
acceptances in the foreign country, and he continues to
hold that title as his indispensable security until the
goods are sold and the vendee is called upon to pay
them.
iv. Title in entruster taken as security only this security is
not an ordinary pledge by the importer to the banker, for
the importer has never owned the goods, and moreover,
he is not able to deliver the possession; but the security
is the complete title vested originally in the banker, and
this characteristic of the transaction has been protected
by the courts.
The entruster shall be entitled to the proceeds from the
sale of the goods, documents, or instruments released
under a trust receipt to the entrustee to the extent the
amount owed to the entruster or as appears in the trust
receipt; or to the return of the goods, documents or
instruments in case of non-sale; and to the enforcement
of all rights conferred on him in the trust receipt, provided
these are not contrary to the provisions of the document.
v. With both loan and security features the load feature is
covered by the letter of credit; the security feature is
covered by the letter of credit, covered by the trust
receipt itself. it is considered a security transaction
intended to aid in financing importers and retail dealers
who do not have sufficient funds or resources to finance
the importation or purchase of merchandise.
vi. Entruster remains a lender and creditor the bank does
not become the real owner of the goods. It is merely the
holder of a security title for the advances it had made to
the importer. The trust receipt does not convert the bank
into an investor; it remains a lender and creditor. This is
because the bank had previously extended a loan which
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vii.

F.

G.

H.

the letter of credit represents the importer, and by that

loan, the importer should be the real owner of the goods.
To consider the bank as the true owner from the inception
of the transaction would be to disregard the load feature
involved
Letter of credit-trust receipt arrangement a bank
extends to a borrower a loan covered by the letter of
credit with the trust receipt as a security for the loan. In
other words, the transaction involves a loan feature
represented by the letter of credit, and a security feature
which is in the covering trust receipt. The title of the bank
to the security is the one sought to be protected and not
the load which is a separate and distinct agreement.

TRUST
RECEIPT
AND
LETTER
OF
CREDIT
DISTINGUISHED
1. Letter of credit:
a. A separate document from a trust receipt.
b. It is an engagement by a bank or other person made
at the request of a costumer that the issuer will
honor drafts or other demands for payment upon
compliance with the conditions specified in the
credit.
c. Through a letter of credit, the 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 the funds mentioned in the letter of
credit plus credit or commitment fees agreed upon.
2. Trust receipt:
a. Executed as a security on the letter of credit.
b. A trust receipt transaction is one where the
entruster, who holds an absolute tile or security
interests over certain goods, documents or
instruments, released the same to the entrustee,
who executes a trust receipt binding himself to hold
the goods, documents or instruments in trust for the
entruster and to sell or otherwise dispose of the
goods, documents and instruments with the
obligation to turn over to the entruster the proceeds,
or as appears in the trust receipt, or return the
goods, documents or instruments themselves if they
are unsold, or not otherwise disposed of, in
accordance with the terms and conditions specified
in the trust receipt.
FORM OF TRUST RECEIPTS; CONTENTS
A trust receipt has no particular form, but every trust receipt
must substantially contain the following:
1. Description of the goods, documents or instruments
subject of the trust receipt;
2. Total invoice of the goods and the amount of the draft to
be paid by the entrustee;
3. An undertaking or a commitment of the entrustee:
a. To hold in trust for the entruster the subject
described;
b. To dispose the subject in the manner provided for in
the trust receipt; and
c. To turn over the proceeds of sale of the subject to the
entruster or as appears in the trust receipt or to
return the subject in the event of their non-sale
within the specified period.
RIGHTS OF THE ENTRUSTER
The entruster shall be entitled to:
1. Be entitled to the proceeds from the sale of the goods,
documents or instruments released under a trust receipt
to the entrustee to the extent of the amount owing to the
entruster or as appears in the trust receipt;
2. The return of the goods, documents or instruments in
case of non-sale;
3. The enforcement of all other rights conferred on him in
the trust receipt provided such are not contrary to the
provisions of this Decree;
4. Cancel the trust and take possession of the goods,
documents or instruments subject of the trust or of the
proceeds realized therefrom at any time upon default or
failure of the entrustee to comply with any of the terms

5.

6.

and conditions of the trust receipt or any other

agreement between the entruster and the entrustee;
Sell the goods, documents or instruments at public or
private sale, and the entruster may, at a public sale,
become a purchaser, when in possession of the goods,
documents or instruments, on or after default of the
entrustee, and after notice to the latter of the intention to
sell, not less than five days after serving or sending of
such notice,
Entitled for any deficiency in the aforementioned sale.

