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Letters of Credit

Special Commercial Laws


(Your) credit is good but
we need cash.
X wants to purchase 10
bouquets of
Juliet Rose from Y, who is
doing business in
France, for her flower shop in
Cebu City
I want to be sure that I
will get paid.
X applies for a Letter of
Credit in favor of Y
with a Philippine
Bank.
Philippine Bank
transmits money to its
correspondent French
Bank.

Y ships the flowers.


French Bank authorizes Y
to withdraw upon
presentation of
documents

Governing Laws
0 Code of Commerce on
Letters of Credit
1 Customs, primarily
those embodied in the
Uniform Customs and
Practice for Documentary
Credit which was adopted
by the International
Chamber of Commerce.
Definition and Nature
2 insuring to a seller payment of
a definite amount upon the
presentation of documents (De
Leon, 2010)
3 an instrument issued by one
merchant to another, or for
the purpose of attending to a
commercial transaction (Code
of Commerce, Art. 567)
4 An original undertaking by the
issuer to substitute its
financial strength for that of
another (the applicant) with
the undertaking to be
conditioned on the
presentation of a draft or
demand for payment (by the
beneficiary) (Dolan, 1991)
Definition and Nature
5 A letter of credit is...
6 an instrument issued by a
bank
7 that guarantees its client's
ability to pay for... goods or
services
8 authorizing an individual or
a firm to draw drafts on the
bank or on its correspondents
for bank's account under
certain conditions of the
credit. (Villanueva)
Prudential Bank v. IAC
(216 SCRA 257)
9 A letter of credit is defined as
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.
10 Once an issuing bank shall
have paid the beneficiary after
the latters compliance with
the terms of the letters of
credit, presentment for
acceptance to the
customer/applicant is not a
condition sine qua non for
reimbursement.
Bank of America NT. & SA v.
CA (G.R. No. 105395,
December 10, 1993)
11 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.
MWSS v. Daway
(G.R. No. 160732, June 21,
2004)
12 The concept of guarantee
vis--vis the concept of
irrevocable letter of credit is
inconsistent with each other.
Letters of Credit are primary
obligations and not security
contracts.
13 While they are security
arrangements, they are not
converted into contracts of
guarantee.
14 The liability of issuing bank
is primary and solidary.
Parties
Bank of America NT. & SA v. CA
(G.R. No. 105395, December 10,
1993)

15There would at least


be three (3) parties:
1. Buyer (Applicant)
2. Issuing bank (Buyer's
Bank)
3. Seller (Beneficiary)
Illustration
16 Most common in
international transactions.
17 Let's assume that Pinoy
Company sells furniture in the
Philippines and Italiano
Company manufactures
furniture in Italy. Pinoy
Company wants to import
$100,000 worth of furniture
manufactured by Italiano
Company , but Italiano
Company is concerned about
Pinoy Company's ability to pay
for them.
18 Who applies for the letter
of credit?
19 Pinoy Company from --
20 Its bank, ABC Bank.
Indicating that
21 Pinoy Company will make
good on the $100,000
payment in the number of
days agreed or ABC Bank will
pay the bill itself.
22 ABC Bank will then send
the letter of credit to Italiano
Company which then ships
the furniture.

23 After shipment, Italiano


Company or Italiano
Companys Bank will then ask
for payment of its $100,000
by ---
24 Presenting a written draft
(also known as a bill of
exchange) to
25 ABC Bank.
26 Who is
protected/benefited in a letter
of credit? Seller or the buyer?
27 Both.
28 Seller: guarantee of
payment.
29 Buyer: protection of
payment.

30 Italiano Company must


present ABC Bank with written
proof of the shipment in order
to get paid.
31 Proof: commercial invoice,
bill of lading or airway bill.
32 After ABC Bank pays
Italiano Company, it turns to
Pinoy Company for
reimbursement.
33 Debit of account, usually
with pledge of securities or
cash collateral.
34 Whats in it for the bank?

Additional Parties
35 Advising (notifying) bank
- conveys to the seller the
existence of the credit.
2. Confirming bank
- lends credence to the letter of
credit issued by a lesser known
issuing bank.
3. Paying bank
- undertakes to encash the drafts
drawn by the exporter.
4. Negotiating bank
- discounts the draft instead of
going to the place of the issuing
bank to claim payment

Obligations of
Correspondent Bank
36 Depending on the functions
assumed:
37 Advising or Notifying Bank
no liability except to notify and
transmit to the beneficiary the
existence of the letter of credit.
38 Negotiating Bank depends on
the stage of negotiation. Before:
no liability. After: contractual
relation will exist.
39 Confirming Bank direct
obligation to the seller and its
liability is primary one as if the
correspondent bank itself issued
the letter of credit.
40 Paying Bank Direct obligation.
Perfection

41 Belman Inc. v. Central Bank


(104 Phil. 877)
42 An irrevocable letter of credit
granted by a bank, which
authorizes a creditor in a foreign
country to draw upon a debtor
of another and to negotiate the
draft through the agent or
correspondent bank or any bank
in the country of the creditor, is a
consummated contract, when
the agent or correspondent
bank or any bank in the country
of the creditor pays or delivers
to the latter the amount in
foreign currency, as authorized
by the bank in the country of
the debtor in compliance with
the letter of credit granted by it.
In Relation to Contract
of Sale
43 Johannes Schuback & Sons
v. CA (227 SCRA 717)
44 The opening of a letter of
credit in favor of a vendor is
only a mode of payment. It is
not among the essential
requirements of a contract of
sale enumerated in Article
1305 and 1474 of the Civil
Code, the absence of any of
which will prevent the
perfection of the contract from
taking place.

