Commercial Law Review
Letters of Credit
LETTERS OF CREDIT
Definition:
Q: What is a letter of credit?
A: Letters of Credit is an engagement 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 with the conditions specified in the
credit.
Example: importation of purchase of goods
Q: Are you applying a loan when you open a letter of
credit?
A: YES.
Reasons why businessmen open letter of credit:
1. Lack of funds
2. Security purposes
3. Dont want to part his money until the goods
are received
Q: What are the relationships may arise in a letter of
credit?
A: General Rule: Three relationships they are: 1. Buyer-
seller (contract of sale); 2. Issuing bank-beneficiary; and
3. Issuing bank-buyer (contract of loan)
Usual conditions imposed by the bank: 1. Financial
capacity; 2. collateral
Applicable Laws:
1. Code of Commerce of Letters of Credit
Article 568 of the Code of Commerce provides
that: A letter of credit shall: 1. Be issued in
favor of a definite person and not to orders; and
2. Be limited to a fixed and specified amount or
to one or more undetermined amount but with
maximum limit stated exactly.
*Letter of credit is not a negotiable instrument.
2. Customs, primarily those embodied in the
Uniform Customs and Practice for Documentary
Credits which was adopted by the International
Chamber of Commerce
Parties to a Letter of Credit:
1. Buyer one who procures the letter of credit
and obliges himself to reimburse the issuing
bank upon receipt of the document of title.
2. Issuing Bank one which 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.
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3. Seller 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.
4. Advising (notifying) Bank may be utilized to
convey to the seller the existence of the credit.
5. Confirming Bank which will lend credence to
the letter of credit issued by a lesser known
issuing bank; the confirming bank is directly
liable to pay the seller-beneficiary.
6. Paying Bank which undertakes to encash the
drafts drawn by the exporter/seller.
7. Negotiating Bank
*Most common parties are the buyer, seller and issuing
bank.
Transactions involved in a Letter of Credit:
a. Independence Principle
This principle provides that the three contracts
entered into in this transaction, the contracts
are: 1. Contract of sale between the buyer and
seller; 2. Contract of the buyer with the issuing
bank; and 3. Letter of Credit proper, are
separate from each other thus any infirmity
from one contract does not affect the other
contracts.
A direct consequence of this principle is the rule
that banks only deal with documents and not
with goods, services or obligations to which
they relate.
*In BPI v De Reny, the SC held that the bank has
no obligation to inquire the specifications of the
goods.
b. Fraud Exception Principle
c. Rule of Strict Compliance
This rule provides that the documentary
requirements imposed by the issuing bank must
be strictly complied with by the beneficiary
otherwise the issuing bank cannot ask for
reimbursement.
Usual documents submitted to the bank:
1. Vouchers;
2. Contract of sale; and
3. Purchase orders
Types of Letters of Credit:
a. Irrevocable Letter of Credit is 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
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 Commercial Law Review
Letters of Credit
Maria Zarah Villanueva - Castro

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.
b. Confirmed Letter of Credit whenever the
beneficiary stipulates that the obligation of the
opening bank shall also be made the obligation
of another bank (also bank that notifies) to
himself.
c. Standby Letter of Credit a security
arrangement for the performance of certain
obligations. It can be drawn against only if
another business transaction is not performed.
It may also be issued in lieu of a performance
bond.
*This type of letter of credit involves an
obligation to do.
*In Transfield v Luzon, the SC held that Luzon
can ran after the Letter of Credit despite the
pending arbitration of before the Commission
because of the independence principle.
*Upon default, the bank pay the beneficiary.
d. Revolving Letter of Credit one that provides
for renewed credit to become available as soon
as the opening bank has advised that the
negotiating or paying bank that the drafts
already drawn by the beneficiary have been
reimbursed to the opening bank by the buyer.
e. Back-to-Back Letter of Credit a credit with
identical documentary requirements and
covering the 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.