Professional Documents
Culture Documents
Transfield V Luzon
Transfield V Luzon
Subject of this case is the letter of credit which has evolved as the
ubiquitous and most important device in international trade. A creation of
commerce and businessmen, the letter of credit is also unique in the number
of parties involved and its supranational character.
Petitioner has appealed from the Decision[1] of the Court of Appeals in CAG.R. SP No. 61901 entitled Transfield Philippines, Inc. v. Hon. Oscar
Pimentel, et al., promulgated on 31 January 2001.[2]
On 26 March 1997, petitioner and respondent Luzon Hydro Corporation
(hereinafter, LHC) entered into a Turnkey Contract [3] whereby petitioner, as
Turnkey Contractor, undertook to construct, on a turnkey basis, a seventy
(70)-Megawatt hydro-electric power station at the Bakun River in the
provinces of Benguet and Ilocos Sur (hereinafter, the Project). Petitioner was
given the sole responsibility for the design, construction, commissioning,
testing and completion of the Project.[4]
The Turnkey Contract provides that: (1) the target completion date of the
Project shall be on 1 June 2000, or such later date as may be agreed upon
between petitioner and respondent LHC or otherwise determined in
accordance with the Turnkey Contract; and (2) petitioner is entitled to claim
extensions of time (EOT) for reasons enumerated in the Turnkey Contract,
among which are variations, force majeure, and delays caused by LHC itself.
[5]
Further, in case of dispute, the parties are bound to settle their differences
through mediation, conciliation and such other means enumerated under
Clause 20.3 of the Turnkey Contract.[6]
LHC IS ALLOWED TO CALL AND DRAW ON, AND ANZ BANK AND
SECURITY BANK ARE ALLOWED TO RELEASE, THE REMAINING
BALANCE OF THE SECURITIES PRIOR TO THE RESOLUTION OF THE
DISPUTES BETWEEN PETITIONER AND LHC.
B.
beneficiary of the standby credit must certify that his obligor has not
performed the contract.[32]
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.[33] 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.[34]
Since letters of credit have gained general acceptability in international
trade transactions, the ICC has published from time to time updates on the
Uniform Customs and Practice (UCP) for Documentary Credits to standardize
practices in the letter of credit area. The vast majority of letters of credit
incorporate the UCP.[35] First published in 1933, the UCP for Documentary
Credits has undergone several revisions, the latest of which was in 1993.[36]
In Bank of the Philippine Islands v. De Reny Fabric Industries, Inc.,[37] this
Court ruled that the observance of the UCP is justified by Article 2 of the Code
of Commerce which provides that in the absence of any particular provision in
the Code of Commerce, commercial transactions shall be governed by
usages and customs generally observed. More recently, in Bank of America,
NT & SA v. Court of Appeals,[38] this Court ruled that there being no specific
provisions which govern the legal complexities arising from transactions
involving letters of credit, not only between or among banks themselves but
also between banks and the seller or the buyer, as the case may be, the
applicability of the UCP is undeniable.
Article 3 of the UCP provides that credits, by their nature, are separate
transactions from the sales or other contract(s) on which they may be based
and banks are in no way concerned with or bound by such contract(s), even if
any reference whatsoever to such contract(s) is included in the credit.
Consequently, the undertaking of a bank to pay, accept and pay draft(s) or
negotiate and/or fulfill any other obligation under the credit is not subject to
claims or defenses by the applicant resulting from his relationships with the
issuing bank or the beneficiary. A beneficiary can in no case avail himself of
the contractual relationships existing between the banks or between the
applicant and the issuing bank.
Thus, the engagement of the issuing bank is to pay the seller or
beneficiary of the credit once the draft and the required documents are
presented to it. The so-called independence principle assures the seller or
the beneficiary of prompt payment independent of any breach of the main
contract and precludes the issuing bank from determining whether the main
contract is actually accomplished or not. Under this principle, banks assume
no liability or responsibility for the form, sufficiency, accuracy, genuineness,
falsification or legal effect of any documents, or for the general and/or
particular conditions stipulated in the documents or superimposed thereon,
nor do they assume any liability or responsibility for the description, quantity,
weight, quality, condition, packing, delivery, value or existence of the goods
represented by any documents, or for the good faith or acts and/or omissions,
solvency, performance or standing of the consignor, the carriers, or the
insurers of the goods, or any other person whomsoever.[39]
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.[40]
Can the beneficiary invoke the independence principle?
Petitioner insists that the independence principle does not apply to the
instant case and assuming it is so, it is a defense available only to respondent
banks. LHC, on the other hand, contends that it would be contrary to common
sense to deny the benefit of an independent contract to the very party for
whom the benefit is intended. As beneficiary of the letter of credit, LHC
asserts it is entitled to invoke the principle.
