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Letters of Credit in money and is not payable to order or to bearer but is issued in beneficiary.

t is issued in beneficiary. It only signifies that the beneficiary may be able to


the name of a specified person. draw funds upon the L/C up to the designated amount specified
therein. It does not convey the notion that a particular sum of
1. Governing Laws
2. Definition and Nature of Letters of Credit money has been specifically reserved or has been held in trust.

 Art. 567-572 of the Code of Commerce on L/C, i.e., “those


Prudential Bank v. IAC, (1992). A letter of credit is an instrument 2012 Bar, Q. 1 (MCQ): Letters of Credit are financial devices in
issued by one merchant to another, or for the purpose of
issued by a bank that guarantees its client’s ability to pay for commercial transactions which will ensure that the seller of the
attending to a commercial transaction” are obsolete, since
imported goods or services, authorizing an individual or a firm to goods is sure to be paid when he parts with the goods and the
modern L/C are strictly bank-to-bank transactions
draw drafts on the bank or on its correspondents for bank’s buyer of the goods gets control of the goods upon payment.
account under conditions specified in the credit. Which statement is most accurate?
(1) L/C Being Commercial Documents Are Also Governed by
Applicable International and Customary Practices
Reliance Commodities, Inc. v. Daewoo Industrial Co. Ltd., (1993). a. The use of the Letter of Credit serves to reduce the risk of
The primary purpose of L/C is to substitute for, and therefore nonpayment of the purchase price in a sale transaction.
Transfield Phil. Inc. v. Luzon Hydro Corp., (2004). Since L/C have
support, the agreement of the buyer-importer to pay money b. The Letters of Credit can only be used exclusively in a sales
gained general acceptability in international trade transactions,
under a contract or other arrangement; but it does not necessarily transaction.
the ICC has published from time to time updates on the Uniform
constitute as a condition for the perfection of such arrangement. c. The Letters of Credit are issued for the benefit of the seller
Customs and Practice (UCP) for Documentary Credits to
only.
standardize practices in the L/C area. The vast majority of L/C
Transfield Phil. Inc. v. Luzon Hydro Corp., (2004). By definition, a d. (a), (b) and (c) are all correct.
incorporate the UCP.
letter of credit is a written instrument whereby the writer
The observance of the UCP is justified by Article 2 of the Code of requests or authorizes the addressee to pay money or deliver 2012 Bar, Q. I(b): Explain the nature of Letters of Credit as a
Commerce which provides that in the absence of any particular goods to a third person and assumes responsibility for payment of financial devise.
provision in the Code of Commerce, commercial transactions shall debt therefor to the addressee. A letter of credit, however,
be governed by usages and customs generally observed. changes its nature as different transactions occur and if carried A: A letter of credit is a financial device developed by merchants
through to completion ends up as a binding contract between the as a convenient and relatively safe mode of dealing with sales of
Metropolitan Waterworks v. Daway, (2004). L/C have long been issuing and honoring banks without any regard or relation to the goods to satisfy the seemingly irreconcilable interests of a seller,
and are still governed by the provisions of the Uniform Customs underlying contract or disputes between the parties thereto. who refuses to part with his goods before he is paid, and a buyer,
and Practice for Documentary Credits of the International who wants to have control of the goods before paying. To break
Chamber of Commerce. In the 1993 Revision it provides in Art. 2 Bank of America v. CA, (1993). A L/C is a financial device the impasse, the buyer may be required to contract a bank to
that "the expressions Documentary Credit(s) and Standby L/Cs developed by merchants as a convenient and relatively safe mode issue a letter of credit in favor of the seller so that, by virtue of the
mean any arrangement, however made or described, whereby a of dealing with sales of goods to satisfy the seemingly latter of credit, the issuing bank can authorize the seller to draw
bank acting at the request and on instructions of a customer or on irreconcilable interests of a seller, who refuses to part with his drafts and engage to pay them upon their presentment
its own behalf is to make payment against stipulated goods before he is paid, and a buyer, who wants to have control simultaneously with the tender of documents required by the
document(s)" of the goods before paying. letter of credit. The buyer and the seller agree on what
documents are to be presented for payment, but ordinarily they
Art. 9 thereof defines the liability of the issuing banks on an To break the impasse, the buyer may be required to contract a are documents of title evidencing or attesting to the shipment of
irrevocable L/C as a "definite undertaking of the issuing bank, bank to issue a L/C in favor of the seller so that, by virtue of the the goods to the buyer.
provided that the stipulated documents are presented to the L/C, the issuing bank can authorize the seller to draw drafts and
nominated bank or the issuing bank and the terms and conditions engage to pay them upon their presentment simultaneously with Once the credit is established, the seller ships the goods to the
of the Credit are complied with, to pay at sight if the Credit the tender of documents required by the L/C. The buyer and the buyer and in the process secures the required shipping documents
provides for sight payment." seller agree on what documents are to be presented for payment, or documents of title. To get paid, the seller executes a draft and
but ordinarily they are documents of title evidencing or attesting presents it together with the required documents to the issuing
Transfield Phil. Inc. v. Luzon Hydro Corp., (2004). The L/C which to the shipment of the goods to the buyer. bank. The issuing bank redeems the draft and pays cash to the
has evolved as the ubiquitous and most important device in seller if it finds that the documents submitted by the seller
international trade. A creation of commerce and businessmen, the Asian Terminals, Inc. v. Philam Insurance Co., (2013). However, conform with what the letter of credit requires. The bank then
L/C is also unique in the number of parties involved and its L/C are employed by the parties desiring to enter into commercial obtains possession of the documents upon paying the seller. The
supranational character. transactions, not for the benefit of the issuing bank but mainly for transaction is completed when the buyer reimburses the issuing
the benefit of the parties to the original transaction, the seller and bank and acquires the documents entitling him to the goods.
