Commercial Laws 1: Letters of Credit
1. Letters of Credit.
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 will honor drafts or other demands
for payment
upon compliance with the conditions specified in the credit.
2. Purpose.
Through a letter of credit, the bank merely substitutes its own promise to pay for the promise to pay of one of its customers.
who in return promises to pay the bank the amount of funds mentioned in the letter of credit plus credit or commitment fees mutually agreed upon.
Although letters of credit are normally used in trade of goods, it is also used as a security for other types of obligations including those arising from:
loan agreements,
contracts for the supply of services or
construction of buildings and infrastructure.
Example:
A contracted Company B for a construction of a building. Company B required a guarantee of payment to commence work.
A approached Bank C to issue a letter of credit in favor of Company B.Bank C shall issue the LC to Company B, promising to pay a specified amount upon presentation of certain documents (e.g., completion certificates, invoices, inspection reports).
Upon completing a milestone, Company B shall submit the required documents to Bank C as proof of progress.Bank C shall review the documents and, if they meet the LC's conditions, pay Company B the agreed amount.
A shall reimburse Bank C for the payment made to Company B, plus any agreed-upon fees for the LC service.
a. Not Prohibited.
A Letter of Credit in itself is not a prohibited form of payment.
It is simply a promise to pay.
Banks issue Letters of Credit as a way to ensure sellers that they will get paid as long as they do what they've agreed to do.
3. Governing Law.
The provisions of the Code of Commerce on Letters of Credit were not repealed by the New Civil Code or any other Special Law.
The provisions of the Code of Commerce on Letters of Credit encompass only Articles 567 to 572 which provide:
ART. 567.
Letters of credit are those issued by one merchant to another, or for the purpose of attending to a commercial transaction.
ART. 568.
The essential conditions of letters of credit shall be:
1. To be Issued In favor of a determined person and not to order.
2. To be llmlted to a fixed and specified amount, or to one or more Indeterminate amounts, but all within a maximum sum the limit of which must be exactly stated.
Letters of credit which do not have one of these conditions shall be considered simply as letters of recommendation.
ART. 569.
The one who issues a letter of credit shall be liable to the person on whom it was issued for the amount paid by virtue of the same within the maximum fixed therein.
Letters of credit cannot be protested, even when not paid, nor can the holder thereof acquire any right of action for said non-payment against the person who issued it.
The payor shall have a right to demand the proof of the identity of the person in whose favor the letter of credit was issued.
ART. 570.
The drawer of a letter of credit may annul it, informing the bearer and the person to him it is addressed of said revocation.
ART. 571.
The holder of a letter of credit shall pay the drawer the amount received without delay.
Should he not do so, an action including attachment may be brought to recover said amount with the legal interest and the current exchange in the place where the payment was made or the place where it was repaid.
ART. 572.
If the holder of the letter of credit does not make use thereof within the period agreed upon with the drawer of the same, or, in the absence of a fixed period, within six months from its date in any point of the Philippines, and within twelve months outside thereof, it shall be void in fact and in law.
3.01. Uniform Customs and Practice.
The provisions of the Code of Commerce on Letters of Credit are already rendered obsolete by the present customs on Letters of Credit.
These customs are embodied in the Uniform Customs and Practice for Documentary Credits (UCP for short) that was adopted by the International Chamber of Commerce.
It was first adopted in 1933 and has since undergone a number of revisions.
The applicability of the UCP was explained in Bank of America, NT & SA v. Court of Appeals:
Being a product of international commerce, the impact of this commercial instrument transcends national boundaries, and it is thus not uncommon to find a dearth of national law that can adequately provide for its governance.
This country is no exception. Our own Code of Commerce basically introduces only its concept under Articles 567-572, inclusive, thereof.
It is no wonder then why great reliance has been placed on commercial usage and practice, which, in any case, can be justified by the universal acceptance of the autonomy of contracts rule.
The rules were later developed into what is now known as the Uniform Customs and Practice for Documentary Credits (UCP) issued by the International Chamber of Commerce.
It is by no means a complete text by itself, for, to be sure, there are other principles, which, although part of lex mercaroria, are not dealt with in the U.C.P.
The latest revision known as UCP 600 took effect on July 1, 2007.
However, UCP 600 must be expressly adopted in the letter of credit to be applicable.
This is not the case with respect to UCP 400, which the Supreme Court itself adopted as an applicable rule even in the absence of stipulation.
The Hongkong & Shanghai Banking Corp., Limited v. National Steel Corp.:
"Letters of credit are defined and their incidences regulated by Articles 567 to 572 of the Code of Commerce.
These provisions must be read with Article 2 of the same code which states that acts of commerce are governed:
by their provisions,
by the usages and customs generally observed in the particular place and,
in the absence of both rules, by civil law.
ln addition, Code of Commerce and special laws and in their absence, by general civil law.
The International Chamber of Commerce (ICC) drafted a set of rules to govern transactions involving letters of credit. This set of rules is known as the Uniform Customs and Practice for Documentary Credits (UCP).
Since its first issuance in 1933, the UCP has seen several revisions, the latest of which was in 2007, known as the UCP 600.
However, for the period relevant to this case, the prevailing version is the 1993 revision called the UCP 400.
Throughout the years, the UCP has grown to become the worldwide standard in transactions involving letters of credit. It has enjoyed near universal application with an estimated 96% of worldwide letters of credit issued subject to the UCP.
Bank of the Philippine Islands v. De Reny Fabric Industries, Inc.:
The Court applied a provision from the UCP in resolving a case pertaining to a letter of credit transaction.
The use of international custom in our jurisdiction is justified by Article 2 of the Code of Commerce which provides that acts of commerce are governed by, among others, usages and customs generally observed.
Feati Bank & Trust Company v. Court of Appeals:
The Court ruled that the UCP should be applied in cases where the letter of credit expressly states that it is the governing rule.
This Court also held that the UCP applies even if it is not incorporated into the letter of the credit.
Metropolitan Waterworks and Sewerage System v. Daway:
Affirmed that letters of credit are governed by the UCP as set by the International Chamber of Commerce.
For the purposes of clarity, letters of credit are governed
primarily by their own provisions,
by laws specifically applicable to them, and by
usage and custom.
Consistent with our rulings in several cases, usage and custom refers to UCP 400.
When the particular issues are not covered by the provisions of the letter of credit, by laws specifically applicable to them and by UCP 400, our general civil law finds suppletory application.
3.02. URC not Applicable.
It should be noted in this connection that there is also another set of rules compiled by the International Chamber of Commerce known as the Uniform Rules for Collections (URC 322).
It was drafted by international experts and has been adopted by the ICC members.
Owing to the status of the ICC and the international representation of its membership, these rules have been widely observed by businesses throughout the world.
It prescribes the:
collection procedures,
technology, and
standards for handling collection transactions for banks.
lnsular Bank of Asia & America v. Intermediate Appellate Court, G.R. No. 74834, November 17, 1988:
The Supreme Court ruled, however, that URC 322 does not constitute custom and usage recognized in commerce.
There is also no sufficient evidence to prove that beneficiaries under a letter of credit commonly resort to collection under URC 322 as a matter of industry practice.
The entire system of letters of credit rely on the assurance that upon presentment of the proper documents, the beneficiary has an enforceable right and the issuing bank a demandable obligation, to pay the amount agreed upon.
Were a party to the transaction allowed to simply set this aside by the mere invocation of another set of norms related to commerce — one that is not established as a custom that is entitled to recognition by this Court — the sanctity of letters of credit will be jeopardized.
To repeat, any law or custom governing letters of credit should have, at its core, an emphasis on the imperative that issuing banks respect their obligation to pay and that seller-beneficiaries may reasonably expect payment in accordance with the terms of a letter of credit.
3.03. Interpretation.
Letters of credit are strictly construed to the end that the rights of those directly parties to them may be preserved and their interest safeguarded.
Like any other writing, it will be construed most strongly against the writer and so as to be reasonable and consistent with honest intentions.
