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What are LETTERS OF CREDIT?
Those issued by one merchant to another for the purpose of attending
to a commercial transaction.
Kinds:
Common Letter of Creditan instrument by which a bank, for the
account of a buyer of merchandise, gives formal evidence to a seller,
of its willingness to permit the seller to draw bills against it, and
stipulates in legal form that all such bills will be honored.
Travelers Letter of Credita letter from a bank addressed to its
correspondents stating that drafts up to a certain sum drawn by the
beneficiary will be honored by the bank.
Essential Conditions:
1.) Issued in favor of a definite person and not to order; and
2.) Amount is fixed and specified.
Duration:
1.) Upon a period fixed by the parties;
2.) If none is fixed, 6 months from its date if used in
the Philippines or 1 year if used abroad.
LETTER OF CREDIT
(Art. 567-572 Code of Commerce)
LETTER OF CREDIT
Letter of credit an arrangement by a bank or other person made at
the request of a customer that the issuer will honor drafts or other
demands for payment upon compliance w/ the conditions specified in
the credit.
Internationally accepted definition of a LC as provided in the
Uniform Customs and Practices for Documentary Credit (UCPDC):
Letter of Credit any arrangement, however named or described,
whereby a bank also known as the issuing bank, acting upon the
request or instruction of another(applicant or customer) or on its own
behalf, binds itself to:
1. Pay to the order of a 3rd person known as beneficiary OR
2. Accepts and pay any draft that may be drawn by the
beneficiary, OR
3. Authorize another bank to:
Pay to the order of a 3rd person known as the
beneficiary.
Accept and pay any draft by the beneficiary, OR
4. Authorize another bank to negotiate against the stipulated
documents.
Note: We are bound by the UCPDC issued by the International
Chamber of Commerce. Sec. 2 of the Code of Commerce states that
in the absence of any particular provision in the code of Commerce,
commercial transactions shall be governed by the usages and customs
generally observed (BPI vs. Nery).
A Letter of Credit is a special contract designed to answer two
concerns:
Sellers refusal to part with his goods before being paid coupled with
the Buyers want of ownership over the goods before paying.
Note: The opening of a LC does not involve specific appropriation
of money in favor of the beneficiary. The correspondent bank does
not receive in advance the money form the buyer or issuing bank but
pays the amount out of its own funds and then later on seek
reimbursement from the issuing bank. It does not convey the notion
that a particular sum of money has been specifically reserved or has
been held in trust.
Note: An LC is not a negotiable instrument. It does Not conform w/
Section 1 of the Negotiable Instruments Law. This is because it does
not contain an unconditional promise to pay a sum certain in money.
The LC is conditioned to the submission of certain documents.
Moreover, the LC is issued in favor of a definite person and not to
order. Therefore, it also lacks the words of negotiability required.
LC is conditioned on
1. Submission of stipulated documents
2. Compliance with the terms of the LC
Is LC a commercial transaction?
YES. Because it is governed by the Code of Commerce.
PARTIES TO THE TRANSACTION:
Basic parties to a letter of credit:
1. Applicant/buyer/importer the one who procures the
letter of credit and obliges himself to reimburse the Issuing
Bank (IB) upon the receipt of the documents of title. He is
the party who initiates the operation of the Letter of Credit
transaction as the buyer of the merchandise and also of the
credit instrument.
2. Issuing Bank is usually the buyers bank; it issues the
letter of credit and undertakes to pay the seller upon receipt
of the draft and proper documents to the buyer upon
reimbursement.
3. Seller/beneficiary is the one who in compliance w/ the
contract of sale ships the goods to the buyer and delivers
the documents of title and drafts to the issuing bank to
recover payment. He is the beneficiary of the instrument
because the instrument is addressed to him and in his favor.
Additional party/parties to the LC:
4. Correspondent Bank
TYPES OF CORRESPONDENT BANK:
1. Advising/Notifying Bank does not have any contractual
relations w/ the buyer but merely serves as an agent of the
issuing bank. Its only responsibility is to transmit the LC.
Thus, it could validly refuse to negotiate or accept, even if
the seller tenders all the documents required under the LC
and it does not become liable as the beneficiary has no
cause of action against the bank.
2. Confirming Bank lends credence to the LC issued by a
lesser known bank. It assumes direct obligation to the
seller/beneficiary and becomes principally liable.
A notifying bank, who also assumes the role of a negotiating bank
does not include assuming the role of a confirming bank and is
therefore not liable to the beneficiary. To be liable, there must be an
absolute assurance that it will undertake the issuing banks obligation
as its own. If it does confirm, the beneficiary become entitled to
proceed against either or both banks in case of breach.
