LETTERS OF CREDIT

A. DEFINITION/CONCEPT

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)

 What is Letter of Credit (LC)?

A: It is any arrangement, however named or described, whereby a bank (issuing bank),
acting at the request and on the instructions of a customer (applicant) or on its own
behalf, binds itself to:
1. Pay to the order of, or accept and pay drafts drawn by a third party (Beneficiary), or
2. Authorize another bank to pay or to accept and pay such drafts, or
3. Authorizes another bank to negotiate, against stipulated document(s),
Note: Provided, the terms and conditions of the credit are complied with. (Art. 2, Uniform
Customs & Practice for Documentary Credits.)

 What is the duration of LC?

1.Upon the period fixed by the parties; or

2.If none is fixed:

a.6 months from its date if used in the Philippines;
b.12 months if used abroad (Art 572, ibid).

 What are the kinds of LC?

COMMERCIAL LETTERS OF CREDIT STANDBY LETTERS OF CREDIT

Involve contracts of sale. Involve non‐sale transactions.
Payable upon presentation by the seller‐
beneficiary of documents that show he has
performed his contract.
Payable upon certification by the
beneficiary of the applicant’s NON‐
performance of the agreement.
(Transfield v. Luzon Hydro Corp., G.R.
No. 146717, Nov. 22, 2004)

 Is irrevocable letter of credit and confirmed letter of credit synonymous?

An irrevocable letter of credit is not synonymous with a confirmed letter of credit. In an

irrevocable letter of credit, the issuing bank may not, without the consent of the
beneficiary and the applicant, revoke its undertaking under the letter, whereas, in a
confirmed letter of credit, the correspondent bank gives an absolute assurance to the
beneficiary that it will undertake the issuing bank’s obligation as its own according to
the terms and condition of the credit. (Prudential Bank and Trust Company v. IAC, G.R.
No. 74886, Dec. 8, 1992)

 Can a court order the release to the applicant the proceeds of an irrevocable
letter of credit without the consent of the beneficiary?

No, such order violates the irrevocable nature of the letter of credit. The terms of an
irrevocable letter of credit cannot be changed without the consent of the parties,
particularly the beneficiary thereof. (Phil. Virginia Tobacco Administration v. De Los
Angeles, G.R. No. L‐27829, Aug. 19, 1988)

B. GOVERNING LAWS

 What is the law governing letter of credit (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)

C. NATURE OF LETTER OF CREDIT

 What is the nature and purpose of LC?

To ensure certainty of payment. The seller is assured of payment because the bank
intervenes and makes the commitment to pay. This addresses problem arising from
seller’s refusal to part with his goods before being paid and the buyer’s refusal to part
with his money before acquiring the goods, thus, facilitating commercial transactions.
  What are the essential conditions of LC?

1. Issued in favor of a definite person and not to order.

Note: The Uniform Commercial Practice for Documentary Credits allows letters of credit
to be payable to order

2. Limited to a fixed or specified amount, or to one or more amounts, but with a

maximum stated limit. (Article 568, Ibid)

(Note: If any of these essential conditions is not present, the instrument is merely
considered as a letter of recommendation.)

 In case the buyer was not able to pay its obligation under the letter of credit,
can the bank take possession over the goods covered by the said letter of
credit?

No. The opening of a Letter of Credit did not vest ownership of the goods in the bank in
the absence of a trust receipt agreement. A letter of credit is a mere financial device
developed by merchants as a convenient and relatively safe mode of dealing with the
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. (Transfield Philippines, Inc. v. Luzon Hydro Corporation, G.R. No.
146717, Nov. 22, 2004
#CASES

I. MICO METALS CORPORATION vs CA & PHILIPPINE BANK OF COMMUNICATIONS

GR NO 117914 FEBRUARY 1, 2002

FACTS:

The BOD of the Mico Metals authorizes President Charles Lee and VP & GM Mariano Sio
to apply for, negotiate and secure the approval of commercial loans and other
banking facilities. The President of MICO applied for a grant of a discounting loan and
credit of 3 million to the PBC for carrying out MICOs line of business. On the same day,
(March 2, 1979), he requested for another discounting loan/ credit of 3Million for
purposes of opening letters of credit and trust receipt.

Mico then availed a several loans to the PBC. As a security, MICO through its VP and
GM Sio executed a Deed of Real Estate Mortgage over its properties situated in Pasig,
Metro Manila.

On March 26, 1979 Charles Lee, Chua Siok Suy, Mariano Sio, Alfonso Yap and Richard
Velasco executed a Surety Agreement in their personal capacity whereby the
petitioners ensure the payments on time. They again obtained additional 4 million for
the purpose of expansion and modernization of the company’s machineries.

MICO applied for a domestic letter of credit (348, 000 & 290, 000).PBC paid the
beneficiary for the price of merchandise, the goods were delivered to MICO which
executed a corresponding trust receipt in fabor of PBC.