1976 Bar, Q. IX(b): Is a letter of credit a commercial transaction? the buyer. Hence, the buyer should be regarded as the person Under this arrangement, the seller gets paid only if he delivers the
Explain your answer. Is it governed by the NIL? Reason. entitled to delivery of the goods. Accordingly, for purposes of documents of title over the goods, while the buyer acquires said
reckoning when notice of loss or damage should be given to the documents and control over the goods only after reimbursing the
A: Yes, it is a commercial transaction because it is covered by the carrier or its agent, the date of delivery to the buyer is controlling. bank (Bank of America NT & SA v. CA, et. al., G.R. No. 105395,
Code of Commerce, and accompanies a commercial transaction. It December 10, 1993)
is not a negotiable instrument because it is not for a sum certain Feati Bank v. CA, (1991). Mere opening of a L/C, does not involve
a specific appropriation of a sum of money in favor of the
However, letters of credit are also used in non-sale settings where convince the beneficiary to enter into the business transaction.
they serve to reduce the risk of non-performance. Generally, The beneficiary can be rest assured of being empowered to call on (a) Buyer (Applicant) – one who procures the L/C and obliges
letters of credit in non-sale settings have come to be known as the L/C as a security in case the commercial transaction does not himself to reimburse Issuing Bank upon receipt of the
standby letters of credit (Transfield Philippines, Inc. v. Luzon push through, or the applicant fails to perform his part of the documents of title
Hydro Corporation, G.R. No. 146717, November 22, 2004) transaction. That is the reason why the party entitled to the (b) Issuing Bank – one issuing the L/C, which undertakes to pay
proceeds is appropriately called “beneficiary” Seller upon receipt of the draft and proper documents of
titles and to surrender the documents to Buyer upon
3. Perfection
Keng Hua Paper Products v. CA, (1998). In a letter of credit, there reimbursement; and
are three (3) distinct and independent contracts: (c) Seller (Beneficiary) – one who in compliance with the
Belman, Inc. v. Central Bank, (1958). L/C is perfected the moment contract of sale ships the goods to the Buyer and delivers
when the correspondent bank pays to the person in whose favor (1) The contract of sale between the buyer and the seller; the documents of title and draft to the Issuing Bank to
the L/C has been opened. Hence, in the illustration when the (2) The contract of the buyer with the issuing bank, and recover payment
Chemical Bank of N.Y. pays Seller $10,000 on October 15, 1973, (3) The letter of credit proper in which the bank promises to pay
and debits $10,000 to the account of Merchant’s Bank, the L/C is the seller pursuant to the terms and conditions stated Other Parties:
perfected. therein
(d) Advising (notifying bank) – to convey to Seller the existence
Johannes Schuback & Sons v. CA, (1993). Opening of a L/C is in The three contracts which make up the letter of credit of the credit
favor of a vendor is only a mode of payment, but it is not among arrangement are to be maintained in a state of perpetual (e) Confirming bank – one which will lend credence to the L/C
the essential requirements of a contract of sale enumerated in separation." A transaction involving the purchase of goods may issued by a lesser known Issuing Bank
Art. 1305 and 1474, CC and therefore the non-opening thereof also require, apart from a letter of credit, a contract of (f) Paying bank – undertakes to encash the drafts drawn by the
does not prevent the perfection of the contract of sale between transportation specially when the seller and the buyer are not in exporter; or
the parties (when not specifically provided as suspensive the same locale or country, and the goods purchased have to be (g) Negotiation bank – one where instead of going to the place
condition) transported to the latter. of the Issuing Bank to claim payment, Seller may approach
Negotiating Bank to have draft discontinued
1979 Bar, Q. II(b): X applied for a letter of credit with the Bank of 2002 Bar, Q. III: Explain the three (3) distinct but intertwined
America in favor of an export company located in Paris, France. contract relationships that are indispensable in a letter of credit 1994 Bar, Q. I(3): In letters of credit in banking transactions,
The application provides that the draft must be drawn and transaction. distinguish the liability of a confirming bank from a notifying
presented not later than May 31, 1978, and X agreed to pay at bank.
maturity any amount that might be drawn or paid upon the faith A: The three (3) distinct but intertwined contract relationships
of the applicant’s credit and to reimburse the bank in said that are indispensable in a letter of credit transaction are: A: In case anything wrong happens to the letter of credit, a
manner. On May 30, 1978, a draft was negotiated by the Bank of confirming bank incurs liability for the amount of the letter of
America’s correspondent bank in Paris against X’s credit; this 1. Between the applicant/buyer/importer and the credit, while a notifying bank does not incur any liability.
was then paid by the Bank of America at the rate prevailing. The beneficiary/seller/exporter – The applicant/buyer/importer
date of maturity of the draft was August 26, 1978. Before the is the one who procures the letter of credit and obliges
date of maturity but after the correspondent bank had paid the 5. Rights and Obligations of Parties
himself to reimburse the issuing bank upon receipt of the
draft, the French franc devaluated. At what rate should X pay documents of title, while the beneficiary/seller/exporter is
the Bank of America in Philippine pesos, at the rate of the franc (a) Special Relations Created; Special Rules Applicable
the one who in compliance with the contract of sale ships
prevailing on May 30, 1978, or at its devalued rate on August 26, the goods to the buyer and delivers the documents of title
1978? Reason. Transfield Phil. Inc. v. Luzon Hydro Corp., (2004). The L/C evolved
and draft to the issuing bank to recover payment for the
as a mercantile specialty, and the only way to understand all its
goods. Their relationship is governed by the contract of sale.
