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Code of Commerce Letters of Credit
Code of Commerce Letters of Credit
Code of Commerce Letters of Credit
LETTERS OF CREDIT
Art. 568
The essential conditions of letters of credit shall be:
a. To be issued in favor of a definite person and not to order
b. To be limited to a fixed and specified amount
= or to one or more undetermined amounts
= but within a maximum limits of which has to be exactly stated.
Art. 569.
The drawer of a letter of credit
= shall be liable to the person on whom it was issued,
= for the amount paid by virtue thereof,
= within the maximum fixed therein.
Art. 570.
The drawer of a letter of credit may annul it,
= informing the bearer and the person to whom it is addressed
= of said revocation.
Art. 571.
The holder of a letter of credit shall pay the amount received to the drawer without delay.
Art. 572.
If the bearer of a letter of credit does not make use thereof within the following period, it shall be void in
fact and in law:
= within the period agreed upon with the drawer
= in default of a period fixed, counted from its date
= within 6 months = in any point in the Philippines,
= within 12 months = outside the Philippines.
Governing Laws
a. Code of Commerce – Art. 567 to Art. 572
b. Commercial usages and practices, universally acceptable
= such as those now institutionalized in what is now also known
Uniform Customs and Practice for Documentary Credits (UCP)
= issued by the International Chamber of Commerce
= 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 has been held as undeniable.
Definition
= 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 conditions specified in the credit.
A letter of credit
= is an instrument issued by the bank
= that guarantees its client’s ability to pay for imported goods or services,
= authorizing an individual or a firm to draw drafts on the bank or on its correspondents for
bank’s account under certain conditions of the credit.
In a letter of credit arrangement, there are three distinct and independent contracts:
a. Contract of Sale between buyer and seller
= it is settled in law that the three contracts which make up the letter of credit arrangement
= to be maintained in a state of perpetual separation;
= a transaction involving the purchase of goods may also require, apart from the letter of credit,
= a 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 buyer.
B. Confirmed LoC
= whenever the beneficiary stipulates that the obligation of the opening bank
= shall also be made the obligation of another bank (also notifying bank) to himself
(both the Issuing Bank and the Notifying Bank shall have the same obligation)
= the opening bank’s payment of the obligation is assured by the notifying bank.
C. Irrevocable LoC
= 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 letter of
credit
= will be duly fulfilled, provided that all terms and conditions of the credit are
complied with.
Consequently,
= if the terms of the letter of credit requires a certification from beneficiary,
= the issuing bank cannot be compelled to pay when no such certification is
issued.
D. Revolving LoC
= one that provides for renewed credit to become available
= as soon as the opening bank has advised that the negotiating or paying bank that the
drafts already drawn by the beneficiary have been reimbursed to the opening bank by
the buyer.
E. Back-to-Back LoC,
= 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.
F. Standy LoC
= a security arrangement for the performance of certain obligations
= it can be drawn against only if another business transaction is not performed.
= it may be issued in lieu of performance bond
In a Standby LoC
= the beneficiary will prove that the obligor failed to perform the secured
obligation
Eg. The contractor failed to construct the building on time.
c. In a contract of guarantee,
= the guarantor’s obligation is merely collateral
= and it arises only upon the default of the person primarily liable
Since Buyer A has no facilities with which to transmit dollars to the US,
= he contacts a bank, say Merchant’s Bank of Manila
= which has a correspondent bank in New York, which is the Chemical Bank of New York
So then,
= Buyer A will be required to deposit with Merchant’s Bank 90% (marginal deposit) of the
amount of the transaction, or $9,000
= so that Buyer A would still owe Merchant’s Bank $1,000.
= Buyer A having deposited said amount, Merchant’s Bank cables Chemical Bank in New York:
“Open an irrevocable letter of credit for “$10,000.”
= Chemical Bank will require Seller B
= to produce genuine shipping papers, such as packing list, before paying him.
= Chemical Bank will now then debit Merchant’s Bank’s account the sum of $10,000.
Insofar as the perfection of letter of credit is concerned, based on the above illustration:
= the letter of credit is perfected the moment when the correspondent bank, which is Chemical
Bank
= pays the person in whose favor the letter of credit has been opened, in this case Seller B
= hence, in this case,
= when Chemical Bank of New York pays Seller B $10,000
= and debits $10,000 dollars to the account of Merchant’s Bank, the letter of credit is
perfected
Johannes Schuback & Sons vs. Court of Appeals (227 SCRA 717, 1993)
= opening of a letter of credit in favor of a vendor
= is only a mode of payment,
= but it is not among the essential requirements of a contract of sale enumerated in Arts.
