LETTERS OF CREDIT

I. DEFINITION

Letters of credit are those issued by one merchant to another, or for the purpose of
attending to a commercial transaction. [Art.567, Code of Commerce]

A letter of credit is an instrument issued by a bank that guarantees that client's

ability to pay for imported goods or services, authorizing an individual or a firm to draw
drafts in the bank or on its correspondence for bank's account under certain conditions of
the credit. By definition, a letter of credit is a written instrument whereby the writer
requests or authorizes the addressee to pay money or deliver goods to a third person and
assumes responsibility for payment of debt therefore to the addressee. [Transfield v.
Luzon Hydro, G.R. No. 146717, November 22, 2004]

A letter of credit however, changes its nature as different transactions occur and if
carried to completion ends up as a binding contract between the issuing and honoring
banks without any regard or relation to the underlying contract or disputes between the
parties thereto.[Transfield v. Luzon Hydro, G.R. No. 146717, November 22,
2004]

NOTE:[ 24 A Words and Phrases 590, Permanent Edition, Cited in Transfield v. Luzon
Hydro, G.R. No. 146717, November 22, 2004]

By definition, a letter of credit is a written instrument whereby the writer requests

or authorizes the addressee to pay money or deliver goods to a third person and assumes
responsibility for payment of debt therefor to the addressee[See Uniform Customs
and Practice for Documentary Credits (UCPDC)]

A letter of credit is any arrangement, however named or described whereby a bank

(the 'Issuing Bank') acting at the request and on the instructions of a customer (the
'Applicant') or on its own behalf:
to make payment to or to the order of a third party (the 'Beneficiary'), or to accept
and pay bills of exchange (called Draft/s) drawn the Beneficiary, or
authorizes another bank to effect such payment, or to accept and pay such bills of
exchange [draft(s)],
authorizes another bank to negotiate, against stipulated document(s), provided that
the terms and conditions of the Credit are complied with.

II. REQUISITES OF LETTERS OF CREDIT

(1) Issued in favor of a definite person and not to order.
(2) Limited to a fixed and specified amount, or to one or more undetermined
amounts, but within a maximum the limits of which has to be stated exactly. Those
 which do not have one of these conditions shall be mere letters of recommendation.
(Art. 568, Code of Commerce)

III. GOVERNING LAW

Letters of Credits have long been and are still governed by the provisions of
the Uniform Customs and Practice for Documentary Credits of the International
Chamber of Commerce. [MWSS v. Daway, GR. No. 160732, June 21, 2004]
Articles 567 to 572 of the Code of Commerce on Letters of Credit
are obsolete. However, in the absence of any provision in the Code of
Commerce, commercial transaction shall be governed by the usages
and customs generally observed. (Sec. 2, Code of Commerce)
The Supreme Court pronounced that the observance of the U.C.P. is justified
by Article 2 of the Code of Commerce. Article 2 of the Code of Commerce
enunciates that in the absence of any particular provision in the Code of Commerce,
commercial transactions shall be governed by the usages and customs generally
observed. .[Bank of The Philippine Islands vs. De Reny Fabric Industries,
Inc., et al, G.R. No. L 24821, October 16, 1970]

IV. PURPOSE
The primary purpose of letters of credit is to substitute for, and therefore support,
the agreement of the buyer-importer to pay money under a contract or other agreement,
but it does not necessarily constitute as a condition for the perfection of such agreement.
[Reliance Commodities vs. Daewoo Industries, G.R. No. L-100831, December
17, 1993]
The use of credits, in commercial transactions, is to reduce the risk of non-payment
of the purchase price under the contract for the sale of goods. However, letters of credit
are also used in non-sale settings where they serve to reduce the risk of non-performance.
Generally, credits in the non-sale settings have come to be known as standby credits.
[Transfield v. Luzon Hydro, G.R. No. 146717, November 22, 2004]

V. NATURE

Letters of Credit is not an ordinary contract.

The letter of credit evolved as a mercantile specialty, and it is an entity unto itself.
The relationship between the beneficiary and the issuer of a letter of credit is not strictly
contractual, because both privity and a meeting of the minds are lacking, yet strict
compliance with its terms is an enforceable right.
 Letters of Credit is not a contract with stipulation pour autrui.

A letter of credit is not a third-party beneficiary contract, because the issuer must
honor drafts drawn against a letter regardless of problems subsequently arising in the
underlying contract. Since the bank's customers cannot draw on the letter, it does not
function as an assignment by the customer to the beneficiary.

Letter of Credit is not a contract of suretyship or guarantee

A letter of credit is not a contract of suretyship or guarantee, because it entails a

primary liability following a default.

Letter of Credit is not a negotiable instrument.

A letter of credit is not in itself a negotiable instrument, because it is not payable to

order or bearer and is generally conditional, yet the draft presented under it is often
negotiable.

A letter of credit is nothing more than a commitment by the issuer that the party in
whose favor it is issued and who can collect upon it, will have his credit against the
applicant of the letter duly paid in the amount specified therein. a letter of credit which
states that the bill shall be duly honored on presentation is not a contract between the
applicant and the issuing bank or between the applicant and the Central Bank. The
contract in which the applicant is a party and on which he can claim a violation of vested
rights is his application for the issuance of the letter of Credit [Climaco vs. Central
Bank of the Phils. Vol. *, Court of Appeals Reports 414, No. 34, 691-R, Sept.
16, 1965]

Letters of credit were developed for the purpose of insuring to a seller payment of a
definite amount upon the presentation of documents and is thus a commitment by the
issuer that the party in whose favor it is issued an who can collect upon it will have his
credit against the applicant of the letter, duly paid in the amount specified in the letter.
They are effect absolute undertakings to pay the money advanced or the amount for which
credit is given on the faith of the instrument. They are primary obligations and not
accessory contracts and while they are security arrangements, they are not converted
thereby into contracts of guaranty. What distinguishes letters of credit from other
accessory contracts, is the engagement of the issuing bank to pay the seller once the draft
and other required shipping documents are presented to it. They are definite undertakings
to pay at sight once the documents stipulated therein are presented. [MWSS v. Daway,
GR. No. 160732, June 21, 2004]

In commercial transactions, a letter of credit is a financial device developed by

merchants as a convenient and relatively safe mode of dealing with sales of goods to
satisfy the seemingly irreconcilable interest of a seller, who refuses to part with his goods
before he is paid, and a buyer, who wants to have control of the goods before paying.
[Bank of America v. Court of Appeals, G.R. 105395, December 10, 1993, citing
William S. Shaterian, Export-Import Banking: The instruments and
Operations Utilized by American Exporters and Importers and Their Bank in
Financing Foreign Trade, 284-374 (1947)]

A letter of credit, does not involve a specific appropriation of money in favour of the
beneficiary. It only signifies that the beneficiary be able to draw funds upon the letter of
credit up to the designated amount specifically reserved or has been held in trust. [Feati
Bank v. Court of Appeals, G.R. No. 94209, April 30, 1991]

VI. DURATION

If the holder of a letter of credit does not make use thereof:

1) within the period agreed upon with the drawer of the same; or
2) If none is fixed:
a. Six (6) months from its date in any point in the Philippines; or
b. Twelve (12) months if used abroad.[Art.572, Code of Commerce]

VII. INDISPENSABLE INTERTWINED CONTRACT RELATIONSHIP

The three (3) distinct but intertwined contract relationships that are indispensable in a
letter of credit transaction are:

1) Between the applicant/buyer/importer and the

beneficiary/seller/exporter (Contract of Sale)

The applicant/buyer/importer is the one who procures the letter of credit

and obliges himself to reimburse the issuing bank upon receipt of the documents of
title, while the beneficiary/seller/exporter is the one who in compliance with the
contract of sale ships the goods to the buyer and delivers the documents of title and
draft to the issuing bank to recover payment for the goods. Their relationship is
governed by the contract of sale.

