LETTERS OF CREDIT paid coupled with the Buyer’s want of ownership or control

Governed by Arts 567-572 of the Code of Commerce over the goods before paying.

TITLE THIRTEEN LETTERS OF CREDIT Letter of Credit Transaction: How?

In Prudential Bank v IAC the Court explained the Letter of
ARTICLE 567. Letters of credit are those issued by one Credit Transaction
merchant to another or for the purpose of attending to a 1. the buyer may contract to a bank to issue a Letter of
commercial transaction. Credit
2. The buyer and seller (in a contract of sale) agree to
ARTICLE 568. The essential conditions of letters of credit shall what documents are to be presented for payment,
be: a. but ordinarily they are documents of title evidencing or
attesting to the shipments of the goods to the buyer
1. To be issued in favor of a definite person and not to order.
3. The issuing bank can authorize the seller to draw
2. To be limited to a fixed and specified amount, or to one or
drafts
more undetermined amounts, but within a maximum the
4. The seller then ships the goods to the buyer
limits of which has to be stated exactly. Those which do not
5. To get paid, the seller executes a draft and presents
have any of these last circumstances shall be considered as
it together with the required documents to the
mere letters of recommendation.
issuing bank.
6. The issuing bank redeems the draft and pays cash to
ARTICLE 569. The drawer of a letter of credit shall be liable to
the seller if it finds that the documents submitted by
the person on whom it was
the seller confirm with what the letter of credit
issued, for the amount paid by virtue thereof, within the
requires.
maximum fixed therein. Letters of credit may not be protested
7. Bank obtains possession of the documents upon
even should they not be paid, nor shall the bearer thereof
paying the seller
acquire any right of action by reason of such non-payment
8. The transaction is completed when the buyer
against the person who issued it. The person paying shall have
reimburses the issuing bank and acquires the
the right to demand the proof of the identity of the person in
documents entitling him to ownership of the goods.
whose favor the letter of credit was issued.
Note: The seller gets paid only if he delivers the documents of
title over the goods while the buyer acquires said documents
ARTICLE 570. The drawer of a letter of credit may annul it,
and control over the goods only after reimbursing the bank.
informing the bearer and the person to whom it is addressed
of such revocation.
In Bank of America v CA the Court defined that a letter of
credit is a financial device developed by merchants as a
ARTICLE 571. The bearer of a letter of credit shall pay the
convenient and relatively safe mode of dealing with sales of
amount received to the drawer without delay. Should he not
goods to satisfy the seeminlgly irreconcilable interests of the
do so, an action involving execution may be brought to recover
seller who refuses to part with his goods and the buyer who
it, with legal interest and the current exchange in the place
wishes to have control over the goods before paying.
where payment was made on the place where it is repaid.
Further here the Court emphasized the Independence
ARTICLE 572. If the bearer of a letter of credit does not make
Principle; The bank in determining compliance with the terms
use thereof within the period agreed upon with the drawer, or,
of the Letter of Credit is required only to examine the shipping
in default of a period fixed, within six months, counted from its
document presented by the seller and is precluded from
date in any point in the Philippines, and with in twelve months
determining whether the main contract of sale between the
anywhere outside thereof, it shall be void in fact and in law.
buyer and seller is accomplished or not.
Notes:
Further in this case the parties to the transaction and the
 Letter of Credit – that issued by one merchant in
different types of correspondent banks were discussed. In this
favor of another for the purpose of attending to a
case Bank of America was only an advising bank hence it did
commercial transaction (567)
not acquire any obligation more than just notifying Inter-Resin
 Bank deals with documents only of the letter of credit issued in its favor.
 A LOC is not a contract of guarantee or suretyship
because it entails primary liability on the part of the issuer-borrower in
default Further an advising bank is bound to check only the apparent
 It is not a negotiable instrument; because it does not contain authenticity of the Letter of credit.
an unconditional promise to pay a sum certain in money. The LC is
conditioned to the submission of certain documents. Moreover, the LC is
issued in favor of a definite person and not to order. PARTIES TO THE TRANSACTION:
Basic parties to a letter of credit:
