3B [SPCL] Digests
TRANSFIELD PHILIPPINES, INC., PETITIONER -
versus-. LUZON HYDRO CORPORATION,
AUSTRALIA AND NEW ZEALAND BANKING
GROUP LIMITED AND SECURITY BANK
CORPORATION, RESPONDENTS.
May 19, 2006
G.R. No.: 146717 Ponente: J. TINGA
Related Article: Tickler:
Doctrine of the Case
Transfield Philippines, Inc. (Transfield) and Luzon
Hydro Corporation (LHC) entered into a Turnkey
Contract. To secure performance of petitioner’s
obligation on or before the target completion date, or
such time for completion as may be determined by the
parties’ agreement, petitioner opened in favor of LHC
two (2) standby letters of credit. Transfield failed to
satisfy its obligation under the Turnkey Contract. In
turn, LHC tried to call on the standby letter of credits.
However, Transfield asserts that the dispute between
the parties must first be resolved, through negotiations
or arbitration, before the beneficiary is entitled to call
on the letter of credit.
In this case, the Supreme Court explained the
difference between a Surety Contract and a standby
letter of credit. In the surety contract setting, there is no
duty to indemnify the beneficiary until the beneficiary
establishes the fact of the obligor’s performance. The
beneficiary may have to establish that fact in litigation.
During the litigation, the surety holds the money and
the beneficiary bears most of the cost of delay in
performance.
In the standby credit case, however, the beneficiary
avoids that litigation burden and receives his money
promptly upon presentation of the required documents.
It may be that the applicant has, in fact, performed and
that the beneficiary’s presentation of those documents
is not rightful. In that case, the applicant may sue the
beneficiary in tort, in contract, or in breach of warranty;
but, during the litigation to determine whether the
applicant has in fact breached the obligation to
perform, the beneficiary, not the applicant, holds the
money. Parties that use a standby credit and courts
construing such a credit should understand this
allocation of burdens. There is a tendency in some
quarters to overlook this distinction between surety
contracts and standby credits and to reallocate
Austine Clarese B. Velasco
burdens by permitting the obligor or the issuer to litigate
the performance question before payment to the
beneficiary.
Parties – Roles
Transfield Philippines Inc.
Luzon Hydro Corporation
ANZ Bank and SBC
Facts
Transfield Philippines, Inc. (Transfield) and Luzon
Hydro Corporation (LHC) entered into a Turnkey
Contract whereby Transfield undertook to construct a
hydro-electric power station at the Bakun River in the
provinces of Benguet and IlocosSur (hereinafter, the
Project).
To secure performance of petitioners obligation on or
before the target completion date, or such time for
completion as may be determined by the parties
agreement, petitioner opened in favor of LHC two (2)
standby letters of credit (hereinafter referred to as the
Securities), with Australia and New Zealand Banking
Group Limited (ANZ Bank), and with Security Bank
Corporation (SBC).
Transfield sought various extensions of time to
complete the Project. The extensions were requested
allegedly due to several factors which prevented the
completion of the Project on target date, such as force
majeure occasioned by typhoon Zeb, barricades and
demonstrations. LHC denied the requests, however.
This gave rise to a series of legal actions between the
parties which culminated in the instant petition.
The first of the actions was a Request for Arbitration
which LHC filed before the Construction Industry
Arbitration Commission (CIAC). This was followed by
another Request for Arbitration, this time filed by
petitioner before the International Chamber of
Commerce (ICC).
Foreseeing that LHC would call on the Securities
pursuant to the pertinent provisions of the Turnkey
Contract, petitioner in two separate letters advised
respondent banks of the arbitration proceedings
already pending before the CIAC and ICC in
connection with its alleged default in the performance
of its obligations. Asserting that LHC had no right to call
on the Securities until the resolution of disputes before
the arbitral tribunals, petitioner warned respondent
banks that any transfer, release, or disposition of the