2) Between the issuing bank and the beneficiary/seller/exporter (the

letter of credit proper)
 The issuing bank is the one that issues the letter of credit and undertakes to
pay the seller upon receipt of the draft and proper documents of title and to
surrender the documents to the buyer upon reimbursement. Their relationship is
governed by the terms of the letter of credit issued by the bank.

The bank obligates itself to pay the seller or to the order of the seller (that is,
it will honor the bills or drafts drawn by the seller) after presentation to the bank of
tender documents stipulated upon, which normally includes document of title.

3) Between the issuing bank and the applicant/buyer/importer (the

contract of the buyer with the issuing bank)

Their relationship is governed by the terms of the application and agreement

for the issuance of the letter of credit by the bank.

The bank agrees to issue the letter of credit in favor of the seller subject to
reimbursement or payment by the buyer of whatever paid to the seller plus proper
consideration agreed upon by the parties.

VIII. TYPES OF LETTERS OF CREDIT

A. AS TO THE TYPE OF THE MAIN CONTRACT

(1) Commercial L/C The main transaction involves a contract of sale. The
credit is payable upon the presentation by the seller of documents that show he has
taken affirmative steps to comply with the sales agreement. The beneficiary of a
commercial credit must demonstrate by documents that he has performed his
contract [Transfield v. Luzon Hydro, G.R. No. 146717, November 22,
2004]
(2) Standby L/C Used in non-sale settings. The credit is payable upon
certification of a party's nonperformance of the agreement. The creditor-beneficiary
of the standby credit must certify that the debtor-applicant has not performed the
principal obligation. [Transfield v. Luzon Hydro, G.R. No. 146717,
November 22, 2004]
A standby Letter of Credit is a security arrangement for the
performance of certain obligations. It can be drawn against only if another business
transaction is not performed of certain obligations. It may be issued in lieu of a
performance bond. It is an absolute undertaking to pay the money advanced or the
amount for which credit is given on the faith of the instrument. [Insular Bank of
Asia vs. IAC, G.R. 74834, November 17, 1988]

Differences between commercial and standby credits:

 1. Commercial credits involve the payment of money under a contract of sale. Such
credit become payable upon presentation by the seller-beneficiary of documents
that shows he has taken affirmative steps to comply with the sales agreement. In
the standby credit, the credit is payable upon certification of a partys non-
performance of the agreement. The documents that accompany the beneficiarys
draft tend to show that the applicant has not performed.

2. The beneficiary of a commercial credit must demonstrate by documents that he

has performed his contract. The beneficiary of the standby credit must certify
that his obligor has not performed the contract.

B. AS TO REVOCABILITY
(1) Revocable L/C One which can be revoked by the issuing bank without the
consent of the buyer and seller.
(2) Irrevocable L/C a definite undertaking on the part of the issuing bank and
constitutes the engagement of that bank to the beneficiary and bona fide holders of
drafts 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. One
which the issuing bank cannot revoke without the consent of the buyer and seller
[Feati Bank and Trust Co. v. CA, 1991]

C. AS TO THE OBLIGATION ASSUMED BY CORRESPONDENT BANK

(1) Unconfirmed L/C One which continues to be the obligation of the issuing
bank
(2) Confirmed L/C One which is supported by the absolute assurance to the
beneficiary that the confirming bank will undertake the issuing bank's obligation as
its own according to the terms and conditions of the credit (Feati Bank and Trust
Co. v. CA, 1991)

IX. PARTIES TO A LETTER OF CREDIT

There would be at least three (3) parties to a letter of credit:
1. Buyer/Exporter/Account Party - one who procures the letter of credit and
obliges himself to reimburse the issuing bank upon receipt of documents of title.

2. Issuing Bank The bank which undertakes:

1) to pay the seller upon receipt of the draft and proper documents of title; and
 2) to surrender the documents to the buyer upon reimbursement. The
obligation of the issuing bank to pay the seller is direct, primary, absolute,
definite and solidary with the buyer, in the absence of stipulation in the letter of
credit.[Metropolitan Waterworks and Sewerage v. Daway (2004)]

Obligations of Issuing Bank:

1. A letter of credit constitutes the primary obligation, and not merely an

accessory contract of the issuing bank, separate from the underlying contract
that it may support. [Insular Bank of Asia and America v. Intermediate
Appellate Court, G.R. No. 74834, November 17, 1988]

2. Obligations of the banks issuing letters of credit is solidary with that of the
person or entity requesting for its issuance, the same being the direct, primary,
absolute, and definite undertaking to pay the beneficiary upon the presentation
of the set of documents required therein. [Metropolitan Waterworks and
Sewerage System (MWSS) v. Daway, G.R. No. 160732, June 21, 2004]

3. Seller/Importer/Beneficiary. one who ships the goods to the buyer in

compliance with a contract of sale and delivers the documents of title and draft
to the issuing bank to recover payment.

Right of the Beneficiary The beneficiary, after complying with the contract of
sale with the buyer of the goods, can recover payment by drawing drafts against
the letters of credit. [See Bank of America, NT &SA v. Court of Appeals,
G.R. No. 105395, December 10, 1993]

Depending on the transaction, the number of parties to the letter of credit may be
increased. Thus, the different types of correspondent banks:

4. Advising/Notifying Bank the bank which conveys to the seller the

existence of the credit. The bank assumes no liability except to notify and/or
transmit to the seller the existence of the letter of credit. A notifying bank is not
a privy to the contract of sale between the buyer and the seller, its relationship is
only with that of the issuing bank and not with the beneficiary to whom he
assumes no liability.

The bank may suggest to the seller its willingness to negotiate, but this fact
alone does not imply that the notifying bank promises to accept the draft drawn
under the documentary credit. [Feati Bank and Trust Co. v. CA, (1991)]

5. Confirming Bank - the bank which lends credence to the letter of credit
issued by a lesser known issuing bank.

The bank assumes a direct obligation to the seller and its liability is a primary
 one as if the bank itself had issued the letter of credit. [Feati Bank and Trust
Co. v. CA, (1991)]

6. Negotiating Bank the bank which discounts the draft presented by the
seller.

The bank buys or discount a draft under the letter of credit. Its liability is
dependent upon the stage of negotiation. If before negotiation, it has no
liability with respect to the seller but after negotiation, a contractual
relationship will then prevail between the negotiating bank and the seller.
[Feati Bank and Trust Co. v. CA, (1991)]

7. Paying Bank the bank which undertakes to encash the drafts drawn by the
seller.

What is the participation of a confirming and advising bank?

The Advising Bank is the bank in the country of the beneficiary which
communicates to the beneficiary the notice of the credit issued by the issuing
bank

The Confirming Bank- is the bank that undertakes that the letter of credit
will be fully paid.

Usually the confirming bank is also the advising bank, otherwise it is utilized
to lend credence to the letter of credit issued by a lesser known issuing bank
and is directly liable to the beneficiary.

X. BASIC PRINCIPLES OF LETTERS OF CREDIT

Doctrine of Strict Compliance

The strict compliance rule in a letter of credit transaction means that the
documents tendered by the seller or beneficiary must strictly conform to the
terms of the letter of credit, i.e., they must include all documents required by
the letter of credit.