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. [41] 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 argumentthat it is only
the issuing bank that may invoke the independence principle on letters of
creditdoes 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.
Petitioners argument that any dispute must first be resolved by the
parties, whether through negotiations or arbitration, before the beneficiary is
entitled to call on the letter of credit in essence would convert the letter of
credit into a mere guarantee. Jurisprudence has laid down a clear distinction
between a letter of credit and a guarantee in that the settlement of a dispute
between the parties is not a pre-requisite for the release of funds under a
letter of credit. In other words, the argument is incompatible with the very
nature of the letter of credit. If a letter of credit is drawable only after
settlement of the dispute on the contract entered into by the applicant and the
beneficiary, there would be no practical and beneficial use for letters of credit
in commercial transactions.
Professor John F. Dolan, the noted authority on letters of credit, sheds
more light on the issue:
The standby credit is an attractive commercial device for many of the same reasons
that commercial credits are attractive. Essentially, these credits are inexpensive and
efficient. Often they replace surety contracts, which tend to generate higher costs than
credits do and are usually triggered by a factual determination rather than by the
examination of documents.
Because parties and courts should not confuse the different functions of the surety
contract on the one hand and the standby credit on the other, the distinction between
surety contracts and credits merits some reflection. The two commercial devices
share a common purpose. Both ensure against the obligors nonperformance. They
function, however, in distinctly different ways.
Traditionally, upon the obligors default, the surety undertakes to complete the
obligors performance, usually by hiring someone to complete that performance.
Surety contracts, then, 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. The benefit of the surety contract to the beneficiary is obvious.
He knows that the surety, often an insurance company, is a strong financial institution
that will perform if the obligor does not. The beneficiary also should understand that
such performance must await the sometimes lengthy and costly determination that the
obligor has defaulted. In addition, the suretys performance takes time.
The standby credit has different expectations. He 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 applicants performance takes place. The standby credit has this opposite effect
of the surety contract: it reverses the financial burden of parties during litigation.
In the surety contract setting, there is no duty to indemnify the beneficiary until the
beneficiary establishes the fact of the obligors performance. The beneficiary may
have to establish that fact in litigation. During the litigation, the surety holds the
money and the beneficiary bears most of the cost of delay in performance.
In the standby credit case, however, the beneficiary avoids that litigation burden and
receives his money promptly upon presentation of the required documents. It may be
that the applicant has, in fact, performed and that the beneficiarys 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. Parties that use a standby credit and courts
construing such a credit should understand this allocation of burdens. There is a
tendency in some quarters to overlook this distinction between surety contracts and
standby credits and to reallocate burdens by permitting the obligor or the issuer to
litigate the performance question before payment to the beneficiary.[42]
While it is the bank which is bound to honor the credit, it is the beneficiary
who has the right to ask the bank to honor the credit by allowing him to draw
thereon. The situation itself emasculates petitioners posture that LHC cannot
invoke the independence principle and highlights its puerility, more so in this
case where the banks concerned were impleaded as parties by petitioner
itself.
Respondent banks had squarely raised the independence principle to
justify their releases of the amounts due under the Securities. Owing to the
nature and purpose of the standby letters of credit, this Court rules that the
respondent banks were left with little or no alternative but to honor the credit
and both of them in fact submitted that it was ministerial for them to honor
the call for payment.[43]
Furthermore, LHC has a right rooted in the Contract to call on the
Securities. The relevant provisions of the Contract read, thus:
4.2.1. In order to secure the performance of its obligations under this Contract, the
Contractor at its cost shall on the Commencement Date provide security to the
Employer in the form of two irrevocable and confirmed standby letters of credit (the
Securities), each in the amount of US$8,988,907, issued and confirmed by banks or
financial institutions acceptable to the Employer. Each of the Securities must be in
form and substance acceptable to the Employer and may be provided on an annually
renewable basis.[44]
8.7.1 If the Contractor fails to comply with Clause 8.2, the Contractor shall pay to the
Employer by way of liquidated damages (Liquidated Damages for Delay) the
amount of US$75,000 for each and every day or part of a day that shall elapse
between the Target Completion Date and the Completion Date, provided that
Liquidated Damages for Delay payable by the Contractor shall in the aggregate not
exceed 20% of the Contract Price. The Contractor shall pay Liquidated Damages for
Delay for each day of the delay on the following day without need of demand from
the Employer.
8.7.2 The Employer may, without prejudice to any other method of recovery, deduct
the amount of such damages from any monies due, or to become due to the Contractor
and/or by drawing on the Security.[45]
A contract once perfected, binds the parties not only to the fulfillment of
what has been expressly stipulated but also to all the consequences which
according to their nature, may be in keeping with good faith, usage, and law.
