LETTERS OF CREDIT Art.

567, Code of Commerce Letters of are those issued by one merchant to another or for the purpose of attending to a commercial transaction. Modern Definition : A letter of credit is an instrument by a bank in behalf of a customer authorizing a beneficiary to draw a draft/s which will be honored on presentation to the bank if drawn in accordance with the terms and conditions specified in the letter of credit. Underlying Idea of a Letter of Credit oughly at least !"# of importations are financed by letters of credit. $he underlying idea of a letter of credit is to ensure certainty of payment. %eller is assured of payment because the bank inter&enes and makes the commitment to pay. It is like your credit card. 'ou walk into a department store and they sell to you on credit although you(re a total stranger because you show your credit card) which means that the bank which issued the credit card tells the seller that it will pay the goods being bought.

Parties to a Letter of Credit *+, $he buyer who procures the letter of credit and obliges himself to reimburse the issuing bank upon receipt of the documents of title*., $he bank issuing the letter of credit) which undertakes to pay the seller upon receipt of the draft and proper documents of titles and to surrender the documents to the buyer upon reimbursement- and */, $he seller) who in compliance with the contract of sale ships the goods to the buyer and deli&ers the documents of title and draft to the issuing bank to reco&er payment. !o" are t#e res$ecti%e re&ations#i$s of t#e $arties 'o%erned( *+, Issuing bank and applicant/buyer/importer 0 $heir relationship is go&erned by the terms of the application and agreement for the issuance of the letter of credit by the bank. *., Issuing bank and beneficiary/seller/e1porter 0 $heir relationship is go&erned by the terms of the letter of credit issued by the bank. */, Applicant and beneficiary 0 $heir relationship is go&erned by the sales contract.

)o%ernin' R*&es *+, Articles "234"3. of the Code of Commerce *., Uniform Customs on 5ocumentary Credits issued by the International Chamber of Commerce Essentia& Conditions of a Letter of Credit $hat it be issued in fa&or of a definite person and not to order- and $hat it be limited to a fi1ed and specified amount) or to one or more undetermined amounts) but within a ma1imum the limits of which has to be stated e1actly. +#en does a &etter of credit ,ecome %oid( A letter of credit becomes &oid if the bearer of a letter of credit does not make use thereof within the period agreed upon with the drawer) or) in default of a period fi1ed) within 2 months) counted from its date) in any point in the 6hilippines) and within +. month anywhere outside thereof) it shall be &oid in fact and in law. I758687587C8 6 I7CI6L8 9 means that a bank) in determining compliance with the terms of a letter of credit is re:uired to e1amine only the shipping documents presented by the seller and is precluded from determining whether the main contract is actually accomplished or not 9 this arrangement assures the seller of prompt payment) independent of any breach of the main sales contract UL8 ;< %$ IC$ C;=6LIA7C8 9 means that the documents tendered by the seller or beneficiary must strictly conform to the terms of the letter of credit) 9 i.e.) they must include all documents re:uired by the letter of credit 9 $hus) a correspondent bank which departs from what has been stipulated under the letter of credit) as when it accepts a faulty tender) acts on its own risk and may not thereafter be able to reco&er from the buyer or the issuing bank) as the case may be) the money thus paid to the beneficiary. Common T-$es of Letters of Credit *+, e&ocable 4 can be cancelled or amended at any time before payment 4 it is intended to ser&e as a means of arranging payment but not as a guarantee of payment *., Irre&ocable 4 obligates the issuing bank to honor drafts drawn in compliance with the credit and 4 can be neither cancelled nor modified without the consent of all parties) including in particular the beneficiary/e1porter */, Confirmed 4 a letter of credit issued by one bank can be confirmed by another) in which case both banks are obligated to honor drafts drawn in compliance with the credit *>, Unconfirmed 4 is the obligation only of the issuing bank ?: @hy would an e1porter want a foreign bank(s letter of credit confirmed by a domestic bankA A: ;ne reason could be if he has doubts about the foreign bank(s ability to pay. %uch doubts may arise if the e1porter is unsure of the financial standing of the foreign bank) or if political or economic conditions in the foreign country are unstable. An underlying assumption is that a confirming bank is better able to Budge the credibility of a bank issuing a letter of credit than is a merchant. *", e&ol&ing 4 is one that is &alid for se&eral transactions o&er a gi&en period of time such as a week or a month 4 most are issued in re&ocable form *2, 7on4 e&ol&ing 4 is one that is &alid for one transaction only