The Doctrine of Strict Compliance provides a settled rule in commercial

transactions involving letters of credit stating that the documents tendered by the
seller/beneficiary must strictly conform to the terms of the letter of credit. The
tender of documents bank which departs from what has been stipulated under the
letters 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, 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-seller. [See Feati
Bank v. CA, GR. No. 94209, April 30, 1991]
The issuing bank must see to it that the terms of the letters of credit are
strictly complied with. There is no room in documentary transactions for the
doctrine of substantial performance. All of the obligations of all the parties must be
measured by the documents tendered, and must not encompass anything outside
the four corners of the documents. And, the documents tendered must be perfect
and strictly comply with the letter of credit, as issued.

Independence Principle
The independence principle in a letter of credit transaction means that a bank,
in determining compliance with the terms of a letter of credit is required to
examine only the shipping documents presented by the seller and is precluded
from determining whether the main contract is actually accomplished or not.
This arrangement assures the seller of prompt payment, independent of any
breach of the main sales contract

Under the independence principle, the obligation under the letter of credit is
independent of the related and originating (usually a contract of sale). In brief of
credit is separate and distinct from the underlying transaction.
Credits, by their nature, are separate transactions from the sales or other
contract(s) on which they may be based and banks are in no way concerned with or
bound by such contract(s), even if any reference whatsoever to such contract(s) is
included in the credit. Consequently, the undertaking of a bank to pay, accept and
pay draft(s) or negotiate and/or fulfil any other obligation under the credit is not
subject to claims or defences by the applicant resulting from his relationships with
the issuing bank or the beneficiary. A beneficiary can in no case avail himself of the
contractual relationship existing between the banks or between the applicant and
the issuing bank.
This principle assures the seller or the beneficiary 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.
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,
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 of standing of the consignor, the carriers, or the insurers of
the goods, or any other person whomsoever.[Bank of The Philippine Islands
vs. De Reny Fabric Industries, Inc., et al, G.R. No. L 24821, October
16, 1970]
Who can invoke the Independence Principle?

The issuing bank can invoke the independence principle but it is not only
party who can do so. 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.
It cannot be reasonably argued that only the issuing bank may invoke the
principle. To say that the independence principle may only be invoked by the
issuing banks would render nugatory the purpose of 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 entitled to the proceeds of the letter of credit is appropriately called
beneficiary.[Transfield v. Luzon Hydro, G.R. No. 146717, November 22,
2004]

Fraud Exception Principle

The fraud exception maintains that despite the banks unconditional obligation
to pay the seller upon presentation of the required documents, the issuing bank
is not bound to pay when there has been fraud by the seller. The test is whether,
standing in the shoes of the paying bank at the time of payment, the fraud was
clear and obvious. If [the] fraud was clear and obvious, the bank pays the
beneficiary at its own peril and it is not entitled to reimbursement. But if [the]
fraud is not clear and obvious, then it is not for a bank to question why the
parties involved had chosen to conduct their business in any particular way.
Fraud is an exception to the independence principle applicable to letters of
credit, which provides that the letter of credit is separate and distinct from the
underlying transaction from which the letter of credit arose. Under this exception,
where there is fraud or forgery in the underlying transaction or the tender of
documents, payment of the credit may be enjoined, and the issuing bank is not
obliged to pay. [Transfield v. Luzon Hydro, G.R. No. 146717, November
22, 2004]
The independent nature of a letter of credit may be:
1. Independent in toto where credit is independent from the justification aspect
and is a separate obligation from the underlying agreement like for instance a
typical standby; or
2. Independence may only be as to the justification aspect like in commercial
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 purposes of the
credit the payment of it constitute fraudulent abuse of the credit. Professor
Dolan opines that the untruthfulness of a certificate accompanying a demand for
payment under a standby credit may qualify as fraud sufficient to support an
injunction against payment.
The remedy for fraudulent abuse is an injunction. However, injunction
should not be granted unless:
a) There is clear proof of fraud;
b) The fraud constitutes fraudulent abuse of the independence purpose
of the letter of credit and not only fraud under the main agreement; and
c) Irreparable injury might follow if injunction is not granted or the
recovery of damages would be seriously damaged.

[See Transfield v. Luzon Hydro, G.R. No. 146717, November 22, 2004]

Prescriptive Period Since the cause of action arises from a contract and
not from solutio indebiti, the prescriptive period is ten (10) years. [National
Commercial Bank of Saudi Arabia v. Court of Appeals, G.R. No. 124267,
January 31, 2003]

Protection of Innocent Party

It is also important to emphasize that the Uniform Commercial Code seeks
to protect innocent parties. Hence, despite the presence of fraud or forgery, the
Code provides that,
(1) the issuer shall honor the presentation, if honor is demanded by
(a) a nominated person who has given value in good faith and without notice
of forgery or material fraud,
(b) a confirmer who has honoured its confirmation in good faith,
(c) a holder in due course of a draft drawn under the letter of credit which
was taken after acceptance by the issuer or nominated person, or
(d) an assignee that was taken for value and without notice of forgery or
material fraud after the obligation was incurred by the issuer or nominated person;
and
(2) the issuer, acting in good faith may honor or dishonour the presentation
in any other case. [Section 5-109, (a), Uniform Commercial Code]
What is the effect of a stay order on beneficiary?
In the case of MWSS v. Hon. Daway, 432 SCRA 599, it was held that the beneficiary
of a stand-by letter of credit can draw on the letter of credit even if the obligor is under a
corporate rehabilitation stay order because the prohibition under the rules is on the
enforcement of claims against the debtor, guarantors or sureties of the debtor whose
obligations are not solidary with the debtor.

What is the effect of payment on an expired letter of credit?

In the case of Rodzssen Company Inc. v. Far East Bank and Trust Company, 357
SCRA 618 it was held that an issuing bank which paid the beneficiary of an
expired letter of credit can recover payment from the applicant who obtained
the goods from the beneficiary to prevent unjust enrichment.
LETTERS OF CREDIT CASES
1. G.R. No. 116996, December 02, 1999
ANDRES VILLALON, PETITIONER, VS. COURT OF APPEALS, INSULAR BANK
OF ASIA AND AMERICA, NOW PHILIPPINE COMMERCIAL INTERNATIONAL
BANK, RESPONDENTS.

2. G.R. No. 146717, November 22, 2004

TRANSFIELD PHILIPPINES, INC., PETITIONER, VS. LUZON HYDRO
CORPORATION, AUSTRALIA AND NEW ZEALAND BANKING GROUP LIMITED
AND SECURITY BANK CORPORATION, RESPONDENTS.

3. G.R. NO. 117913, February 01, 2002

CHARLES LEE, CHUA SIOK SUY, MARIANO SIO, ALFONSO YAP, RICHARD
VELASCO AND ALFONSO CO, PETITIONERS, VS. COURT OF APPEALS AND
PHILIPPINE BANK OF COMMUNICATIONS, RESPONDENTS.
G.R. NO. 117914. February 1, 2002
MICO METALS CORPORATION, PETITIONER, VS. COURT OF APPEALS AND
PHILIPPINE BANK OF COMMUNICATIONS, RESPONDENTS.