MICO applied to open foreign letter of credit in favor of Ta Jih Enterprise Co Ltd. PBC
informed its bank in Taiwan (Irving Tust Company) of the approved letter of credit
(11960) which the latter acknowledges upon the advice of PBC. On January 1982 MICO
applied for another foreign credit ($1900).

In all the transactions involving foreign letters of credit, PBCom turned over to MICO the
necessary documents such as the bills of lading and commercial invoices to enable the
latter to withdraw the goods from the port of Manila.

Upon the maturity of all credit availed by MICO, PBC then demanded payment. Upon
failure of MICO to pay all obligations, PBC extrajudicially foreclosed the real estate
mortgage. PBC filed a complaint to the RTC which the petitioners denied allegations
made by PBC.

ISSUES:

Whether the proceeds of the loans and letters of credit transactions were delivered to
MICO.

HELD:
Yes, the letters of credit show that the pertinent materials/merchandise have been
received by MICO. The drafts signed by the beneficiary/suppliers in connection with the
corresponding letters of credit proved that said suppliers were paid by PBCom for the
account of MICO.

Modern letters of credit are usually not made between natural persons. They involve
bank to bank transactions. Historically, the letter of credit was developed to facilitate
the sale of goods between, distant and unfamiliar buyers and sellers. It was an
arrangement under which a bank, whose credit was acceptable to the seller, would at
the instance of the buyer agree to pay drafts drawn on it by the seller, provided that
certain documents are presented such as bills of lading accompanied the
corresponding drafts. Expansion in the use of letters of credit was a natural
development in commercial banking.

Parties to a commercial letter of credit include

(a) the buyer,

(b) the seller,

(c) the opening bank

(d) the notifying bank

(e) negotiating bank

(f) the paying bank

(g) the confirming bank

II. Transfield Philippines, Inc., - versus -Luzon Hydro Corporation, Australia and New
Zealand Banking Group Limited and Security Bank Corporation, respondents.
G.R. No. 146717, November 22, 2004

FACTS:

On March 1997, Luzon Hydro Corporation entered into a Turnkey contract whereby it
undertook to construct on a turnkey (is a type of project that is constructed so that it
can be sold to any buyer as a completed product.) basis, a 70 Megawatt hydroelectric
power station at Bakun River in the Provinces of Benguet and Ilocos Sur. The turnkey
contract included the date of completion of the project, June 1, 2000.

To secure the performance of the project, petitioner openedin favor of LHC two
standby letters of credit with a local branch of respondent Australia and New Zealand
Banking Group Limited (ANZ Bank) with respondent Security Bank corporation (SBC) in
the amount of US $8,988,907.00.
During the construction of the projects, petitioner sought various extensions of time due
to typhoon. LHC denied the request which gave rise to a series of legal actions
between the parties.

ISSUE:
Whether Luzon Hydroelectric Corp. has the right to call and draw on the securities
before the resolution of petitioners and LHC’s disputes by the appropriate tribunal.

HELD:
Petitioners argument that any dispute must first be resolved by the parties, whether
through negotiations or arbitration, before the beneficiary is entitled to call on the letter
of credit in essence would convert the letter of credit into a mere guarantee.

The independent nature of the letter of credit may be: (a) independence in toto where
the credit is independent from the justification aspect and is a separate obligation from
the underlying agreement like for instance a typical standby; or (b) independence may
be only as to the justification aspect like in a commercial letter of credit or repayment
standby, which is identical with the same obligations under the underlying agreement.
In both cases the payment may be enjoined if in the light of the purpose of the credit
the payment of the credit would constitute fraudulent abuse of the credit.

Jurisprudence has laid down a clear distinction between a letter of credit and a
guarantee in that the settlement of a dispute between the parties is not a pre-requisite
for the release of funds under a letter of credit. In other words, the argument is
incompatible with the very nature of the letter of credit. If a letter of credit is drawable
only after settlement of the dispute on the contract entered into by the applicant and
the beneficiary, there would be no practical and beneficial use for letters of credit in
commercial transactions.

The engagement of the issuing bank is to pay the seller or beneficiary of the credit
once the draft and the required documents are presented to it. The so-called
independence principle assures the seller or the beneficiary of prompt payment
independent of any breach of the main contract and precludes the issuing bank from
determining whether the main contract is actually accomplished or not. Under this
principle, banks assume no liability or responsibility for the form, sufficiency, accuracy,
genuineness, falsification or legal effect of any documents, or for the general and/or
particular conditions stipulated in the documents or superimposed thereon, nor do they
assume any liability or responsibility for the description, quantity, weight, quality,
condition, packing, delivery, value or existence of the goods represented by any
documents, or for the good faith or acts and/or omissions, solvency, performance or
standing of the consignor, the carriers, or the insurers of the goods, or any other person
whomsoever.

