Letters of Credit

Definition/concept
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 the 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

documents to the buyer upon reimbursement. As it is the one issuing the instrument, it should be a strong bank, well known and well regarded in international trading circles.

Governing laws Uniform Customs and Practice for Documentary Credits (UCP) issued by the International Chamber of Commerce
The pertinent provisions of the U.C.P. (1962 Revision) are: Article 3. An irrevocable credit is 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. An irrevocable credit may be advised to a beneficiary through another bank (the advising bank) without engagement on the part of that bank, but when an issuing bank authorizes or requests another bank to confirm its irrevocable credit and the latter does so, such confirmation constitutes a definite undertaking of the confirming bank. . . . Article 7. Banks must examine all documents with reasonable care to ascertain that they appear on their face to be in accordance with the terms and conditions of the credit," Article 8. Payment, acceptance or negotiation against documents which appear on their face to be in accordance with the terms and conditions of a credit by a bank authorized to do so, binds the party giving the authorization to take up documents and reimburse the bank which has effected the payment, acceptance or negotiation.

3. Seller - 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. He is also the beneficiary of the credit instrument because the instrument is addressed to him and is in his favour. While the bank cannot compel the seller to ship the goods and avail of the benefits of the instruments, however, the seller may recover from the bank the value of his shipment is made within the terms of the instrument, even though he hasnt given the bank any direct consideration for the banks promises contained in the instrument

4. Correspondent bank/advising bank - to convey to the seller the existence of the credit or a confirming bank which will lend credence to the letter of credit issued by the lesser known issuing bank or paying bank which undertakes to encash the drafts drawn by the exporter. Furthermore, another bank known as the negotiating bank may be approached by the buyer to have the draft discounted instead of going to the place of the issuing bank to claim payment

Basic principles of letter of credit Doctrine of independence

TRANSFIELD PHILIPPINES, INC v. LUZON HYDRO CORPORATION, AUSTRALIA and NEW ZEALAND BANKING GROUP LIMITED and SECURITY BANK CORPORATION

Provisions of Code of Commerce

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 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. -x-x-x As discussed above, in a letter of credit transaction, such as in this case, where the credit is stipulated as irrevocable, there is a definite undertaking by the issuing bank to pay the beneficiary provided that the stipulated documents are presented and the conditions of the credit are complied with. Precisely, the independence principle liberates the issuing bank from the duty of ascertaining compliance by the parties in the main contract. As the principles nomenclature clearly suggests, the obligation under the letter of credit is independent of the related and originating contract. In brief, the letter of credit is separate and distinct from the underlying transaction. Given the nature of letters of credit, petitioners argument that it is only the issuing bank that may invoke the independence principle on letters of credit does not impress this Court. To say that the independence principle may only be invoked by the issuing banks would render nugatory the purpose for which the letters of credit are used in commercial transactions. As it is, the independence doctrine works to the benefit of both the issuing bank and the beneficiary. Letters of credit are employed by the parties desiring to enter into commercial transactions, not for the benefit of the issuing bank but mainly for the benefit of the parties to the original transactions. With the letter of credit from the issuing bank, the party who applied for and obtained it may confidently present the letter of credit to the beneficiary as a security to convince the beneficiary to enter into the business transaction. On the other hand, the other party to the business transaction, i.e., the beneficiary of the letter of credit, can be rest assured of being empowered to call on the letter of credit as a security in case the commercial transaction does not push through, or the applicant fails to perform his part of the transaction. It is for this reason that the party who is entitled to the proceeds of the letter of credit is appropriately called beneficiary.

Nature - 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.