4. G.R. No. 187268, September 04, 2013

JOVITO C. PLAMERAS, PETITIONER, VS. PEOPLE OF THE PHILIPPINES,
RESPONDENT

5. G.R. No. 115997, November 27, 2000

SECURITY BANK & TRUST COMPANY, PETITIONER, VS. COURT OF APPEALS
AND TRANSWORLD ENTERPRISES AND TURIANO SAN ANDRES,
RESPONDENTS

6. G.R. No. 128661, August 08, 2000

PHILIPPINE NATIONAL BANK/NATIONAL INVESTMENT DEVELOPMENT
CORPORATION, PETITIONERS, VS. THE COURT OF APPEALS, CHINA
BANKING CORPORATION, RESPONDENTS

7. G.R. No. 122539, March 04, 1999

JESUS V. TIOMICO, PETITIONER, VS. THE HON. COURT OF APPEALS
(FORMER FIFTH DIVISION AND PEOPLE OF THE PHILIPPINES,
RESPONDENT

8. G.R. NO. 161865, March 10, 2005

LAND BANK OF THE PHILIPPINES, PETITIONER, VS. MONETS EXPORT AND
MANUFACTURING CORPORATION, SPOUSES VICENTE V. TAGLE, SR. AND
MA. CONSUELO G. TAGLE, RESPONDENTS
9. G.R. No. 187919, April 25, 2012
RAFAEL H. GALVEZ AND KATHERINE L. GUY, PETITIONERS, VS. HON.
COURT OF APPEALS AND ASIA UNITED BANK, RESPONDENTS.

G.R. NO. 187979

ASIA UNITED BANK, PETITIONER, VS. GILBERT G. GUY, PHILIP LEUNG,
KATHERINE L. GUY, RAFAEL H. GALVEZ AND EUGENIO H. GALVEZ, JR.,
RESPONDENTS.

G.R. NO. 188030

GILBERT G. GUY, PHILIP LEUNG AND EUGENIO H. GALVEZ, JR.,
PETITIONERS, VS. ASIA UNITED BANK, RESPONDENT

10. G.R. No. 126204, November 20, 2001

NATIONAL POWER CORPORATION, PETITIONER, VS. PHILIPP BROTHERS
OCEANIC, INC., RESPONDENT

11. G.R. NO. 143788, September 09, 2005

DANFOSS, INC., PETITIONER, VS. CONTINENTAL CEMENT CORPORATION,
RESPONDENT

12. G.R. No. 145578, November 18, 2005

JOSE C. TUPAZ IV AND PETRONILA C. TUPAZ, PETITIONERS, VS. THE COURT
OF APPEALS AND BANK OF THE PHILIPPINE ISLANDS, RESPONDENTS

13. G.R. No. 149193, April 04, 2011

RICARDO B. BANGAYAN, PETITIONER, VS. RIZAL COMMERCIAL BANKING
CORPORATION AND PHILIP SARIA, RESPONDENTS

14. G.R. No. 159622, July 30, 2004

LANDL & COMPANY (PHIL.) INC., PERCIVAL G. LLABAN AND MANUEL P.
LUCENTE, PETITIONERS, VS. METROPOLITAN BANK & TRUST COMPANY,
RESPONDENT

15. G.R. No. 167805, November 14, 2008

ARNOLD STA. CATALINA, PETITIONER, VS. PEOPLE OF THE PHILIPPINES,
RESPONDENT

16. G.R. No. 162575, December 15, 2010

BEATRIZ SIOK PING TANG, PETITIONER, VS. SUBIC BAY DISTRIBUTION,
INC., RESPONDENT

17. G.R. No. 116863, February 12, 1998

KENG HUA PAPER PRODUCTS CO. INC., PETITIONER, VS. COURT OF
APPEALS; REGIONAL TRIAL COURT OF MANILA, BR. 21; AND SEA-LAND
SERVICE, INC., RESPONDENTS

18. G.R. NO. 151895, February 16, 2005

BANK OF COMMERCE, PETITIONER, VS. TERESITA S. SERRANO,
RESPONDENT
19. G.R. NOS. 160577-94, December 16, 2005
GREGORIO SINGIAN, JR., PETITIONER, VS. THE HONORABLE
SANDIGANBAYAN (THIRD DIVISION), THE PEOPLE OF THE PHILIPPINES,
AND THE PRESIDENTIAL COMMISSION ON GOOD GOVERNMENT,
RESPONDENTS

20.G.R. No. 142381, October 15, 2003

PHILIPPINE BLOOMING MILLS, INC., AND ALFREDO CHING, PETITIONERS,
VS. COURT OF APPEALS AND TRADERS ROYAL BANK, RESPONDENTS

21. G.R. No. 170633, October 17, 2007

MCC INDUSTRIAL SALES CORPORATION, PETITIONER, VS. SSANGYONG
CORPORATION, RESPONDENT

22. G.R. No. 187919, February 20, 2013

RAFAEL H. GALVEZ AND KATHERINE L. GUY, PETITIONERS, VS. HON.
COURT OF APPEALS AND ASIA UNITED BANK, RESPONDENTS.

23. G.R. No. 157309, March 28, 2008

MARLOU L. VELASQUEZ, PETITIONER, V.S. SOLIDBANK CORPORATION,
RESPONDENT

24. G.R. No. 137378, October 12, 2000

PHILIPPINE ALUMINUM WHEELS, INC., PETITIONER, VS. FASGI
ENTERPRISES, INC., RESPONDENT

25. G.R. No. 109376, January 20, 2000

PANFILO O. DOMINGO, PETITIONER, VS. THE SANDIGANBAYAN (SECOND
DIVISION) AND THE PEOPLE OF THE PHILIPPINES, RESPONDENTS

26. G.R. No. 94209 April 30, 1991

FEATI BANK & TRUST COMPANY (now CITYTRUST BANKING
CORPORATION), petitioner, vs. THE COURT OF APPEALS, and BERNARDO
E. VILLALUZ, respondents.

27. G.R. No. 74886 December 8, 1992

PRUDENTIAL BANK, petitioner, vs. INTERMEDIATE APPELLATE COURT,
PHILIPPINE RAYON MILLS, INC. and ANACLETO R. CHI, respondents

28.G.R. No. 105395 December 10, 1993

BANK OF AMERICA, NT & SA, petitioners, vs. COURT OF APPEALS, INTER-
RESIN INDUSTRIAL CORPORATION, FRANCISCO TRAJANO, JOHN DOE
AND JANE DOE, respondents

29. G.R. No. L-24821 October 16, 1970

BANK OF THE PHILIPPINE ISLANDS, plaintiff-appellee, vs. DE RENY FABRIC
, INC., AURORA T. TUYO and AURORA CARCERENY alias AURORA C.
GONZALES, defendants-appellants

30.G.R. No. 186063, January 15, 2014

 PHILIPPINE NATIONAL BANK, PETITIONER, VS. SAN MIGUEL
CORPORATION, RESPONDENT

31. G.R. No. 183486 , February 24, 2016

THE HONGKONG & SHANGHAI BANKING CORPORATION, LIMITED,
Petitioner, vs.
NATIONAL STEEL CORPORATION and CITYTRUST BANKING
CORPORATION (NOW BANK OF THE PHILIPPINE ISLANDS), Respondents

32. G.R. No. L-100831 December 17, 1993

RELIANCE COMMODITIES, INC., petitioner, vs.DAEWOO INDUSTRIAL CO.,
LTD., respondent.

33. G.R. No. 109087 May 9, 2001

RODZSSEN SUPPLY CO. INC., petitioner, vs. FAR EAST BANK & TRUST CO.,
respondent.

Bar Exam Question and Suggested Answer 1990-2013

No.I. Letter of Credit (2012)

ABC Company filed a Petition for Rehabilitation with the Court. An Order was
issued by the Court, (1) staying enforcement of all claims, whether money or otherwise
against ABC Company, its guarantors and sureties not solidarily liable with the company;
and (2) prohibiting ABC Company from making payments of its liabilities, outstanding as
of the date of the filing of the Petition. XYC Company is a holder of an irrevocable Standby
Letter of Credit which was previously procured by ABC Company in favor of XYC
Company to secure performance of certain obligations. In the light of the Order issued by
the Court.