I.

ENTRUSTER IS NOT RESPONSIBLE ON SALE BY

ENTRUSTEE
The entruster holding a security of interest shall not be
responsible as principal or as vendor under any sale or
contract to sell made by the entrustee.

J.

OBLIGATIONS OF THE ENTRUSTEE

The entrustee shall:
1. Hold the goods, documents or instruments in trust for the
entruster and shall dispose them strictly in accordance
with the terms and conditions set by the trust receipt;
2. Receive the proceeds in trust for the entruster and turn
over the same to the entruster to the extent of the
amount owed or as what appears in the trust receipt;
3. Insure the goods for their total value against loss from
fire, theft, pilferage or other casualties;
4. Returns the goods, documents, instruments in the event
of non-sale or upon demand of the entruster; and
5. Observe all other terms and conditions of the trust receipt
that are not contrary to PD 115.

K.

LIABILITY OF THE ENTRUSTEE FOR LOSS

The risks of loss shall be borne by the trustee. Loss of the
subject of a trust receipt, which is pending of their disposition,
irrespective of whether or not it was due to the fault or
negligence of the entrustee, shall not extinguish his obligation
to the entruster for the value thereof.

L.

RIGHT OF PURCHASER FOR VALUE AND IN GOOD FAITH

Any purchaser or goods from an entrustee with right to sell, or
of documents or instruments through their customary form of
transfer, who buys the goods, documents or instruments for
value and in good faith from the entrustee, acquires said
subjects for value and in good faith from the entrustee,
acquires said subjects free from the entrusters security
interest.

M. VALIDITY OF ENTRUSTERS CLAIM AGAINST OTHER

CREDITORS
The entrusters security interest in the subjects in accordance
with the terms of the trust receipt shall be valid as against all
creditors of the entrustee for the duration of the trust receipt
agreement.
N.

IMPORTANT POINTS OF P.D. No. 115

1. Under PD 115, although the entrustee is not the owner of
the goods under a trust receipt (ownership is retained by
the entruster), anyone who acquires the goods from the
entrustee acquires good title (ownership).
2. Although the entrustee is not the owner of the goods
covered by a trust receipt, should the goods be lost while
in his possession, he will bear the risk of loss.
3. The Trust Receipts Law does not seek to enforce payment
of a loan but rather, it punishes the dishonesty and abuse
of confidence in the handling of money or goods to the
prejudice of another regardless of whether the latter is
the owner.
4. Since the entrustee has neither absolute ownership, free
disposal nor the authority to freely dispose of the goods
subject of the trust receipt transaction, the said entrustee
cannot validly subject them to a chattel mortgage.
5. The offense punished under Presidential Decree No. 115
is in the nature of malum prohibitum.
6. Damage to the entruster need not be proven because the
nature of the trust receipt agreements and the damage to
trade circles and the banking community in case of
violation thereof is the basis for the criminal offense.
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7.
8.

9.

O.

Acquittal of the entrustee in the criminal charge of estafa

does not dissolve the civil liability arising from the trusts
receipt agreement.
The penal provisions of PD 115 apply even when the trust
receipt issued covers goods or items not destined for sale
or for use in manufacture, and would include items
obtained under a trust receipt used to repair and
maintain equipment used in business.
The surrender of the goods to the bank, if unsold merely
extinguishes the entrustees criminal liability under the
Trust Receipts Law.

