Letters of are those issued by

one merchant to another or for the

purpose of attending to a

commercial transaction.

letter

of

credit

is

an

instrument by a bank in behalf of a customer

authorizing a beneficiary to draw a draft/s which will be honored on presentation to the bank if drawn in accordance with the terms and conditions specified in the letter of credit.

Underlying Idea of a Letter of Credit

Roughly at least 85% of importations are financed by letters of credit. The underlying idea of a letter of credit is to ensure certainty of payment. Seller is assured of payment because the bank intervenes and makes the commitment to pay.

It is like your credit card. You walk into a department store and they sell to you on credit although youre a total stranger because you show your credit card, which means that the bank which issued the credit card tells the seller that it will pay the goods being bought.

1) The buyer who procures the letter of credit and obliges himself to reimburse the issuing bank upon receipt of the documents of title; 2) The bank issuing the letter of credit, 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; and

3) The seller, 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.

How are the respective relationships of the parties governed?

Issuing bank and applicant/buyer/importer > Their relationship is governed by the terms of the application and agreement for the issuance of the letter of credit by the bank.

Issuing bank and beneficiary/seller/exporter > Their relationship is governed by the terms of the letter of credit issued by the bank.
Applicant and beneficiary > Their relationship is governed by the sales contract.

Governing Rules:
Articles 567-572 of the Code of Commerce
Uniform Customs on Documentary Credits issued by the International Chamber of Commerce

ESSENTIAL CONDITIONS OF A LETTER OF CREDIT

That it be issued in favor of a definite person and not to order; and
That it be limited to a fixed and specified amount, or to one or more undetermined amounts, but within a maximum the limits of which has to be stated exactly.

When does a letter of credit become void?

A letter of credit becomes VOID if the bearer of a letter of credit does not make use thereof within the period agreed upon with the drawer, or, in default of a period fixed, within 6 months, counted from its date, in any point in the Philippines, and within 12 month anywhere outside thereof, it shall be void in fact and in law.

INDEPENDENCE PRINCIPLE
means that a bank, in determining compliance with the terms of a letter of credit is required to examine only the shipping documents presented by the seller and is precluded from determining whether the main contract is actually accomplished or not

this arrangement assures the seller of prompt payment, independent of any breach of the main sales contract

RULE OF STRICT COMPLIANCE

means that the documents tendered by the seller or beneficiary must strictly conform to the terms of the letter of credit,

i.e., they must include all documents required by the letter of credit Thus, a correspondent 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 may not thereafter be able to recover from the buyer or the issuing bank, as the case may be, the money thus paid to the beneficiary.

(1) Revocable - can be cancelled or amended at any time before payment - it is intended to serve as a means of arranging payment but not as a guarantee of payment (2) Irrevocable - obligates the issuing bank to honor drafts drawn in compliance with the credit and - can be neither cancelled nor modified without the consent of all parties, including in particular the beneficiary/exporter (3) Confirmed - a letter of credit issued by one bank can be confirmed by another, in which case both banks are obligated to honor drafts drawn in compliance with the credit (4) Unconfirmed - is the obligation only of the issuing bank

Common Types of Letters of Credit

Q: Why would an exporter want a foreign banks letter of credit confirmed by a domestic bank?
A: One reason could be if he has doubts about the foreign banks ability to pay. Such doubts may arise if the exporter is unsure of the financial standing of the foreign bank, or if political or economic conditions in the foreign country are unstable. An underlying assumption is that a confirming bank is better able to judge the credibility of a bank issuing a letter of credit than is a merchant.

(5) Revolving - is one that is valid for several transactions over a given period of time such as a week or a month - most are issued in revocable form (6) Non-Revolving - is one that is valid for one transaction only
(7) Cumulative - in which case undrawn amounts carry over to future periods (8) Non-Cumulative - in which case any amount not used by the beneficiary during the specified period may not be drawn against in a later period

(9) Standby - is a bank-issued option on a loan involving 3 parties: a. the bank issuing the credit, b. the party requesting for such issuance (otherwise known as the account party) and c. the beneficiary - 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 which case the issuing bank disburses a specified sum to the beneficiary and books an equivalent loan to its customers

Important Points:
A basic principle in letters of credit is that the bank deals with documents only. = Aside from certain conditions, the seller will be required to submit certain documents together with the draft that he will draw in order to collect. = These documents shall be negotiated and agreed upon between the buyer and the seller. = Normally, the seller would have to submit together with the draft a bill of lading, packing list, commercial invoice. = As banks deal with documents only, they are not qualified to deal with goods. Theyre not competent to deal with a thousand and one types of goods. They will act on the basis of the documents only.