(b) Explain the nature of Letters of Credit as a financial devise. (5%)

ANSWER:
A letter of credit is a financial device developed by merchants as a convenient and
relatively safe mode of dealing with sales of goods to satisfy the seemingly irreconcilable
interests of a seller, who refuses to part with his goods before he is paid, and a buyer, who
wants to have control of the goods before paying. To break the impasse, the buyer may be
required to contract a bank to issue a letter of credit in favor of the seller so that, by virtue
of the letter of credit, the issuing bank can authorize the seller to draw drafts and engage
to pay them upon their presentment simultaneously with the tender of documents
required by the letter of credit. The buyer and the seller agree on what documents are to
be presented for payment, but ordinarily they are documents of title evidencing or
attesting to the shipment of the goods to the buyer. Once the credit is established, the
seller ships the goods to the buyer and in the process secures the required shipping
documents or documents of title.
To get paid, the seller executes a draft and present it together with the required
documents to the issuing bank. The issuing bank redeems draft and pays cast to the seller
if it finds that the documents submitted by the seller conform with what the letter of credit
requires. The bank then obtains possession of the documents upon paying the seller. The
transaction is completed when the buyer reimburses the issuing bank and acquires the
documents entitling him to the goods. Under this arrangement, the seller gets paid only if
he delivers the documents of title over the goods, while the buyer acquires the said
documents and control over the goods only after reimbursing the bank. (Bank of
America NT & SA v. CA, et al., G.R. No. 105395, December 10,1993)
However, letters of credit are also used in non-sale settings where they serve to reduce the
risk of nonperformance. Generally, letters of credit in non-sale settings have come to be
known as standby letters of credit. (Transfield Philippines, Inc. v. Luzon Hydro
Corporation, et al., G.R. No. 146717, November 22,2004)

No.XVII. Independence Principle (2010)

The Supreme Court has held that fraud is an exception to the independence
principle governing letters of credit. Explain this principle and give an example of how
fraud can be an exception. (3%)

ANSWER:

The independence principle posits that the obligations of the parties to a letter of
credit are independent of the obligations of the parties to the underlying transaction.
Thus, the beneficiary of the letter of credit, which is able to comply with the documentary
requirements under the letter of credit, must be paid by the issuing or confirming bank,
notwithstanding the existence of a dispute between the parties to the underlying
transaction, say a contract of sale of goods where the buyer is not satisfied with the quality
of the goods delivered by the seller.

The Supreme Court in Transfield Philippines, Inc. v. Luzon Hydro

Corporation, 443 SCRA 307 (2004) for the first time declared that fraud is an
exception to the independence principle. For instance, if the beneficiary fraudulently
presents to the issuing or confirming bank documents that contain material facts that, to
his knowledge, are untrue, then payment under the letter of credit may be prevented
through a court injunction.

No.I. Letter of Credit; Liabilities of a Confirming and Notifying Bank (2008)

 X Corporation entered into a contract with PT Construction Corp. for the latter to
construct and build a sugar mill with six (6) months. They agreed that in case of delay, PT
Construction Corp. will pay X Corporation P100,000 for every day of delay. To ensure
payment of the agreed amount of damages, PT Construction Corp. secured from Atlantic
Bank a confirmed and irrevocable letter of credit which was accepted by X Corporation in
due time. One week before the expiration of the six (6) month period, PT Construction
Corp. requested for an extension of time to deliver claiming that the delay was due to the
fault of X Corporation. A controversy as to the cause of the delay which involved the
workmanship of the building ensued. The controversy remained unresolved. Despite the
controversy, X Corporation presented a claim against Atlantic Bank by executing a draft
against the letter of credit.

(A) Can Atlantic Bank refuse payment due to the unresolved controversy?
Explain. (3%)

ANSWER:

No, Atlantic Bank cannot refuse payment to the unresolved controversy between
the two companies. The Bank is solidarily liable to pay based on the terms and conditions
of the Letter of Credit. In FEATI Bank v. Court of Appeals, G.R. No.94209, 30 April 1991,
the Court held that an irrevocable letter of credit is independent of the contract between
the buyer-applicant and the seller-beneficiary.

(B) Can X Corporation claim directly from PT Construction Corp.? Explain.

(3%)

Yes, X Corporation can claim directly from PT Construction Corp. The irrevocable
letter of credit was merely a security arrangement that did not replace the main contract
between the two companies. In FEATI Bank c. CA, G.R. No. 94209, 30 April 1991, opening
a letter of credit does not involve a specific appropriation of money in favor of the
beneficiary. It only signifies that the beneficiary may draw funds up to the designated
amount. It does not mean that a particular sum of money has been specifically reserved of
held in trust.

Letter of Credit; Mortgage (2005)

Ricardo mortgaged his fishpond to AC Bank to secure a P1 Million loan. In a

separate transaction, he opened a letter of credit with the same bank for $500,000.00 in
favor of HS Bank, a foreign bank, to purchase outboard motors. Likewise, Ricardo
executed a Surety Agreement in favor of AC Bank.

The outboard motors arrived and were delivered to Ricardo, but he was not able to pay the
purchase price thereof. a) Can AC Bank take possession of the outboard motors?
Why?
b) Can AC Bank also foreclose the mortage over the fishpond? Explain. (5%)

Answer:

a) No, for AC Bank has no legal standing, much less a lien, on the outboard motors.
Insofar as AC bank is concerned, it has privity with the person of Ricardo under Surety
Agreement, and a lien on the fishpond based on the real estate mortgage constituted
therein.

b) Yes, but only to enforce payment of the principal loan of P1 Million secured by the real
estate mortgage on the fishpond.

Letters of Credit; Liability of a Notifying Bank (2003)

a) What liability, if any is incurred by an advising or notifying bank in a letter of credit
transaction?
b) Bravo Bank received from Cisco Bank by registered mail an irrevocable letter of credit
issued by Delta Bank for the amount of Y Company in the amount of US$10,000,000 to
cover the sale of canned fruit juices. The beneficiary of the letter of credit was x
Corporation which later on partially availed itself of the letter of credit by submitting to
Bravo Bank all documents relative to the shipment of the cans of fruit juices. Bravo Bank
paid X Corporation for its partial availment. Later, however, it refused further availment
because of suspicions of fraud being practiced upon it and, instead, sued X Corporation to
recover what it had paid the latter. How would you rule if you were the judge to decide the
controversy? (6%)
Answer:
a) It incurs no liability unless it is also the negotiating bank.
b) I will rule in favor of X Corporation since no fraudulent actions or evidence has been
proven and the letters of credit is guaranteed by the negotiating banks.

Letters of Credit; Three Distinct Contract Relationship (2002)

Explain the three (3) Distinct but intertwined contract relationships that are
indispensable in a letter of credit transaction.

Answer:

The three (3) distinct but intertwined contract relationships that are indispensable in a
letter of credit transaction are:
1) Between the applicant/buyer/importer and the
beneficiary/seller/exporter. -
 The applicant/buyer/importer is the one who procures the letter of credit and
obliges himself to reimburse the issuing bank upon receipt of the documents of title, while
the beneficiary/seller/exporter is the one who in compliance with the contract of sale
ships the goods to the buyer and delivers the documents of title and draft to the issuing
bank to recover payment for the goods. Their relationship is governed by the contract of
sale.

