LETTERS OF CREDIT IN BANKING TRANSACTIONS Once the letter of credit is established, the seller ships the goods to the
, the seller ships the goods to the buyer
By
SEVERIANO S. TABIOS
§ I. Introduction
The decision of the Supreme Court in Bank of America vs. Court of
Appeals, G.R. No. 105395, December 10, 1993, gives bankers and their
clients very instructive guidelines on the use of letters of credit in banking
transactions in international trade. In that case, which involves an
interpretation of the rights of parties to a letter of credit, whereby Bank of
America sought reimbursement of the amount it had paid to Inter-Resin
Industrial Corporation on a letter of credit received by the bank by registered
mail, which turned out to be spurious, the Supreme Court after giving a very
instructive discourse on the nature of letters of credit in international trade
declared that the bank could recover from Inter-Resin Industrial Corporation
on the latter’s partial availment as beneficiary of the letter of credit, because
on the basis of evidence the bank did not assume the responsibility of a
confirming bank.
Because of the importance of letters of credit in banking transactions involving
international trade, this brief study is presented to guide advocates in handling
letters of credit for their clients.
§ II. Nature and Importance of Letters of Credit
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.
(Bank of America vs. Court of Appeals, supra, citing William S. Shaterian,
Export-Import Banking: The Instruments and Operations Utilized by American
Exporters and Importers and their Banks in Financing Foreign Trade [The
Ronald Press Company: New York, 1947, pp. 284-374], James J. White &
Robert S. Summers (eds), Uniform Commercial Code [West Publishing Co.:
St. Paul, 1988] pp. 806-883, and John H. Jacson and William J. Davey, Legal
Problems of International Economic Relations: Cases, Materials and Text on
the National and International Economic Relations, 2nd Ed., [West Publishing
Co.: St. Paul] pp. 52-63). 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. (Bank of America vs. Court of Appeals, et al., supra.)
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 with what the letter of credit requires. The bank then obtains
possession of the documents upon paying the seller. The transaction is
completed when the buyer reimburses the issuing bank and acquires the
documents entitling him to the goods. 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. (Bank of America vs. Court of Appeals, et al., supra.)
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. (Bank of America vs. Court of
Appeals, et. al., supra.)
§ III. Laws Governing A Letter of Credit Transaction
According to the Supreme Court, since the impact of commercial credit
instruments transcends national boundaries, it being a product of international
commerce, it is thus not uncommon to find a dearth of national law that can
adequately provide for its governance. Our own Code of Commerce basically
introduces only its concept under Articles 567 to 572, 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 (“U.C.P.”) 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
mercatoria, are not dealt with in the U.C.P. (Bank of America vs. Court of
Appeals, et, al., supra.)
The Uniform Customs and Practices for documentary credits were first
published in 1933. The current version was adopted by the International
Chamber of Commerce Council in 1983 and published as Publication No. 400
in July of that year. This current version has the blessing of the United Nations
Commission on International Trade Law (UNCITRAL). The Uniform Customs
and Practices are not “law” because of the act of any legislative or court, but
because they have been explicitly and implicitly made part of the contract of
letters of credit. Many of the letters of credit in the United States are governed
by the Uniform Customs and Practices and not by the UCC (Uniform
Commercial Code). (White & Summers, Op. Cit., pp. 881-883).
In the case of Bank of P.I. vs. De Nery, 35 SCRA 256 (1970), the Supreme
Court declared that the observance of the U.C.P. is justified by Article 2 of the
Code of Commerce which expresses that, in the absence of any particular
provision in the Code of Commerce, commercial transactions shall be
governed by usages and customs generally observed. It further observed 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 U.C.P. is undeniable. Furthermore, in the case
of FEATI Bank and Trust Co. vs. Court of Appeals, 196 SCRA 576 (1991), the
Supreme Court accepted the application of the international commercial credit
regulatory set of rules in our jurisdiction to the extent of their pertinency.
§ IV. Parties to A Letter of Credit Transaction
There are several parties to a letter of credit transaction. These parties are the
following:
1. 1.The Buyer who procures the letter of credit and obliges himself to
reimburse the issuing bank upon receipt of the documents of title. He
is the party who initiates the operation of the letter of credit transaction
as buyer of the merchandise and also of the credit instrument. His
contract is with the bank which is to issue the instrument and is
