Transfield Philippines, Inc. v Luzon Hydro Corp.

443 S 307 ( 2004)

The letter of credit evolved as a mercantile specialty, and the only way to understand all its
facets is to recognize that it is an entity unto itself.

a) The relationship between the beneficiary and the issuer of a letter of credit is not strictly
contractual, because both privity and a meeting of the minds are lacking, yet strict
compliance with its terms is an enforceable right.
b) Nor is it a third-party beneficiary contract, because the issuer must honor drafts drawn
against a letter regardless of problems subsequently arising in the underlying contract.
c) Since the banks customer cannot draw on the letter, it does not function as an
assignment by the customer to the beneficiary.
d) Nor, if properly used, is it a contract of suretyship or guarantee, because it entails a
primary liability following a default.
e) Finally, it is not in itself a negotiable instrument, because it is not payable to order or
bearer and is generally conditional, yet the draft presented under it is often negotiable

USE OF LC

- In commercial transactions, a letter of credit is a financial device developed by

merchants as a convenient and relatively safe mode of dealing with sales of goods to
satisfy the seemingly irreconcilable interests of a seller, who refuses to part with his
goods before he is paid, and a buyer, who wants to have control of the goods before
paying
- The use of credits in commercial transactions serves to reduce the risk of nonpayment of
the purchase price under the contract for the sale of goods. However, credits are also
used in non-sale settings where they serve to reduce the risk of nonperformance.
Generally, credits in the non-sale settings have come to be known as standby credits.

IMPORTANCE OF LC

- Letters of credit are employed by the parties desiring to enter into commercial
transactions, not for the benefit of the issuing bank but mainly for the benefit of the
parties to the original transactions. With the letter of credit from the issuing bank, the
party who applied for and obtained it may confidently present the letter of credit to the
beneficiary as a security to convince the beneficiary to enter into the business
transaction. On the other hand, the other party to the business transaction, i.e., the
beneficiary of the letter of credit, can be rest assured of being empowered to call on the
letter of credit as a security in case the commercial transaction does not push through,
 or the applicant fails to perform his part of the transaction. It is for this reason that the
party who is entitled to the proceeds of the letter of credit is appropriately called
beneficiary.

INDEPENDENCE PRINCIPLE - in a letter of credit transaction, such as in this case, where the
credit is stipulated as irrevocable, there is a definite undertaking by the issuing bank to pay the
beneficiary provided that the stipulated documents are presented and the conditions of the
credit are complied with.

- Precisely, the independence principle liberates the issuing bank from the duty of
ascertaining compliance by the parties in the main contract. As the principles
nomenclature clearly suggests, the obligation under the letter of credit is independent of
the related and originating contract. In brief, the letter of credit is separate and distinct
from the underlying transaction.
- The so-called independence principle assures the seller or the beneficiary of prompt
payment independent of any breach of the main contract and precludes the issuing bank
from determining whether the main contract is actually accomplished or not. Under this
principle, banks assume no liability or responsibility for the form, sufficiency, accuracy,
genuineness, falsification or legal effect of any documents, or for the general and/or
particular conditions stipulated in the documents or superimposed thereon, nor do they
assume any liability or responsibility for the description, quantity, weight, quality,
condition, packing, delivery, value or existence of the goods represented by any
documents, or for the good faith or acts and/or omissions, solvency, performance or
standing of the consignor, the carriers, or the insurers of the goods, or any other person
whomsoever

- As it is, the independence doctrine works to the benefit of both the issuing bank and the
beneficiary. To say that the independence principle may only be invoked by the issuing
banks would render nugatory the purpose for which the letters of credit are used in
commercial transactions.

- With respect to the issue of whether the respondent banks were justified in releasing
the amounts due under the Securities, this Court reiterates that pursuant to the
independence principle the banks were under no obligation to determine the veracity of
LHCs certification that default has occurred. Neither were they bound by petitioners
declaration that LHCs call thereon was wrongful. To repeat, respondent banks
undertaking was simply to pay once the required documents are presented by the
beneficiary.

- the independence principle is not without limits and it is important to fashion those
limits in light of the principles purpose, which is to serve the commercial function of the
credit. If it does not serve those functions, application of the principle is not warranted,
and the common law principles of contract should apply.
 FRAUD EXCEPTION PRINCIPLE – an exception to the independence principle.

