Banking with Raffy Morales 2nd Semester, 2007-2008

The Three Regulatory Authorities in the Philippines 1. Bangko Sentral ng Pilipinas (BSP) - regulatory authority for banks - exercises regulatory authority over non-bank financial institutions (NBFI) to the extent that the latter have quasi-banking functions - provides policy directions for money, banking, and credit • • NBQF – non-bank financial institutions with quasi-banking functions NBBSFI – non-bank bangko sentral-regulated financial institutions over

Capitalization of determined by requirements.

banks Basel

is II

Before 1980: The were no UBs because the existing paradigm was the Glass Steagall Act, which was a reaction to the Wall Street crash in 1929. The Wall Street incident was brought about by the active participation of banks in the stock market. In 1980: It has become riskier to invest in banking than in securities so there was shift back to UB recognition in the Philippines. In fact, in the US, it was only in 1999 with the enactment if Gramm, Leach & Bliley Act that the demise of Glass Steagall Act was formalized. Banking Definition: the taking of funds by an entity to lend the same out to others Two Juridical Relations in Banking: 1. depositor and bank 2. bank and borrower Term Structure Risk: the risk lies in the fact that the bank is borrowing short (deposit may be withdrawn anytime) but is lending long (loans may not be demanded or called out anytime). Quasi-banking Definition: the taking of deposit substitutes by an entity to lend the same out to others Previously, deposit substitutes impose higher interests and are not subject to withholding tax. But joint IMF-CBP Banking survey Commission proposed that quasi-banking institutions be regulated so that their acts may be supervised. Thus, amendment of the General Banking Act (GBA).
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2. Insurance Commission supervisional authority insurance companies 3. Securities Commission • • and

Exchange

The BSP is the central monetary authority in the country. The Central Bank of the Philippines continues to exist as CB Board of Liquidators.

Banking Institutions 1. Commercial Bank (KB) 2. Universal Bank (UB) - KB + functions as investment house + invests in non-allied undertaking does away with compartmentalization of banking institutions - can perform all functions of a bank 3. Expanded Commercial Bank (EKB) • Capitalization of KB and UB higher than other banks. It is PhP4.95B and PhP2.4 paid up capital for UB and KB, respectively.

Banking with Raffy Morales 2nd Semester, 2007-2008

It is required that a quasi-bank has at least twenty (20) lenders at one time. Deposits v. Deposit Substitutes
As to Documenta tion As to Insuran ce As to Reserve Requirem ents and Withholdin g Tax If client deposits PhP, tax and yield is 20%. If client deposits foreign currency and is a resident, 7.5%. If client is alien, exempted. Same

Deposit

CD, passbook, checkbook

Insured with PDIC

- black market was eventually legalized and banks wanted to partake in the action 4. investment companies 5. securities and dealers and brokers 6. pawnshops 7. money brokers 8. fund managers 9. lending investors 10. non-bank thrift institutions 11. specialized non-banks Historical Background of Banking As far back as Babylonian time, banking took place in temples. For modern banking, it originated in Italy. Bank came from the word banca which meant bench. Consequently, banca rota meant bankrupt. The oldest operating bank in the world is in Italy. For the English, banking originated from the London Goldsmith. In the Philippines, banking began in the 1800s. The first bank in the country is the Banco Espanol-Filipino, now the BPI, which was chartered in 1851. It was followed by the Standard Chartered Bank (1873) then the HSBC (1880). The oldest savings bank is the Monte de Piedad Bank. Foreign banks in the Philippines are either a branch or an offshore banking unit (OBUs) which is the functional equivalent of local bank FCDUs. (Take Note: For foreign exchange transactions, FCDUs must have US$100 reserve at hand to service a deposit.) Bank Structure A bank is established through a stock corporation with minimum paid-up capital of PhP4.95B if it is a universal bank.
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Deposit Substitu tes

PN, certificate of assignment , certificate of participatio n with recourse to bank

Not insured with PDIC

Non-Bank Financial Institutions (NBFIs) 1. insurance companies 2. investment houses – underwriting activities in IPO (* the function of the underwriter is to make sure that the issue of securities is successful) - in the Philippines, we follow firm underwriting principles and not best efforts principle - securities are good as sold when given to investment house 3. finance companies - covered by Financing Company Act - money brokers usually handle remittance exchanges

Banking with Raffy Morales 2nd Semester, 2007-2008

UB IH

RBU (Bank Prope r)

