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Commercial Law Review

Letters of Credit
Maria Zarah Villanueva - Castro

LETTERS OF CREDIT 3. Seller one who in compliance with the


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