A: X should pay the Bank of America at the rate of the franc facets is to recognize that it is an entity unto itself
2. Between the issuing bank and the
prevailing on May 30, 1978, the date when the Bank of America’s beneficiary/seller/exporter – The issuing bank is the one that
correspondent bank in Paris, France, paid the letter of credit to (a) The relationship between the beneficiary and the issuer of a
issues the letter of credit and undertakes to pay the seller
the export company in French Franc, the letter of credit having L/C is not strictly contractual, because both privity and a
upon receipt of the draft and proper documents of title and
been consummated at that time. (Belman Cia., Incorprada v. meeting of the minds are lacking, yet strict compliance with
to surrender the documents to the buyer upon
Central Bank of the Philippines, L-10195, Nov. 29, 1958) its terms is an enforceable right;
reimbursement. Their relationship is governed by the terms
(b) Nor is it a third-party beneficiary contract (pour autrui),
of the letter of credit issued by the bank.
because the issuer must honor drafts drawn against a letter
4. Parties and Contracts Covered in L/C Agreement 3. Between the issuing bank and the applicant/buyer/importer
regardless of problems subsequently arising in the
– Their relationship is governed by the terms of the
underlying contract;
Transfield Phil. Inc. v. Luzon Hydro Corp., (2004). L/C are application and agreement for the issuance of the letter of
(c) Since the bank's customer (Applicant-Buyer) cannot draw on
employed by parties desiring to enter into commercial credit by the bank.
the letter, it does not function as an assignment by the
transactions, not for the benefit of the issuing bank but mainly for customer to the beneficiary;
the benefit of the parties to the original transactions. With the L/C Bank of America v. CA, (1993). There would be at least three (3)
from the issuing bank, the party who applied for an obtained it parties to a L/C arrangement:
may confidently present it to the beneficiary as a security to
(d) Nor, if properly used, is it a contract of suretyship or A: xerox copy of the Bill of Lading. Would you advise the bank to
guarantee, because it entails a primary liability following a allow the drawdown on the Letter of Credit?
default; 1. No. The letter of credit provides as a condition a certification
(e) Finally, it is not in itself a negotiable instrument, because it is of AC. Without such certification, there is no obligation on a. No, because the rule of strict compliance in commercial
not payable to order or bearer and is generally conditional, the part of FE Bank to advance payment of the letter of transactions involving letters of credit, requiring
yet the draft presented under it is often negotiable. credit. (Feati Bank v. CA) documents set as conditions for the release of the fund,
2. No. FE Bank may have confirmed the letter of credit when it has to be strictly corn plied with or else funds will not be
Feati Bank v. CA, (1991). It is a fundamental rule that an notified BV, that an irrevocable letter of credit has been released.
irrevocable credit is independent not only of the contract transmitted to it on its behalf. But the conditions in the b. Yes, because an irrevocable letter of credit means that the
between the buyer-applicant and the seller-beneficiary, but also letter of credit must first be complied with, namely that the issuing bank undertakes to release the fund anytime when
of the credit agreement between the issuing bank and the buyer- draft be accompanied by a certification from AC. Further, claimed by the beneficiary, regardless of the kind of
applicant. confirmation of a letter of credit must be expressed. (Feati document presented.
Bank v. CA) c. Yes, because the issuing bank can always justify to CCC
The non-compliance by buyer with its contract with issuing bank Corporation that xerox copies are considered as faithful
has no bearing with the agreement between the buyer and the (b) Rule of Strict Compliance reproduction of the original copies.
seller. The relationship between the issuing bank and the notifying d. Yes, because the issuing bank really has no discretion to
bank, on the other hand is more similar to that of an agency and Feati Bank v. CA, (1991). It is a settled rule in commercial determine whether the documents presented by the
not that of a guarantee, since the latter is merely to follow the transactions involving L/C that the documents tendered must beneficiary are sufficient or not.
instructions of the issuing bank which is to notify or to transmit strictly conform to the terms of the L/C. The tender of documents
the L/C to the beneficiary. by the beneficiary (seller) must include all documents required by (c) Obligations of Applicant; Obligations of Correspondent
the letter. A correspondent bank which departs from what has Bank
1993 Bar, Q. VIII: BV agreed to sell to AC, a Ship and been stipulated under L/C, as when it accepts a faulty tender, acts
Merchandise Broker, 2,500 cubic meters of logs at $27 per cubic on its own risks and it may not thereafter be able to recover from BPI v. De Reny Fabrics, (1971)
meter FOB. After inspecting the logs, CD issued a purchase order. the buyer or the issuing bank, as the case may be, the money thus
paid to the beneficiary Thus the rule of strict compliance. Facts:
On the arrangements made upon instruction of the consignee,
H&T Corporation of LA, California, the SP Bank of LA issued an Commercial transactions involving letters of credit are governed 1. De Reny Fabrics (DRF) asked BPI to open a L/C with its U.S.
irrevocable letter of credit available at sight in favor of BV for by the rule of strict compliance. An irrevocable credit is not correspondent bank for the payment of chemical dyes
the total purchase price of the logs. The letter of credit was synonymous with a confirmed credit. An irrevocable L/C refers to ordered from a U.S. factory.
mailed to FE Bank with the instruction “to forward it to the the duration of the L/C, and simply means that the issuing bank 2. When the proper documents of U.S. seller were presented,
beneficiary.” The letter of credit provided that the draft to be may not without the consent of the beneficiary (seller) and the BPI’s correspondent bank paid the seller.
drawn is on SP Bank and that it be accompanied by, among other applicant (buyer) revoke his undertaking under the letter, because 3. But when the crates arrived in Manila, it was found that the
things, a certification from AC, stating that the logs have been the issuing bank does not reserve the right to revoke the credit. U.S. factory had swindled DRF, as crates contained only
approved prior shipment in accordance with the terms and chalk.
conditions of the purchase order. A confirmed L/C pertains to the kind of obligation assumed by the 4. DRF refused to pay BPI, alleging that the latter’s U.S.
correspondent bank, which means that the correspondent bank correspondent bank was negligent in not seeing to it that
Before loading on the vessel chartered by AC, the logs were gives an absolute assurance to the beneficiary that it will the shipping document actually tallied with what was loaded
inspected by custom inspectors and representatives of the undertake the issuing bank’s obligation as its own according to the aboard the ship.