4. Kinds of Letter of Credit.
Letters of Credit can either be: CS
Commercial Letter of Credit, or
Standby Letter of Credit.
a. Commercial Letter of Credit
The most common type of Letters of Credit is a Commercial Credit which is used in the trade of goods.
b. Standby Letter of Credit.
Standby Letter of Credit is a security arrangement for the performance of certain obligations like performance of work or service.
It can be drawn against only if another business transaction is not performed.
It may be issued in lieu of a performance bond.
Standby Letter of Credit, in effect, is an absolute undertaking 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; separate and independent agreements.
However, while they are security arrangements, they are not converted into and are different from contracts of guaranty.
A Standby Letter of Credit secures the performance of some service or work.
The issuer of Standby Letter of Credit is committed to honor the credit upon evidence or a mere declaration of the customer's default in the underlying transaction with the beneficiary.
c. Distinctions
There are significant differences between commercial and standby credits.
Commercial Letter of Credit
involve the payment of money under a contract of sale;
payable upon the presentation by the seller-beneficiary 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.
b. Standby Letter of Credit.
is a security arrangement for the performance of certain obligations like performance of work or service;
payable upon certification of a party's nonperformance of the agreement.
The documents that accompany the beneficiary's draft tend to show that the applicant has not performed his contract.
the beneficiary of the standby credit must certify that his obligor has not performed the contract.
4.01. Kinds of Commercial Credit.
Letters of credit that are used in the trade of goods may be further classified as follows: CIRBG-SSFS
Confirmed LC.
There is a confirmed Letter of credit whenever the beneficiary stipulates that the obligation of the opening bank shall also be made the obligation of a bank to himself.
When this occurs, we have what is known as a confirmed commercial credit and the bank local to the beneficiary becomes the Confirming Bank.
Irrevocable LC.
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.
Revolving Letter of Credit.
It is a credit 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.
This type of letter of credit is desirable when a series of shipments are to be made over a period of time and the total amount is greater than the amount the bank or the buyer is willing to have outstanding at any given time.
Back-to-Back Letter of Credit
It refers to a credit with identical documentary requirements and covering the same merchandise as another letter of credit, except for a difference in the price of the merchandise as shown by the invoice and the draft.
The second letter of credit can be negotiated only after the first is negotiated.
General Letter of Credit
It is one addressed to any and all persons without naming any one in particular.
It does not restrict the beneficiary's right to transfer his interest thereunder.
Special Letter of Credit
It is addressed to a particular individual, firm or corporation by name.
In other words, there is a limit to permissible transfer.
Straight Letter of Credit
It is one that does not run in favor of purchasers of drafts drawn thereunder.
Fixed Letter of Credit
It can be exhausted either:
when drafts for payment have been drawn by the beneficiary for the full amount of the credit or
when the time or period for drawing upon the letter has expired.
Sight Letter of Credit
It is payable on demand as distinguished from Time Letter of Credit which is payable within a certain period.
In transactions where the letter of credit is payable on sight, the issuer must pay upon due presentment.
a. Irrevocable Letter of Credit as Distinguished from Confirmed Letter of Credit.
Irrevocable Letter of Credit
refers to the duration of the letter of credit;
simply means that the issuing bank may not without the consent of the beneficiary (seller) and the applicant (buyer) revoke his undertaking under the letter;
the issuing bank does not reserve the right to revoke the credit.
b. Confirmed Letter of Credit
pertains to the kind of obligation assumed by the correspondent bank;
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 conditions of the credit.
b. Consummation of Irrevocable Letter of Credit
Feati Bank and Trust Co.:
An irrevocable letter of credit granted by a bank, which authorizes a creditor in a foreign country to draw upon a debtor or another and to negotiate the draft through the agent or correspondent bank or any bank in the country of the creditor, is a consummated contract, when the agent or correspondent bank or any bank in the country of the creditor pays or delivers to the latter the amount in foreign currency, as authorized by the bank in the country of the debtor in compliance with the letter of credit granted by it.
It is the date of the payment of the amount in foreign currency to the creditor in his country by the agent or correspondent bank of the bank in the country of the debtor that turns from executory to executed or consummated contract.
5. Nature of Letters of Credit.
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. STSG
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.
A letter of credit is also 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 customer cannot draw on the letter, it does not function as an assignment by the customer to the beneficiary.
It is also not, if properly used, a contract of suretyship or guarantee, because it entails a primary liability following a default.
Finally, 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.
Summary:
❌ strictly contractual
❌ third-party beneficiary contract
❌ contract of suretyship or guarantee
❌ negotiable instrument
❌ stipulation pour autrui
❌ assignment
a. Financial Device
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 nonpayment of the purchase price under the contract for the sale of goods.
However, credits are also used in non-settings where they serve to reduce the risk of nonperformance.
Generally, credits in the non-sale settings have come to be known as standby credits.
b. The Hongkong & Shanghai Banking Corp., Limited v. National Steel Corp , G.R. No. 183486, February 24, 2016:
"A letter of credit generally arises out of a separate contract requiring the assurance of payment of a third party.
In a transaction involving a letter of credit, there are usually three transactions and three parties:
The first transaction, which constitutes the underlying transaction in a letter of credit, is a contract of sale between the buyer and the seller.
The contract may require that the buyer obtain a letter of credit from a third party acceptable to the seller.
The obligations of the parties under this contract are governed by our law on sales.
The second transaction is the issuance of a letter of credit between the buyer and the issuing bank.
The buyer requests the issuing bank to issue a letter of credit naming the seller as the beneficiary.
In this transaction, the issuing bank undertakes to pay the seller upon presentation of the documents identified in the letter of credit.
The buyer, on the other hand, obliges himself or herself to reimburse the issuing bank for the payment made.
In addition, this transaction may also include a fee for the issuing bank's services.
This transaction constitutes an obligation on the part of the issuing bank to perform a service in consideration of the buyer's payment.
The obligations of the parties and their remedies in cases of breach are governed by the letter of credit itself and by our general law on obligations, as our civil law finds suppletory application in commercial documents.
The third transaction takes place between the seller and the issuing bank.
The issuing bank issues the letter of credit for the benefit of the seller.
The seller may agree to ship the goods to the buyer even before actual payment provided that the issuing bank informs him or her that a letter of credit has been issued for his or her benefit.
This means that the seller can draw drafts from the issuing bank upon presentation of certain documents identified in the letter of credit.
The relationship between the issuing bank and the seller is not strictly contractual since there is
no privity of contract
nor meeting of the minds between them.
It also does not constitute a stipulation pour autrui in favor of the seller since
the issuing bank must honor the drafts drawn against the letter of credit regardless of any defect in the underlying contract.
Neither can it be considered as an assignment by the buyer to the seller-beneficiary as
the buyer himself cannot draw on the letter.
From its inception, only the seller can demand payment under the letter of credit.
It is also not a contract of suretyship or guaranty since
it involves primary liability in the event of default.
Nevertheless, while the relationship between the seller-beneficiary and the issuing bank is not strictly contractual, strict payment under the terms of a letter of credit is an enforceable right. This enforceable right finds two legal underpinnings:
First, letters of credit, as will be further explained, are governed by recognized international norms which dictate strict compliance with its terms.
Second, the issuing bank has an existing agreement with the buyer to pay the seller upon proper presentation of documents.
Thus, as the law on obligations applies even in commercial documents, the issuing bank has a duty to the buyer to honor in good faith its obligation under their agreement. As will be seen in the succeeding discussion, this transaction is also governed by international customs which this Court has recognized in this jurisdiction.
In simpler terms, the various transactions that give rise to a letter of credit proceed as follows: SO-PP-H-RR-PC
Once the seller ships the goods, he or she obtains the documents required under the letter of credit.
He or she shall then present these documents to the issuing bank which must then pay the amount identified under the letter of credit after it ascertains that the documents are complete.
The issuing bank then holds on to these documents which the buyer needs in order to claim the goods shipped.
The buyer reimburses the issuing bank for its payment at which point the issuing bank releases the documents to the buyer.