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3. Paying Bank the bank w/c pays the beneficiary. It may
either be the opening/issuing bank or any other bank in the
place of the beneficiary.
4. Negotiating Bank any bank in the place of the
beneficiary w/c buys or discounts the sellers draft. Its
liability depends on the stage of negotiation. If BEFORE
negotiation, such that it suggests its willingness to
negotiate, it has no liability w/ respect to the seller. But if
AFTER negotiation, a contractual relationship will then
prevail between them.
Note: A bank does not become a negotiating bank unless he pays the
draft and becomes the holder of said document.
As such, the IB may notify the seller of the opening of the LC either
directly or through a correspondent bank, w/c may either be a mere
advising bank or a Confirming Bank.
Note: The IB has the option to tap a correspondent bank or not.
The liability of a Correspondent Bank depends on what kind of
function it plays in the LC transaction.
RELATIONSHIP OF THE PARTIES is governed by-
1. Issuing bank and applicant the relationship is governed
by the terms of the application and agreement for the
issuance of the LC by the bank.
2. Issuing bank and the Beneficiary the relationship is
governed by the terms of the LC issued by the bank
3. Applicant and beneficiary the relationship is governed by
the contract they entered into. ex. Sales
INDEPENDENCE PRINCIPLE-
The bank in determining compliance with the terms of the LC is
required only to examine the shipping document presented by the
seller and is precluded from determining whether the main contract is
accomplished or not
DOCTRINE OF STRICT COMPLIANCE-
The document tendered by the seller must strictly conform to the
terms of the LC . The correspondent bank which departs from what
has been stipulated under the LC, as 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 benefic
In short, the documents presented must comply w/ those stipulated
on. In a LC, the banks only deals w/ documents and not w/ goods.
Can a breach of contract be invoked against the Issuing Bank?
NO. Because if all the documents stipulated have been submitted and
the IB finds that they conform w/t the LC requires, then the IB must
pay the seller. In a LC transaction the banks deal only w/ documents
not goods, so banks pays if the documents are OK 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.
Note: A loan transaction may give rise to LC. An LC does not arise
only because of sale or importation. Example: Standby LC.
Standby Letter of Credit (SLC) it is a bank issued option on loan
involving 3 parties: the bank issuing the credit, the party requesting
for such issuance (otherwise known as the account party) and the
beneficiary.
Under the terms of a SLC, the beneficiary has the right to
trigger the loan option (referred to as TAKING DOWN THE LOAN)
if the account party fails to meet its commitment, in w/c case the
issuing bank disburses a specified sum to the beneficiary and books
an equivalent loan to its customer.
SLCs may support non-financial obligations such as those of
bidders, or financial obligations such as those of borrowers. In the
latter case, the borrower purchases an SLC and names the lender as
beneficiary. Should the borrower default, the beneficiary has the
right to take down the SLC and receive the principal balance from the
issuing bank. The borrowers loan obligation is then passed to the
bank.
When the Notifying Bank (NB) may be held liable:
The NB is liable if:
1. It did not notify the seller of the opening of the LC, or
2. It did not determine the apparent authenticity of the
required documents.
Note: Only the APPARENT AUTHENTICITY is to be determined.
The NB does not warrant the authenticity of the LC but only its
apparent authenticity. So if the LC turns out to be spurious, NB is not
liable for damages unless obvious that it is not authentic.
Therefore, Notifying Bank/Advising Bank is liable if it acts beyond
the scope of its authority.
When may the Advising Bank (AB) be equally liable with the
Issuing Bank (IB)?
Ordinarily, an AB, whose obligation is merely to advise the
seller/beneficiary of the opening of a LC has no liability. The
opening of a LC does not make the IB liable at once because there is
no liability. The liability is conditioned and dependent on the tender
or submission of the documents stipulated upon by the parties. If the
beneficiary requires that the obligation of the IB shall also be made
the obligation of the AB to him, there is what is known as a
CONFIRMED COMMERCIAL CREDIT and the AB shall become a
Confirming Bank. In this situation, the liability of the CB is primary
and it is as if the credit were issued by the IB and the CB jointly, thus
giving the beneficiary or holder for value of the drafts drawn under
the credit, the right to proceed against either or both banks, the
moment the credit instrument has been breached.
The CB is liable only when the documents are submitted and
gets reimbursed by the IB because there is no privity of contract with
the applicant.
Thus, an AB becomes a CB when the above mentioned
conditions occur. In such a case, the CB acquires the same liabilities
as the Issuing Bank and is bound by the same conditions as an IB.