Essential Conditions of a Letters


of Credit:
45 Issued in favor of a definite
person.
46 Limited to a fixed or
specified amount, or to one
or more amounts, but with a
maximum stated limit.
Duration of Letters of Credit:
47 Upon the period fixed by
the parties; or
48 If none is fixed, one year
from the date of issuance.
Independent Contracts Involved
in a Letter of Credit
49 Keng Hua Paper Products v. CA
(286 SCRA 257)
50 In a letter of credit, there are
three distinct and independent
contracts: (1) the contract of sale
between the buyer and the seller,
(2) the contract of the buyer with
the issuing bank, and (3) the letter of
credit proper in which the bank
promises to pay the seller pursuant
to the terms and conditions stated
therein.
51 The contract of carriage, as
stipulated in the bill of lading in the
present case, must be treated
independently of the contract of sale
between the seller and the buyer,
and the contract for the issuance of a
letter of credit between the buyer
and the issuing bank.
52 Feati Bank v. CA (196SCRA
576)
53 It is a fundamental rule
that an irrevocable credit is
independent not only of the
contract between the buyer
and the seller but also of the
credit agreement between the
issuing bank and the buyer.
The relationship between the
buyer and the issuing bank is
entirely independent from the
letter of credit issued by the
latter. The contract between
the two has no bearing as to
the non-compliance by the
buyer with the agreement
between the latter and the
seller.

Rights and Obligations


of Parties in Letter of
Credit
54 Bank of Philippine Islands
v. De Reny Fabric Industries,
Inc. (35 SCRA 256)
55 The buyer-applicant cannot
shift the burden of loss to the
correspondent bank on
account of the violation by the
seller-beneficiary of its
obligation.
56 Banks do not deal with the
property to be exported or
shipped to the importer, but
deal only with the documents.
Rights and Obligations
of Parties in a Letter of
Credit
57 Insular Bank v. IAC (167
SCRA 450)
58 Letter of credit constitutes
the primary obligation, and
not merely an accessory
contract of the issuing bank
separate from the underlying
contract that it may support.
Consequently, beneficiary of a
letter of credit issued to secure
payment of a loan may collect
on its entirety, even if
borrower claims it made
partial payments already.
Rights and Obligations
of Parties in a Letter of
Credit

59 Phil. Virginia Tobacco


Adm. v. De los Angeles
(164 SCRA 543)
60 An irrevocable letter of
credit during its lifetime
cannot be cancelled or
modified without the
express permission of the
beneficiary.
Consequence of
Payment:
Expired Letter of Credit
61 An issuing bank which paid
the beneficiary upon an
expired letter of credit can
recover the payment from the
applicant which obtained the
goods from the beneficiary to
prevent unjust enrichment.
(Rodzssen Supply Cp. V. Far
East Bank and Trust Co., G.R.
No. 109087, May 9, 2001)
Basic Principles of
Letter of Credit
62 Doctrine of
Independence
63 Fraud Exception
Principle
64 Doctrine of Strict
Compliance

65 Transfield Philippines, Inc. v.


Luzon Hydro Corporation
Australia, et. al.
66 Doctrine of Independence
67 The letter of credit is
separate and distinct from the
underlying or principal
obligation.
68 The settlement of a dispute
between the parties is not a pre-
requisite for the release of funds.
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.
Fraud Exception
Principle
69 The untruthfulness of a
certificate may qualify as
fraud, sufficient to support an
injunction against payment.
70 However, injunction
should not be granted unless:
1) There is clear proof of fraud
2) The fraud constitutes
fraudulent abuse of the
independent purpose of the
letter of credit and not only
fraud under the underlying
obligation; and
3) Irreparable injury might
follow if injunction is not
granted or the recovery of
damages would be seriously
affected.

Doctrine of Strict
Compliance
71 Under this rule, the
documents tendered by
the beneficiary must
strictly conform to the
terms of the letter of
credit.
72 If the letter of credit
requires a certification
from a beneficiary, issuing
bank cannot be compelled
to pay when no such
certification is issued.
73 If an honoring entity
accepts a faulty tender, it
acts on its own risk and
may not thereafter recover
from the applicant or
issuer the money paid to
the beneficiary.

Letter of Credit-
Trust Receipt
Transaction
74 Bank extends a loan
covered by the letter of
credit with trust receipt as
security for the loan.
75 The two are separate
and involve different
undertakings and
obligations.