The buyer is then able to present these documents in order to claim the goods. At this point, all the transactions are completed.
The seller received payment for his or her performance of his obligation to deliver the goods.
The issuing bank is reimbursed for the payment it made to the seller.
The buyer received the goods purchased.
Owing to the complexity of these contracts, there may be a correspondent bank which facilitates the ease of completing the transactions.
A correspondent bank may be NNC
a notifying bank,
a negotiating bank or
a confirming bank depending on the nature of the obligations assumed.
A notifying bank
undertakes to inform the seller-beneficiary that a letter of credit exists.
It may also have the duty of transmitting the letter of credit.
As its obligation is limited to this duty, it assumes no liability to pay under the letter of credit.
A negotiating bank, on the other hand, purchases drafts at a discount from the seller-beneficiary and presents them to the issuing bank for payment.
Prior to negotiation, a negotiating bank has no obligation.
A contractual-relationship between the negotiating bank and the seller-beneficiary arises only after the negotiating bank purchases or discounts the drafts.
A confirming bank may honor the letter of credit issued by another bank or confirms that the letter of credit will be honored by the issuing bank.
A confirming bank essentially insures that the credit will be paid in accordance with the terms of the letter of credit.
It therefore assumes a direct obligation to the seller-beneficiary.
Parenthetically, when banks are involved in letters of credit transactions, the standard of care imposed on banks engaged in business imbued with public interest applies to them.
Banks have the duty to act with the highest degree of diligence in dealing with clients.
Thus, in dealing with the parties in a letter of credit, banks must also observe this degree of care.
5.01. Distinguished from Guaranty.
The settlement of a dispute between the parties is not a prerequisite for the release of funds under a 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.
a. Standby Credit and Surety Contracts
Like a surety, the bank will be liable under a Standby Credit if there is default in the secured obligation.
However, a Standby Letter of Credit is different from a surety in some important aspects.
In one case Transfield Phils. vs. Luzon Hydro Corp. (443 SCRA 307, 2004), the Supreme Court cited Professor John F. Dolan who explained the difference between a Standby Letter of Credit and a suretyship:
Standby Credit
inexpensive and efficient
triggered by the examination of documents
reasonably expects that he will receive cash in the event of nonperformance, that he will receive it promptly, and that he will receive it before any litigation with the obligor (the applicant) over the nature of the applicant's performance takes place.
reverses the financial burden of parties during litigation
Surety Contracts
generate higher costs
triggered by a factual determination
upon the obligor's default, the surety undertakes to complete the obligor's performance, usually by hiring someone to complete that performance
often involve costs of determining whether the obligor defaulted (a matter over which the surety and the beneficiary often litigate) plus the cost of performance
benefit of the surety contract to the beneficiary is obvious
no duty to indemnify the beneficiary until the beneficiary establishes the fact of the obligor's performance
beneficiary may have to establish that fact in litigation; the surety holds the money and the beneficiary bears most of the cost of delay in performance.
Summary:
Purpose:
Surety Contract:
Upon the obligor's default, the surety (often an insurance company) undertakes to complete the performance.
Standby Credit:
Provides cash promptly in the event of nonperformance.
Operation:
Surety Contract:
Involves costs for determining the default and performing the obligations.
Requires the surety to hire someone to complete the performance.
Standby Credit:
The beneficiary receives funds before any litigation over the applicant's performance.
Reverses the financial burden during litigation, as the beneficiary receives the money upfront.
Cost and Efficiency:
Surety Contract:
Typically generate higher costs due to the need for factual determinations and performance completion.
Beneficiary may face lengthy and costly determinations of default.
Standby Credit:
More cost-effective and efficient.
Replace surety contracts by providing quicker access to funds.
Financial Burden During Litigation:
Surety Contract:
No duty to indemnify the beneficiary until the default is established, often through litigation.
The surety holds the money while the beneficiary bears the cost of delay.
Standby Credit:
Beneficiary receives payment before litigation, shifting the financial burden to the applicant (the obligor).
Expectation of Performance:
Surety Contract:
Beneficiary waits for performance completion by the surety, which takes time.
Standby Credits:
Beneficiary expects immediate cash payment upon nonperformance.
b. Litigation in Standby Credit
In a standby credit, the beneficiary avoids the burden of litigation and receives his money promptly upon presentation of the required documents.
It may be that the applicant has performed his obligation and that the beneficiary's presentation of those documents is not rightful.
In that case, the applicant may sue the beneficiary in tort, in contract, or in breach of warranty; but, during the litigation to determine whether the applicant has in fact breached the obligation to perform, the beneficiary, not the applicant, holds the money.
6. Parties.
There would at least be three parties in a Commercial Letter of Credit transaction:
the buyer
who procures the letter of credit and
obliges himself to reimburse the issuing bank upon receipt of the documents of title;
the bank issuing the letter of credit,
which undertakes to pay the seller upon receipt of the draft and proper documents of titles and
to surrender the documents to the buyer upon reimbursement; and
the seller,
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.
The buyer is also known as the Account Party.
a. Increasing the Number of Parties
The number of the parties, not infrequently and almost invariably in international trade practice, may be increased.
Thus, the services of an:
advising (notifying) bank
may be utilized to convey to the seller the existence of the credit; or,
confirming bank
which will lend credence to the letter of credit issued by a lesser known issuing bank; or,
paying bank
which undertakes to encash the drafts drawn by the exporter.
negotiating bank
to have the draft discounted instead of going to the place of the issuing bank to claim payment, the buyer may approach another bank
b. Charles Lee, et al. v. Court of Appeals, et al. G.R. No. 117913, February 1, 2002, 163 SCAD 253:
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:
the buyer or the importer,
the seller, also referred to as beneficiary,
the opening bank which is usually the buyer's bank which actually issues the letter of credit
the notifying bank which is the correspondent bank of the opening bank through, which it advises the beneficiary of the letter of credit
negotiating bank which is usually any bank in the city of the beneficiary.
the paying bank which buys or discounts the drafts contemplated by the letter of credit, if such draft is to be drawn on the opening bank or on another designated bank not in the city of the beneficiary, and
the confirming bank which, upon the request of the beneficiary, confirms the letter of credit issued by the opening bank.
6.01. Issuing Bank
The issuing (or opening) bank issues the letter of credit obligating itself to pay the seller or accept any draft or bill that is drawn by the seller upon receipt of the tender documents stipulated in the letter.
Thus, the obligations of the Issuing Bank are:
to make a payment to or to the order of a third party (the 'Beneficiary’) or to accept and pay the bills of exchange (Draft) drawn by the Beneficiary or
to authorize another bank to effect such payment, or to accept and pay such bills of exchange (Draft), or
to authorize another bank to negotiate, against stipulated document provided that the terms and conditions of the Credit are complied with.
Solidary Liability.
Except when the letter of credit specifically stipulates otherwise, the obligation of the issuing bank is solidary with the person requesting for its issuance.
Examination of Tender Documents.
All instructions to issue, confirm or advise a credit must state precisely the documents against which payment, acceptance or negotiation is to be made."
Tender documents that may be stipulated upon as specified in the UCP are the:
Bill of Lading
Insurance Documents
Commercial Invoices
Warehouse Receipts
Delivery Orders
Consular Invoices and
various certificates like Certificates of Origin, Certificate of Weight, Certificate of Quality, or Certificate of Analysis.
The Hongkong & Shanghai Banking Corp., Limited v. National Steel Corp G.R. No. 183486, February 24, 2016:
HSBC as the issuing bank, has the obligation to immediately pay NSC upon presentment of the documents listed in the Letter of Credit.