Securities in favor of LHC or any person claiming under
LHC would constrain it to hold respondent banks liable
for liquidated damages.
Transfield as plaintiff filed a Complaint for Injunction,
with prayer for temporary restraining order and writ of
preliminary injunction, against herein respondents as
defendants before the RTC of Makati.
RTC Ruling:
The RTC denied petitioners application for a writ of
preliminary injunction. It ruled that petitioner had no
legal right and suffered no irreparable injury to justify
the issuance of the writ. Employing the principle of
independent contract in letters of credit, the trial court
ruled that LHC should be allowed to draw on the
Securities for liquidated damages. It debunked
petitioners contention that the principle of independent
contract could be invoked only by respondent banks
since according to it respondent LHC is the ultimate
beneficiary of the Securities. The trial court further
ruled that the banks were mere custodians of the funds
and as such they were obligated to transfer the same
to the beneficiary for as long as the latter could submit
the required certification of its claims.
CA Ruling:
Petitioner elevated the case to the CA via a Petition for
Certiorari under Rule 65, with prayer for the issuance
of a temporary restraining order and writ of preliminary
injunction. Petitioner submitted to the appellate court
that LHCs call on the Securities was premature
considering that the issue of its default had not yet
been resolved with finality by the CIAC and/or the ICC.
It asserted that until the fact of delay could be
established, LHC had no right to draw on the Securities
for liquidated damages.
LHC claimed that petitioner had no right to restrain its
call on and use of the Securities as payment for
liquidated damages. It averred that the Securities are
independent of the main contract between them as
shown on the face of the two Standby Letters of Credit
which both provide that the banks have no
responsibility to investigate the authenticity or accuracy
of the certificates or the declarants capacity or
entitlement to so certify.
The CA issued a temporary restraining order, enjoining
LHC from calling on the Securities or any renewals or
substitutes thereof and ordering respondent banks to
Austine Clarese B. Velasco
3B [SPCL] Digests
cease and desist from transferring, paying or in any
manner disposing of the Securities.
The appellate court dismissed the petition for certiorari.
The appellate court expressed conformity with the trial
court’s decision that LHC could call on the Securities
pursuant to the first principle in credit law that the credit
itself is independent of the underlying transaction and
that as long as the beneficiary complied with the credit,
it was of no moment that he had not complied with the
underlying contract. Further, the appellate court held
that even assuming that the trial courts denial of
petitioners application for a writ of preliminary
injunction was erroneous, it constituted only an error of
judgment which is not correctible by certiorari, unlike
error of jurisdiction.
Petitioner contends that the courts below improperly
relied on the independence principle on letters of credit
when this case falls squarely within the fraud exception
rule. Respondent LHC deliberately misrepresented the
supposed existence of delay despite its knowledge that
the issue was still pending arbitration, petitioner
continues.
Petitioner asserts that LHC should be ordered to return
the proceeds of the Securities pursuant to the principle
against unjust enrichment and that, under the
premises, injunction was the appropriate remedy
obtainable from the competent local courts.
LHC filed a Counter-Manifestation stating that
petitioners Manifestation enlarges the scope of its
Petition for Review of the Decision of the Court of
Appeals. LHC notes that the Petition for Review
essentially dealt only with the issue of whether
injunction could issue to restrain the beneficiary of an
irrevocable letter of credit from drawing thereon.
In its Comment to petitioners Motion for Leave to File
Addendum to Petitioners Memorandum, LHC stresses
that the question of whether the funds it drew on the
subject letters of credit should be returned is outside
the issue in this appeal. At any rate, LHC adds that the
action to enforce the ICCs partial award is now fully
within the Makati RTCs jurisdiction in Civil Case No.
04-332. LHC asserts that petitioner is engaged in
forum-shopping by keeping this appeal and at the
same time seeking the suit for enforcement of the
arbitral award before the Makati court.
Respondent SBC in its Memorandum contends that the
Court of Appeals correctly dismissed the petition for
certiorari. Invoking the independence principle, SBC