Tru st Unit

BPI v. IAC, citing Simex v. CA: Banking business is affected with public interest. By the nature of its functions, a bank is under obligation to treat the accounts of its depositors with meticulous care, always having in mind the fiduciary nature of their relationship. The Concept of Systemic Risk Nostro/Vostro Account refers to the deposit balance of a bank in another bank. (N-my account, V-your account) If a depositor bank has huge deposit balance in depository bank, systemic risk is high. The risk is compounded by net settlement mode, hence the shift to gross settlement real time, and by time differential. Core Functions of Bank 1. taking of deposits 2. lending out money Deposit transactions (and deposit substitute transactions) are with recourse to bank, otherwise, it is a sale.
PhP deposit
Clien t Bank

FCDU

• •

There are differences in tax regime and taxability of deposits. A different permit is required for the trust department; RBU and FCDU officers must not be involved in the Trust Operations. For IH functions, the UB may either establish a subsidiary (separate entity) or create a unit in the bank. The trust department is also involved in Investment Management Activities (IMA) (The department acts as the agent of the IMA but it does not necessarily imply a trust relationship.).

Powers of a KU: 1. general powers incident to corporation (Section 36, Corpo Code) 2. powers as may be necessary to carry on the business of KU (Section 29, GBA) Are banks limited to taking deposits and giving loans? NO. See Section 29, GBA. BPI v. CA (2000): In dealing with its depositors, a bank should exercise its functions, not only with the diligence of a good father of a family but it should do so with the highest degree of care.

Savings Acct, Currency/checking Acct Cert. of Time Deposit

CBTC v. CA: Not all fiduciary relationships is a trust transaction. Samsung v. FEBTC: The decision was based on NIL. Bank is liable on a forged check because of signature specimen card which it holds. IMPORTANT! For the Bar, use “high degree of diligence and observe lofty
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Banking with Raffy Morales 2nd Semester, 2007-2008

standards of integrity and performance” as standard of degree of diligence as stated in Prudential Bank v. Lim and Cadiz v. CA. Ponente for these cases was Tinga, J. In FEBTC v. Pacilan (2005), the bank was exonerated of any liability as the act complained of is only simple negligence. The negligence consisted of the repeated improper and irregular handling of account which constrained bank to close the same in accord with rules and regulations governing its depositors’ account (damnum absque injuria). Ring-Fencing Clause GR: Head office is responsible for liabilities of branches. Exception: Ring-Fencing Clause (When contract provides that assets of branch solely liable for its liabilities) Sir: The SC was wrong in Citibank, N.A. v. Sabeniano when it said that Citibank Mla and Citibank Geneva are distinct and separate entities. They are merely branches of one juridical personality, hence, may be held liable for debts of each other unless there is a ring-fencing clause. Powers of KU (Section 29) A. general powers incident to corporation (Section 36, Corpo Code) B. all powers as may be necessary to carry on the business of a KU such as: a. accepting drafts and issuing LCs draft = bill of exchange Three Parties: 1. drawer – maker 2. payee 3. drawee bank – one who opened the checking account Documents of Payment:

1. document of acceptance - Banker’s acceptance as differed from trade acceptance, the former may be considered as security provided by bank and takes on the obligation. - Such is important in relation to the first payee as the latter may now negotiate the draft with somebody else 2. L/C - Letter of credit - Mode of settling obligation especially trade transactions located in two locations (cross border transactions, international trade transactions) 3. O/A - open account b. discounting and negotiating evidence of debt In this function, the bank actually sells evidence of debt. The agency involved in debt securities is not the SEC but rather the Philippine Debt and Exhange (PDEX). Section X238, Manual of Regulations for Banks GR: Financial assets may be readily sold or negotiated. Exception: If entity selling or negotiating is a bank. (Section X238). A bank cannot sell its financial assets on a without recourse basis unless: 1. These are registered with the SEC Except: government assets and securities 2. The securities are to be sold to qualified buyers as provided in Section 10.1 of Securities Regulation Code (SRC). This rule is for the protection of buyers. Rationale for Exceptions:
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Banking with Raffy Morales 2nd Semester, 2007-2008

1. As to government securities - The government is credit-worthy Sir: The exception must include all other exempt securities mentioned in Section 9 of SRC, because same ratio applies. 2. Type of investor (Subsection 10.1 (1), SRC) Just like the Government, these entities may fend for themselves. Examples include banks, registered IH and insurance companies. SEC Memorandum 06-2007 provides who are other qualified buyers. c. accepting and crediting demand deposits d. receiving other types of deposit and deposit substitutes (core bank function) e. buying and selling forex and gold or silver bullion f. acquiring marketable bonds and other debt securities g. extending credit (core bank function) Other Banking Services ( Section 29 in relation to Section 53) a. receive in custody funds, documents ad valuable objects b. act as security broker c. lend out safety deposit box d. act as managing agent, adviser, consultant, administrator of investment, management/advisory/consultancy accounts e. make collections and payments for accounts of others and perform such other services for their customers as are not incompatible with banking business Units within the Bank 1. Regular Banking Unit (RBU) – bank proper