*3, Cumulati&e 4 in which case undrawn amounts carry o&er to future periods *!, 7on4Cumulati&e 4 in which case any amount not used by the beneficiary during the specified period may not be drawn against in a later period *C, %tandby 4 is a bank4issued option on a loan in&ol&ing / parties: a. the bank issuing the credit) b. the party re:uesting for such issuance *otherwise known as the account party, and c. the beneficiary 4 the beneficiary has the right to trigger the loan option *referred to as taking down the loan, if the account party fails to meet its commitment) in which case the issuing bank disburses a specified sum to the beneficiary and books an e:ui&alent loan to its customers Important 6oints: A basic principle in letters of credit is that the bank deals with documents only . 9 Aside from certain conditions) the seller will be re:uired to submit certain documents together with the draft that he will draw in order to collect. 9 $hese documents shall be negotiated and agreed upon between the buyer and the seller. 9 7ormally) the seller would ha&e to submit together with the draft a bill of lading) packing list) commercial in&oice. 9 As banks deal with documents only) they are not :ualified to deal with goods. $hey(re not competent to deal with a thousand and one types of goods. $hey will act on the basis of the documents only. BPI vs De Reny Fabrics Gr No. L-24821 October 16, 1 !" <AC$%: 5e eny <abrics imported dyes. It applied for a letter of credit for its payment with D6I. Upon submission of the re:uired documents by the seller) D6I paid the seller. @hen the crates arri&ed) it was found that they did not contain dyes) but chalk. 5e eny <abric thus refused to pay. E8L5: 7oF D6I as a bank deals with documents only. %o long as the seller submitted the documents re:uired) the bank has to pay) and the customer has to reimburse the bank. $he bank will not guarantee that the goods as deli&ered by the seller comply with the terms and conditions of the contract.

Fraud in letters of credit 9 It(s possible to commit fraud because the seller can submit forged or false documents. 9 $o minimize the risk) the seller can be re:uired to submit a certification by a reputable sur&eyor who will say that he e1amined the goods and found them to be in accordance with the specifications. Letters of credit are interpreted strictly 9 81ample: @here a letter of credit was issued for the importation of noodles) and the in&oice said Gwoodle)H the bank can refuse to pay) because the bank doesn(t know. It might think that a woodle is some e1otic food coming from $imbuktu. Procedure when with discrepancy 9 %eller) to collect) will draw a bill of e1change) addressed to the bank which issued the letter of credit. $hen he will submit the documents re:uired. Dut typographical errors can happen. @hen the bank recei&es the documents) the bank will now forward that to the buyer. In the co&er letter) the bank will state the discrepancies that they disco&ered) and will ask the buyer if he agrees to wai&e the discrepancy. If the buyer wai&es) bank will pay. If he refuses) bank will not pay. #o$ac% case

=rs. Cora Iacob made nati&e bags. Duyer ordered 6/million worth of bags from her) to be sold to Eawaii. Duyer inspected the bags and found the :uality impressi&e. Duyer applied for a letter of credit to pay) which stated that among the documents to be submitted to collect was a commercial in&oice issued by GCoBac)H the name of =rs. Iacob(s business. Eowe&er in the in&oice) the buyer deliberately misspelled CoBac) by adding a Gk.H %o when =rs. Iacob submitted the in&oice) the bank refused to pay) claiming discrepancy. $he bank asked the buyer if it will wai&e the discrepancy. $he buyer refused. $he bank dishonored the letter of credit. Later) the buyer offered to pay only 6+million to =rs. Iacob. Red Clause 9 $his phrase means that the beneficiary can get payment in ad&ance although the goods being sold has not yet been deli&ered. 9 In the old days) the American companies would produce mink coats) so they would send their representati&es to China to buy the skins and fur from the hunters in the mountains. %ince these hunters only accepted cash) the manufacturers would apply for letters of credit) where the beneficiaries would be their representati&es who will buy the furs in the mountains. $he letter of credit would allow the beneficiary to collect the money in ad&ance although he has not yet shipped the skin and the fur. 9 So why red? Decause in those days) the said clause was written in red ink. $his is common in sugar trading. An American company will buy sugar here. Company will open a letter of credit with the trader as beneficiary) who will in turn buy from the sugar central. If the beneficiary fails to deli&er the goods) that(s Bust too bad. Duyer will ha&e to reimburse the bank. !er"reen Clause 9 $his phrase means that the bank commits to continue renewing the letter of credit. 9 So why e!er"reen? Decause it(s always fresh. <or instance) a foreign corporation not doing business in the 6hils sues here asking for a pro&isional remedy. $he court re:uired it to post a bond. %urety will go) teka muna# you$re not doin" business here% Supposin" we pay huh# how will we "et reimbursement from you?% &ou$re not here% 'e need security% (et a stand)by letter of credit% Dank will then issue the letter of credit) telling the surety) *k# if you submit a certification that you ha!e been held liable# to"ether with that draft# we will pay+ 7ow it(s possible that the case drags on beyond the e1piration date of the letter of credit. %urety will then say) ,ank# make an undertakin" that you will keep renewin" the letter of credit until the case has been finally decided% $he bank will then use an Ge&ergreen clause.H Feati Ban% vs. #& GR No. 42" &'ri( )", 1 1 <AC$%: $he letter of credit was issued in California) and <eati Dank was the correspondent bank) so it was the one who recei&ed the tele1 and notified the seller about the letter of credit. %eller sued <eati Dank. E8L5: 7oF $he notifying bank is not liable. It will only be Bointly and se&erally liable with the opening bank if it confirmed the letter of credit. A letter of credit may be re!ocable or irre!ocable+ 9 Usually the beneficiary insists that it should be an irre&ocable letter of credit for certainty of payment. 9 If re&ocable) which is &ery &ery rare) the bank can re&oke it anytime) without need of notifying the beneficiary. P*i(. +ir,inia -obacco &./inistration #ase <AC$%: 6hil $obaccco sold tobacco to someone) who paid through a domestic letter of credit. Duyer sued) and obtained a court order ordering the bank not to pay the said beneficiary) and instead turn o&er the proceeds to the buyer. E8L5: $hat order is &oidF It goes against the inherent nature of an irre&ocable letter of credit. Re!ol!in" letter of credit is automatically renewed+ 9 It may be re&ol&ing as to month) as when the bank e&ery month makes a&ailable 6"J)JJJ. It may also be re&ol&ing as to amount as when the bank makes a&ailable 6"J)JJJ) subBect to renewal upon consumption of the entire amount in a month. It may be cumulati&e) as when you used up only 6>J)JJJ of the alloted 6"J)JJJ for the month) in the ne1t month) another 6"J)JJJ shall be a&ailable) plus the amount which was not used up. A letter of credit is a contract with a stipulation for the benefit of a - rd person+ 9 It is a contract between the customer who applied for it and the bank which issued it for the benefit of the beneficiary of the letter of credit.