1305 and 1475 of the Civil Code
= and therefore, the non-opening of the letter of credit does not prevent the perfection of
the contract of sale between the parties (when not specifically provided as suspensive
condition)
a. The Buyer
= who procures the letter of credit
= and obliges himself to reimburse the issuing bank upon receipt of the documents of
title;
c. 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.
Functions assumed by a correspondent bank, classified according to the obligations taken up by it,
whether:
a. as a notifying bank,
b. a negotiation bank
c. or as a confirming bank
d. An Advising (notifying) bank
= may be utilized to convey to the seller the existence of the credit
= it assumes no liability except to notify the beneficiary of the letter of credit
1. a notifying bank is not liable to pay the drafts drawn against the letter of credit;
2. suggests to 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
3. it has no privity to the sale between buyer and seller,
= and its relationship is only with that of the issuing bank.
e. A confirming bank
= which will lend credence to the letter of credit issued by a lesser known issuing bank;
= the confirming bank is directly liable to pay the seller-beneficiary;
Obligations:
= assumes a direct obligation to the seller as if the correspondent bank itself had issued
the letter of credit.
f. A paying bank
= which undertakes to encash the draft drawn by the exporter/seller
g. Negotiating bank
= instead of going to the place of the issuing bank to claim payment
= the buyer may approach another bank, termed the negotiating bank,
= to have the draft discounted.
Obligations:
= if before negotiation,
= it has no liability with respect to the seller
C. Negotiating Bank
= has right of recourse against the Issuing Bank and,
= until reimbursement is obtained,
= the drawer continues to assume a contingent liability thereon.
Transfield Philippines, Inc. vs. Luzon Hydor Corp. (443 SCRA 307, 2004)
The letter of credit evolved as a mercantile specialty, and the only way to understand all its facets is to
recognize that it is an entity unto itself:
b. Nevertheless,
= the letter of credit is not a third-party beneficiary contract (pour autrui)
= because the Issuer must honor drafts drawn against the letter of credit
= regardless of the problems subsequently arising in the underlying contract
d. If properly used,
= letter of credit is not a contract of suretyship or guarantee,
= because it entails a primary liability on the part of the Issuer following default;
It is a fundamental rule
= that an Irrevocable LoC is independent
= not only of the contract between the buyer-applicant and the seller-beneficiary
(meaning the contract of sale)
= but also of the credit agreement between the Issuing Bank and the Buyer-Applicant.
= the tender of documents by the beneficiary-seller must include all documents required,
= and that 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 therefore be able to recover from the buyer or the
issuing bank, as the case may be,
= the money thus paid to the beneficiary-seller
Facts:
De Reny Fabrics (Applicant-Buyer) asked BPI (Issuing Bank) to open a letter of credit with its US
correspondent bank
= for the payment of chemical dyes ordered from a US Factory (Beneficiary-Seller).
When the proper documents of US Seller were presented, BPI’s correspondent bank paid the seller.
But when the crates arrived in Manila, it was found that the US factory swindled De Reny, as the crates
only contained colored chalks.
De Reny refused to pay BPI, alleging that the latter’s US correspondent bank was negligent in not
seeing to it that the shipping documents actually tallied with what was loaded aboard the ship.
It was proven that US correspondent bank made payment only after presentation of genuine shipping
documents by US factory.
Issue:
Whether or not De Reny is liable.
Held.
Yes, De Reny is liable.
Application for the letter of credit contained the stipulation that the correspondent bank will pay upon
presentation of genuine shipping documents,
= to which stipulation De Reny must be bound.
It is merely the obligation of the bank to pay upon the presentation of genuine documents.
The correspondent bank
= is not duty bound to open and inspect the crates to see whether the contents
thereof tally with the description in the letter of credit.
Independent Principle
= engagement of the Issuing Bank is to pay seller-beneficiary of the credit once the draft and
the required documents are presented to it.
A letter of credit is drawable on its own terms, and compliance therewith cannot be avoided because
of pending issues with respect to the main contract.
Independence Principle
= it is important to emphasize in this connection that few things are more clearly settled in law
= than that 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/Buyer resulting from his
relationship with the Issuing bank or the Beneficiary/Seller
= 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 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.
Example:
The bank has no duty to verify whether what has been described in the letters credit or
drafts or hat was shipping documents actually tallies with what was loaded aboard the
ship.