2. Foreign Currency Deposit Unit (FCDU) – usually has interlocking administrator with RBU - different from OBU; to create incentive for local depositors 3. Trust Department – independent bank unit - managed by trust officers who are directly answerable to the BoD Fidelity Bank v. Cenzon (1990): A banking institution which has been declared insolvent and subsequently ordered closed by the Central Bank cannot be held liable to pay interest on bank deposits which accrued during the period when the bank is actually closed and non-operational. Unless a bank engages in transactions, it cannot carry out its role as depository obligated to pay stipulated interest. Cancio v. CA: Under RA 6426, as amended, the transferability abroad of foreign currency deposits is unrestricted. Salvacion v. Central Bank: Exemption in Section 113, Central Bank Circular 960 does not apply to foreign transients. The general rule is that FCDU deposits may not be levied upon or garnished. This case however presented an exemption (a foreign transient convicted of child rape.) The case was decided based on natural law. Sir: It would have been better if the Court simply issued a forfeiture order because in such case, FCDU account still covered. Also, AMLA is another exemption to the GR. Systemic Measures Risk: Certain Prudential

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Banking with Raffy Morales 2nd Semester, 2007-2008

(i) Reserves – amount that is part of the deposit and is set apart by the bank from the sum it lends out Function: 1. It is the first line of defense of a bank during a bank urn. 2. It is used by the BSP to control money supply, inflation. * Contract money supply = increase reserve Increase money supply = decrease reserve 3. It is used to mop up excess liquidity. Types: 1. Statutory/Regular Reserve - deposited with the BSP; 60% of reserve is used free of charge (Free Reserve). The free reserve is used by the BSP in investment in RoP bonds and treasury notes. It is also important in controlling money supply. The other 40% is interest-earning. 2. Liquidity Reserve - this can be complied with by the bank investing in RoP bonds or treasury notes which are being handled by SDA of BSP. The total amount is interest-earning. In the Philippines, we practice fractional reserve banking system. For FCDU deposits, there is a different reserve system because bank is required to maintain 100% asset cover. 30% of this asset cover must be liquid. (ii) Insurance of Deposits (PDIC) – moral hazard; PhP250000 of deposit insured with PDIC or its equivalent in dollar deposits. It is only PhP250000 precisely because it is a moral hazard. The bank has to be prudent in its transactions.

(iii) Single Borrower’s Limit (SBL) – limit of amount a bank can lend to a single borrower or a group of related borrowers in order to insure diversification and reduction of risk Computed at: (20% of net worth of bank + 10% inceremental) X 25% net worth SBL: Securities, Borrowing, Lending Collateral: non-risk item/asset – amount of loan covered by this kind of asset is not included in computation of SBL, ie, RoP bonds. The amount secured is also non-risk. Example: 25% net worth = PhP50M =SBL Company A would like to borrow PhP100M from bank. Possible? Yes if PhP50M is secured by pledge of RoPs amounting to PhP50M. What are other non-risk assets? US treasury and the likes. Chargeback Subsection 35.5(c), GBL: Loans and other credit accommodations covered by assignment of deposits maintained in lending bank and held in the Philippines. This is another device to comply with SBL.

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Banking with Raffy Morales 2nd Semester, 2007-2008

Situation 1.
PhP50 M Co. A Bank

• Foreclosed properties: real and other properties acquired (ROPA) • Due to increase in NPL/NPA in bank’s balance sheet, SPV Act was enacted. This refers to vulture funds.
Note: If loan is not in litigation, debtor may not benefit from discounted amount.

Assigned to Bank Co. A

PhP100M

Situation 2.
PhP50 M Co. A Bank A

• SPV: vehicle in the form of stock corporations which buy NPL/NPAs of banks. These are authorized to issue documents to pay NPL/NPAs; however, the law prohibits transfer of assets to friction costs.
(vi) Capital Adequacy: refers to minimum capitalization and additional capital adequacy ratio during operations (Risk-weight) In the Philippines, we adopted 10% capital adequacy ratio. Illustration: Under Bassel I: If lent to Republic = 0 risk If lent to Province of Cebu = 50% risk weight Under Bassel II: Even if it is the Republic which borrowed, loan is subject to 20% risk weight if denominated in US$. For this purpose, bank capital has been classified under: Tier I: common stock Tier II: subordinating debt (at least 5 years; must not exceed 100% of Tier I) (vii) Equity Investment Limit: every investment of a bank must be approved by the Monetary Board; it may not invest all its net worth in a single transaction, whether allied or non-allied.
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Assignment of Deposit PhP100M