BPI vs De Reny Fabrics

Gr No. L-24821 October 16, 1970

FACTS: De Reny Fabrics imported dyes. It applied for a letter of credit for its payment with BPI. Upon submission of the required documents by the seller, BPI paid the seller. When the crates arrived, it was found that they did not contain dyes, but chalk. De Reny Fabric thus refused to pay.
HELD: No! BPI as a bank deals with documents only. So long as the seller submitted the documents required, the bank has to pay, and the customer has to reimburse the bank. The bank will not guarantee that the goods as delivered by the seller comply with the terms and conditions of the contract.

 Fraud in letters of credit

= Its possible to commit fraud because the seller can submit forged or false documents. = To minimize the risk, the seller can be required to submit a certification by a reputable surveyor who will say that he examined the goods and found them to be in accordance with the specifications.

Letters of credit are interpreted strictly

= Example: Where a letter of credit was issued for the importation of noodles, and the invoice said woodle, the bank can refuse to pay, because the bank doesnt know. It might think that a woodle is some exotic food coming from Timbuktu.

Procedure when with discrepancy

= Seller, to collect, will draw a bill of exchange, addressed to the bank which issued the letter of credit. Then he will submit the documents required. But typographical errors can happen. When the bank receives the documents, the bank will now forward that to the buyer. In the cover letter, the bank will state the discrepancies that they discovered, and will ask the buyer if he agrees to waive the discrepancy. If the buyer waives, bank will pay. If he refuses, bank will not pay.

Cojack case
Mrs. Cora Jacob made native bags. Buyer ordered P3million worth of bags from her, to be sold to Hawaii. Buyer inspected the bags and found the quality impressive. Buyer applied for a letter of credit to pay, which stated that among the documents to be submitted to collect was a commercial invoice issued by Cojac, the name of Mrs. Jacobs business. However in the invoice, the buyer deliberately misspelled Cojac, by adding a k. So when Mrs. Jacob submitted the invoice, the bank refused to pay, claiming discrepancy. The bank asked the buyer if it will waive the discrepancy. The buyer refused. The bank dishonored the letter of credit. Later, the buyer offered to pay only P1million to Mrs. Jacob.

Red Clause
This phrase means that the beneficiary can get payment in advance although the goods being sold has not yet been delivered.

In the old days, the American companies would produce mink coats, so they would send their representatives to China to buy the skins and fur from the hunters in the mountains. Since these hunters only accepted cash, the manufacturers would apply for letters of credit, where the beneficiaries would be their representatives who will buy the furs in the mountains. The letter of credit would allow the beneficiary to collect the money in advance although he has not yet shipped the skin and the fur.
So why red? Because in those days, the said clause was written in red ink. This is common in sugar trading. An American company will buy sugar here. Company will open a letter of credit with the trader as beneficiary, who will in turn buy from the sugar central. If the beneficiary fails to deliver the goods, thats just too bad. Buyer will have to reimburse the bank.

Evergreen Clause
=This phrase means that the bank commits to continue renewing the letter of credit. So why evergreen? Because its always fresh. For instance, a foreign corporation not doing business in the Phils sues here asking for a provisional remedy. The court required it to post a bond. Surety will go, E teka muna, youre not doing business here! Supposing we pay huh, how will we get reimbursement from you?! Youre not here! We need security! Get a stand-by letter of credit! Bank will then issue the letter of credit, telling the surety, Ok, if you submit a certification that you have been held liable, together with that draft, we will pay. Now its possible that the case drags on beyond the expiration date of the letter of credit. Surety will then say, Bank, make an undertaking that you will keep renewing the letter of credit until the case has been finally decided! The bank will then use an evergreen clause.