Facts:
• TPI as contractor under a turnkey construction agreement, submitted to LHC standby letters of
credit to secure the performance of its (TPI) obligations.
• Delays in the completion of the project resulted in the filing of arbitration proceedings on whether
TPI could benefit from force majeure for non-completion of the project on due date.
• While the arbitral proceedings were pending, and despite TPI’s notice to the banks that LHC cannot
call on the letters of credit until final settlement of the issues,
• nevertheless, the banks notified TPI that they would pay on the letters of credit upon demand of
LHC, based on the delay of completion.
Issues:
1. Can LHC call on the letters of credit despite the pendency of the resolution of the issue whether TPI
has defaulted in its obligation to complete the project on due date?
2. Only the issuing bank and not LHC can claim the “Independence Principle.”
Held:
1. Yes.
= the independence principle liberates the Issuing Bank from the duty of ascertaining
compliance by the parties in the main contract.
= as the principle’s 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.
= the argument that any dispute must first be resolved by the parties 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.
2. No.
= to say that the independence principle may only be invoked by the issuing banks
= would render nugatory the purpose for which letters of credit are used in commercial
transactions.
= as it is, the independence doctrine works to the benefit both of the issuing bank and the
beneficiary.
General Rule:
= the applicant (buyer) cannot enjoin the payment of the obligation of the Issuing Bank under
the letter of credit
= based on any irregularity or non-performance of an obligation.
Exception:
= is when there is fraud or forgery in the underlying transaction or the tender documents.
= 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 credit.
The remedy for fraudulent abuse is an injunction which should not be granted unless:
a. there is clear proof of fraud;
b. fraud constitutes fraudulent abuse of the independent purpose of the letter of credit
= and not only fraud under the main agreement;
c. irreparable injury might follow if injunction is not granted
= or the recovery of damages would be seriously damaged
= the effect of the stay order under Sec. 6(b), Rule 4 of the Interim Rules of Procedure for
Corporate Rehabilitation
= which enjoins the enforcement of all claims against guarantors and sureties
= “who are not solidarily liable with the debtor”
= cannot apply to the letter of credit issued in behalf of the debtor-applicant
= since the obligation of the issuing banks under the letter of credit is primary and solidary.
Margin Fee
= is a tax on sale of foreign exchange
= and sale being consensual,
= it falls due as soon as the local bank opens the letter of credit
A Trust Receipt
= Is a security transaction intended to aid in financing importers and retail dealers
= who do not have sufficient funds or resources to finance the importation or purchase of
merchandise,
= and who may not be able to acquire credit except thru utilization, as collateral, of the
merchandise imported or purchased.
= Consequently, a clause in the letter of credit making a party solidary liable therein,
= cannot be extended to apply to the trust receipt.
A Letter of Credit
= is an engagement by a bank or other persons made at the request of a customer
= that the issuer will honor draft or other demands for payment
= upon compliance with the conditions specified in the credit.
= Entrustee
= is one who executes a trust receipt
= binding himself to hold the goods, documents or instruments in trust for the entruster
= and to sell or otherwise dispose of the goods, documents and instruments
= with the obligation to turn over to the entruster the proceeds thereof
= to the extent of the amount owing the entruster, or as appears in the trust receipt,
= or return the goods, documents or instruments themselves if they are unsold, or not
otherwise dispose of
= in accordance with the terms and conditions specified in the trust receipt.
Illustration:
Buyer “A”
= in Manila agrees to buy
Seller “B”
= in New York, offers to sell merchandise worth $10,000 FOB New York
Since Buyer A has no facilities with which to transmit dollars to the US,
= he contacts a bank, say Merchant’s Bank of Manila
= which has a correspondent bank in New York, which is the Chemical Bank of New York
= so, Merchant Bank here is the Issuing Bank
= and the Chemical Bank is the Correspondent or the Notifying Bank
So then,
= Buyer A will be required to deposit with Merchant’s Bank 90% (marginal deposit) of the
amount of the transaction, or $9,000
= so that Buyer A would still owe Merchant’s Bank $1,000.
= Buyer A having deposited said amount, Merchant’s Bank cables Chemical Bank in New York:
“Open an irrevocable letter of credit for “$10,000.”
= Chemical Bank will require Seller B
= to produce genuine shipping papers, such as packing list, before paying him.
= Chemical Bank will now then debit Merchant’s Bank’s account the sum of $10,000.