Bank B

SBL not complied with in Situation 2. Assignment of deposits must be MAINTAINED in the LENDING BANK. Depository bank and lending bank must be the same. (iv) DOSRI – Sec. 36, GBL - definition of related interest in manual of banks - if the directors fall in the DOSRI, there must be a written waiver of confidentiality (v) Loan-loss Provision – 5% of unclassified restructured loan or 1% of unclassified loan; this serves as allowance for probable losses

• NPL/NPA: loans/assets

non-performing

Banking with Raffy Morales 2nd Semester, 2007-2008

See Agan case for what are allied and non-allied enterprises. The importance of the difference lies in the fact that only UB may invest in non-allied enterprises. An example of a nonallied enterprise is an airport terminal. ForEx Liberalization 1940s-1950s: period of control 1960s: decontrol 1970s: floating rate of exchange 1980s: moratorium (restructuring of external debts) 1992: end of moratorium; issuance of Brady Bonds to change credit schedules (IOUs and PNs); dollar salting1 took place 1997: Asian Financial Crisis BSP Circular 1389, as amended Uniform Currency Act was repealed by RA8183. The Act mandated that all obligations be denominated in PhP, otherwise void. Sec. 72, New CB Act2: provision answer to exchange crisis. How liberalized is our ForEx? For nontrade transactions (invisibles), there is a limit to the amount of dollars one can acquire, so it’s not very liberalized. As for our loan agreements, they are patterned after euro-dollar loan agreements. The latter refers to US$ deposited outside of the US.
1 2

Interest Equalization Tax: there are two interest benchmarks. LIBOR: London Inter-Bank Offered Rate (offer deposit; floating rate) LIBID: London Inter-Bank Bid Rate (banks bidding for deposit) Why did euro-dollar increase? If a US non-resident issues bonds in the US, such issuance is not subject to interest. However, if borrower is a US resident, issuance is subject to interest. Hence, the passing of the law which equalizes the situation. This led to non-residents depositing US$ in other countries. Also, USSR and China concerned in US banks so they deposited outside US. Two Concepts in relation to Euro-dollar Loans: 1. Matched Funding Illustration: December 24: value date, drawdown date December 22: trade date (loan to be approved in two days); bank agrees to deposit Value date: between borrowing and lending banks in the interbank market Drawdown date: between borrowing bank and its own individual borrower; there is two-day notice rule Reprising date: after a period (end of funding agreement), bank will look for another lending bank to provide funds Roll-over: takes place when original lending bank agrees to extend period. (Note: interbank lending only for six (6) months but borrowing of individual from bank may be for a longer period.) Interest v. Lumpsum Interest period: borrower to pay interest to bank every after a given period Lumpsum: at the end of agreement, principal and interest
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Depositing of dollars abroad the Monetary Board, with the concurrence of at east five (5) of its members and with the approval of the President of the Philippines, may temporarily suspend or restrict sales of exchange by the Bangko Sentral, and may subject all transactions in gold and foreign exchange to license by the Bangko Sentral, and may require that any foreign exchange thereafter obtained by any person residing or entity operating in the Philippines be delivered to the Bangko Sentral or to any bank or agent designated by the Bangko Sentral for the purpose, at the effective exchange rate or rates: Provided, however, That foreign currency deposits made under Republic Act No. 6426 shall be exempt from these requirements.

Banking with Raffy Morales 2nd Semester, 2007-2008

What is a prime rate? It’s the T-bill rate. Pari Passu: Equal Pace : commitment by a borrower that the loan agreement will rank equally with other unsecured obligations of the borrower save those with statutory preference. Note: Don’t notarize dollar loan agreement so as not to violate the pari passu clause. The notarization will give the agreement preference. Negative Pledge: enforcer of pari passu clause as it prohibits borrower from giving security interests to its other lenders without giving specific lender a share in the collateral. The borrower cannot encumber upon his property in favor of a select lender without including specific lenders. This extends to any security interest arrangement. Prepayment: GR: Bank may not coerce borrowers to prepay. Exception: However, borrowers may voluntarily do so. When there is prepayment, the payment is applied in the inverse order of maturities so as to insure regular investment flow for the bank. Prepaid amount may not be reborrowed since it is not a revolving facility. : In case of diversion of loan proceeds, there could be mandatory prepayment. Hence, it is important to state the purposes for which the loan will be used. 2. Net Lending Parts of Euro-Dollar Loan Agreement: (Refer to SyCip handout of Sir)