represented by the Commercial Credit of Agreement form which he
signs, supported by the mutually made promises contained in the
Agreement. (Shaterian, Op. Cit., pp. 291-292).
2. The Opening Bank which is usually the buyer’s bank which issues the
letter of credit and 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. Also known as the Issuing Bank, because
it actually issues the instrument, it should be a strong bank, well known
and well regarded in international trading circles. In this connection,
the purposes of commercial credit may not be readily accomplished
unless the opening bank is well known and well regarded. (Shaterian,
Op. Cit., p. 292)
3. 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. He is also called the beneficiary of the credit
instrument, because the instrument is addressed to him and is in his
favor. While the bank cannot compel the seller as beneficiary of the
letter of credit to ship the goods and avail of the benefits of the
instruments, however, the seller may recover from the bank the value
of his shipment 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. In this regard, 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. (Shaterian, Op. Cit., p. 292).
4. The Correspondent Bank which may be an Advising Bank to convey
to the seller the existence of the credit or a Confirming Bank which will
lend credence to the letter of credit issued by a lesser known issuing
bank or a Paying Bank which undertakes to encash the drafts drawn
by the exporter. Furthermore, another bank known as Negotiating
Bank may be approached by the buyer to have the draft discounted
instead of going to the place of the issuing bank to claim payment.
§ IV. Responsibilities of Banks in Commercial Credit Transactions
The responsibilities of the different banks involved in commercial credit
transactions vary, depending on their respective roles in the transactions.
Thus, if the beneficiary is to be advised by the issuing bank by cable, the
services of an Advising or Notifying Bank must always be utilized. The
responsibility of the Notifying Bank is merely to convey or transmit to the seller
or beneficiary the existence of the credit. However, if the beneficiary requires
that the obligation of the issuing bank shall also be made the obligation of a
bank to himself, there is what is known as a confirmed commercial credit and
the bank notifying the beneficiary of the credit shall become a Confirming
Bank. In this situation, the liability of the Confirming Bank is primary and it is
as if the credit were issued by the Issuing 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. In other words, the Confirming Bank assumes primary
liability to the seller as if it had issued the letter of credit. (FEATI Bank & Trust
Co. vs. Court of Appeals, 196 SCRA 576 (1991). In this regard, the Confirming
Bank receives a commission for its confirmation from the Issuing Bank which
the Issuing Bank, in turn, passes on to the buyer of the merchandise.
(Shaterian, Op. Cit., pp. 294-295).
Moreover, the Paying Bank on which the drafts are to be drawn it may be the
Issuing Bank or the Advising Bank. If the beneficiary is to draw and receive
payment in his own currency, the Advising Bank may 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 Issuing Bank has with it. If the
Issuing Bank maintains no account with the Paying Bank, the Paying Bank
reimburses itself by drawing a bill of exchange on the Issuing Bank, in dollars,
for the equivalent of the local currency paid to the beneficiary, at the buying
rate for dollar exchange. The beneficiary is entirely out of the transaction
because his draft is completely discharged by the payment, and the credit
arrangement between the Paying Bank and the Issuing Bank does not concern
him. (Shaterian, Op. Cit., pp. 293-294).

If the draft contemplated by the credit instrument is to be drawn on the Issuing

Bank or on other designated banks 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 an Advising or
Notifying Bank are used, the beneficiary is apt to offer his drafts to the Advising
Bank for negotiation, thus giving the Advising 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. (Shaterian, Op. Cit.,
p. 293).

§ VI. Liability in Commercial Credit Transactions

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 documents tendered by the beneficiary 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 risk 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 where no discretion to waive any
requirements is allowed should be followed. (FEATI Bank & Trust Co. vs. Court
of Appeals, 196 SCRA 576 (1991).

However, in the case of a discounting arrangement, wherein a Negotiating

Bank pays the draft of a beneficiary of a letter of credit in order to save such
beneficiary from the hardship of presenting the documents directly to the
Issuing Bank, the Negotiating Bank can seek reimbursement of what had been
paid to the beneficiary who as drawer of the draft continues to assume a
contingent liability thereon. Thus, the Negotiating Bank has the ordinary right
of recourse against the seller or beneficiary in the event of dishonor by the
Issuing Bank. (Bank of America vs. Court of Appeals, et al., supra.)