EXERCISES:
1. Tom Cruz obtained a loan of P1 Million from XYZ
Bank to finance purchase of 5,000 bags of
fertilizer. He executed a trust receipt in favor of
XYZ Bank over the 5,000 bags of fertilizer. Tom
Cruz withdrew the 5,000 bags from the warehouse
to be transported to Lucena City where his store
was located. On the way, armed robbers took from
Tom Cruz the 5,000 bags of fertilizer. Tom Cruz now
claims that his obligation to pay the loan to XYZ
Bank is extinguished because the loss was not due
to his fault. Is Tom Cruz correct? Explain.
2. C contracted D to renovate his commercial
building. D ordered construction materials from E
and received delivery thereof. The following day, C
went to F Bank to apply for a loan to pay for the
construction materials. As security for the loan, C
was made to execute a trust receipt. One year
later, after C failed to pay the balance on the loan,
F Bank charged him with violation of the Trust
Receipts Law.
a. What is a Trust Receipt?
b. Will the case against C prosper?
3. What acts or omissions are penalized under the
Trust Receipts Law? ANSWER: Failure of the entrustee
to turn over the proceeds of the sale of the goods,
documents or instrument covered by a trust receipt to the
extent of the amount owing to the entruster or to return
the goods, documents or instruments if they were not
sold or disposed of in accordance with the terms of the
receipt is penalized as estafa under Art. 315(10b) of the
Revised Penal Code. (Sec. 13, PD 115)
4. Is the lack of intent to defraud a bar to the
prosecution of these acts or omissions?
ANSWER: No. The offense is malum prohibitum.
5. Ricardo mortgaged his fishpond to AC Bank to
secure a P1 Million loan. In a separate transaction,
he opened a letter of credit with the same bank for
$500,000.00 in favor of HS Bank, a foreign bank, to
purchase outboard motors. Likewise, Ricardo
executed a Surety Agreement in favor of AC Bank.
The outboard motors arrived and were delivered to
Ricardo, but he was not able to pay the purchase
price thereof.
a. Can AC Bank take possession of the
outboard motors? Why?
b. Can AC Bank also foreclose the mortgage
over the fishpond?
CONCURRENCE AND PREFERENCE OF CREDITS

A.

LIABILITY FOR OBLIGATIONS

The debtor is liable with all his property, present and future,
for the fulfillment of his obligations, subject to the exemptions
provided by law.

B.

EXEMPT PROPERTY
1. Family home constituted jointly by husband and wife or
by unmarried head of a family (Article 152, Family Code).
Exceptions:
i.
for non-payment of taxes;
ii.
for debts incurred prior to the constitution of the
family home;

iii.

for debts secured by mortgages on the premises

before or after such constitution; and
iv.
for debts due to laborers, mechanics, architects,
builders, material men and others who have
rendered service or furnished material for the
construction of the building.
2. Right to receive support as well as any money or property
obtained as such support. (Article 205, Family Code)
3. Tools and implements necessarily used by him in his
trade or employment;
4. Two horses, or two cows, or two carabaos or other beasts
of burden, such as the debtor may select, not exceeding
one thousand pesos in value and necessarily used by him
in his ordinary occupation;
5. His necessary clothing and that of all his family;
6. Household furniture and utensils necessary for
housekeeping and used for that purpose by the debtor,
such as the debtor may select, of a value not exceeding
one thousand pesos;
7. Provisions for individual or family use insufficient for three
months;
8. The professional libraries of attorneys, judges,
physicians, pharmacists, dentist, engineers, surveyors,
clergymen, teachers and other professionals, not
exceeding three thousand pesos in value;
9. One fishing boat and net, not exceeding the total value of
one thousand pesos, the property of any fisherman, by
the lawful use of which he earns a livelihood;
10. So much of the earnings of the debtor for his personal
services within the month preceding the levy as are
necessary for the support of his family;
11. Lettered gravestones;
12. All moneys, benefits, privileges or annuities accruing or in
any manner growing out of any life insurance, if the
annual premiums paid do not exceed five hundred pesos,
and if they exceed the sum, a like exemption shall exist
which shall bear the same proportion to the moneys,
benefits privileges and annuities so accruing or growing
out of such insurance that said five hundred pesos bears
to the whole premiums paid;
13. The right to receive legal support, or money or property
obtained as such support, or any pension or gratuity from
the government;
14. Copyrights and other properties especially exempted by
law (Section 12, Rule 39); and
15. Property under legal custody and of the public dominion.
C.

PREFERRED CREDITS WITH RESPECT TO SPECIFIC

MOVABLE PROPERTY
1. Duties, taxes and fees due thereon to the state or any
subdivision thereof;
2. Claims arising from misappropriation, breach of trust, or
malfeasance by public officials committed in the
performance of their duties, on the movables, money or
securities obtained by them;
3. Claims for the unpaid price of movable sold, on said
movables, so long as they are in the possession of the
debtor, up to the value of the same, and if the movable
has been resold by the debtor and the price is still
unpaid, the lien may be enforced on the price; this right is
not lost by the immobilization of the thing by destination,
provided it has not lost its form, substance and identity;
neither is the right lost by the sale of the thing together
with other property for a lump sum, when the price
thereof can be determined proportionally;
4. Credits guaranteed with a pledge so long as the things
pledged are in the hands of the creditor, or those
guaranteed by a chattel mortgage upon the things
mortgaged, up to the value thereof;
5. Credits for making repairs, safekeeping or preservation or
personal property on the movable thus made, repaired,
kept or possessed;
6. Claims for laborers wages, on the goods manufactured or
the work done;
7. For expenses of salvage, upon the goods salvaged;
8. Credits between the landlord and the tenant arising from
the contract of tenancy on shares, on the share of each in
the fruits or harvest;
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9.
10.

