[G.R. No. 146717.

November 22, 2004]

TRANSFIELD PHILIPPINES, INC., petitioner, vs. LUZON HYDRO

CORPORATION, AUSTRALIA and NEW ZEALAND BANKING GROUP
LIMITED and SECURITY BANK CORPORATION, respondents.

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]
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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:
---------------------
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.
At any rate, should petitioner finally prove in the pending arbitration proceedings that
LHCs draws upon the Securities were wrongful due to the non-existence of the fact of
default, its right to seek indemnification for damages it suffered would not normally be
foreclosed pursuant to general principles of law.
Moreover, in a Manifestation,[62] dated 30 March 2001, LHC informed this Court that
the subject letters of credit had been fully drawn. This fact alone would have been sufficient
reason to dismiss the instant petition.
Settled is the rule that injunction would not lie where the acts sought to be enjoined
have already become fait accompli or an accomplished or consummated act.[63] In Ticzon
v. Video Post Manila, Inc.[64] this Court ruled that where the period within which the former
employees were prohibited from engaging in or working for an enterprise that competed
with their former employerthe very purpose of the preliminary injunction has expired, any
declaration upholding the propriety of the writ would be entirely useless as there would be
no actual case or controversy between the parties insofar as the preliminary injunction is
concerned.
In the instant case, the consummation of the act sought to be restrained had rendered
the instant petition mootfor any declaration by this Court as to propriety or impropriety of
the non-issuance of injunctive relief could have no practical effect on the existing
controversy.[65] The other issues raised by petitioner particularly with respect to its right to
recover the amounts wrongfully drawn on the Securities, according to it, could properly be
threshed out in a separate proceeding.