Parties to a letter of credit

1. Buyer - procures the letter of credit and obliges himself to reimburse the issuing bank upon receipt of the documents of title. He is the one initiating the operation of the transaction as buyer of the merchandise and also of the credit instrument. His contract with the bank which is to issue the instrument and is represented by the Commercial Credit Agreement form which he signs, supported by the mutually made promises contained in the agreement

Fraud exception principle

TRANSFIELD PHILIPPINES, INC. v. LUZON HYDRO CORPORATION, AUSTRALIA and NEW ZEALAND BANKING GROUP LIMITED and SECURITY BANK CORPORATION

2. Opening bank - usually the buyers bank which issues the letter of credit and undertakes to pay the seller upon receipt of the draft and proper documents of titles to surrender the

Next, petitioner invokes the fraud exception principle. It avers that LHCs call on the Securities is wrongful because it fraudulently misrepresented to ANZ Bank and SBC that there is already a breach in the Turnkey Contract knowing fully well

that this is yet to be determined by the arbitral tribunals. It asserts that the fraud exception exists when the beneficiary, for the purpose of drawing on the credit, fraudulently presents to the confirming bank, documents that contain, expressly or by implication, material representations of fact that to his knowledge are untrue. In such a situation, petitioner insists, injunction is recognized as a remedy available to it. Citing Dolans treatise on letters of credit, petitioner argues that the independence principle is not without limits and it is important to fashion those limits in light of the principles purpose, which is to serve the commercial function of the credit. If it does not serve those functions, application of the principle is not warranted, and the common law principles of contract should apply. It is worthy of note that the propriety of LHCs call on the Securities is largely intertwined with the fact of default which is the self-same issue pending resolution before the arbitral tribunals. To be able to declare the call on the Securities wrongful or fraudulent, it is imperative to resolve, among others, whether petitioner was in fact guilty of delay in the performance of its obligation. Unfortunately for petitioner, this Court is not called upon to rule upon the issue of default such issue having been submitted by the parties to the jurisdiction of the arbitral tribunals pursuant to the terms embodied in their agreement. Would injunction then be the proper remedy to restrain the alleged wrongful draws on the Securities? Most writers agree that fraud is an exception to the independence principle. 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 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.

2. Whether or not a Standby Letter of Credit is a guaranty HELD: First Issue: The rules on corporate rehabilitation do not apply to SLCs. MWSS can properly draw on Maynilads SLC with Citicorp. corporate rehabilitation do not apply to SLCs. The rules on

The rules on corporate rehabilitation (particularly Section 6b of Rule 4) do not apply to MWSS as the prohibition is against the enforcement of claims against guarantors, or sureties of debtors whose obligations are NOT solidary with the debtor. Being a solidary obligation, a Standby Letter of Credit is excluded. RECENT JURISPRUDENCE MERCANTILE LAW Letter of Credit is not a guaranty Second Issue: Standby

A Standby Letter of Credit is not a guaranty because under a Standby Letter of Credit, the bank undertakes a primary obligation. On the other hand, a guarantor undertakes a collateral obligation which arises only upon the debtors default. A Standby Letter of Credit is a primary obligation and not an accessory contract. First, the claim is not one against the debtor but against an entity that respondent Maynilad has procured to answer for its non-performance of certain terms and conditions of the Concession Agreement, particularly the payment of concession fees. Secondly, Section 6 (b) of Rule 4 of 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. Respondent Maynilads claim that the banks are not solidarily liable with the debtor does not find support in jurisprudence. As held in Feati Bank & Trust Company vs. CA that the concept of guarantee vis--vis the concept of irrevocable letter of credit are inconsistent with each other. The guarantee theory destroys the independence of the banks responsibility from the contract upon which it was opened and the nature of the contracts is mutually in conflict with each other. In contracts of guarantee, the guarantors obligation is merely collateral and it arises only upon the default of the person primarily liable. On the other hand, in an irrevocable letter of credit, the bank undertakes a primary obligation. A letter of credit is defined as an engagement by a bank or other person made at the request of a customer that the issuer shall honor drafts or other demands of payment upon compliance with conditions specified in the credit

Doctrine of strict compliance

Letters of credit are to be strictly complied with which documents, and shipping documents must be followed as stated in the letter. There is no discretion in the bank or trust company to waive any requirements. The terms of the letter constitutes an agreement between the purchaser and the bank. the observance of the U.C.P. in this jurisdiction 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. There being no specific provision which governs the legal complexities arising from transactions involving letters of credit not only between the banks themselves but also between banks and seller and/or buyer, the applicability of the U.C.P. is undeniable.