Bureau of Forestry, who certified to the good condition and terms and conditions of the credit. 5. It was proven that U.S. correspondent bank made payment
exportability of the logs. After the loading was completed, the only after presentation of genuine shipping documents by
Chief Mate of the vessel issued a mate receipt of the cargo which Hence, the mere fact that a L/C is irrevocable does not necessarily U.S. factory.
stated that the logs are in good condition. However, AC refused imply that the correspondent bank in accepting the instructions of
to issue the required certification in the letter of credit. Because the issuing bank has also confirmed the L/C. Consequently, if the Issue: WON DRF may be held liable
of the absence of certification, FE Bank refused to advance terms of the L/C require a certification from beneficiary, issuing
payment on the letter of credit. bank cannot be compelled to pay when no such certification is Held:
issued.
1. May Fe Bank be held liable under the letter of credit? 1. DRF is liable. Application for the L/C contained the
Explain. 2012 Bar, Q. 3 (MCQ): At the instance of CCC Corporation, AAA stipulation that the correspondent bank will pay upon
2. Under the facts above, the seller, BV, argued that FE Bank, Bank issued an irrevocable Letter of Credit in favor of BBB presentation of genuine shipping documents, to which
by accepting the obligation to notify him that the Corporation. The terms of the irrevocable Letter of Credit state stipulation DRF must be bound.
irrevocable letter of credit has been transmitted to it on his that the beneficiary must present certain documents including a 2. Besides, a custom in international banking and financing
behalf, has confirmed the letter of credit. Consequently, FE copy of the Bill of Lading of the importation for the bank to negates any duty on the part of a bank to verify whether
Bank is liable under the letter of credit. Is the argument release the funds. BBB Corporation could not find the original what is described in the L/C of shipping documents actually
tenable? Explain. copy of the Bill of Lading so it instead presented to the bank a tally with what is loaded aboard a ship.
3. It is merely the obligation of the bank to pay upon the (a) Advising or Notifying Bank – correspondent bank assumes
presentation of genuine documents. no liability, except to notify and/or transmit to the Phil. Virginia Tobacco Adm. V. De los Angeles, (1988). During the
4. The correspondent bank is not duty bound to open and beneficiary the existence of the L/C. thus: lifetime of an irrevocable L/C, it cannot, even by court order, be
inspect the crates to see whether the contents thereof tally cancelled nor modified, nor can the applicant be released, without
with the description in the L/C 1. A notifying bank is not liable to pay the drafts drawn against the express permission of the beneficiary in whose favor it is
the L/C; issued; otherwise, it would destroy its irrevocability.
2015 Bar, Q. V(B): Is the Uniform Customs and Practice for 2. Suggest to seller its willingness to negotiate, but this fact
Documentary Credits of the International Chamber of Commerce alone does not imply that the notifying bank promises to Land Bank v. Monet’s Export and Mfg. Corp., (2005). Land Bank
applicable to commercial letters of credit issued by a domestic accept the draft drawn under the documentary credit; was being faulted when it failed to protect the importer’s interest
bank even if not expressly mentioned in such letters of credit? 3. It has not privity to the sale between buyer and seller, and when it paid the suppliers under the L/C despite discrepancies in
What is the basis for your answer? its relationship is only with that of the issuing bank the shipment vis-à-vis the order specifications of the importer.

A: Yes, the SC has held that the observance of the Uniform (b) Negotiating Bank – buys or discounts a draft under the L/C It was held that a L/C is drawable on its own terms, and
Customs and Practice in the Philippines, is justified by Art. 2 of the and its liability is dependent upon the stage of negotiation: if compliance therewith cannot be avoided because of pending
Code of Commerce, which enunciates that in the absence of any before negotiation, it has no liability with respect to the issues with respect to the main contract.
particular provision in the Code of Commerce, commercial seller but after negotiation, a contractual relationship will
transactions shall be governed by generally-observed usages and then prevail between the negotiating bank and the seller; (e) Independent Doctrine; Fraud as Proper Defense
customs (BPI v. De Reny Fabric Industries, Inc. v. G.R. No. L-24821, (c) Confirming Bank – the correspondent bank assumes a direct
October 16, 1970) obligation to the seller and its liability is a primary one as if Transfield Phil. Inc. v. Luzon Hydro Corp., (2004)
the correspondent bank itself had issued the L/C
1981 Bar, Q. III: “A” applies with Prime Bank for a letter of credit Facts:
(d) Obligations of Issuing Bank; Rights of Beneficiary (Seller)
in the amount of P50,000 in favor of Melmart Trading of
California, to cover “A’s” importation of 500 bales of cotton. 1. Transfield Phil. Inc. (TPI) as contractor under a turnkey
Insular Bank v. IAC, (1988). L/C constitutes the primary obligation, construction agreement, submitted to Luzon Hydro Corp.
and not merely an accessory contract, of the issuing bank (LHC) standby L/C to secure the performance of its (TPI)
After shipment, Melmart Trading presented all the pertinent
separate from the underlying the contract that it may support. obligations.
documents to Prime Bank’s correspondent Bank in San
Consequently, beneficiary of a L/C issued to secure payment of 2. Delays in the completion of the project resulted in the filing
Francisco, California, and obtained payment under the letter of
loan may collect on its entirety, even if the borrower claims it of arbitration proceedings on whether TPI could benefit
credit. Prime Bank now seeks payment from “A” who refuses to
made partial payments. from force majeure (storm) for non-completion of the
pay on the ground that Melmart Trading violated certain
conditions in their Contract of Sale and, therefore, should not project on due date.