These documents are:
one original commercial invoice;
one packing list;
one non-negotiable copy of clean on board ocean bill of lading made out to order, blank endorsed marked 'freight collect and notify applicant;
copy of Mill Test Certificate made out 'to whom it may concern;
copy of beneficiary's telex to applicant advising shipment details including DIC No., shipping marks, name of vessel, port of shipment, port of destination, bill of lading date, sailing and ETA dates, description of goods, size, weight, number of packages and value of goods latest two days after shipment date; and
beneficiary's certificate certifying that:
one set of non-negotiable copies of documents (being those listed above) have been faxed to applicant latest two days after shipment date; and
one set of documents including one copy each of invoice and packing list, 3/3 original bills of lading plus one non-negotiable copy and three original Mill Test Certificates have been sent to applicant by air courier service latest two days after shipment date.
c. Standards for Examination (Under Article 13 of the UCP 500)
Banks must examine all documents stipulated in the Credit with reasonable care, to ascertain whether or not they appear on their face to be in compliance with the terms and conditions of the Credit.
Compliance of the stipulated documents on their face with the terms and conditions of the Credit shall be determined by international standard banking practice as reflected in these Articles.
Documents which appear on their face to be inconsistent with one another will be considered as not appearing on their face to be in compliance with the terms and conditions of the Credit.
Documents not stipulated in the Credit will not be examined by banks if they receive such documents, they shall return them to the presenter or pass them on without responsibility.
The Issuing Bank, the Confirming Bank, If any, or a Nominated Bank acting on their behalf shall each have a reasonable time, not to exceed seven banking days following the day of receipt of the documents to examine the documents and to determine whether to take up or refuse the documents and to inform the party from which it received the documents accordingly.
If a Credit contains conditions without stating the document[s] to be presented in compliance therewith, banks will deem such conditions as not stated and will disregard them.
d. Doctrine of Strict Compliance
The issuing bank must see to it that the terms of the letters of credit are strictly complied with.
The issuing bank is duty bound:
to examine the tender documents and
to make sure that the same tender documents strictly comply with the specifications in the Letters of Credit.
For instance, the enumeration of the specific documents that must be submitted is controlling. In addition, the required provisions in the tender documents must also be complied with.
The issuing bank has no discretion to waive any of the requirements.
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.
e. Payment
The issuing bank may or may not be the paying bank.
Bank of America, NT and SA vs. CA, GR No. 105395, December 10, 1993
The Paying Bank is the bank on which the drafts are to be drawn.
It may be the opening bank, it may be a bank other than the opening bank and not in the city of the beneficiary, or it may be a bank in the city of the beneficiary, usually the advising bank.
If the beneficiary is to draw and receive payment in his own currency, the notifying bank will be indicated as the paying bank also.
When the draft is to be paid in this manner, the paying bank assumes no responsibility but merely pays the beneficiary and debits the payment immediately to the account which the opening bank has with it.
If the opening bank maintains no account with the paying bank, the paying bank reimburses itself by drawing a bill of exchange on the opening bank, in dollars, for the equivalent of the local currency paid to the beneficiary, at its buying rate for dollar exchange.
The beneficiary is entirely out of the transaction because his draft is completely discharged by payment, and the credit arrangement between the paying bank and the opening bank does not concern him.
If the draft contemplated by the credit instrument is to be drawn on the opening bank or on another designated bank not in the city of the seller, any bank in the city of the seller which buys or discounts the draft of the beneficiary becomes a Negotiating Bank.
As a rule, whenever the facilities of a notifying bank are used, the beneficiary is apt to offer his drafts to the notifying bank for negotiation, thus giving the notifying bank the character of a negotiating bank also.
By negotiating the beneficiary's drafts, the negotiating bank becomes "an endorser and bona fide holder" of the drafts and within the protection of the credit instrument.
It is also protected by the drawer's signature, as the drawer's contingent liability, as drawer, continues until discharged by the actual payment of the bills of exchange.
Problem (2013 Bar)
Muebles Classico, Inc. (MC), a Manila-based furniture shop, purchased hardwood lumber from Surigao Timber, Inc. (STn, a Mindanao based logging company. MC was to pay STI the amount of P5 million for 50 tons of lumber. To pay STI, MC opened a letter of credit with Banco de Plata (BDP). BDP duly informed STI of the opening of a letter of credit in its favor. In the meantime, MC - which had been undergoing financial reverses filed a petition for corporate rehabilitation. The rehabilitation court issued a Stay Order to stay the enforcement of all claims against MC.
After shipping the lumber, STI went to BDP, presented the shipping documents, and demanded payment of the letter of credit opened in its favor. MC, on the other band, informed the bank of the Stay Order and instructed it to deny payment to STI because of the Stay Order. BDP comes to you for advice.
Should the claim be granted?
Yes, STI's claim should be granted.
The claims against the letter of credit are NOT affected by the rehabilitation proceedings against the debtor. The claim is not a claim against the debtor under rehabilitation. It is also well settled that the claim against the bank under a letter of credit is solidary in nature.
6.02. Seller-Beneficiary.
The seller of the merchandise is called the Beneficiary of the credit instrument.
The instrument is addressed to him and is in his favor.
It is the written contract of the bank, which has created the instrument.
The bank cannot compel the beneficiary to ship and avail himself of the benefits of the instrument.
However, the seller may recover from the bank the value of his shipment if made within the terms of the instrument, even though he has not given the bank any direct consideration for the bank's promises contained in the instrument.
By a stretch of imagination, and in order to support the instrument as a two-sided contract, supported by mutually given considerations, the courts seem to hold that the commission paid or to be paid by the buyer to the bank is also the consideration flowing from the seller to the bank.
a. Strict Compliance
When the seller avails of the letter of credit, his obligation is to deliver to the paying bank the tender documents stipulated in the letter of credit whether the bank is the issuing bank or confirming bank.
The Doctrine of Strict Compliance is applicable; strict compliance with the terms of the letter of credit is necessary when the seller performs his obligation to present the tender documents.
Feati Bank and Trust Co. v. Court of Appeals, G.R. No. 94209. April 30, 1991:
It is a settled rule in commercial transactions involving letters of credit that the documents tendered must strictly conform to the terms of the letter of credit.
The tender of documents by the beneficiary (seller) must include all documents required by the letter.
A correspondent bank which departs from what has been stipulated under the letter of credit, as when it accepts a faulty tender, acts on its own risks and it may not thereafter be able to recover from the buyer or the issuing bank, as the case may be, the money thus paid to the beneficiary. Thus, the rule of strict compliance.
Anglo-South American Trust Co. v. Uhe, et al. (184 N.E. 741 [1933])
We have heretofore held that these 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 constitute an agreement between the purchaser and the bank.
Banks are granted a little discretion to accept a faulty tender as when the other documents may be considered immaterial or superfluous, this theory could lead to dangerous precedents.
Since a bank deals only with documents, it is not in a position to determine whether or not the documents required by the letter of credit are material or superfluous.
The mere fact that the document was specified therein readily means that the document is of vital importance to the buyer.
It is absolutely necessary for the protection of the banking and mercantile community that all conditions contained in the letter be strictly complied with, however onerous they may be.
The seller should strictly observe the terms and conditions under which the credit is to become available and unless he does this, he will have no cause of action against the bank for refusing to honor this draft.
6.03. Account Party: Buyer-Importer.
The buyer-importer is the person who applies for and for whose benefit the issuing bank issues the letter of credit.
Under the independent contract between the buyer and the issuing bank, which is in the form of a credit agreement, the buyer obligates himself to reimburse the issuing bank when the latter complies with the terms of the letter.
6.04. Notifying or Advising Bank.
The notifying bank is a correspondent bank of the issuing bank.
It assumes no liability except to notify and/or transmit to the beneficiary the existence of the letter of credit.
The relationship between the issuing bank and the notifying bank is similar to that of agency and not a guarantee.
However, the bank that elects to advise the Credit "shall take reasonable care to check the apparent authenticity of the Credit which it advises."
If the advising/notifying bank cannot establish such apparent authenticity of the Credit, it must inform without delay the bank from which the instructions appear to have been received.
6.05. Confirming Bank.
The confirming bank not only notifies the beneficiary but it also assumes the direct obligation to the seller.
Its liability is primary; it is as if the confirming bank issued the letter of credit.