Events of Default: events which would enable the lender to make the instrument/loan a demand loan Two Important Elements: 1. occurrence of event of default 2. acceleration of lender of the loan (without this, the term loan remains a term loan) Types of Default: 1. Payment: note that it is not usual to give grace period for principal; it’s usually just for the interest. 2. Covenant: breach of one of the affirmative or negative covenants. Materiality standard may be included. 3. Representation 4. Cross: breach in one agreement is deemed breach in another 5. Cross-Acceleration: breach in one agreement is not default in another, unless the default caused the acceleration of other loan. This is more beneficial to borrower. Illustration: There are two agreements, I and II where Bank A and Borrower B are parties. There was default in Agreement I. In Cross Default, there is also default in Agreement II. In Cross-Acceleration Default, there is only a grant to Bank to accelerate obligation in Agreement II. Dio v. Japor: Although usury interest is legally non-existent, lenders do not have blanket authority to charge unconscionable rates of interest. CBTC v. CA: while it may be acceptable for practical reasons given the fluctuating economic conditions for banks to stipulate that interest rate on a loan not be fixed and instead be made dependent upon prevailing market conditions, there should
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Banking with Raffy Morales 2nd Semester, 2007-2008

always be a reference rate upon which to peg such variable interest rate. : Marginal deposit must be subtracted from amount of loan before computation of interest and other charges. CBC v. CA: Maturity date of notes is not controlling as far as accrual of cause of action is concerned. What said date indicates is the time when the obligation matures, when payment would commence subject to presentation, notation, and cancellation of notes. Prescription begins to set in upon date of actual demand. Present Sharing Clause: this refers not only to actual payment but also to setoffs. Judgment Currency Clause: this clause is found in loans not denominated in PhP and provides that if the lender sues borrower and favorable judgment is rendered in PhP and upon conversion, lender is not fullypaid of the amount of loan, the borrower shall pay the shortfall. Closing Opinion: Issued by lender’s counsel to provide for qualifications regarding provisions in the loan agreement and apprise lender of possible issues which may arise regarding the same. Qualifications in Euro-Dollar Loan Agreement Closing Opinion: 1. exceptions to payment of scheduled installments due to bankruptcy, rehabilitation, etc. 2. possible requirements of BSP approval 3. exchange crisis provision in CB Act 4. conflict of laws provision in Civil Code 5. Rules of Court provisions on enforcement of foreign judgment

6. on pari passu provision 7. enforcement of obligations subject to equity 8. Corporation Code provision on foreign corporation’s right to sue 9. effect of injunctions and court orders to covenants’ effectivity 10. waiver of sovereign immunity 11. judgment currency clause (Don’t express any opinion due to res judicata issue) Why was CB closed? 1. high interest payment in Jobo bills 2. Jumbo loans: “syndicating” of debtors 3. Swap loans
US$ loan Foreign Lender PhP

FCDU PhP loan Filipino borrowe r

CB US$, fixed rate of forex with losses shouldered by CB

Loan Transfer & Participation No without recourse assignment or transfer of financial assets, Unless: 1. SEC registration Except: Government securities 2. Buyers are one of those specified in Section X238. Who are these buyers? Qualified buyers under Section 10.1 of SRC. Sir: Exception must include all other exempt securities. (Note: See SEC Memo 06-2007 for discussion of qualified buyer.) Participation v. Assignment • Participation: only beneficial title over asset is transferred.
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Banking with Raffy Morales 2nd Semester, 2007-2008

• Assignment: transfer of both legal and beneficial title over the asset.
In participation, participant may subparticipate its obligation and right, unless it is prohibited by the principal bank. Silent Participation: this occurs when the borrower is not notified of the participation. This is used to hide from borrower the fact that it(bank) lessens its exposure to show that there is full trust on borrower’s creditworthiness. There are two risks involved, to wit: 1) delivery risk of bank and 2) creditworthiness of borrower. Illustration: Bank loans out to Company A. X is participant. If A goes under, X cannot directly sue A since there is no privity of contract between them. Thus, X must rely on Bank to collect from A. Difference between Assignment of Note & Novation: In assignment, assignee merely steps into shoes, no change in instrument. It does not attract DST. In novation, whole PN is changed so there is new transaction and DST is collected. Other Issues on Loan Transaction: 1. BSP Approval: not required for PhP loans BSP registration is necessary for nonresidents if they open PhP accounts unless such is supported by inward forex remittance. 2. Payment of DST Rate of DST is .5% of loan. This is imposed wherever the loan is executed. If short term, it is prorated.