Metropolitan Waterworks v. Daway, (2004). Obligations of the 3. While the arbitral proceedings were pending, and despite
have been paid under the letter of credit.
banks issuing the L/C is solidary with that of the person or entity TPI’s notice to the banks that LHC cannot call on the L/C until
requesting for its issuance, the same being a direct primary, final settlement of the issues, nevertheless the banks
Can the bank recover from “A”? Reasons.
absolute and definite undertaking to pay the beneficiary upon the notified TPI that they would pay on the L/C upon demand of
presentation of the set of documents required therein. LHC, based on the delay of completion
A: Yes, Prime bank can recover from “A”. Banks in providing
financing in international business transactions (such as that
Transfield Phil. Inc. v. Luzon Hydro Corp., (2004). Independent Issue:
entered into by “A” with Prime Bank) do not deal with the
Principle: The engagement of the issuing bank is to pay the seller
property to be exported or shipped to the importer (by Melmart
or beneficiary of the credit once the draft and the required (1) WON LHC call on the L/C despite the pendency of the
Trading), but deal only with documents. The custom in
documents are presented to it. The so-called "independence resolution of the issue on whether TPI has defaulted in its
international banking negates any duty on the part of the banks to
principle" assures the seller or the beneficiary of prompt payment obligations to complete the project on due date
verify whether what has been described in the letters of credit or
independent of any breach of the main contract and precludes the (2) WON only the issuing bank and not LHC can claim the
drafts or shipping documents actually tallies with what is loaded
issuing bank from determining whether the main contract is “independent principle
aboard ship. (BPI v. De Reny Fabric Industries, Inc., Oct. 16, 1970)
actually accomplished or not.
Transfield Phil., Inc. v. Luzon Hydro Corp., (2004). While the bank Held:
Under this principle, banks assume no liability or responsibility for
is bound to honor the credit, it is the beneficiary who has the right the form, sufficiency, accuracy, genuineness, falsification or legal
to ask bank to honor the credit by allowing him to draw thereon, WON LHC can call on the L/C
effect of any documents, or for the general and/or particular
and not the buyer-applicant. conditions stipulated in the documents or superimposed thereon, 1. Precisely, the independence principle liberates the issuing
nor do they assume any liability or responsibility for the bank from the duty of ascertaining compliance by the parties
Feati Bank v. CA, (1991). In commercial transactions involving L/C, description, quantity, weight, quality, condition, packing, delivery,
the functions assumed by a correspondent bank are classified in the main contract.
value or existence of the goods represented by any documents, or 2. As the principle's nomenclature clearly suggests, the
according to the obligations taken up by it: whether as a notifying for the good faith or acts and/or omissions, solvency,
bank, a negotiation bank or as a confirming bank: obligation under the L/C is independent of the related and
performance or standing of the consignor, the carriers, or the
insurers of the goods, or any other person whomsoever.
originating contract. In brief, the L/C is separate and distinct A: No. Under the doctrine of independence in a letter of credit, under the L/C, must be paid by the issuing or confirming bank,
from the underlying transaction. the obligation of the issuing bank to pay the beneficiary is distinct notwithstanding the existence of a dispute between the parties to
3. The argument that any dispute must first be resolved by the and independent from the main and originating contract the underlying transaction, say a contract of sale of goods where
parties through negotiations or arbitration before the underlying the letter of credit. Such obligation to pay does not the buyer is not satisfied with the quality of the goods delivered
beneficiary is entitled to call on the L/C in essence would depend on the fulfillment or non-fulfillment of the originating by the seller.
convert the L/C into a mere guarantee. contract. It arises upon tender of the stipulated documents under
the letter of credit. In the present case, the tender of the The SC in Transfield Philippines, Inc. v. Luzon Hydro Corp. (2004)
WON the Independent Principle can be invoked by LHC certificate of default entitles Y to payment under the standby for the first time declared that fraud is an exception to the
letter of credit, notwithstanding the fact that X Company was not independence principle. For instance, if the beneficiary
4. To say that the independence principle may only be invoked in default. This is without prejudice to the right of X Company to fraudulently presents to the issuing or confirming bank
by the issuing banks would render nugatory the purpose for proceed against Y Company under the law on contracts and documents that contain material facts that, to his knowledge, are
which the L/C are used in commercial transactions. damages (Insular Bank of Asia and America v. IAC, G.R. No. 74834, untrue, then payment under the L/C may be prevented through a
5. As it is, the independence doctrine works to the benefit of November 17, 1988) court injunction.
both the issuing bank and the beneficiary.