[46]
A careful perusal of the Turnkey Contract reveals the intention of the parties
to make the Securities answerable for the liquidated damages occasioned by
any delay on the part of petitioner. The call upon the Securities, while not an
exclusive remedy on the part of LHC, is certainly an alternative recourse
available to it upon the happening of the contingency for which the Securities
have been proffered. Thus, even without the use of the independence
principle, the Turnkey Contract itself bestows upon LHC the right to call on
the Securities in the event of default.
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 commonlaw 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 defaultsuch issue having been submitted by the parties to
the jurisdiction of the arbitral tribunals pursuant to the terms embodied in their
agreement.[47]
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. [48] 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.[49]
In its complaint for injunction before the trial court, petitioner alleged that it
is entitled to a total extension of two hundred fifty-three (253) days which
would move the target completion date. It argued that if its claims for
extension would be found meritorious by the ICC, then LHC would not be
entitled to any liquidated damages.[50]
In the instant case, petitioner failed to show that it has a clear and
unmistakable right to restrain LHCs call on the Securities which would justify
the issuance of preliminary injunction. By petitioners own admission, the right
of LHC to call on the Securities was contractually rooted and subject to the
express stipulations in the Turnkey Contract.[55] Indeed, the Turnkey Contract
is plain and unequivocal in that it conferred upon LHC the right to draw upon
the Securities in case of default, as provided in Clause 4.2.5, in relation to
Clause 8.7.2, thus:
4.2.5 The Employer shall give the Contractor seven days notice of calling upon any
of the Securities, stating the nature of the default for which the claim on any of the
Securities is to be made, provided that no notice will be required if the Employer calls
upon any of the Securities for the payment of Liquidated Damages for Delay or for
failure by the Contractor to renew or extend the Securities within 14 days of their
expiration in accordance with Clause 4.2.2. [56]
8.7.2 The Employer may, without prejudice to any other method of recovery, deduct
the amount of such damages from any monies due, or to become due, to the
Contractor and/or by drawing on the Security.[57]
The pendency of the arbitration proceedings would not per se make LHCs
draws on the Securities wrongful or fraudulent for there was nothing in the
Contract which would indicate that the
parties intended that all disputes regarding delay should first be settled
through arbitration before LHC would be allowed to call upon the Securities. It
is therefore premature and absurd to conclude that the draws on the
Securities were outright fraudulent given the fact that the ICC and CIAC have
not ruled with finality on the existence of default.
Nowhere in its complaint before the trial court or in its pleadings filed
before the appellate court, did petitioner invoke the fraud exception rule as a
ground to justify the issuance of an injunction.[58] What petitioner did assert
before the courts below was the fact that LHCs draws on the Securities would
be premature and without basis in view of the pending disputes between
them. Petitioner should not be allowed in this instance to bring into play the
fraud exception rule to sustain its claim for the issuance of an injunctive relief.
Matters, theories or arguments not brought out in the proceedings below will
ordinarily not be considered by a reviewing court as they cannot be raised for
the first time on appeal.[59] The lower courts could thus not be faulted for not
applying the fraud exception rule not only because the existence of fraud was
fundamentally interwoven with the issue of default still pending before the
arbitral tribunals, but more so, because petitioner never raised it as an issue in
its pleadings filed in the courts below. At any rate, petitioner utterly failed to
show that it had a clear and unmistakable right to prevent LHCs call upon the
Securities.
Of course, prudence should have impelled LHC to await resolution of the
pending issues before the arbitral tribunals prior to taking action to enforce the
Securities. But, as earlier stated, the Turnkey Contract did not require LHC to
do so and, therefore, it was merely enforcing its rights in accordance with the
tenor thereof. Obligations arising from contracts have the force of law
between the contracting parties and should be complied with in good faith.
[60]
More importantly, pursuant to the principle of autonomy of contracts
embodied in Article 1306 of the Civil Code, [61] petitioner could have
incorporated in its Contract with LHC, a proviso that only the final
determination by the arbitral tribunals that default had occurred would justify
the enforcement of the Securities. However, the fact is petitioner did not do so;
hence, it would have to live with its inaction.
With respect to the issue of whether the respondent banks were justified in
releasing the amounts due under the Securities, this Court reiterates that
pursuant to the independence principle the banks were under no obligation to
determine the veracity of LHCs certification that default has occurred. Neither
were they bound by petitioners declaration that LHCs call thereon was
wrongful. To repeat, respondent banks undertaking was simply to pay once
the required documents are presented by the beneficiary.