2. Mico Metals Corp. v. Court of Appeals and Philippine Bank of Communications, G.R. No. 117914, Feb. 1, 2002
FACTS -A petition for review of the decision of the CA ordering defendantsappellees jointly and severally to pay plaintiff PBCom a certain sum arising from ordinary loans, letters of credit and trust receipt transactions granted by the plaintiff plus legal interest until fully paid. -On March 2, 1979, Charles Lee, as President of MICO wrote private respondent Philippine Bank of Communications (PBCom) requesting for a grant of a discounting loan/credit line in the sum of Three Million Pesos (P3,000,000.00) for the purpose of carrying out MICOs line of business as well as to maintain its volume of business.On the same day, Charles Lee requested for another discounting loan/credit line of Three Million Pesos (P3,000,000.00) from PBCom for the purpose of opening letters of credit and trust receipts. -On March 26, 1979, MICO availed of the first loan of One Million Pesos (P1,000,000.00) from PBCom. Upon maturity of the loan, MICO caused the same to be renewed, the last renewal of which was made on May 21, 1982 under a promissory note. Two more loans to complete the three million were availed by MICO under the same terms. -As security for the loans, MICO through its Vice- President and General Manager, Mariano Sio, executed on May 16, 1979 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, in their personal capacities executed a Surety Agreement in favor of PBCom whereby the petitioners jointly and severally, guaranteed the prompt payment on due dates or at maturity of overdrafts, promissory notes, discounts, drafts, letters of credit, bills of exchange, trust receipts, and other obligations of every kind and nature, for which MICO may be held accountable by PBCom. -On July 14, 1980, petitioner Charles Lee, in his capacity as president of MICO, wrote PBCom and applied for an additional loan in the sum of Four Million Pesos (P4,000,000.00). The loan was intended for the expansion and modernization of the companys machineries. Upon approval of the said application for loan, MICO availed of the additional loan of Four Million Pesos (P4,000,000.00) as evidenced by a promissory note. -As per agreement, the proceeds of all the loan availments were credited to MICOs current checking account with PBCom. To induce the PBCom to increase the credit line of MICO, Charles Lee, Chua Siok Suy, Mariano Sio, Alfonso Yap, Richard Velasco and Alfonso Co (hereinafter referred to as petitioners-sureties), executed another surety agreement in favor of PBCom on July 28, 1980, whereby they jointly and severally guaranteed the prompt payment on due dates or at maturity of overdrafts, promissory notes, discounts, drafts, letters of credit, bills of exchange, trust receipts and all other obligations of any kind and nature for which MICO may be held accountable by PBCom. -On two occasions, MICO filed with PBCom an application for a domestic letter of credit. The corresponding irrevocable letters of credit was approved. Thereafter, the domestic letters of credit was negotiated and accepted by MICO as evidenced by the corresponding bank draft issued for the purpose. After the suppliers of the merchandise was paid, trust receipts upon MICOs own initiative, was executed in favor of PBCom. On three occasions MICO applied for authority to open a foreign letter of credit in favor of various corporations and thus, the corresponding letter of credits was then issued by PBCom with cables sent to the beneficiaries advising that said beneficiaries may draw funds from the account of PBCom in its correspondent banks New York Office. As in past transactions, MICO executed in favor of PBCom a corresponding trust receipt. In all the transactions involving foreign letters of credit, PBCom turned over to