Alternative: Under the fraud exception principle, the beneficiary 2008 Bar, Q. I: X corporation entered into a contract with PT
Transfield Phil. Inc. v. Luzon Hydro Corp., (2004). The may be enjoined from collecting on the letter of credit in case of Construction Corp. for the latter to construct and build a sugar
independent nature of the letter of credit may be: fraudulent abuse of credit. The issuance of a certificate of default, mill within six (6) months. They agreed that in case of delay, PT
despite the fact that X Company is not in default, constitutes Construction Corp. will pay X Corporation P100,000 for every day
(a) Independence in toto where the credit is independent from fraudulent abuse of credit (Transfield Philippines v. Luzon Hydro of delay. To ensure payment of the agreed amount of damages,
the justification aspect and is a separate obligation from the Corp., G.R. No. 146717, November 22, 2004) PT Construction Corp. secured from Atlantic Bank a confirmed
underlying agreement like for instance a typical standby; or 2012 Bar, Q. 4 (MCQ): AAA Carmakers opened an irrevocable and irrevocable letter of credit which was accepted by X
(b) Independence may be only as to the justification aspect like Letter of Credit with BBB Banking Corporation with CCC Cars Corporation in due time. One week before the expiration of the
in a commercial letter of credit or repayment standby, which Corporation as beneficiary. The, irrevocable Letter of Credit was six (6) month period, PT Construction Corp. requested for an
is identical with the same obligations under the underlying opened to pay for the importation of ten (1 0) units of Mercedes extension of time to deliver claiming that the delay was due to
agreement. Benz S class. Upon arrival of the cars, AAA Carmakers found out the fault of X Corporation. A controversy as to the cause of the
that the cars were all not in running condition and some parts delay which involved the workmanship of the building ensued.
In both cases the payment may be enjoined if in the light of the were missing. As a consequence, AAA Carmakers instructed BBB The controversy remained unresolved. Despite the controversy,
purpose of the credit the payment of the credit would constitute Banking Corporation not to allow drawdown on the Letter of X Corporation presented a claim against Atlantic Bank by
fraudulent abuse of the credit. Credit. Is this legally possible? executing a draft against the letter of credit.

Most writers agree that fraud is an exception to the independence a. No, because under the "Independence Principle", (a) Can Atlantic Bank refuse payment due to the unresolved
principle. Professor Dolan opines that the untruthfulness of a conditions for the drawdown on the Letters of Credit are controversy? Explain.
certificate accompanying a demand for payment under a standby based only on documents, like shipping documents, and (b) Can X Corporation claim directly from PT Construction
credit may qualify as fraud sufficient to support an injunction not with the condition of the goods subject of the Corp.? Explain.
against payment. The remedy for fraudulent abuse is an importation. A:
injunction. However, injunction should not be granted unless: b. Yes, because the acceptance by the importer of the goods
subject of importation is material for the drawdown of the (a) Atlantic Bank cannot refuse to pay because in a letter of
(a) There is clear proof of fraud; Letter of Credit. credit, where the credit is stipulated as irrevocable, there is
(b) The fraud constitutes fraudulent abuse of the independent c. Yes, because under the "Independence Principle", the seller a definite undertaking by the issuing bank to pay the
purpose of the letter of credit and not only fraud under the or the beneficiary is always assured of prompt payment if beneficiary, provided that the stipulated documents are
main agreement; and there is no breach in the contract between the seller and the presented and the conditions of the credit are complied
(c) Irreparable injury might follow if injunction is not granted or buyer. with. Under the “independence principle”, the issuing bank
the recovery of damages would be seriously damaged. d. No, because what was opened was an irrevocable letter of is not obligated to ascertain compliance by the parties in the
credit and not a confirmed letter of credit. main contact. In other words, where the legal relation arises
2015 Bar, Q. V(A): A standby letter of credit was issued by ABC from a letter of credit, such letter of credit contains the
Bank to secure the obligation of X Company to Y Company. 2010 Bar, Q. XVII: The Supreme Court has held that fraud is an entire contact of the parties and the resulting obligations
Under the standby letter of credit, if there is failure on the part exception to the "independence principle" governing letters of should be measured by its provisions. It is unaffected by any
of X Company to perform its obligation, then Y Company will credit. Explain this principle and give an example of how fraud breach of contract on the part of one of the parties or by any
submit to ABC Bank a certificate of default (in the form can be an exception. controversy which may arise between them (Transfield
prescribed under the standby letter of credit) and ABC Bank will Philippines, Inc. v. Luzon Hydro Corp., 2004)
have to pay Y Company the defaulted amount. Subsequently, Y A: The “independence principle” posits that the obligation of the (b) Yes, X Corp. can claim directly from PT Construction Corp.
Company submitted to ABC Bank a certificate of default parties to a L/C are independent of the obligations of the parties The call upon the letter of credit is not exclusive; it is merely
notwithstanding the fact that X Company was not in default. Can to the underlying transaction. Thus, the beneficiary of the L/C, an alternative remedy in case of delay due to the fault of PT
ABC Bank refuse to honor the certificate of default? Explain. which is able to comply with the documentary requirements
Construction Corp. (Transfield Philippines, Inc. v. Luzon (1) Being a product of international commerce, it is not BUYER in Manila agrees to SELLER in New York offers to
Hydro Corp., 2004) uncommon to find a dearth of national law that can buy sell merchandise worth
adequately provide for the governance of the L/C, and $10,000 FOB N.Y.
(f) Effect of Applicant Being under Rehabilitation Proceedings therefore the observance of the Uniform Customs and
Practice is justified in the absence of any particular provision (a) Since the Buyer has no facilities with which to transmit
Metropolitan Waterworks v. Daway, (2004). The effects of the in the Code of Commerce, commercial transactions shall be dollars to the U.S., he contacts Merchant’s Bank of Manila,
stay order under Rule 4, Sec. 6(b) of the Interim Rules of governed by usages and customs generally observed. which has a correspondent bank in New York, the Chemical
Procedure for Corporate Rehabilitation which enjoins the (2) An advising or notifying bank does not incur any obligation Bank of New York.