- The “fraud exception” exists when the beneficiary, for the purpose of drawing on the
credit fraudulently presents to the negotiating bank documents that contain material
representations of fact that to his knowledge are untrue. Even here, unless it is clear
from the documents themselves that they are fraudulent, banks must be reluctant to be
a party to decide that fraud occurred.
-

- Most writers agree that fraud is an exception to the independence principle. Professor
Dolan opines that the untruthfulness of a certificate accompanying a demand for
payment under a standby credit may qualify as fraud sufficient to support an injunction
against payment.

Would injunction then be the proper remedy to restrain the alleged wrongful draws on
the Securities?

- YES> The remedy for fraudulent abuse is an injunction. However, injunction should not
be granted unless:

(a) there is clear proof of fraud;

1) The fraud must be established. – it must be an “outright fraud” such as fraudulent

presentation of documents for non-existent cargo or similar p”proven manifest
fraud.”

2) The injunction can only be employed in order to prevent a payment to the

beneficiary in case the fraud in relation to presentation of documents took place.

(b) the fraud constitutes fraudulent abuse of the independent purpose of the letter of
credit and not only fraud under the main agreement; and

(c) irreparable injury might follow if injunction is not granted or the recovery of
damages would be seriously damaged

-Before a writ of preliminary injunction may be issued, there must be a clear showing by the
complaint that there exists a right to be protected and that the acts against which the writ is to
be directed are violative of the said right. It must be shown that the invasion of the right sought
to be protected is material and substantial, that the right of complainant is clear and
unmistakable and that there is an urgent and paramount necessity for the writ to prevent
serious damage. Moreover, an injunctive remedy may only be resorted to when there is a
pressing necessity to avoid injurious consequences which cannot be remedied under any
standard compensation.
- In the instant case, petitioner failed to show that it has a clear and unmistakable right to
restrain LHCs call on the Securities which would justify the issuance of preliminary injunction. By
petitioners own admission, the right of LHC to call on the Securities was contractually rooted
and subject to the express stipulations in the Turnkey Contract. Indeed, the Turnkey Contract is
plain and unequivocal in that it conferred upon LHC the right to draw upon the Securities in case
of default, as provided in Clause 4.2.5, in relation to Clause 8.7.2, thus:

Is there a need to wait for the settlement of dispute before one can call on the LC?

- Petitioners argument that any dispute must first be resolved by the parties, whether
through negotiations or arbitration, before the beneficiary is entitled to call on the letter
of credit in essence would convert the letter of credit into a mere guarantee.
Jurisprudence has laid down a clear distinction between a letter of credit and a
guarantee in that the settlement of a dispute between the parties is not a pre-requisite
for the release of funds under a letter of credit. In other words, the argument is
incompatible with the very nature of the letter of credit. If a letter of credit is drawable
only after settlement of the dispute on the contract entered into by the applicant and
the beneficiary, there would be no practical and beneficial use for letters of credit in
commercial transactions.

STANDBY LETTER OF CREDIT – is a security arrangement for the performance of certain

obligations. It can be drawn against only if another business transaction is not performed. It
may be issued in lieu of a performance bond.

There are three significant differences between commercial credit and standby credits.

Commercial Credit (LC) Stand-by letter of credit

1. Used in sale setting where it serves to Used in non-sale setting where it serves to
reduce risk of non-payment reduce risk of non-performance

2. Such credits become payable upon
the presentation by the seller-
beneficiary of documents that show
he has taken affirmative steps to
comply with the sales agreement.
In the standby type, the credit is payable upon
certification of a party's nonperformance of the
agreement. The documents that accompany the
beneficiary's draft tend to show that the
applicant has not performed.

3. The beneficiary of a commercial credit The beneficiary of the standby credit must
must demonstrate by documents that certify that his obligor has not performed the
he has performed his contract. contract.
 STANDBY LETTER OF CREDIT VS SURETY CONTRACT

SIMILARITY: The two commercial devices share a common purpose. Both ensure against the
obligors nonperformance. They function, however, in distinctly different ways.

- Traditionally, upon the obligors default, the surety undertakes to complete the obligors
performance, usually by hiring someone to complete that performanceThe standby
credit has different expectations. He reasonably expects that he will receive cash in the
event of nonperformance, that he will receive it promptly, and that he will receive it
before any litigation with the obligor (the applicant) over the nature of the applicants
performance takes place. The standby credit has this opposite effect of the surety
contract: it reverses the financial burden of parties during litigation.
- In the surety contract setting, there is no duty to indemnify the beneficiary until the
beneficiary establishes the fact of the obligors performance..

- In the standby credit case, however, the beneficiary avoids that litigation burden and
receives his money promptly upon presentation of the required documents

FORWARD EXCHANGE – the procedure whereby the issuing bank liquidate its obligation w/
the negotiating bank