Cases: 1. Metropolitan Waterworks and Sewerage System v. Hon. Reynaldo B. Daway and Maynilad Water Services, Inc., G.R. No. 160732, June 21, 2004
A Standby Letter of Credit is not a guaranty because under a Standby Letter of Credit, the bank undertakes a primary obligation. On the other hand, a guarantor undertakes a collateral obligation which arises only upon the debtors default. A Standby Letter of Credit is a primary obligation and not an accessory contract. Maynilad obtained a 20-year concession to manage, repair, refurbish, and upgrade existing Metropolitan Waterworks and Sewerage System (MWSS) water delivery and sewerage services in Metro Manilas west zone. Maynilad, under the concession agreement undertook to pay concession fees and its foreign loans. To secure its obligations, Maynilad was required under Section 9 of the concession contract to put up a bond, bank guarantee or other security acceptable to MWSS. Pursuant to this requirement, Maynilad arranged on July 14, 2000 for a three-year facility with a number of foreign banks led by Citicorp Intl for the issuance of an irrevocable standby letter of credit (SLC) in the amount of $ 120 million in favor of MWSS for the full and prompt payment of Maynilads obligations to MWSS. The concession contract was amended to incorporate a mechanism that would protect Maynilad from foreign exchange losses. The depreciation of the peso, however, still took its toll on Maynilad, forcing the latter to file a notice of early termination of the concession contract citing MWSS failure to protect the company from foreign exchange losses under the amended concession accord. For this reason, MWSS filed notice with Citicorp that it would draw $98 million on the SLC of Maynilad. Maynilad which was undergoing corporate rehabilitation opposed, however, on the ground that the interim rules for Corporate Rehabilitation prohibit claims against the concerned corporation, its guarantors, and sureties not solidarily liable with the petitioner (company). ISSUE: 1. Whether or not the rules on corporate rehabilitation bar recovery on an Standby Letter of Credit