Upon execution of loan, pay DST 5 days of following month. It is arguable that DST is to be paid upon execution of PN as the loan agreement is a real contract for which the object need to be delivered for its perfection. Delivery takes place when PN has been issued. Re transfer of loan: apply Section 199(f), NIRC, so no DST if no change in tenor of obligation, ie silent participation. 3. Truth in Lending Act DBP v. Arcilla: Sir says this is a wrong decision in view of Section 6, paragraphs (a) and (b) of the Law. The SC rules contrary to clear provision of the law. 4. Statutes for protection of deposit transactions a. Secrecy of Bank Deposits Act (RA 1405) This covers PhP deposits and investments in government bonds. This includes bonds in foreign currency. Ejercito v. CA: trust placements were characterized as deposits as the money was deemed as for the boosting of economic development. The SC said that RA1405 is broad enough to cover trust department. Sir: The decision is very unconvincing. Take note that trust department has no depository character and when the law referred to investment, it meant investment in bonds. b. RA 6426, as amended This is for non-Php denominated deposits. CBC v. CA: a co-payee is deemed a codepositor. 3. Exclusions to Confidentiality Rule
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Banking with Raffy Morales 2nd Semester, 2007-2008

RA 1405, Section 2, cf: Subsection 55.1(b), GBL 4. Survivorship Agreement In view of survivorship agreements, no money is transferred to the estate so estate tax not required to be paid. Section 97 of the NIRC does not apply. These agreements have been upheld by the SC in Vitug v. CA and Rivera v. PBC. Moreover, using Mapang v. Gatmaytan, it has proven to be a fullproof estate device as not only depostis may be covered. Letters of Credit (L/C) & Trust Receipts (TR) • Letters of Credit: documents against payment usually used in transborder transactions Feati bank v. CA: 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, as the case may be, the money thus paid to the beneficiary Thus the rule of strict compliance. (Read original, good discussion.) Four Contracts in relation to L/C: 1. issuing bank and buyer 2. buyer and seller 3. issuing bank and confirming bank 4. confirming bank and seller PNB v. Pineda: In an L/C with TR transaction, the L/C represents the loan while the TR the security. The fact that goods have been delivered to the bank does not extinguish the

liability under the TR, foreclosure is necessary.

• Trust Receipts: security involved in
the issuance of letters of credit where the entrustor (bank) releases to the entrustee (borrower) goods for the latter to sell in order and such proceeds shall be used to pay obligation with entrustor.

Violation of trust receipts law is malum prohibitum. However, it is prosecuted in relation to estafa under Section 315(1)(b), RPC. Allied Bank v. Ordonez: SC expanded the coverage of trust receipts law. Even goods ultimately not for sale deemed included. (The doctrine was reiterated in DBP v. Prudential Bank) Sir: This is wrong. The law is clear and penal laws must be strictly construed. As a consequence, trust receipts have been used to burden or frighten debtors with possible penal indictment. Vintola v. IBAA: The transaction has two features: 1) loan feature and 2) security feature. Given the definition of security interest, it was necessary for the law in Section 10, PD 115 to provide that it is the entrustee who bears the loss. Pp. v. Nitafan: Acts involving the violation of the trust receipts agreement occurring after the enactment of PD 115 would make accused criminally liable for estafa pursuant to Section 13, PD 115. Sir: The statement in the case that provides that the title of the bank to the security is the one sought to be protected is WRONG. The TR is not separate from the L/C, it is but an accessory to the loan transaction.

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Banking with Raffy Morales 2nd Semester, 2007-2008

L/Cs are subject to .15% DST while loans are subject to .5%. Sir: I don’t know why BIR does not collect DST rate for loan when it has been stated several times that L/Cs are documents denoting loan agreements. How to avoid payment of higher DST when there is L/C and TR? Put the two in an Omnibus Agreement to comprise a single transaction. In such case, only higher DST is required to be paid. Who is the true owner of goods covered by TR? Let’s qualify. The bank-entrustor has legal title but the borrower-entrustee has beneficial title. Upon selling of the goods, the borrower-entrustee is authorized to pass both legal and beneficial title to buyer. Set-Off or Netting This refers to the concept of compensation in the Civil Code. This is a mode of extinguishment of obligations usually used in a hold-out. To be able to use this in a conventional manner, all requisites of legal compensation must exist. The ISDA Master Agreement is a good example where set-off or netting is used. This has been upheld in our jurisdiction. Comfort Letter Comfort letters are usually sent by a parent company for a subsidiary to the would-be lender bank that it will maintain fiscal integrity and/or controlling interest in the subsidiary. The loan secured by a comfort letter is an unsecured, clean loan. This is not a guarantee but rather more of a moral obligation imposed by parent