Feati Bank vs. CA

GR No. 94209 April 30, 1991
FACTS: The letter of credit was issued in California, and Feati Bank was the correspondent bank, so it was the one who received the telex and notified the seller about the letter of credit. Seller sued Feati Bank. HELD: No! The notifying bank is not liable. It will only be jointly and severally liable with the opening bank if it confirmed the letter of credit. A letter of credit may be revocable or irrevocable. = Usually the beneficiary insists that it should be an irrevocable letter of credit for certainty of payment. = If revocable, which is very very rare, the bank can revoke it anytime, without need of notifying the beneficiary.

Phil. Virginia Tobacco Administration Case

FACTS: Phil Tobaccco sold tobacco to someone, who paid through a domestic letter of credit. Buyer sued, and obtained a court order ordering the bank not to pay the said beneficiary, and instead turn over the proceeds to the buyer. HELD: That order is void! It goes against the inherent nature of an irrevocable letter of credit.

Revolving letter of credit is automatically renewed. = It may be revolving as to month, as when the bank every month makes available P50,000. It may also be revolving as to amount as when the bank makes available P50,000, subject to renewal upon consumption of the entire amount in a month. It may be cumulative, as when you used up only P40,000 of the alloted P50,000 for the month, in the next month, another P50,000 shall be available, plus the amount which was not used up.
A letter of credit is a contract with a stipulation for the benefit of a 3rd person. = It is a contract between the customer who applied for it and the bank which issued it for the benefit of the beneficiary of the letter of credit.

A letter of credit is a primary, absolute and unconditional obligation. = It is not an accessory obligation.

Philamlife Case
FACTS: A couple took a housing loan from Philamlife. Philamlife, dissatisfied with the real estate mortgage executed by the spouses, required them to get a stand-by letter of credit. Insular Bank of Asia in America issued the letter of credit, agreeing to pay upon presentment of Philamlife of a certification that the spouses had defaulted on the loan. Philamlife later drew a draft and submitted the certification. Insular Bank refused to pay the entire face amount of the letter of credit, claiming that it was told by the spouses that some payments have been made. It thus insists that the said payments should be deducted from the amount due. HELD: No! A letter of credit is not an accessory obligation. It is supposed to be independent of the underlying transaction which gave rise to its issuance. Thats why the bank will have to pay even if there be a deficiency or defect in the goods. The couple thus would have to reimburse the bank. Their remedy would be to run after Philamlife for reimbursement of overpayment. But meanwhile, they would have to reimburse the bank.

Bank of America vs. CA

FACTS: A Philippine company sold rope to a buyer in Thailand. To pay for it, the buyer applied for a letter of credit from a bank in Thailand. The correspondent bank in RP was Bank of America and so it notified the seller here that a letter of credit had been opened in the Thai bank. The seller thus drew a bill of exchange to collect, and then they indorsed it to Bank of America, which credited them the proceeds right away. But when the bill of exchange was presented, the Thai Bank dishonored it, saying that the letter of credit is fake. Bank of America sued the beneficiary to recover.

HELD: Bank of America liable! Under negotiable instruments law, the drawer warrants that the bill of exchange will be paid.

Marginal Deposits = In the old days, the marginal deposits were one of the tools used by the Central Bank to reduce the demand for dollars. = For example, it was then required that for every letter of credit, marginal deposit of say 30% must be given to the bank. But now, banks do not require marginal deposits unless the financial standing of the customer is in bad shape.
Stipulation on Banks Lien on Applicants Property = Whenever you apply for any transaction in the bank, there is a usually a stipulation in the application giving the bank the right of lien on money or property you own which it may have in its possession.

PNB Case
FACTS: Somebody applied for a letter of credit in the Phil. National Bank, having the said stipulation in the appliaction. PNB has the right to set-off or demand reimbursement with any deposit. Later, the applicant assigned his time deposit to a 3rd party. When the amount fell due, the question was who has a better right to collect the money, assignee or PNB? HELD: PNB! It had lien on the deposit. The assignee merely stepped into the shoes of the assignor, and so it must honor the lien.