argues that it was under no obligation to look into the
validity or accuracy of the certification submitted by
respondent LHC or into the latter’s capacity or
entitlement to so certify. It adds that the act sought to
be enjoined by petitioner was already fait accompli and
the present petition would no longer serve any
remedial purpose.
In a similar fashion, respondent ANZ Bank in its
Memorandum posits that its actions could not be
regarded as unjustified in view of the prevailing
independence principle under which it had no
obligation to ascertain the truth of LHCs allegations
that petitioner defaulted in its obligations. Moreover, it
points out that since the Standby Letter of Credit No.
E001126/8400 had been fully drawn, petitioners prayer
for preliminary injunction had been rendered moot and
academic.
Petitioner insists that the independence principle does
not apply to the instant case and assuming it is so, it is
a defense available only to respondent banks. LHC, on
the other hand, contends that it would be contrary to
common sense to deny the benefit of an independent
contract to the very party for whom the benefit is
intended. As beneficiary of the letter of credit, LHC
asserts it is entitled to invoke the principle.
Issue/s
1. Whether the independence principle on
letters of credit may be invoked by a
beneficiary thereof where the
beneficiary’s call thereon is wrongful or
fraudulent? (YES)
2. Whether a dispute must first be resolved,
through negotiations or arbitration,
before the beneficiary is entitled to call
on the letter of credit? (NO)
Ruling
1. The independence principle on letters of
credit may be invoked. 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
Austine Clarese B. Velasco
3B [SPCL] Digests
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.
Given the nature of letters of credit,
petitioner’s argument that it is only the issuing
bank that may invoke the independence
principle on letters of credit does not impress
this Court. 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. As it is, the
independence doctrine works to the benefit of
both the issuing bank and the beneficiary.
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.
While it is the bank which is bound to honor
the credit, it is the beneficiary who has the
right to ask the bank to honor the credit by
allowing him to draw thereon. The situation
itself emasculates petitioner’s posture that
LHC cannot invoke the independence
principle and highlights its puerility, more so
in this case where the banks concerned were
impleaded as parties by petitioner itself.
It is worthy of note that the propriety of LHCs
call on the Securities is largely intertwined
with the fact of default which is the self-same
issue pending resolution before the arbitral

tribunals. To be able to declare the call on the
Securities wrongful or fraudulent, it is
imperative to resolve, among others, whether
petitioner was in fact guilty of delay in the
performance of its obligation. Unfortunately
for petitioner, this Court is not called upon to
rule upon the issue of default such issue
having been submitted by the parties to the
jurisdiction of the arbitral tribunals pursuant to
the terms embodied in their agreement.
2. The 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.
Professor John F. Dolan, the noted authority
on letters of credit, sheds more light on the
issue:
The standby credit is an attractive commercial
device for many of the same reasons that
commercial credits are attractive. Essentially,
these credits are inexpensive and efficient.
Often they replace surety contracts, which
tend to generate higher costs than credits do
and are usually triggered by a factual
determination rather than by the examination
of documents.
Because parties and courts should not
confuse the different functions of the surety
contract on the one hand and the standby
credit on the other, the distinction between
surety contracts and credits merits some
reflection. The two commercial devices share
a common purpose. Both ensure against the
obligors nonperformance. They function,
however, in distinctly different ways.
Austine Clarese B. Velasco
3B [SPCL] Digests
Traditionally, upon the obligors default, the
surety undertakes to complete the obligors’
performance, usually by hiring someone to
complete that performance. Surety contracts,
then, often involve costs of determining
whether the obligor defaulted (a matter over
which the surety and the beneficiary often
litigate) plus the cost of performance. The
benefit of the surety contract to the
beneficiary is obvious. He knows that the
surety, often an insurance company, is a
strong financial institution that will perform if
the obligor does not. The beneficiary also
should understand that such performance
must await the sometimes lengthy and costly
determination that the obligor has defaulted.
In addition, the surety’s performance takes
time.
The 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 applicant’s
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
obligor’s performance. The beneficiary may
have to establish that fact in litigation. During
the litigation, the surety holds the money and
the beneficiary bears most of the cost of delay
in performance.
In the standby credit case, however, the
beneficiary avoids that litigation burden and
receives his money promptly upon
presentation of the required documents. It
may be that the applicant has, in fact,
performed and that the beneficiary’s
presentation of those documents is not
rightful. In that case, the applicant may sue
the beneficiary in tort, in contract, or in breach
of warranty; but, during the litigation to
determine whether the applicant has in fact
breached the obligation to perform, the
beneficiary, not the applicant, holds the
money. Parties that use a standby credit and
courts construing such a credit should
 3B [SPCL] Digests

understand this allocation of burdens. There

is a tendency in some quarters to overlook
this distinction between surety contracts and
standby credits and to reallocate burdens by
permitting the obligor or the issuer to litigate
the performance question before payment to
the beneficiary.

Disposition:

WHEREFORE, the instant petition is DENIED, with

costs against petitioner.
Petitioner is hereby required to answer the charge
of forum-shopping within fifteen (15) days from
notice.

SO ORDERED.

Austine Clarese B. Velasco