company unto itself to ensure that subsidiary will not default. Why issue a comfort letter? 1. parent company may be prohibited to issue guarantees under contract 2. comfort letters do not affect credit standing of parent company since it is not required to be footnoted in statement of assets and liabilities 3. company policy may prohibit the issuance of guarantees These letters may not be enforced in Philippine courts. But in case subsidiary defaults and parent does not help out, reputation of letter-issuer is affected. Thus, parent company usually make good their moral duties. Other Issues: • After-acquired Properties/ incurred Obligation Clauses After-

A stipulation in mortgage documents which seeks to cover properties (obligations) acquired (incurred) by mortgagor after execution of mortgage agreement. Is AIO valid in REM/ chattel mortgage? REM: Article 2091, CC suggests that even future properties are subject to mortgages. CM: No, in view of Section 5, Chattel Mortgage Law re affidavit of good faith. Is AAP valid in REM/ Chattel Mortgage? REM: Yes, in view of Article 2085, CC. CM: No, in view of Section 7 of Chattel Mortgage Law. However, there are exceptions to this. Torres v. Limjap: Spirit and intent of the Chattel Mortgage Law is to promote business and trade. Section 7 apparently contradicts after-acquired property clause. But this is not applicable to drug stores, bazaars, and
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Banking with Raffy Morales 2nd Semester, 2007-2008

all other stores in the nature of a revolving and floating business. PBTC v. Dahican Lumber: The case expanded the Torres v. Limjap doctrine. In all cases where the properties given as collateral are perishable or subject to inevitable wear and tear or were intended to be sold, or to be used – thus becoming subject to inevitable wear and tear, they shall be replaced with others to be thereafter acquired by the mortgagor. Is it possible to contractually agree on future properties which do not fall in the exception to be covered by afteracquired properties? Not really, a new chattel mortgage document must be executed to supplement first document. In project financing, two distinct schedules of present and future assets are required. A supplement needs to be submitted when the future assets have been acquired. Belgian Catholic Missionaries v. Magallanes Press: The increase of mortgage security becomes a new mortgage in itself, inasmuch as the original mortgage did not contain any stipulation in regard to the increase of the mortgage credit, and even if it did said that the increase would take effect only from the date of increase. A mortgage that contains a stipulation in regard to future advances in the credit will take effect only from the date the same are made and not from date of mortgage. ACME v. CA: A chattel mortgage can only cover obligations existing at the time the mortgage is constituted in view of good faith requirement under Section 5 of the law.

Sir’s Opinion: After incurred obligations may be secured by a promise which is actionable by way of specific performance to compel mortgagor to execute another mortgage document. Ong Liong Tiak v. Luneta Motors: Instruments of mortgage are binding while they subsist, not only upon the parties executing them but also upon those who later, by purchase or otherwise, acquire the properties referred to therein. The right of those who acquire cannot and should not be superior to that of the creditor who has in his favor an instrument of mortgage executed with the formalities of the law, in good faith, and without the least indication of fraud. (This case supports after incurred obligation clause although J. Dizon, the ponente, did not give a legal basis.) Prudential Bank v. Alviar: A dragnet clause in the first security instrument constituted a continuing offer by the borrower to secure further loans under the security of first instrument and that when lender accepted a different security, he did not accept offer. Lender must go after specific securities or collaterals first before going after the mortgage in the first security instrument. In case of shortfall, foreclose REM. Sir: You can contractually agree upon making the REM covered by the dragnet clause as primary security. Differentiating Pledge and Chattel Mortgage Pledge In pledge, the pledgor cannot be made answerable for deficiency after foreclosure since the principal obligation is extinguished. Thus,
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Banking with Raffy Morales 2nd Semester, 2007-2008

foreclosure of pledge must be your last remedy. Possible Solution: Subject pledge to foreign law. Chattel Mortgage: GR: Action for deficiency is allowed. (Chattel Mortgage Law, Garrido v. Tuason) Exception: Article 1484(3), Civil Code/ Recto Law. Magna Financial v. Colaina: A contract of chattel mortgage is the nature of a conditional sale of personalty. Sir: This is wrong. The characterization of CM as conditional sale has been abandoned since the enactment of Civil Code. See Cerra v. Rodriguez. Dacion en Pago with Repurchase as an Alternative to Foreclosure of Mortgage This set-up is used to do away with foreclosure proceeding. Effect of Stay Order on Enforcement of Security In Petition for Rehabilitation, the Court may issue a stay order which works as a standstill order prohibiting creditors to enforce their securities. Redemption Period GR: If bank is mortgagee and mortgage is REM, redemption period is one (1) year from date of sale (date of registration of certificate of sale) both in judicial and extrajudicial foreclosure. Exception: In extrajudicial foreclosure with the mortgagor being a juridical person, redemption period is three (3) months from date of sale. May a foreign-owned corporation be a mortgagee of real property? Yes, subject to limitations provided in RA 133, as amended. What are these limitations?