11.
12.

13.

Credits for transportation, upon the goods carried, for the

price of the contract and incidental expenses, until their
delivery and for thirty days thereafter;
Credits for lodging and supplies usually furnished to
travelers by hotelkeepers, on the movables belonging to
the guest as long as such movables are in the hotel, but
not for money loaned to the guests;
Credits for seeds and expenses for cultivation and harvest
advanced to the debtor, upon the fruits harvested;
Credits for rent for one year, upon the personal property
of the lessee existing on the immovable leased on the
fruits of the same, but not on money or instruments of
credit;
Claims in favor of the depositor if the depository has
wrongfully sold the thing deposited, upon the price of the
sale.

In the foregoing cases, if the movables to which the lien or

preference attaches have been wrongfully taken, the creditor
may demand them from any possessor within thirty (30) days
from the unlawful seizures.
Summary:
a. taxes
b. malversation by public officials
c. vendors lien
d. pledge, chattel mortgage
e. mechanics lien
f.)
laborers wages
g.)
salvage
h.)
tenancy
i.)
carriers lien
J.)
hotels lien
k.)
crop loan
l.)
rentals - one year
m.)
deposit
Note:
The foregoing enumeration is not an order to preference
(Articles 2248 2249)
D.
Preferred Credits
Immovable Property
1.

with

Respect

lien of materialmen
mortgage
expenses of preservation
recorded attachments
warranty in partition
conditional donations
premiums for 2 year insurers

Note: The foregoing enumeration is not an order of

preference (Carried Lumber Co. vs. ACCFA, 83 SCRA 411 [1975]).
E.
Order of Preference
Properties of the Debtor

with

Respect

to

Other

1.
Proper funeral expenses for the debtor, or children under
his or her parental authority who have no property of their own,
when approved by the court;
2.
Credits for services rendered the insolvent by employees,
laborers, or household helpers for one year preceding the
commencement of the proceedings in insolvency;
3.
Expenses during the last illness of the debtor or of his or
her spouse and children under his or her parental authority, if they
have no property of their own;
4.
Compensation due to the laborers of their dependents
under laws providing for indemnity for damages in cases of labor
accident or illness resulting from the nature of the employment;
5.
Credits and advancements made to the debtor for
support of himself or herself, and family, during the last preceding
insolvency;
6.
Support during the insolvency proceedings, and for three
months thereafter;

Specific

7.
Fines and civil indemnification arising from a criminal
offense;

sold upon the

8.
Legal expenses, and expenses incurred in the
administration of the insolvents estate for the common interest of
the creditors, when properly authorized and approved by the
court;

to

Taxes due upon the land or building;

2.
For the unpaid price of real property
immovable sold;

d.)
e.)
f.)
g.)
h.)
i.)
j.)

3.
Claims of laborers. Masons, mechanics and other
workmen, as well as of architects, engineers and contractors,
engaged in the construction, reconstruction or repair of buildings,
canals or other works, upon said buildings, canals or other works;
4.
Claims of furnishers of materials used in the construction,
reconstruction, or repair of buildings, canals, and other works,
upon said buildings, canals or other works;
5.
Mortgage credits recorded in the Registry of Property,
upon the real estate mortgage;
6.
Expenses for the preservation or improvement of real
property when the law authorizes reimbursement, upon the
immovable preserved or improved;
7.
Credits annotated in the Registry of Property, by virtue of
a judicial order, by attachments or executions, upon the property
affected, and only as to later credits;

9.
Taxes and assessments due the national government,
other those mentioned in Articles 2241, No. 1, and 2242, No. 1;
10.
Taxes and assessments due any province, other than
those mentioned in Articles 2241, No. 1 and 2242, No. 1;
11.
Taxes and assessments due any city or municipality other
than those mentioned in Articles 2241, No.1 and 2242, No. 1;
12.
Damages fro death or personal injuries caused by a
quasi-delict;
13.
Gifts due to public and private institutions of charity or
beneficence;
14.
Credits which without special privilege, appear in (a) a
public instrument; or (b) in the final judgment, if they have been
the subject of litigation. These credits shall have preference
among themselves in the order of priority of the dates of the
instruments and of the judgments, respectively (Article 2244)