2) Between the issuing bank and the beneficiary/seller/exporter. -

The issuing bank is the one that issues the letter of credit and undertakes to pay the
seller upon receipt of the draft and proper documents of title and to surrender the
documents to the buyer upon reimbursement. Their relationship is governed by the terms
of the letter of credit issued by the bank.

3) Between the issuing bank and the applicant/buyer/importer. - Their

relationship is governed by the terms of the application and agreement for the issuance of
the letter of credit by the bank.

Letters of Credit; Liability of a confirming and notifying bank (1994)

In letters of credit in banking transactions, distinguish the liability of a confirming

bank from a notifying bank.

Answer:

In case anything wrong happens to the letter of credit, a confirming bank incurs
liability for the amount of the letter of credit, while a notifying bank does not incur any
liability.

Letters of Credit; Certification from Consignee (1993)

BV agreed to sell to Ac, a Ship and Merchandise Broker, 2,500 cubic meters of logs
at $27 per cubic meter FOB. After inspecting the logs, CD issued a purchase order.

On the arrangements made upon instruction of the consignee, H&T Corporation of

LA, California, the SP Bank of LA issued an irrevocable letter of credit available at sight in
favor of BV for the total purchase price of the logs. The letter of credit was mailed to FE
bank with the instruction "to forward it to the beneficiary." The letter of credit provided
that the draft to be drawn is on SP Bank and that it be accompanied by, among other
things, a certification from AC, stating that the logs have been approved prior shipment in
accordance with the terms and conditions of the purchase order. Before loading on the
vessel chartered by AC, the logs were inspected by custom inspectors and representatives
of the Bureau of Forestry, who certified to the good condition and exportability of the logs.
After the loading was completed, the Chief Mate of the vessel issued a mate receipt of the
cargo which stated that the logs are in good condition. However, AC refused to issue the
required certification in the letter of credit. Because of the absence of certification FE
Bank refused to advance payment on the letter of credit.
1) May Fe Bank be held liable under the letter of credit? Explain.

2) Under the facts above, the seller, BV, argued that FE Bank, by accepting
the obligation to notify him that the irrevocable letter of credit has been
transmitted to it on his behalf, has confirmed the letter of credit. Is the
argument tenable? Explain.

Answer:

1) No. The letter of credit provides as a condition a certification of AC, Without such
certification, there is no obligation on the part of FE Bank to advance payment of the letter
of credit. (Feati Bank v. CA 196 SCRA 576)

2) No. FE Bank may have confirmed the letter of credit when it notified BV, that an
irrevocable letter of credit has been confirmed to it on its behalf. But the conditions in the
letter of credit must first be complied with, namely that the draft be accompanied by a
certification from AC. Further, confirmation of a letter of credit must be expressed. (Feati
Bank v. CA, 196 SCRA 576)
FOR REFERENCE: FROM SECTION B

LETTERS OF CREDIT

Abstract

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. (Transfield Philippines, Inc. vs. Luzon Hydro Corporation, et al., G.R. No.
146717, November 22, 2004,)

In commercial transactions involving letters of credit, the functions assumed by a

correspondent bank are classified according to the obligations taken up by it. The
correspondent bank may be called a notifying bank, a negotiating bank, or a confirming
bank. (Feati Bank & Trust Company vs. CA, G.R. No. 94209, April 30, 1991)

In case of a notifying bank, the correspondent bank assumes no liability except to

notify and/or transmit to the beneficiary the existence of the letter of credit. (Kronman
and Co., Inc. v. Public National Bank of New York, 218 N.Y.S. 616 [1926]; Shaterian,
Export-Import Banking, p. 292, cited in Agbayani, Commercial Laws of the Philippines,
Vol. 1, p. 76). A negotiating bank, on the other hand, is a correspondent bank which
buys or discounts a draft under the letter of credit. Its liability is dependent upon the
stage of the negotiation. If before negotiation, it has no liability with respect to the seller
but after negotiation, a contractual relationship will then prevail between the negotiating
bank and the seller. (Scanlon v. First National Bank of Mexico, 162 N.E. 567 [1928])

In the case of a confirming bank, the correspondent bank assumes a direct

obligation to the seller and its liability is a primary one as if the correspondent bank itself
had issued the letter of credit. (Shaterian, Export-Import Banking, p. 294, cited in
Agbayani Commercial Laws of the Philippines, Vol. 1, p. 77)

A notifying bank is not a privy to the contract of sale between the buyer and the
seller, its relationship is only with that of the issuing bank and not with the beneficiary to
whom he assumes no liability. It follows therefore that when the petitioner refused to
negotiate with the private respondent, the latter has no cause of action against the
petitioner for the enforcement of his rights under the letter. (Kronman and Co., Inc. v.
Public National Bank of New York)

As earlier stated, there must have been an absolute assurance on the part of the
petitioner that it will undertake the issuing banks obligation as its own. Verily, the loan
agreement it entered into cannot be categorized as an emphatic assurance that it will
carry out the issuing banks obligation as its own.

The case of Scanlon v. First National Bank perspicuously explained the relationship
between the seller and the negotiating bank, viz:

It may buy or refuse to buy as it chooses. Equally, it must be true that it owes no
contractual duty toward the person for whose benefit the letter is written to
discount or purchase any draft drawn against the credit. No relationship of agent
and principal, or of trustee and cestui, between the receiving bank and the
beneficiary of the letter is established. (P.568)

Whether therefore the petitioner is a notifying bank or a negotiating bank, it

cannot be held liable. Absent any definitive proof that it has confirmed the letter
of credit or has actually negotiated with the private respondent, the refusal by the
petitioner to accept the tender of the private respondent is justified.

The relationship between the issuing bank and the notifying bank, on the
contrary, is more similar to that of an agency and not that of a guarantee. It may be
observed that the notifying bank is merely to follow the instructions of the issuing bank
which is to notify or to transmit the letter of credit to the beneficiary. (See Kronman v.
Public National Bank of New York). Its commitment is only to notify the beneficiary. It
does not undertake any assurance that the issuing bank will perform what has been
mandated to or expected of it. As an agent of the issuing bank, it has only to follow the
instructions of the issuing bank and to it alone is it obligated and not to buyer with whom
it has no contractual relationship.

In fact the notifying bank, even if the seller tenders all the documents required
under the letter of credit, may refuse to negotiate or accept the drafts drawn thereunder
and it will still not be held liable for its only engagement is to notify and/or transmit to the
seller the letter of credit.

Finally, even if we assume that the petitioner is a confirming bank, the petitioner
cannot be forced to pay the amount under the letter. As we have previously explained,
there was a failure on the part of the private respondent to comply with the terms of the
letter of credit. (Feati Bank & Trust Company vs. CA, G.R. No. 94209, April 30, 1991)

Laws Governing LC

It is the Uniform Customs and Practice (UCP) for documentary Credits for International
Chamber of Commerce governs the Letters of credit (Metropolitan Waterworks vs.
Daway, G.R. No. 160723, July 21, 2004).

Articles 567 to 572 of the Code of Commerce on Letters of Credit are obsolete.
However, in the absence of any provision in the Code of Commerce, commercial
transaction shall be governed by the usages and customs generally observed. (Sec. 2,
Code of Commerce)

1. Three separate transactions in LC

(a) Issuing bank and applicant/buyer/importer Their relationship is governed by the

terms of the application and agreement for the issuance of the letter of credit by the
bank. Unless the contrary is provided for, the liability of the issuing bank is solidary with
the buyer

(b) Issuing bank and beneficiary/seller/exporter- Their relationship is governed by the

terms of the letter of credit issued by the bank, and

(c) Applicant and beneficiary Their relationship is governed by the sales contract.