A letter of credit is a primary# absolute and unconditional obli"ation+ 9 It is not an accessory obligation.

P*i(a/(i0e #ase <AC$%: A couple took a housing loan from 6hilamlife. 6hilamlife) dissatisfied with the real estate mortgage e1ecuted by the spouses) re:uired them to get a stand4by letter of credit. Insular Dank of Asia in America issued the letter of credit) agreeing to pay upon presentment of 6hilamlife of a certification that the spouses had defaulted on the loan. 6hilamlife later drew a draft and submitted the certification. Insular Dank refused to pay the entire face amount of the letter of credit) claiming that it was told by the spouses that some payments ha&e been made. It thus insists that the said payments should be deducted from the amount due. E8L5: 7oF A letter of credit is not an accessory obligation. It is supposed to be independent of the underlying transaction which ga&e rise to its issuance. $hat(s why the bank will ha&e to pay e&en if there be a deficiency or defect in the goods. $he couple thus would ha&e to reimburse the bank. $heir remedy would be to run after 6hilamlife for reimbursement of o&erpayment. Dut meanwhile) they would ha&e to reimburse the bank. Ban% o0 &/erica vs. #& <AC$%: A 6hilippine company sold rope to a buyer in $hailand. $o pay for it) the buyer applied for a letter of credit from a bank in $hailand. $he correspondent bank in 6 was Dank of America and so it notified the seller here that a letter of credit had been opened in the $hai bank. $he seller thus drew a bill of e1change to collect) and then they indorsed it to Dank of America) which credited them the proceeds right away. Dut when the bill of e1change was presented) the $hai Dank dishonored it) saying that the letter of credit is fake. Dank of America sued the beneficiary to reco&er. E8L5: Dank of America liableF Under negotiable instruments law) the drawer warrants that the bill of e1change will be paid. .ar"inal /eposits 9 In the old days) the marginal deposits were one of the tools used by the Central Dank to reduce the demand for dollars. 9 <or e1ample) it was then re:uired that for e&ery letter of credit) marginal deposit of say /J# must be gi&en to the bank. Dut now) banks do not re:uire marginal deposits unless the financial standing of the customer is in bad shape. Stipulation on ,ank$s Lien on Applicant$s Property 9 @hene&er you apply for any transaction in the bank) there is a usually a stipulation in the application gi&ing the bank the right of lien on money or property you own which it may ha&e in its possession. PNB #ase <AC$%: %omebody applied for a letter of credit in the 6hil. 7ational Dank) ha&ing the said stipulation in the appliaction. 67D has the right to set4off or demand reimbursement with any deposit. Later) the applicant assigned his time deposit to a / rd party. @hen the amount fell due) the :uestion was who has a better right to collect the money) assignee or 67DA E8L5: 67DF It had lien on the deposit. $he assignee merely stepped into the shoes of the assignor) and so it must honor the lien.