Function of a Negotiating Bank (NB):
It accepts or gives value to the draft and w/c later on sells the draft to
the IB. The IB then reimburses the NB. What happens is that the NB
buys the draft at a discounted price and then sells it to the IB for its
face value.
If LC is disowned by the IB, can the Negotiating Bank ask
reimbursement from the seller? Under what principle?
YES. Seller is a drawer of the draft accepted and paid by the
Negotiating Bank. Therefore, the seller has contingent liability on
such draft.
Can a Confirming Bank become a Notifying Bank?
NEVER, because they have different liabilities. The CBs liability is
primary while the NBs liability comes only after negotiation (Before
negotiation, there is no liability).
It is the application for the opening of a LC w/c governs the
relationship between the buyer and the IB. This implies
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that the buyer/applicant is not concerned w/ the terms of the
LC between the IB and the seller/beneficiary.
As to the IB, it is not a guarantor because its liability is not
subsidiary since the condition of the submission of the
document is determinative of the liability not the
nonpayment of the buyer.
The IB opens a LC for a consideration w/c comes in the
form of a commission.
If the IB does not advance the payment in favor of the
seller/beneficiary, may the buyer/applicant recover the
commission paid?
No More because this is the consideration. But he may recover the
margin fee.
What among other things, should be stipulated upon the
application for a LC?
The documents w/c the seller should submit to the IB.
In LC transactions, the IB deals only w/ the documents, not w/
goods. The IB is not bound or required to examine the goods. For as
long as the required documents are submitted by the seller, the IB
pays the seller.
If the goods turned out to be defective, is this a valid defense to
avoid payment by the IB to the seller?
NO. As long as the documents submitted by the seller are complete
and in conformity w/ what the LC requires, the IB is bound to pay the
seller. This is true even if the goods turned out to be defective.
How about the buyer, is he still bound to reimburse the IB despite
the defective goods received by him?
YES. The buyer has no course of action against the IB. The buyer
has a COA against the seller.
If the documents submitted by the seller are incomplete and the
IB still pays the seller, is the buyer still bound to pay the IB?
NO. Because the IB should not have paid the seller knowing the
documents to be incomplete. The IB deals only w/ documents.
Can the beneficiary demand payment form the CB?
YES. Since the CB is equally liable w/ the IB.
If the beneficiary proceeds against the CB, the CB may ask
reimbursement from the IB. But if the beneficiary proceeds directly
against the CB; it has no right to collect from the IB. The beneficiary
may compel the CB to accept drafts it has drawn.
How is payment made by the Issuing Bank?
Payment by the IB is done through:
1. Direct payment or wire transfer or credit in the account of
the beneficiary
2. Drawing of a draft by the beneficiary against the IB pay
to my order
3. IB may authorize the Confirming Bank to pay
4. Authorize Correspondent Bank to accept and pay any draft
drawn
5. Authorize the negotiation of any draft drawn by the
beneficiary.
Note: If the drawee doesnt pay, go to the drawer who is secondarily
liable.
Apart form the bill of lading, what additional documents may be
needed as a condition of the LC for honoring a draft?
1. Commercial invoice it is a document signed and issued
by the seller and contains a precise description of the
merchandise and the terms of the sale such as unit prices,
amount due form the buyer and shipping conditions related
to charges such as FOB (Free on Board), FAS (Free
Alongside), C and F (Cost and Freight) or CIF (Cost,
Insurance, Freight).
2. Consular invoice document issued by the consulate of
the importing country to provide customs information and
statistics for that country and to help prevent false
declaration of value.
3. Certificate of analysis may be required to ascertain that
certain specifications of weight, purity, sanitation, etc.,
have been met. These specifications may be required by
health or other officials of the importing country, or they
may be insisted by the importer as assurance that it is
receiving what it ordered.
4. Export declaration it is a document prepared by the
exporter to assist the government to prepare export
statistics.
Note: Documents to be passed are not unilaterally determined by the
bank but agreed upon by the buyer and seller.
Document of Title (Bill of Lading) given to the seller upon
shipment of goods. This is to be given to the IB to be able for the
seller to get payment.
Is there a scheme where the IB may release the documents of title
to the buyer w/o being reimbursed first by the buyer?
YES. By the IB letting the buyer execute a trust receipt.
Failure of the buyer to open the Letter of Contract does not prevent
the birth of the Sales Contract.
The opening of the letter of credit is only a mode of payment. The
letter of the credit is not an essential requisite to the contract of sale.