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 maturity of all credit availments obtained by MICO from PBCom, the latter made a demand for payment. For failure of petitioner MICO to pay the obligations incurred despite repeated demands, private respondent PBCom extrajudicially foreclosed MICOs real estate mortgage. Aside from the unpaid balance of Five Million Four Hundred Forty-One Thousand Six Hundred Sixty-Three Pesos and Ninety Centavos (P5,441,663.90), MICO likewise had another standing obligation in the sum of Four Hundred Sixty-One Thousand Six Hundred Pesos and Six Centavos (P461,600.06) representing its trust receipts liabilities to private respondent. PBCom then demanded the settlement of the aforesaid obligations from herein petitioners-sureties who, however, refused to acknowledge their obligations to PBCom under the surety agreements. Hence, PBCom filed a complaint with prayer for writ of preliminary attachment before the Regional Trial Court of Manila. -Petitioners (MICO and herein petitioners-sureties) denied all the allegations of the complaint filed by respondent PBCom, and alleged that: a) MICO was not granted the alleged loans and neither did it receive the proceeds of the aforesaid loans and since no loan was ever released to or received by MICO, the corresponding real estate mortgage and the surety agreements signed concededly by the petitioners- sureties are null and void. -The trial court gave credence to the testimonies of herein petitioners and dismissed the complaint filed by PBCom. In ruling for herein petitioners, the trial court said that PBCom failed to adequately prove that the proceeds of the loans were ever delivered to MICO. Hence, inasmuch as no consideration ever passed from PBCom to MICO, all the documents involved therein, such as the promissory notes, real estate mortgage including the surety agreements were all void or nonexistent for lack of cause or consideration. The trial court said that the lack of proof as regards the existence of the merchandise covered by the letters of credit bolstered the claim of herein petitioners that no purchases of the goods were really made and that the letters of credit transactions were simply resorted to by the PBCom and Chua Siok Suy to accommodate the latter in his financial requirements. -CA reversed the said decision and pronounced: Every negotiable instrument is deemed prima facie to have been issued for valuable consideration and every person whose signature appears thereon to have become a party thereto for value, the Court of Appeals said that while the subject promissory notes and letters of credit issued by the PBCom made no mention of delivery of cash, it is presumed that said negotiable instruments were issued for valuable consideration. -Petitioners contend that there was no proof that the proceeds of the loans or the goods under the trust receipts were ever delivered to and received by MICO. ISSUE WON the proceeds of the loans and letters of credit transactions were ever delivered to MICO HELD: YES -In civil cases, the party having the burden of proof must establish his case by preponderance of evidence. During the trial of an action, the party who has the burden of proof upon an issue may be aided in establishing his claim or defense by the operation of a presumption, or, expressed differently, by the probative value which the law attaches to a specific state of facts. A presumption may operate against his adversary who has not introduced proof to rebut the presumption. The effect of a legal presumption upon a burden of proof is to create the necessity of presenting evidence to meet the legal presumption or the prima facie case created thereby, and which if no proof to the contrary is presented and offered, will prevail. The burden of proof remains where it is, but by the presumption the one who has that burden is relieved for the time being from introducing evidence in support of his averment, because the presumption stands in the place of evidence unless rebutted. Under Section 3, Rule 131 of the Rules of Court the following presumptions, among others, are satisfactory if uncontradicted: a) That there was a sufficient consideration for a contract and b) That a negotiable instrument was given or indorsed for sufficient consideration. As observed by the Court of Appeals, a similar presumption is found in Section 24 of the Negotiable Instruments Law which provides that every negotiable instrument is deemed prima facie to have been issued for valuable consideration and every person whose signature appears thereon to have become a party for value. Negotiable instruments which are meant to be substitutes for money, must conform to the following requisites to be considered as such a) it must be in writing; b) it must be signed by the maker or drawer; c) it must contain an unconditional promise or order to pay a sum certain in money; d) it must be payable on demand or at a fixed or determinable future time; e) it must be payable to order or bearer; and f) where it is a bill of exchange, the drawee must be named or otherwise indicated with reasonable certainty. Negotiable instruments include promissory notes, bills of exchange and checks. Letters of credit and trust receipts are, however, not negotiable instruments. But drafts issued in connection with letters of credit are negotiable instruments. -Private respondent PBCom presented the following documentary evidence to prove petitioners credit availments and liabilities: Promissory Notes, Irrevocable letter of credits, drafts, trust receipts. -The above-cited documents presented have not merely created a prima facie case but have actually proved the solidary obligation of MICO and the petitioners, as sureties of MICO, in favor of respondent PBCom. While the presumption found under the Negotiable Instruments Law may not necessarily be applicable to trust receipts and letters of credit, the presumption that the drafts drawn in connection with the letters of credit have sufficient consideration. Under Section 3(r), Rule 131 of the Rules of Court there is also a presumption that sufficient consideration was given in a contract. Hence, petitioners should have presented credible evidence to rebut that presumption as well as the evidence presented by private respondent PBCom. 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. On the other hand, aside from their bare denials petitioners did not present sufficient and competent evidence to rebut the evidence of private respondent PBCom. Petitioner MICO did not proffer a single piece of evidence, apart from its bare denials, to support its allegation that the loan transactions, real estate mortgage, letters of credit and trust receipts were issued allegedly without any consideration.

3. Transfield Philippines, Inc. v. Luzon Hydro Corporation, Australia and New Zealand Banking Group Limited and Security Bank Corporation, G.R. NO. 146717, Nov. 22, 2004
The letter of credit evolved as a mercantile specialty, and the only way to understand all its facets is to recognize that 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. Nor is it 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 banks customer cannot draw on the letter, it does not function as an assignment by the customer to the beneficiary. Nor, if properly used, is it a contract of suretyship or guarantee, because it entails a primary liability following a default. Finally, it 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. 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 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. The use of credits in commercial transactions serves to reduce the risk of non payment of the purchase price under the contract for the sale of goods. However, credits 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. There are three significant differences between commercial and standby credits. First, commercial credits involve the payment of money under a contract of sale. Such credits become payable upon the presentation by the seller-beneficiary of documents that show he has taken affirmative steps to comply with the sales agreement. In the standby type, the credit is payable upon certification of a party's non performance of the agreement. The documents that accompany the beneficiary's draft tend to show that the applicant has not performed. 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. 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. A letter of credit, however, changes its nature as different transactions occur and if carried through 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.