The pendency of the arbitration proceedings would not per se make LHCs draws on the
Securities wrongful or fraudulent for there was nothing in the Contract which would
indicate that the parties intended that all disputes regarding delay should first be
settled through arbitration before LHC would be allowed to call upon the Securities. It is
therefore premature and absurd to conclude that the draws on the Securities were
outright fraudulent given the fact that the ICC and CIAC have not ruled with finality on
the existence of default.

The instant petition was DENIED, with costs against petitioner.

III. METROPOLITAN WATERWORKS AND SEWERAGE SYSTEM, petitioner,

- versus -
HON. REYNALDO B. DAWAY, in his capacity as Presiding Judge of the Regional Trial
Court of Quezon City, Branch 90, and Maynilad Water Services, Inc., respondents
G.R. No. 160732, June 21, 2004

FACTS:

MWSS granted Maynilad under a Concession Agreement to manage, operate, repair,

decommission and refurbish the existing MWSS water delivery and sewerage in the West
Zone Service Area, for which Maynila undertook to pay the corresponding concession
fees which, among other things, consisted of payments of petitioner’s mostly foreign
loans.
To secure the concessionaire’s performance of its obligations, Maynilad was required
under the contract to put up a bond, bank guarantee or other security acceptable to
MWSS.

In compliance with this requirement, Maynilad arranged for a 3-year facility with a
number of foreign banks led by Citicorp Int’l Ltd., for the issuance oa an Irrevocable
Standby Letter of Credit in favor of MWSS for the full and prompt performance of
Maynilad’s obligations to MWSS as aforestated.

Later, the parties agreed to resolve the issues between them through an amendment of
the Concession Agreement which is based on the terms set down in MWSS Board of
Trustees Resolution which provided inter alia for a formula that would allow Maynilad to
recover foreign exchange losses it had incurred or would incur under the terms of the
Concession Agreement.
However, Maynila served upon MWSS a Notice of Event of Termination, claiming that
MWSS failed to comply with its obligations under the Concession Agreement and its
amendment regarding the adjustment mechanism that would cover Maynilad’s foreign
losses. Maynilad filed a Notice of Early Termination of the concession, which was
challenged and eventually brought before the Appeals Panel by MWSS. The Panel
ruled that there was no Event of Termination defined in the Concession Agreement ant
that, therefore, Maynilad should pay the concession fee tht had fallen due.

The award of the Appeals Panel became final, MWSS, thereafter, submitted a written
notice to Citicorp Int’l Ltd, as agent for the participating banks, that by virtue of
Maynilad’s failure to perform its obligations under the Concession Agreement, it was
drawing on the Irrevocable Standby Letter of Credit and thereby demanded payment.

Prior to this, hoever, Maynilad had filed a petition for rehabilitation before the RTC of
Quezon City which resulted in the issuance of the Stay Order and the disputed Order of
November 27, 2003.
ISSUE:
Whether the rehabilitation court sitting as such, acted in excess of its authority or
jurisdiction when it enjoined MWSS from seeking the payment of the concession fees
from the banks that insured the Irrevocable Standby Letter of Credit in its favor.

HELD:

The Petition for Certiorari was GRANTED. The Order of November 27, 2003 of the RTC of
Quezon City is declared null and void, and was set aside.

The claim is not one against the debtor but against an entity that Maynilad has
procured to answer for its non-performance of certain terms and conditions of the
Concession Agreement, particularly the payment of concession fees.

The Interim Rules does not enjoin the enforcement of all claims against guarantors and
sureties, but only those claims against guarantors and sureties who are not solidarily
liable with the debtor. Maynilad’s claim that the banks are not solidarily liable with the
debtor does nt find support in jurisprudence.

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 and 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 in 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.
Parties to a letter of credit:
The original parties:
 Buyer or importer - he procures the letter of credit and obliges himself
to reimburse the issuing bank upon receipt of the document of title
from the seller.
 Issuing bank – the bank which issue the letter of credit and undertakes
to pay the seller upon receipt of the draft/documents of title, and to
surrender the documents of title to the buyer upon reimbursement.
 Seller/Beneficiary /exporter - he ships the goods to the buyer and
delivers the documents of title to the issuing bank recover payment.
Other parties may include:

 Advising or notifying bank - Takes responsibility to communicate with

necessary parties under letter of credit and other required authorities.
The advising bank is the party who sends documents under Letter of
Credit to opening bank.
 Confirming Bank - As a party of letter of credit confirms and guarantee
to undertake the responsibility of payment or negotiation acceptance
under the credit.
 Paying Bank - The paying bank may be the issuing bank, the
confirming bank or the notifying bank.
 Negotiating bank – One who negotiates documents delivered to bank
by beneficiary of LC. Negotiating bank is the bank who verifies
documents and confirms the terms and conditions under LC on behalf
of beneficiary to avoid discrepancies