8.
Claims of co-heirs for warranty in the partition of an
immovable among them, upon the real property thus divided;
9.
Claims of donors or real property for pecuniary charges or
other conditions imposed upon the donee, upon the immovable
donated;
10.
Credits of insurers, upon the property insured, for the
insurance premium for two years.
Summary: a.)
taxes
b.)
vendors lien
c.)
contractors lien

Summary:
year

a)
b)

funeral expenses
wages of employees one

c)
d)
e)
f)
g)
h)
i)
j)
k)

expenses of last illness

workmens compensation
support for one year
support during insolvency
fines in crimes
legal expenses - administration
taxes
tort
donations

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l)

or

appearing in public instrument

DBP vs. NLRC

(229 SCRA 350)

final judgment
Note:
1.
In contrast with Articles 2241 and 2242, Article 2244
creates no liens on determinate property which follow such
property. What Article 2244 creates are simply rights in favor or
certain creditors to have the cash and other assets of the insolvent
applied in a certain sequence or order of priority (Republic vs.
Peralta, 150 SCRA 37 [1987]).
2.
Article 2244 relates to the property of the insolvent that
is not burdened with the liens or encumbrances created or
recognized by Article 2241 and 2242.
3.

Recent Jurisprudence on Concurrence

and Preference of Credits

a)
A foreclosing bank creditor cannot be held liable for
unpaid wages and the like of the employees of the mortgagor. The
employees should file their claims in a proceeding in bankruptcy
on their employer. (Development Bank of the Philippines vs.
National Labor Relations Commissions, 186 SCRA 841 [1990]).
b)
From the provisions of Article 110 of the Labor Code and
Section 10, Rule VIII, Book III of the Revised Rules and Regulations
Implementing the Labor Code, a declaration of bankruptcy or a
judicial liquidation must be present before the workers preference
may enforced. (Development Bank of the Philippines vs. Santos,
171 SCRA 138 [1989]).
DBP vs. NLRC
(236 SCRA 117)
1.
To the extent that claims for unpaid wages fall outside the
scope of Articles 2241(6) and 2242(3), they would come within the
ambit of the category of ordinary preferred credits under Article
2242.
1.

The right of first preference as regards unpaid

wages recognized by Article 110 of the Labor
Code does not constitute a lien on the property
of the insolvent debtor in favor or workers. It is
a right to a first preference in the discharge of
the funds of the judgment debtor.

BPI vs. Court of Appeals

(229 SCRA 223)
Whenever a distressed corporation asks SEC for
rehabilitation and suspension of payments, preferred creditor may
no longer assert such preference, but shall stand on equal footing
with other creditors.
This rule will enable the rehabilitation
receiver to effectively exercise his powers free from judicial and
extrajudicial interference that might unduly hinder rescue of the
company.

F.

1.

Article 110 of the Labor Code as amended must

be viewed and read in conjunction with the
provisions of the Civil Code on concurrence and
preference of credits.

2.

The Civil Code and Labor Code provisions require

judicial proceedings in rem in adjudication of
creditors claims against the debtors assets to
become operative.

3.

RA 6715 expanded worker preference to cover

not only unpaid wages but also other monetary
claims of laborers, to which even claims of the
Government must be deemed subordinate.

4.

Amendatory provisions of RA 5715 which

became effective on 21 March 1989 should only
be given prospective application.

Order of Preference of Credits

1.
Those credits which enjoy preference with respect to
specific movable, excluded all others to the extent of the value of
the personal property to which the preference refers (Article
2246).
2.
If there are two or more credits with respect to the same
specific movable property, they shall be satisfied pro-rata, after
the payment of duties, taxes, and fees due the State or any
subdivision thereof (Article 2247).
3.
Those credits which enjoy preference in relation to
specific real property or real rights, exclude all others to the extent
of the value of the immovable or real right to which the preference
refers (Article 8).
4.
If there are two or more credits with respect to the same
specific real property or real rights, they shall be satisfied pro rata,
after the payment of the taxes and assessments upon the
immovable property or real right (Article 2249).
5.
The excess, if any, after the payment of the credits which
enjoy preference with respect to specific property, real or
personal, shall be added to the free property which the debtor
may have, for the payment of the other credits (Article 2250).
6.
Those credits which do not enjoy any preference with
respect to specific property and those which enjoy preference, as
to the amount not paid, shall be satisfied according to the
following rules:
a.
b.

In the order established in Article 2244;

Common credits referred to in Article 2245 shall
enjoy no preference and shall be paid pro rata
regardless of dated (Article 2251).

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