Bank of America, NT & SA v. Court of Appeals, G.R. No. 105395, December 10, 1993:
Commercial credits issued by American banks in favor of foreign sellers are invariably issued only by larger well known banks, no seller requests that they be confirmed by another bank.
The standing of the opening bank is good enough.
But many foreign banks are not particularly strong or well known, compared with banks issuing these credit instruments.
Indeed, many banks operating abroad are only known through the Banker's Almanac.
They serve a useful purpose in their own small communities and perhaps maintain dollars account with the larger banks.
But their names are quite meaningless to the exporter, and when the foreign buyer offers to his seller a credit instrument issued by such a bank, the seller may not receive the protection and other facilities which an instrument issued by a large, strong, and well known bank will give him.
To overcome this, he requests that the credit as issued by the local bank of the foreign buyer be confirmed by a well known bank, which will turn out to be a bank with which the local bank of the buyer carries a dollar account.
The liability of the confirming bank is a primary one and is not contingent in any sense of the word.
It is as if the credit were issued by the opening and confirming banks jointly, thus giving the beneficiary or a holder for value of drafts drawn under the credit, the right to proceed against either or both banks, the moment the credit instrument has been breached.
The confirming bank receives a commission for its confirmation from the opening bank which the opening bank, in turn, passes on to the buyer of the merchandise.
6.06. Negotiating Bank
A negotiating bank is a correspondent bank that buys or discounts a draft under the letter of credit. Its liability is dependent upon the stage of the negotiation.
Before negotiation, it has no liability with respect to the seller.
After negotiation, a contractual relationship will then prevail between the negotiating bank and the seller.
It may buy or refuse to buy as it chooses.
Equally, it must be true that it owes no contractual duty toward the person 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.
Negotiation means the giving of value for Drafts and/or documents by the bank authorized to negotiate.
Mere examination of documents without giving of value does not constitute negotiation.
8. Transaction Involved.
Bank of America, NT & SA v. Court of Appeals, G.R. No. 105395, December 10, 1993
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 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 to 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.
Independent Contracts.
There are at least three distinct and independent contracts involved in a letter of credit namely:
the contract of sale between the buyer and the seller;
the contract of the buyer with the issuing 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 is paid to the seller plus proper consideration agreed upon by the parties.
the letter of credit proper
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 the document of title.
Other contracts may be actually involved.
contract between the confirming bank and the issuing bank
if payment is made through a confirming bank
Under this contract, the confirming bank is authorized to make payments after securing the tender documents.
Thereafter, the confirming bank is obligated to transmit the tender documents to the issuing bank; the issuing bank then has the obligation to reimburse the confirming bank for the amount that the latter paid to the seller.
contract between the confirming bank and the seller
whereby the latter can compel the bank to pay upon presentation of the tender documents.
b. Independence Principle.
Transfield Philippines, Inc. v. Luzon Hydro Corporation, et al., G.R No. 146717:
Few things are more clearly settled in law than that the contracts involved in a letter of credit arrangement are to be maintained in a state of perpetual separation.
The undertaking of the bank to pay, accept and pay drafts or negotiate and/or fulfill any obligation under the Credit is not subject to claims or defenses by the Applicant resulting from his relationship with the issuing bank or the beneficiary.
In the same manner, the beneficiary can in no case avail himself of the contractual relationships existing between the banks or between the applicant and the issuing bank.
The "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.
Bangayan v. Rizal Commercial Banking Corp., G.R. No. 149193, April 4, 2011:
This independence principle in letters of credit:
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.
The "independence principle" is what differentiates a letter of credit from any other accessory contract.
The Hongkong & Shanghai Banking Corp., Limited v. National Steel Corp G.R. No. 183486, February 24, 2016:
What characterizes letters of credit, as distinguished from other accessory contracts, is the engagement of the issuing bank to pay the seller once the draft and the required shipping documents are presented to it.
In turn, this arrangement assures the seller of prompt payment, independent of any breach of the main sales contract.
By this so-called "independence principle," the bank determines compliance with the letter of credit only by examining the shipping documents presented; it is precluded from determining whether the main contract is actually accomplished or not.
b. Character of Definiteness.
The obligation of the issuer is imbued with the character of definiteness in that not even the defect or breach in the underlying transaction will affect the issuing bank's liability.
This is the Independence Principle in the law on letters of credit.
Article 17 of UCP 400 explains that under this principle, an issuing bank assumes 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.
✅ Thus, as long as the proper documents are presented, the issuing bank has an obligation to pay even if the buyer should later on refuse payment.
The Supreme Court likewise relied on Article 17 of the UCP (1983 Ed.) and the disquisition of White and Summers:
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.
According to White and Summers, op. cit. Bankers (describe) the transaction between the bank and the beneficiary as a paper transaction.
By that they mean the bank issuer's agent should be able to sit with a necktie and a white shirt at a desk in s bank and by looking at papers that are presented to him determine whether the bank is obliged to make payment or not.
He is not obligated and, indeed, is foreclosed from donning his overalls and going into the field to determine whether the underlying contract has been performed. This is the principal reason why careful courts and lawyers state that the letter of credit is not a guarantee.
In a typical guarantee, the guarantor will agree to make payments if, and only if, the customer has failed to fulfill his obligation on the underlying contract. If his obligation has been avoided because of the acts of the beneficiary, typically there would be no obligation to guarantee and thus no duty on the guarantor to pay.
Letters of credit are different, and they are explicitly and consciously designed to be different in this respect.
In effect, the beneficiary under a letter of credit has bargained for the right to be paid and thus often to be the defendant instead of the plaintiff in the ensuing litigation on the underlying contract, to be sued at home instead of being a plaintiff abroad.
c. Independent Contracts.
The contract of sale is independent from the letter of credit itself.
The letter of credit is also independent of the contract between the buyer and the issuing bank.
Consequently, violation of the contract of sale will not necessarily affect the letter of credit obligation of the issuing bank to the seller so long as the tender documents are delivered to the former.
In other words, the letter of credit constitutes the complete agreement, and is independent of the contract of sale between the buyer and the seller, and is unaffected by any breach on the part of the seller or the buyer or by any controversy which may arise between the buyer and the seller or by any other transaction between the buyer and the seller.
In the same manner, the letter of credit is independent not only of the contract between the seller and the buyer but also of the credit agreement between the buyer and the issuing bank.
The contract between the buyer and the issuing bank has no bearing as to the non-compliance by the buyer with the agreement between the latter and the seller.
Refusal of the buyer to pay the seller is not a defense that is available to the issuing bank.
The letter of credit is also independent of any contract of carriage that may have been involved.
A transaction involving the purchase of goods may also require, apart from a letter of credit, contract of transportation specially when the seller and the buyer are not in the same locale or country, and the goods purchased have to be transported to the latter.
The contract of carriage must be treated independently of the contract of sale between the buyer and the seller and the contract for the issuance of a letter of credit between the buyer and the issuing bank.
Consequently, any discrepancy between the amount of the goods described in the commercial invoice in the contract of sale and the amount allowed in the letter of credit will not affect the validity and enforceability of the contract of carriage as embodied in the bill of lading.
As the bank cannot be expected to look beyond the documents presented to it by the seller pursuant to the letter of credit, neither can the carrier be expected to go beyond the representations of the shipper in the bill of lading and to verify their accuracy vis-a-vis the commercial invoice and the letter of credit.
A letter of credit 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.
8.01. Banks Deal With Documents.
A direct consequence of the "independence principle," is the rule that:
✅ banks only deal with documents and
❌ not with goods, services or obligations to which they relate.
Banks that provide financing in international business transactions do not deal with the property to be exported or shipped to the importer, but deal only with documents.
Existing rules negate any duty on the part of a bank to verify whether what has been described in the letters of credits or drafts or shipping documents actually tallies with what was loaded aboard the ship.
Payment, negotiation or acceptance against documents in accordance with the terms and conditions of the credit by a bank authorized to do so binds the buyer or the party giving the authorization to take up the documents and reimburse the bank making the payment, negotiation or acceptance.