enforcement of all claims against guarantors and sureties “who by such notification and is only bound to check the apparent (b) A L/C is made not between the two (2) banks: between
are not solidarily liable with the debtor”, cannot apply to the L/C authenticity of the L/C Merchant’s Bank and its correspondent bank, the Chemical
issued in behalf of the debtor-applicant since the obligation of the (3) Negotiating bank has a right of recourse against the issuer Bank of New York, there is an element of trust. The
issuing banks under the L/C is primary and solidary. bank and, until reimbursement is obtained, the drawer correspondence is a mutual agreement whereby Merchant’s
continues to assume a contingent liability thereon Bank can ask Chemical Bank in New York to pay Seller in
2013 Bar, Q. XIV (MCQ): Muebles Classico, Inc. (MC), a Manila- (4) Between seller and the negotiation bank there is the usual New York $10,000. Chemical Bank will pay because it trusts
based furniture shop, purchased hardwood lumber from Surigao relationship existing between a drawer and the purchaser of Merchant’s Bank, i.e. the credit of Merchant’s Bank is good
Timber, Inc. (STI), a Mindanao-based logging company. MC was drafts; the involved bank deals only the documents and not with Chemical Bank
to pay STI the amount of P5.0 million for 50 tons of lumber. To on the goods described in those documents (c) It works both ways; thus: if Seller in Manila has sugar which
pay STI, MC opened a letter of credit with Banco de Plata (BDP). he offers to sell and which Buyer in New York agrees to buy,
BOP duly informed STI of the opening of a letter of credit in its (h) Margin Fee Chemical Bank can request Merchant’s Bank to pay Seller in
favor. Manila. The credits of either bank is good with each other.
Pacific Oxygen Co. v. Central Bank, (1968). Margin fee is a tax on (d) Buyer will be required to deposit with Merchant’s Bank 90%
In the meantime, MC- which had been undergoing financial the sale of foreign exchange and sale being consensual, it falls due (marginal deposit) of the amount of the transaction, so that
reverses- filed a petition for corporate rehabilitation. The as soon as the local bank opens the L/C. Buyer would still owe Merchant’s Bank $1,000. Buyer having
rehabilitation court issued a Stay Order to stay the enforcement deposited said amount, Merchant’s Bank cables Chemical
of all claims against MC. Abad v. CA, (1990). The marginal deposit requirement is a Central Bank in New York: “Open an irrevocable letter of credit for
Bank (now BSP) measure to cut off excess currency liquidity which $10,000”. Chemical Bank will require Seller to produce
After shipping the lumber, STJ went to BDP, presented the would create inflationary pressure. It is a collateral security given genuine shipping papers, such as the packing list, before
shipping documents, and demanded payment of the letter of by the debtor, and is supposed to be returned to him upon paying him. Chemical Bank will not debit Merchant’s Bank
credit opened in its favor. MC, on the other hand, informed the compliance with his obligation. The applicant for a L/C is entitled account the sum of $10,000.
bank of the Stay Order and instructed it to deny payment to STI to have the marginal deposit first deducted from the principal (e) Buyer still owes Merchant’s Bank $1,000, and the bill of
because of the Stay Order. BDP comes to you for advice. Your obligation under the L/C and for interest to accrue only on the lading covering the goods will be delivered to Merchant’s
best advice is to __________. balance, and such deposit is supposed to be returned upon the Bank and not to Buyer, so as to protect the bank against
buyer’s compliance with his obligation, since compensation takes Buyer. When the goods arrive in Manila, Merchant’s Bank
(a) grant STI's claim. Under the "Independence Principle," the effect by operation of law. will advise Buyer; but Buyer must first pay $1,000 before he
bank deals only with the documents and not the underlying can take possession of the goods.
circumstances; hence, the presentation of the letter of credit 6. Letters of Credit – Trust Receipt Transactions (f) If Buyer does not have money yet, Merchant’s Bank may
is sufficient. release the goods to Buyer under a trust receipt, which is a
(b) deny STI's claim. The Stay Order covers all claims against the RCBC v. Alfa RTW Manufacturing Corp., (2001). Under a “letter of document issued by the bank in favor of Buyer whereby the
debtor and binds all its creditors. The letter of credit is a credit – trust receipt transaction, a bank extends to a borrower a latter admits that the goods still belong to Merchant’s Bank,
claim against the debtor that is covered by the Stay Order. loan covered by the letter of credit, with the trust receipt as and which authorizes to sell the goods and apply the
(c) grant STI's claim. The letter of credit is not a claim against security of the loan. A trust receipt is "a security transaction proceeds thereof to the payment of his debt with
the debtor under rehabilitation, but against the bank which intended to aid in financing importers and retail dealers who do Merchant’s Bank.
has assumed a solidary obligation. (MWSS v. Daway, G.R. not have sufficient funds or resources to finance the importation (g) The procedure whereby the Merchant’s Bank liquidates its
No. 160732, June 21, 2004) or purchase of merchandise, and who may not be able to acquire obligation with Chemical Bank is called “Forward Exchange”
(d) deny STI's claim. If the bank disregards the Stay Order, it credit except thru utilization, as collateral, of the merchandise
may be subject to contempt by the rehabilitation court. STI imported or purchased.” Bank of Commerce v. Serrano, (2005). A L/C is a separate
should file its claim with the rehabilitation court. document from a trust receipt. While the trust receipt may have
(e) file an action for inter pleader to resolve the parties' In contracts contained in trust receipts, the contracting parties been executed as a security on the letter of credit, still the two
competing claims. may establish agreements, terms and conditions they may deem documents involve different undertakings and obligations.
advisable, provided that they are not contrary to law, morals or Consequently, a clause in the L/C making a party solidarily liable
(g) Summary Rules Pertaining to L/C public order therein cannot be extended to apply to the trust receipt.