Process:

The buyer may be required to contract a bank to issue a letter of credit, the
issuing bank can authorize the seller to raw drafts and engage to pay
them upon their presentment simultaneously with the tender of documents
required by the letter of credit. The buyer and seller agree on what
documents are to be presented for payment, but ordinarily they are
documents of title evidencing or attesting to the shipment of the goods to the
buyer.

Once the letter of credit is established, the seller ships the goods to the
buyer and in the process secures the required shipping documents and
documents of title. To get paid, the seller executes a draft and presents it
together with the required documents to the issuing bank.

The issuing bank redeems the draft and pays cash to the seller if it finds
that the documents submitted by the seller conform with what the letter of
credit requires. The bank then obtains possession of the documents upon paying
the seller. The transaction is completed when the buyer reimburses the issuing
bank and acquires the documents entitling him to the goods. The seller gets
paid only if he delivers the documents of title over the goods while the buyer
acquires the said documents and control over the goods only after
reimbursing the bank.
2. Explain banks are responsible for examining documents in LC

The issuing bank in determining compliance with the terms of the letter of credit
is required to examine only the shipping documents presented by the seller and
is precluded from determining whether the main contract is actually
accomplished or not. This arrangement assures the seller of prompt payment,
independent of any breach of the main sales contract.

3. Definition of LC

A letter of credit is basically an open letter of request whereby one person

requests another to advance money or give credit to a third person for a certain
amount and promises to repay the person advancing the money.

4. What does LC facilitate?

They are intended generally to facilitate the purchase and sale of goods by
providing assurance to the seller of prompt payment upon compliance with
specified conditions or presentation of stipulated documents without the seller
having to rely upon the solvency and good faith of the buyer.

5. What are the modes of payment?

Payment can be made in several different ways: by the buyer remitting cash
with his order; by open account whereby the buyer remits payment at an agreed
time after receiving the goods; or by documentary collection through a bank in
which case the buyer pays the collecting bank for account of the seller in
exchange for shipping documents which would include, in most cases, the
document of title to the goods. In the aforementioned methods of payment, the
seller relies entirely on the willingness and ability of the buyer to effect payment.

6. What are the benefits?

General: LC is a substitute for, and therefore support, the agreement of the

buyer-importer to pay money under a contract or other arrangement. This
instrument is basically a credit security through availment of credit facilities of
the participating banks.
 To The Exporter/Seller:
Letters of credit open doors to international trade by providing a secure
mechanism for payment upon fulfilment of contractual obligations.
A bank is substituted for the buyer as the source of payment for goods or services
exported.
The issuing bank undertakes to make payment, provided all the terms and
conditions stipulated in the
letter of credit are complied with.
Financing opportunities, such as pre-shipment finance secured by a letter of credit
and/or discounting ofaccepted drafts drawn under letters of credit, are available in
many countries.
Bank expertise is made available to help complete trade transactions successfully.
Payment for the goods shipped can be remitted to your own bank or a bank of your
choice.

To the Importer/Buyer
Payment will only be made to the seller when the terms and conditions of the
letter of credit are complied with.
The importer can control the shipping dates for the goods being purchased.
Cash resources are not tied up.

7. Two kinds of LC

A. LOCAL- 3 parties are involved

(a) The Buyer- he is the one who procures the letter of credit and obliges himself
to reimburse the issuing bank upon receipt of the documents of title
(b) The Issuing Bank- is the bank from whom the letter of credit is procured and
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
(c) The seller- who in compliance with the contract of sale ships the goods to
the buyer and deliver the documents of title and draft to the issuing bank to
recover payment.

B. INTERNATIONAL
 (a) The Customer- who is the party who applies to a bank in one country for the
opening of a letter of credit in favor of the seller in another country
(b) The Issuing Bank- is the bank in the country of the customer to which the
customer applies for the issuance of a letter of credit
(c) The Beneficiary- who is the party in another country who is the creditor of
the customer. Usually, he is the one selling goods to the customer
(d) The Advising Bank is the bank in the country of the beneficiary which
communicates to the beneficiary the notice of the credit issued by the issuing
bank
(e) The Confirming/Correspondent Bank- is the bank that undertakes that the
letter of credit will be fully paid. Usually the confirming bank is also the advising
bank, otherwise it is utilized to lend credence to the letter of credit issued by a
lesser known issuing bank and is directly liable to the beneficiary.

8. STATE OF PERPETAUL SEPARATION

It is clearly settled in law that there are thus three contracts which make up the
letter of credit transaction: The contract between buyer and seller, buyer and
issuing bank, and the letter of credit proper. These transactions are to be
maintained in a state of perpetual separation.

9. INDEPENDENCE PRINCIPLE

The issuing bank in determining compliance with the terms of the letter of credit
is required to examine only the shipping documents presented by the seller and
is precluded from determining whether the main contract is actually
accomplished or not. This arrangement assures the seller of prompt payment,
independent of any breach of the main sales contract. This known as the
independence principle in a letter of credit transaction.

The relationship of the buyer and the bank is separate and distinct from the
relationship of the buyer and seller in the main contract; the bank is not required
to investigate if the contract underlying the LC has been fulfilled or not because
in transactions involving LC, banks deal only with documents and not goods (BPI
v. De Reny Fabric Industries, Inc., L-2481, Oct. 16, 1970). In effect, the buyer
has no course of action against the issuing bank.

10. STRICT COMPLIANCE DOCTRINE

 The rule of strict compliance in a letter of credit transaction means that the
documents tendered by the seller or beneficiary must strictly conform to the
terms of the letter of credit, i.e., they must include all documents required by the
letter of credit such as: (a) a draft which is also called a bill of exchange, is an
order written by an exporter/seller instructing an importer/buyer or its agent to
pay a specified amount of money at a specified time (b) a bill of lading, which is a
document issued to the exporter by a common carrier transporting the
merchandise, and (c) invoices.

Thus, a correspondent bank which departs from what has been stipulated under
the LC acts on its own risk and 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. (Feati Bank and Trust Company v. CA, G.R. No. 940209, Apr. 30,
1991)

11. FRAUD EXCEPTION PRINCIPLE

By way of exception to the independence principle, the Fraud exception rule

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 v. Luzon Hydro, G.R. No. 146717, Nov.
22, 2004)

Requisites:

(a) there is clear proof of fraud;

(b) the fraud constitutes fraudulent abuse of the independent purpose of the letter of
credit and not only fraud under the main agreement; and
(c) irreparable injury might follow if injunction is not granted or the recovery of
damages would be seriously damaged.

12. ESSENTIAL REQUISITES of LC

(a) That it be issued in favor of a definite person and not to order;

(b) and That it be limited to a fixed and specified amount, or to one or more
undetermined amounts, but within a maximum the limits of which has to be stated
exactly.
 Hence, a letter of credit is not a negotiable instrument because it is required
to be drawn in favor of a definite person.

Those which do not have any of the essential conditions shall be considered
merely as a letter of recommendation.

13. WAIVER TO ANNUL LC

The bank or drawer of a letter of credit shall be liable to the person on whom it
was issued for the amount paid by virtue thereof, within the maximum fixed
therein, while a notifying bank does not incur any liability except to notify the
beneficiary of the letter of credit. Before paying, it shall have the right to demand
the proof of the identity of the person in whose favor the letter of credit is issued.