Thus, the applicant cannot recover on the ground that the issuing bank paid the seller despite the alleged discrepancies in the shipment vis-a-vis the order specifications.
What is important is delivery of tender documents (like a document of title) that conforms with what the letters of credit require.
Obligations of the Bank.
What is only necessary is for the bank to:
make sure that the tender documents are complete and
the seller strictly complied with the terms and conditions of the letters of credit.
Article 15 of the UCP 500 provides that:
banks"assume no liability or responsibility for the form, sufficiency, accuracy, genuineness, falsification or legal effect of any document[s] or for the general and/or particular conditions stipulated in the document[s] 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 document[s] or for the good faith or acts and/or omissions, solvency, performance or standing of the consignors, the carriers, the forwarders, the consignees or the insurers of the goods, or any other person whomsoever.
Settlement of Dispute.
If the letter of credit is drawable only after the settlement of any dispute on the main contract (like sale), then there would be no practical and beneficial use for letters of credit in commercial transactions.
8.02. Who Can Invoke the Independence Principle.
The issuing bank can invoke the independence principle but it is not the only party who can do so.
Even the beneficiary, in proper cases, can invoke the doctrine.
While it is the bank that 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.
Not Only Issuing Bank.
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 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 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”.
11. Fraud Exception.
Transfield Phils. vs. Luzon Hydro Corp. (443 SCRA 307, 2004)
The Supreme Court recognized what is known as the "fraud exception" to the independence principle.
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.
The Court observed that most writers agree that fraud is an exception to the independence principle and cited Professor Dolan's opinion that the untruthfulness of a certificate accompanying a demand for payment order under standby credit may qualify as fraud sufficient to support an injunction against payment.
Background
It should be noted that the UCP does not contain a “fraud exception.”
However, the exception is expressly stated in the Uniform Commercial Code in the United States and had been adopted in both American and English cases.
Section 5-109 the UCC provides that the applicant may ask the court for an injunction if:
a required document is forged or materially fraudulent or
that the honor of the presentation would facilitate a material fraud by the beneficiary on the issuer or applicant.
It has been observed that the "fraud exception" provides a reasonable balance between the interests of offering minimal protection to bank customers and of assuring reasonable certainty in the execution of international transactions.
Origin of Exception
The fraud exception originated from the dissent of Justice Cardozo in Maurice O' Meara Co. v. National Park Bank:
I dissent from the view that, if [the issuing bank] chooses to investigate and discovers thereby that the merchandize tendered is not in truth the merchandize which the documents describe, it may be forced by the delinquent seller to make payment of the price irrespective of its knowledge.
The view of Justice Cardozo was later adopted in the leading case of Sztejn v. J. Henry Schroder Banking Corporation, where the court issued an injunction to bar payment by the issuing bank where the buyer alleged that there was intentional fraud and the beneficiary was a party to the fraud.
Requirements for Injunction under the Fraud Exception
The remedy for fraudulent abuse is an injunction.
However, the Supreme Court ruled in Transfield Philippines, Inc. v. Luzon Hydro Corporation, that injunction should not be granted unless: CII
there is clear proof of fraud;
the fraud constitutes fraudulent abuse of the independent purpose of the letter of credit and not only fraud under the main agreement; and
irreparable injury might follow if injunction is not granted or the recovery of damages would be seriously damaged.
d. Courts May Enjoin Payment
The Official Comments on Section 5-109 of the Uniform Commercial Code rely on the explanation in Ground Air Transfer v. Westates Airlines, where it was pointed out that courts may enjoin payment: FD-DC
where the circumstances plainly show that the underlying contract forbids the beneficiary to call a letter of credit;
where the circumstances show that the contract deprives the beneficiary of even a colorable right to call on a letter of credit;
where the contract and circumstances reveal that the beneficiary's demand for payment has absolutely no basis in fact; and
where the beneficiary's conduct has so vitiated the transaction that the legitimate purposes of the independence of the issuer's obligation would no longer be served.
e. Independent Nature.
The independent nature of the letter of credit may be:
independence in toto
where the credit is independent from the justification aspect and
is a separate obligation from the underlying agreement; or
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.
8.04. Protection of the 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:
the issuer shall honor the presentation, if honor is demanded by a:
nominated personn
who has given value in good faith and without notice of forgery or material fraud,
confirmer
who has honored its confirmation in good faith,
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
assignee of the issuer's or nominated person's deferred obligation
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
the issuer, acting in good faith, may honor or dishonor the presentation in any other case.
PROBLEMS:
1. 2012 Bar:
AAA Carmakers opened an irrevocable Letter of Credit with BBB Banking Corporation with CCC Cars Corporation as beneficiary. The irrevocable Letter of Credit was opened to pay for the importation of ten units of Mercedes Benz S class. Upon arrival of the cars, AAA Carmakers found out that the cars were all not in running condition and some parts were missing. As a consequence, AAA Carmakers instructed BBB Banking Corporation not to allow drawdown on the Letter of Credit.
Is this legally possible?
No, because the "Independence Principle" applies.
Under the Independence Principle, the undertaking of the bank to pay, accept and pay drafts or negotiate and/or fulfill any obligation under the Credit is not subject to claims or defenses by the Applicant resulting from his relationship with the issuing bank or the beneficiary.
The letter of credit "constitutes the complete agreement, and is independent of the contract of sale between the buyer and the seller, and is unaffected by any breach on the part of the seller or the buyer or by any controversy which may arise between the buyer and the seller or by any other transaction between the buyer and the seller.
2. 1993 Bar, Feati Bank and Trust Company v. Court of Appeals, G.R. No. 94209, April 30, 1991:
BV agreed to sell to AC, a ship and merchandise broker, 2500 cubic meters of logs at $27.00 per cubic meter FOB. After inspecting the logs CD issued a purchase order. On the arrangements made upon the instructions of the consignee, H and T Corporation of 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 to shipment in accordance with the terms and conditions of the purchase order. Before loading on the vessel chartered by AC, custom inspectors and representatives of the bureau of forestry, who certified to the good condition and exportability of the logs, inspected the logs. After loading was completed the chief mate of the vessel issued a mate receipt of the cargo that stated that the logs are in good condition. However, AC refused to issue the required certification. Because of the absence of certification, FE Bank refused to advance payment on the letter of credit.
May FE Bank be held liable under the letter of credit? Explain.
No. Under the doctrine of strict compliance, the issuing bank is duty bound to examine the tender documents and to make sure that the same tender documents strictly complies with the specifications in the Letters of Creilit.
Thus, enumeration of the specific documents that must be submitted is controlling. In adddition, the required provisions in the tender documents must also be complied with. The issuing bank has no discretion to waive any of the requirements.
In this case, the presentation of a photocopy does not strictly comply with the requirements of the letter ofcredit. In this case, one of the tender documents is the certification of AC. Hence, without such certification, the funds cannot be released by FE.
Under the facts above, the seller, BV, argued the 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. Consequently, FE Bank is liable under the letter of credit.
Is the argument tenable? Explain.
No, the argument is not tenable.
The fact that FE Bank confirmed the letter of credit will not change the obligation of FE Bank under the doctrine of strict compliance.
The obligation to strictly comply with the requirements of the letters of credit remains although FE Bank confirmed the letter of credit.
3. 2012 Bar:
At the instance of CCC Corporation, AAA Bank issued an irrevocable Letter of Credit in favor of BBB Corporation. The terms of the irrevocable Letter of Credit state that the beneficiary must present certain documents including a copy of the Bill of Lading of the importation for the bank to release the funds. BBB Corporation could not find the original copy of the Bill of Lading so it instead presented to the bank a xerox copy of the Bill of Lading.
Would you advise the bank to allow the drawdown on the Letter of Credit?
No. Under the doctrine of strict compliance, the issuing bank is duty bound to examine the tender documents and to make sure that the same tender documents strictly comply with the specifications in the Letters of Credit.
Thus, the enumeration of the specific documents that must be submitted is controlling. In addition, the required provisions in the tender documents must also be complied with. The issuing bank has no discretion to waive any of the requirements.