The corporation may foreclose but may not bid. It may only receive proceeds of foreclosure sale. The foreclosure must be in a judicial proceeding. Banco Filipino v. CA (2005): The right of redemption must be exercised within the specified time limit, which is one (1) year from date of registration of certificate of sale. In case of disagreement over the redemption price, the redemptioner may preserve his right of redemption through judicial action which in every case must be filed within the same one (1) year. Note: Redemption amount as provided in Section 47 of GBL is different from that in Rules of Court. This is to insure that the bank will not incur losses. Bukidnon Doctors v. MetroBank: In extrajudicial foreclosure, a writ of possession shall be issued as a matter of course upon proper motion after expiration of redemption period without the mortgagor exercising his right of redemption. Other Tax Matters A. Applicable Taxes 1. Income Tax 2. DST (.5% for mortgage) 3. Gross Receipt Tax

loan,

.2%

for

Omnibus Agreement: a contract similar to a syndicated loan which includes volumes of agreements Omnibus Agreement is a tax avoidance scheme since only the higher rate of DST is paid (ie, that of loan). Since guarantee is not subject to DST, it makes no sense to include the same to the agreement since it only raises the base for computation of DST.
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Banking with Raffy Morales 2nd Semester, 2007-2008

Problem: Pari Passu Representation violation in view of notarization of mortgage. Solution: There must be waiver of preference re notarization of mortgage agreement. Also, include a provision that the notarization does not apply to the loan. FCDU Tax Transaction with Resident Non-residents, OBU & local commercial banks including foreign bank branches Tax Status
10% Final Tax Exempt

ISDA: International Derivatives Association

Swaps

and

Types: 1. Option Contract a. Call Option: right, not obligation, of buyer to exercise option to buy PN within a specified period b. Put Option: right, not obligation, of seller to exercise option to sell PN within a specified period 2. Forward Transaction Illustration: Co. A will buy US$1M 6mths from now at PhP40=US$1 ForEx Rate in Situation 6mths PhP50=US$1 In the money PhP30=US$1 Out of the money; but in the market PhP40=US$1 At the money; exercise forward given assured amount 3. Currency Swap It is the simultaneous buying and selling of currencies involving spot (near leg) and forward (far leg) rates. A bank cannot engage in derivative transactions without necessary BSP license. Onapal v. CA: In ISDA, there is netting off of agreements which may give rise to gambling issues. In case there is but pretended delivery of goods involved in the transactions, the Civil Code provision prohibiting gambling is violated. FPIC v. CA: Cherry picking is not allowed in Philippine jurisdiction. The powers granted to the conservator, enormous and extensive as they are, cannot extend to the post facto repudiation of perfected transactions. Otherwise, they would infringe upon
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Originating Bank Structure This is otherwise known as fronting bank structure. It takes advantage of tax exemption status of foreign lenders. It is a form of tax avoidance. In this structure, a foreign bank acts as creditor on record while domestic bank participates silently.
US$

NLB

SMC

US$

PhP

FCDU

FCDU

Derivative Transactions This is a contract for differences. The income is derived from the difference between agreed settlement price and actual market price on the agreed settlement date. Derivative: financial asset the price of which is derived from value of other financial assets

Banking with Raffy Morales 2nd Semester, 2007-2008

non-impairment of contracts clause in Constitution. Securitization: See Securitization Act of 2004. This involves the transfer of credit risks in a true sale transaction to transform the receivables into assetbacked securities. Due Diligence: Two Types: 1. Prospectus: undertaken by underwriter in offer of securities 2. Securities: undertaken by buyer in insuring that property to be acquired is worth-buying Defense of due diligence in insuring omission or non-disclosure of material facts is but a mitigating circumstance. The SRC only recognizes knowledge defense. Certain Other Matters 1. AMLA (RA 9160) 2.Securities Regulation Code The Code is for consumer protection. The SEC no longer issues “license to sell”, rather it declares securities as defective to protect buyers. Redherring: prospecturs review of preliminary

GR: Every security must be registered. Exception: 1. exempt securities 2. exempt transactions 3. offshore offering of securities

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