The drawer of a letter of credit may annul it, informing the bearer and the person
to whom it is addressed of such revocation. The waiver of the right to annul
makes the letter of credit irrevocable.

14. STANDBYLETTER OF CREDIT

A standby letter of credit is a bank-issued option on a loan involving three parties:

the bank issuing the credit, the party requesting for such issuance (otherwise
known as the account party) and the beneficiary. Under the terms of standby
letter of credit (SLC), 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 equivalent loan to its customer. SLCs may support
nonfinancial obligations such as those of bidders, or financial obligations such as
those of borrowers. In the latter case, the borrower purchases an SLC and
names the lender as beneficiary. Should the borrower default, the beneficiary has
the right to take down the SLC and receive the principal balance from the issuing.

15. PRESCRIPTIVE PERIOD of LC

A letter of credit becomes void 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 fixed,
a. within 6 months counted from its date, in any point in the Philippines,
b. within 12 months anywhere outside thereof, it shall be void in fact and in law.
16. RED CLAUSE LC

A red clause letter of credit incorporates a clause, traditionally written in red,

which authorizes the bank acting as the negotiating or paying bank to pay the
beneficiary in advance of shipment. This enables the purchase and accumulation
of goods from a number of different suppliers, and the arrangement of shipment
in accordance with the letter of credit terms. Such advances will be deducted
from the amount due to be paid when the documents called for are presented
under the letter of credit. If the beneficiary fails to ship the goods or cannot do so
before the expiry of the letter of credit, the issuing bank is bound to reimburse the
negotiating or paying bank, recovering its payment from the applicant.

17. BACK TO BACK LC

Back to Back Letter of Credit is a credit with identical documentary requirements

and covering the same merchandise as another letter of credit, except for the
difference in price of the merchandise as shown by the invoice and draft. The
second letter of credit can only be negotiated after the first is negotiated.

18. DEFERRED PAYMENT LC

Under a deferred payment letter of credit, the applicant does not pay until a
future date determined in accordance with the terms of the letter of credit.

19. TRANSFERRABLE LC

A transferable letter of credit allows the beneficiary to act as a middleman and

transfer his rights under a letter of credit to another party or parties who may be
suppliers of the goods. Depending on whether the letter of credit permits partial
shipments, fractional amounts may be transferred to more than one beneficiary.
The letter of credit however, can be transferred only once: the secondary
beneficiaries cannot transfer their rights to a third party. Transfer of a letter of
credit can be made on specific application by the original beneficiary to the
authorized transferring bank

To be transferable, a letter of credit must be so marked by the issuing bank which

can only do so on the applicants specific instructions. The applicant should be
aware that any second beneficiary, the probable supplier, is usually a party not
likely known to the applicant.
20. SIGHT OR TERM/USANCE

Letters of credit can permit the beneficiary to be paid immediately upon

presentation of specified documents (sight letter of credit), or at a future date as
established in the sales contract (term/usance letter of credit).

21. REVOCABLE/ IRREVOCABLE

An irrevocable letter of credit obligates the issuing bank to honor drafts drawn in
compliance with the credit and can be neither cancelled nor modified without the
consent of all parties, including in particular the beneficiary/exporter.

A revocable letter of credit can be cancelled or amended at any time before

payment; it is intended to serve as a means of arranging payment but not as a
guarantee of payment

22. UNCONFIRMED/ CONFIRMED LC

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.

An unconfirmed letter of credit is the obligation only of the issuing bank provided
all terms and condition of LC have been complied with.
Why would an exporter want a foreign banks letter of credit confirmed by a
domestic bank? One reason could be if he has doubts.

23. CIRCULAR LC

The document is called a circular letter of credit when it is not addressed to any
particular correspondent. In effect, a letter of credit is a draft, save that the
amount is merely stated as a maximum not to be exceeded. Letters of credit,
mainly used by travellers, greatly simplify non-local business transactions.

24. NEGOTIATION LC

Under UCP 600 (Uniform Customs and Practice for Documentary Credits, 2007
revision, article 2) negotiation means the purchase by the nominated bank of
drafts (drawn on a bank other than the nominated bank) and/or documents under
a complying presentation, by advancing or agreeing to advance funds to the
beneficiary on or before the banking day on which reimbursement is due to the
nominated bank.
 Unfortunately, the term "negotiable credit" is understood and applied in different
ways in different parts of the world.

25. REIMBURSEMENT LC

Any standard lc having special payment conditions that, the negotiating bank is
authorized to claim and get the payment against the lc directly from the opening
bank's nominated agency bank after presentation of credit confirmed documents
is known as reimbursement LC or direct reimbursement Lc. In most of the cases
payment of the import, thus is already effected prior to receipt of the documents
and consignment by the importer.

26. REVOLVING LC

Revolving Letter of Credit-one that provides for renewed credit to become

available as soon as the opening bank has advised the negotiating or paying
bank that the drafts already drawn by the beneficiary have been reimbursed to
the opening bank by the buyer.

Revolving letter of credit - is established when there are regular shipments of the
same commodity between supplier and customer. Eliminates the need to issue
an letter of credit for each transaction

27. CUMULATIVE/NON-CUMULATIVE

For a non-cumulative revolving letter of credit, the beneficiary can draw each
revolving amount for any given period, and any unused portions cannot be
drawn on the subsequent periods.

Cumulative revolving letter of credit means that the unused sums in the L/C
can be added to the upcoming shipments.

28. STRAIGHT CREDIT

A type of letter of credit. A straight credit can only be paid at the counters of the
paying bank or a named drawee bank that has been authorized to make
payment. Payment can only be made to the beneficiary named in the letter
of credit, and not to an intermediary or negotiating bank. The beneficiary named
in a straight credit must present documents at the paying bank or named drawee
bank on or before the expiration date stipulated in the letter of credit. The term is
derived from the fact that payment is made straight or directly to the beneficiary.
 Letter of Credit | SPECIAL COMMERCIAL LAW

A straight credit differs from a negotiable credit because payment in the latter
can be made to a negotiating bank. A straight credit contains clauses such as
we engage with you that all drafts drawn in compliance with the credit terms
will be duly honored upon presentation, which basically highlight the restriction
of payment to the beneficiary only.

29. ACCEPTANCE LETTER OF CREDIT

An acceptance credit is a type of letter of credit that is paid by a time draft

authorizing payment on or after a specific date, if the terms of the letter of
credit have been complied with. There are two types of acceptance credit,
confirmed and unconfirmed. Unconfirmed acceptance credit means that the
seller takes the risk that payment will not be made, due to any number of
contingencies such as shipment non-delivery, confiscation by customs
authorities, or any other
problems. Confirmed acceptance credit means that the bank upon which the
credit has been issued, essentially guarantees payment as long as the terms of
the letter of credit have been complied with.

30. DOCUMENTARY LC

A documentary letter of credit is an obligation of the bank that opens the letter
of credit (the issuing bank) to pay the agreed amount to the seller on behalf of
the buyer, upon receipt of the documents specified in the letter of credit. The
letter of credit is opened by the bank on the basis of the buyers (importers)
instructions, which are compiled in accordance with the terms of the contract.
Both the importer and exporter should take into account that the letters of
credit constitute a transaction separate from the purchase and sale agreement
or other agreements on which they are based. The banks obligations under
the letter of credit are set forth in the letter of credit itself, and the bank deals
exclusively with documents, not with goods or services.

Documentary letters of credit are the safest means for international trade
settlement both for importers and exporters of goods.

31. CLEAN LC

A letter of credit payable upon presentation of the draft, without any supporting
document being required.

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