LETTERS OF CREDIT

ARTICLE 567.
Letters of credit are those issued by one merchant to another or for the purpose of attending to a
commercial transaction.

ARTICLE 568.
The essential comditions of letters of credit shall be:
1. To be issued in favor of a definite person and not to order.
2. To be limited to a fixed and specified amount, or to one or more undetermined amounts,
but within a maximum limits of which has to be stated exactly.

LETTER OF CREDIT DEFINED.

- Is a letter from a merchant or bank or banker in one place, addressed to another, in another place
or country, requesting the addressee to pay money or deliver goods to a third party named therein,
the writer of the letter undertaking to provide him the money for the goods or to repay him.
- It is a letter requesting one person to make advances to a third person on the credit of the writer
who assumes responsibility for payment of the debt therefor to the addressee.

PARTIES TO A LETTER OF CREDIT.

1. The buyer or importer;
2. The seller, also referred to as beneficiary
3. The opening bank which is usually the buyer’s bank which actually issues the letter of credit;
4. The notifying bank which is the corresponding bank of the opening bank through which it
advises the beneficiary of the letter of credit;
5. Negotiating bank which is usually any bank in the city of the beneficiary. The services of the
notifying bank must always be utilized if the letter of credit is to be advised to the beneficiary
through cable;
6. The paying bank which buys or discounts that drafts contemplated by the letter of credit, if such
draft is to be drawn on the opening bank or on another designated bank not in the city of
beneficiary.
7. The confirming bank which, upon the request of the beneficiary, confirms the letter of credit
issued by the opening bank.

KINDS OF LETTERS OF CREDIT.

1. Commercial Letter of Credit – involve the payment of money under a contract of sale. 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. (Transfield Philippines vs Luzon
Hydro Corp.)

2. Standby Letter of Credit – 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. (Transfield Philippines vs Luzon Hydro Corp.)

BASIC PRINCIPLES OF LETTERS OF CREDIT.

1. Strict Compliance Rule - It is a settled rule in commercial transactions involving letters of credit
that the documents tendered must strictly conform to the terms of the letter of credit. The tender
of documents by the beneficiary (seller) must include all documents required by the letter. 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 risks and it may not thereafter be able to recover
from the buyer or the issuing bank (FBTC vs CA)

2. 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.

The independent nature of the letter of credit may be:

(a) independence in toto where the credit is independent from the justification aspect and is a
separate obligation from the underlying agreement like for instance a typical standby; or

(b) independence may be only as to the justification aspect like in a commercial letter of credit
or repayment standby, which is identical with the same obligations under the underlying
agreement. In both cases the payment may be enjoined if in the light of the purpose of the credit
the payment of the credit would constitute fraudulent abuse of the credit. (Transfield Philippines
vs Luzon Hydro Corp.)

3. Fraud Exception Rule – It provides that the untruthfulness of a certificate accompanying a

demand for payment under a standby letter of credit may qualify as fraud sufficient to support an
injunction against payment. (Transfield Philippines vs Luzon Hydro Corp.)