Bank of America v. CA, (1993). The following rules apply to L/C: Illustration: A letter 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. Through a letter of credit, the Feati Bank v. CA, (1991). The concept of guarantee vis-à-vis the letter of credit with the same bank for $500,000.00 in favor of HS
bank merely substitutes its own promise to pay for the promise to concept of an irrevocable credit are inconsistent with each other. Bank, a foreign bank, to purchase outboard motors. Likewise,
pay of one of its customers who in return promises to pay the Ricardo executed a Surety Agreement in favor of AC Bank.
bank the amount of funds mentioned in the letter of credit plus (a) Firstly, the guarantee theory destroys the independence of
credit or commitment fees mutually agreed upon. the bank’s responsibility from the contract upon which it The outboard motors arrived and were delivered to Ricardo, but
was opened. he was not able to pay the purchase price thereof.
By contrast, a trust receipt transaction is one where the entruster, (b) Secondly, in a contract of guarantee, the guarantor’s
who holds an absolute title or security interests over certain obligation is merely collateral and it arises only upon the a. Can AC Bank take possession of the outboard motors?
goods, documents or instruments, released the same to the default of the person primarily liable; while in an irrevocable Why?
entrustee, who executes a trust receipt binding himself to hold credit the bank undertakes a primary obligation b. Can AC Bank also foreclose the mortgage over the
the goods, documents or instruments in trust for the entruster fishpond? Explain.
and to sell or otherwise dispose of the goods, documents and Distinguishing Commercial Credits from Standby Credits
instruments with the obligation to turn over to the entruster the A:
proceeds thereof to the extent of the amount owing to the Transfield Phil. Inc. v. Luzon Hydro Corp., (2004). A letter of
entruster, or as appears in the trust receipt, or return the goods, credit is a financial device developed by merchants as a a. If what Ricardo executed is a trust receipt, AC Bank can take
documents or instruments themselves if they are unsold, or not convenient and relatively safe mode of dealing with sales of goods possession of the outboard motors so that it can exercise its
otherwise disposed of, in accordance with the terms and to satisfy the seemingly irreconcilable interests of a seller, who lien and sell them (Sec. 7, Trust Receipts Law). If what
conditions specified in the trust receipt. refuses to part with his goods before he is paid, and a buyer, who Ricardo executed is a Surety Agreement, AC Bank cannot
2016 Bar, Q. XVII(a): Explain what is a "Letter of Credit" as a wants to have control of the goods before paying. The use of take possession of the outboard motors, because it has no
financial device and a "Trust Receipt" as a security to the Letter credits in commercial transactions serves to reduce the risk of lien on them.
of Credit. nonpayment of the purchase price under the contract for the sale
of goods. However, credits are also used in non-sale settings Alternative: No. The opening of a L/C did not vest ownership of
where they serve to reduce the risk of nonperformance. the outboard motors in the bank in the absence of a trust receipt
2016 Bar, Q. XVII(b): PJ Corporation (PJ) obtained a loan from
Generally, credits in the non-sale settings have come to be known agreement. A letter of credit is a mere financial device developed
ABC Bank (ABC) in the amount of P10 million for the purchase of
as standby credits. by merchants as a convenient and relatively safe mode of dealing
100 pieces of ecodoors. Thereafter, a Letter of Credit was
with the sales of goods to satisfy the seemingly irreconcilable
obtained by PJ against such loan. The beneficiary of the Letter of
There are three significant differences between commercial and interests of a seller, who refuses to part with his goods before he
Credit is Scrap Metal Corp. (Scrap Metal) in Beijing, China. Upon
standby credits: is paid, and a buyer, who wants to have control of the goods
arrival of 100 pieces of ecodoors, PJ executed a Trust Receipt in
before paying (Transfield Philippines, Inc. v. Luzon Hydro
favor of ABC to cover for the value of the ecodoors for its release
(a) First, commercial credits involve the payment of money Corporation, 2004)
to PJ. The terms of the Trust Receipt is that any proceeds from
under a contract of sale. Such credits become payable upon
the sale of the ecodoors will be delivered to ABC as payment.
the presentation by the seller-beneficiary of documents that b. AC Bank can also foreclose the mortgage over the fishpond if
After the ecodoors were sold, PJ, instead of paying ABC, used the
show he has taken affirmative steps to comply with the sales Ricardo fails to pay the loan of P1M.
proceeds of the sale to order from Scrap Metal another 100
agreement.
pieces of ecodoors but using another bank to issue a new Letter
(b) In the standby type, the credit is payable upon certification
of Credit fully covered by such proceeds.
of a party's nonperformance of the agreement.
(c) The documents that accompany the beneficiary's draft tend
PJ refused to pay the proceeds of the sale of the first set of
to show that the applicant has not performed. The
ecodoors to ABC, claiming that the ecodoors that were delivered
beneficiary of a commercial credit must demonstrate by
were defective. It then instructed ABC not to negotiate the
documents that he has performed his contract.
Letter of Credit that was issued in favor of Scrap Metal.
(d) The beneficiary of the standby credit must certify that his
obligor has not performed the contract.
As counsel of ABC, you are asked for advice on whether or not to
grant the instruction of PJ. What will be your advice?
2012 Bar, Q. 2(MCQ): Letter of Credit which is used in non-sale
transaction, where it serves to reduce the risk of non-
7. Distinguished from Other Contracts and Agreements performance is called -

(a) Distinguished from Guarantee a. irrevocable letter of credit;


b. standby letter of credit;
Transfield Phil. Inc. v. Luzon Hydro Corp., (2004). Unlike a c. confirmed letter of credit;
guarantee, the settlement of a dispute between the parties is not d. None of the above.
a pre-requisite for the release of funds under a L/C and a
guarantee, the settlement of a dispute between the parties is not
2005 Bar, Q. XI: Ricardo mortgaged his fishpond to AC Bank to
a pre-req for the releases of funds under a L/C.
secure a P1 Million loan. In a separate transaction, he opened a