In this case, the presentation of a photocopy does not strictly comply with the requirements of the letter of credit. Hence, the funds should not be released.
4. Feati Bank and Trust Company v. Court of Appeals, G.R. No. 94209, April 30, 1991:
On June 3, 1971, Bernardo E. Villaluz agreed to sell to the then defendant Axel Christiansen 2,000 cubic meters of Lauan Jogs at $27.00 per cubic meter FOB. After inspecting the logs, Christiansen issued purchase order No. 76171. On the arrangements made and upon the instructions of the consignee, Hanmi Trade Development, Ltd., de Santa Ana, California, the Security Pacific National Bank of Los Angeles, California issued Irrevocable Letter of Credit No. IC- 46268 available at sight in favor of Villaluz for the sum of $54,000.00, the total purchase price of the Lauan Jogs. The letter of credit was mailed to the Feati Bank and Trust Company (now Citytrust) with the instruction to the latter that it "forward the enclosed letter of credit to the beneficiary." The letter of credit further provided that the draft to be drawn is on Security Pacific National Bank and that it be accompanied by the following documents:
Signed Commercial Invoice in four copies showing the number of the purchase order and certifying that:
All terms and conditions of the purchase order haue been complied with and that all logs are fresh cut and quality equal to, or better than that described in HA. Christiansens telex #201 of May 1, 1970, and that all logs have been. marked "BEV-EX"
One complete set of documents, including 1/3 original bills of lading was airmailed to Consignee and Parties to be advised by Hans-Axel Christiansen, Ship and Merchandise Broker.
One set of non-negotiable documents was airmailed to Han Mi Trade Development Company and one set to Consignee andParties to be advised by Hans-Axel Christiansen, Ship and Merchandise Broker.
Tally sheets in quadruplicate.
2/3 Original Clean on Board Ocean Bills of Lading with Consignee and Parties to be advised by Hans Axel Christiansen, showing Freight Prepaid and marked Notify:
Han Mi Trade Deuelopment Company, Ltd., Santa Ana, California.
Letter of Credit No. 46268 dated June 7, 1971
Han Mi Trade Deuelopment Company, Ltd., P.O. Box 10480,
Santa Ana, California 92711 and
Han Mi Trade Deuelopment Company, Ltd., Seoul, Korea
Certification from Han-Axel Christiansen., Ship and Merchandise Broker, stating that loge have been approved prior to shipment in accordance with terms and conditions of corresponding purchase Order. (Record, Vol. 1, pp. 11-12)
Also incorporated by reference in the letter of credit is the Uniform Customs and Practice for Documentary Credits (1962 Revision).
Later, Christiansen refused to issue the certification as required in paragraph 4 of the letter of credit, despite several requests made by the private respondent. Because of the absence of the certification by Christiansen, the Feati Bank and Trust Company refused to advance the payment on the letter of credit.
Is FEATI Bank liable under the letter of credit despite non-compliance by the beneficiary with the terms thereof?
No FEATI Bank is not liable.
The letter merely provided that the petitioner "forward the enclosed original credit to the beneficiary." Considering the aforesaid instruction to the petitioner by the issuing bank, the Security Pacific National Bank, it is indubitable that the petitioner is only a notifying bank and not a confirming bank.
If FEATI bank was a confirming bank, then a categorical declaration should have been stated in the letter of credit that the petitioner is to honor all drafts drawn in conformity with the letter of credit. What was simply stated therein was the instruction that the petitioner forward the original letter of credit to the beneficiary.
Since FEATI bank was only a notifying bank, its responsibility was solely to notify and or transmit the documentary of credit to the private respondent and its obligation ends there. The notifying 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.
A notifying bank is not privy to the contract of sale between the buyer and the seller; its relationship is only with 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.
In order that the FEATI bank may be held liable under the letter, there should be proof that the petitioner confirmed the letter of credit which is not the case here.
However, euen assuming for the sake of argument that FEATI is a confirming bank, FEATI bank is still not liable because the beneficiary failed to comply with the requirements of the Letter of Credit (LC). There must be strict compliance with the requirements of the LC.
5. Bank ofAmerica, NT& SA v. Court ofAppeals, G.R. No. 105395, December 10, 1993:
On March 5, 1981, petitioner Bank of America, NT & SA, Manila, received by registered mail an Irrevocable Letter of Credit No. 20272/81 purportedly issued by Bank of Ayudhya, Samyaek Branch, for the account of General Chemicals, Ltd., of Thailand in the amount of $2,782,000.00 to cover the sale of plastic ropes and "agricultural files," with the petitioner as advising bank and private respondent Inter-Resin Industrial Corporation as beneficiary. On March 11, 1981, Bank ofAmericawrote Inter-Resin informing the latter of the foregoing and transmitting, along with the bank's communication, the letter of credit. Upon receipt of the letter-advice with the letter of credit, Inter-Resin sent Atty. Emiliano Tanay to Bank of America to have the letter of credit confirmed. The bank did not. Reynaldo Dueiias, bank employee in charge of letters of credit, however, explained to Atty. Tanay that there was no need for confirmation because the letter of credit would not have been transmitted if it were not genuine.
Between March 26 to April 10, 1981, Inter-Resin sought to make a partial availment under the letter of credit by submitting to Bank of America invoices, covering the shipment of 24,000 bales of polyethylene rope to General Chemicals valued at $1,320,600.00, the corresponding packing list, export declaration and bill of lading. Finally, after being satisfied that Inter-Resin's documents conformed with the conditions expressed in the letter of credit, Bank of America issued in favor of Inter-Resin a Cashier's Check for P10,219,093.20, "the Peso equivalent of the draft (for) $1,320,600.00 drawn by Inter-Resin, after deducting the costs for documentary stamps, postage and mail insurance." The check was picked up by Inter-Resin's Executive Vice-President Barcelina Tio. On April 10, 1981, Bank of America wrote Bank of Ayudhya advising the latter of the availment under the letter of credit and sought the corresponding reimbursement therefor.
Meanwhile, Inter-Resin, through Ms. Tio, presented to Bank of America the documents for the second availment under the same letter of credit consisting of a packing list, bill of lading, invoices, export declaration and bills in set, evidencing the second shipment of goods. Immediately upon receipt of a telex from Bank of Ayudhya declaring the letter of credit fraudulent, Bank of America stopped the processing of Inter-Resin's documents and sent a telex to its branch office in Bangkok, Thailand, requesting assistance in determining the authenticity of the letter of credit. Bank of America kept Inter-Resin informed of the developments.
Bank of America sued Inter-Resin for the recovery of Pl0,219,093.20 the peso equivalent of the draft for $320,600.00 on the partial availment of the now disowned letter of credit. On the other hand, Inter-Resin claimed that not only was it entitled to retain Pl0,219,093.20 on its first shipment but also to the balance $1,461,400.00 covering the second shipment.
Can Bank of America be deemed to have warranted the authenticity of the letter of credit?
No. Bank of America is merely an advising or notifying bank.
It expressly stated that "[t]he enclosure is solely an advise of credit opened by the abovementioned correspondent and conveys no engagement by us." This written reservation by Bank of America in limiting its obligation only to being an advising bank is in consonancewith the provisions of UCP.
As an advising or notifying bank, Bank of America did not incur any obligation more than just notifying Inter-Resin of the letter of credit issued in its favor, let alone to confirm the letter of credit.
The bare statement of the bank employee, aforementioned, in responding to the inquiry made by Atty. Tanay, Inter-Resin's representative, on the authenticity of the letter of credit certainly did not have the effect of novating the letter of credit and Bank of America's letter of advise, nor can it justify the conclusion that the bank must now assume total liability on the letter of credit. Indeed, Inter-Resin itself cannot claim to have been all that free from fault.
As the seller, the issuance of the letter of credit should have obviously been a great concern to it. It would have, in fact, been strange if it did not, prior to the letter of credit, enter into a contract, or negotiated at the very least, with General Chemicals.
In the ordinary course of business, the perfection of contract precedes the issuance of a letter of credit.
Bringing the letter of credit to the attention of the seller is the primordial obligation of an advising bank.
The view that Bank of America should have first checked the authenticity of the letter of credit with Bank of Ayudhya, by using advanced mode of business communications, before dispatching the same to Inter-Resin finds no real support in Article 18 of the UCP which states that: "Banks assume no liability or responsibility for the consequences arising out of the delay and/or loss in transit of any messages, letters or documents, or for delay, mutilation or other errors arising in the transmission of any telecommunication .. . "
As advising bank, Bank of America is bound only to check the "apparent authenticity" of the letter of credit, which it did. Clarifying its meaning, Webster's Ninth New Collegiate Dictionary explains that the word "Apparent suggests appearance to unaided senses that is not or may not be borne out by more rigorous examination or greater knowledge."
Can Bank of America recover against Inter-Resin under the draft executed in its partial availment of the letter of credit?
Yes, Bank of America can recover what it has paid under the letter of credit when the corresponding draft for partial availment thereunder and the required documents therefor were later negotiated with it by Inter-Resin.
This kind of transaction is what is commonly referred to as a discounting arrangement.
This time, Bank of America, has acted independently as a negotiating bank, thus saving Inter-Resin from the hardship of presenting the documents directly to Bank of Ayudhya to recover payment. (Inter-Resin, of course, could have chosen other banks with which to negotiate the draft and the documents.)
As a negotiating bank, Bank of America has a right of recourse against the and until reimbursement is obtained, Inter-Resin, as the drawer of the draft, continues to assume a contingent liability thereon.
Inter-Resin admits having received P10,219,093.20 from Bank of America on the letter of credit transaction and in having executed the corresponding draft. That payment to Inter-Resin has given, as aforesaid, Bank of America the right of reimbursement from the issuing bank, Bank of Ayudhya which, in turn, could then seek indemnification from the buyer (the General Chemicals of Thailand).
Since Bank of Ayudhya disowned the letter of credit, however, Bank of America may now turn to Inter-Resin for restitution.
6. Bank of the Philippine Islands v. DeReny Fabric Industries, Inc., G.R. No. L-24821, October 16, 1970:
The record shows that on four different occasions in 1961, the De Reny Fabric Industries, Inc., a Philippine corporation through its co-defendants-appellants, Aurora Carcereny, alias Aurora C. Gonzales, and Aurora T. Tuyo, president and secretary, respectively of the corporation, applied to the Bank for four irrevocable commercial letters of credit to cover the purchase by the corporation of goods described in the covering UC applications as "dyestuffs of various colors" from its American supplier, the J.B. Distributing Company. All the applications of the corporation were approved, and the corresponding Commercial UC Agreements were executed pursuant to banking procedures. Under these agreements, the aforementioned officers of the corporation bound themselves personally as joint and solidary debtors with the corporation. Pursuant to banking regulations then in force, the corporation delivered to the Bank peso marginal deposits as each letter of credit was opened.
By virtue of the foregoing transactions, the Bank issued irrevocable commercial letters of credit addressed to its correspondent ban.ks in the United States, with uniform instructions for them to notify the beneficiary thereof, the J.B. Distributing Company, that they have been authorized to negotiate the latter's sight drafts up to the amounts mentioned therein, respectively, if accompanied, upon presentation, by a full set of negotiable clean "on board" ocean bills of lading, covering the merchandise appearing in the UCs, that is, dyestuffs of various colors. Consequently, the J.B. Distributing Company drew upon, presented to and negotiated with these banks, its sight drafts covering the amounts of the merchandise ostensibly being exported by it, together with clean bills of-lading, and collected the full value of the drafts up to the amounts appearing in the U Cs as above indicated. These correspondent banks then debited the account of the Bank of the Philippine Islands with them up to the full value of the drafts presented by the J.B. Distributing Company, plus commission thereon, and, thereafter, endorsed and forwarded all documents to the Bank of the Philippine Islands.
In the meantime, as each shipment (covered by the abovementioned letters of credit) arrived in the Philippines, the De Reny Fabric Industries, Inc. made partial payments to the Bank amounting, in the aggregate, to P90,000.00. Further payments were, however, subsequently discontinued by the corporation when it became established as a result of a chemical test conducted by the National Science Development Board, that the goods that arrived in Manila were colored chalks instead of dyestuffs.
The corporation also refused to take possession of these goods, and for this reason, the Bank caused them to be deposited with a bonded warehouse paying therefor the amount of Pl2,609.64 up to the filing of its complaint with the court below on December 10, 1962. The amount that is supposed to be payable to the Bank as provided for in the UC Agreements is P291,807.46, with interest thereon at the rate of 7% per annum. However, the defendants refused to pay the bank arguing that it was the duty of the foreign correspondent banks of the Bank of the Philippine Islands to take the necessary precaution to insure that the goods shipped under the covering UCs conformed with the item appearing therein, and, that the foregoing banks having failed to perform this duty, no claim for recoupment against the defendants-appellants, arising from the losses incurred for the non-delivery or defective delivery of the articles ordered, could accrue.
Is the refusal of the defendants to pay the Bank justified?
No. The refusal of the defendants to pay the Bank is not justified.
Under the terms of their Commercial Lettet· of Credit Agreements with the Bank, the appellants agreed that the Bank shall not be responsible for the "existence, character, quality, quantity, conditions, packing, value, or delivery of the property purporting to be represented by documents; for any difference in character, quality, quantity, condition, or value of the property from that expressed in documents," or for "partial or incomplete shipment, or failure or omission to ship any or all of the property referred to in the Credit," as well as "for any deviation from instructions, delay, default or fraud by the shipper or anyone else in connection with the property the shippers or vendors and ourselves (purchasers) or any of us."
Having agreed to these terms, the appellants have, therefore, no recourse but to comply with their covenant. But even without the stipulation recited above, the appellants cannot shift the burden of loss to the Bank on account of the violation by their vendor of its prestation.
Banks, in providing financing in international business transactions such as those entered into by the appellants, do not deal with the property to be exported or shipped to the importer, but deal only with documents. Section 10 of the ''Uniform Customs and Practices for Commercial Documentary Credits Fixed for the Thirteenth Congress of International Chamber of Commerce," to which the Philippines is a signatory nation provides that "in documentary credit operations all parties concerned deal in documents and not in goods. Payment, negotiation or acceptance against documents 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 the documents and reimburse the Banlc making the payment, negotiation or acceptance.
The existence of a custom in international banking and financing cycles negating any duty on the part of a bank to verify whether what has been described in letters of credits or drafts or shipping documents actually tallies with what was loaded aboard ship, having been positively proven as a fact, the appellants are bound by this established usage. They were, after all, the ones who tapped the facilities afforded by the Bank in order to engage in international business.
7. Philippine National Bank v. San Miguel Corporation, G.R. No. 186063, January 15, 2014:
SMC entered into an Exclusive Dealership Agreement with Mr. RG wherein the latter was given the right to trade, deal, market and sell various beer products. Mr. RG was given a credit line by SMC and this credit line was secured by a letter ofcredit in favor ofSMC issued by PN Bank by virtue of which RG was granted a credit line with PN Bank. Under the credit agreement, PN Bank has the obligation to release the proceeds of RG's credit line with PN Banlt to SMC upon presentation of the invoices and official receipts of RG's purchases of beer products. RG availed of the credit line with PN Bank and the proceeds were released to SMC. Later RG defaulted in paying PN Bank. Judgment was rendered against RB in a case filed by PN Bank against RG ordering RG to pay unpaid obligation.
Is PN Bank still liable to SMC under the letter of credit although there is already a judgment against RG?
Yes. The obligation under the letter of credit is independent of the related and originating contract.
The letter of credit is separate and distinct from the underlying transaction.
PN Bank cannot evade responsibility on the sole ground that the judgment found RG liable and ordered him to pay the amount sought to be recovered by SMC.
PN Bank's liability, if any, under the Jetter of credit must still be determined.
Comments
Post a Comment