A Letter of Credit is a financial device designed to answer two 1. Applicant/buyer/importer –
concerns: Seller’s refusal to part with his goods before being
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  the one who procures the letter of credit and
obliges himself to reimburse the Issuing
Bank (IB) upon the receipt of the documents
of title.
 He is the party who initiates the operation
of the Letter of Credit transaction as the
buyer of the merchandise and also of the
credit instrument.
2. Issuing Bank –
 is usually the buyer’s bank;
 it issues the letter of credit and undertakes
to pay the seller upon receipt of the draft
and proper documents to the buyer upon
reimbursement.
3. Seller/beneficiary –
 is the one who in compliance w/ the contract
of sale ships the goods to the buyer
 and delivers the documents of title and
drafts to the issuing bank to recover
payment.
 He is the beneficiary of the instrument
because the instrument is addressed to him
and in his favor.
4. Correspondent Bank
4 TYPES OF CORRESPONDENT BANK: (ACPN)
1. Advising/Notifying Bank – does not have any contractual
relations w/ the buyer but merely serves as an agent of the
issuing bank. Its only responsibility is to transmit the
LC. Thus, it could validly refuse to negotiate or accept, even
if the seller tenders all the documents required under the
LC and it does not become liable as the beneficiary has no
cause of action against the bank.
2. Confirming Bank – lends credence to the LC issued by a
lesser known bank. It assumes direct obligation to the
seller/beneficiary and becomes principally liable.
A notifying bank, who also assumes the role of a negotiating
bank does not include assuming the role of a confirming
bank and is therefore not liable to the beneficiary.
To be liable, there must be an absolute assurance that it will
undertake the issuing bank’s obligation as its own. If it does
confirm, the beneficiary become entitled to proceed
against either or both banks in case of breach.
3. Paying Bank – the bank w/c pays the seller. It may either
be the opening/issuing bank or any other bank in the place
of the seller.
4. Negotiating Bank – any bank in the place of the seller w/c
buys or discounts the seller’s draft. Its liability depends on
the stage of negotiation. If BEFORE negotiation, such that
it suggests its willingness to negotiate, it has no liability w/
respect to the seller. But if AFTER negotiation, a contractual
relationship will then prevail between them.
Essential Conditions of LC: (2)
1. Issued in favor of determinate person not to order
2. Limited to
1. a fixed and specified amount
2. OR to one or more indeterminate amounts;
but all within a maximum sum the limit of
which must be exactly stated
Absent these = it is not a LC but a letter of recommendation
DOCTRINE OF STRICT COMPLIANCE-
The document tendered by the seller must strictly conform to
the terms of the LC. The correspondent bank which departs
from what has been stipulated under the LC, as when it accepts
a faulty tender, acts on his own risk and may not thereafter
recover from the buyer or issuing bank , the money paid to the
beneficiary.
In short, the documents presented must comply w/ those
stipulated on the LC. In a LC, the banks only deals w/
documents and not w/ goods.
Note: A loan transaction may give rise to Letter of Credit. A
Letter of Credit does not arise only because of sale or
importation. Example: Standby LC.
Standby Letter of Credit (SLC) – it is a bank issued option
on loan involving 3 parties:
1. the bank issuing the credit,
2. the party requesting for such issuance (otherwise
known as the account party)
3. and the beneficiary.
Under the terms of a SLC, the beneficiary has the right to
trigger the loan option (referred to as TAKING DOWN THE
LOAN) if the account party fails to meet its commitment, in
w/c case the issuing bank disburses a specified sum to the
beneficiary and books an equivalent loan to its customer.
SLC’s may support non-financial obligations such as those of
bidders, or financial obligations such as those of
borrowers. In the latter case, the borrower purchases an
SLC and names the lender as beneficiary. Should the
borrower default, the beneficiary has the right to take down
the SLC and receive the principal balance from the issuing
bank. The borrower’s loan obligation is then passed to the
bank.
Example: You will bid but you won’t release money just yet;
then SLC are proof that you have available money.
Note: SLC may be considered as security arrangement but
they are not considered or converted contracts of guarantee
and bank does not act as a guarantor.
In HSBC v National Steel 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.
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The second transaction is the issuance of a letter of credit between negotiating bank or a confirming bank depending on the nature of
the buyer and the issuing bank. The buyer requests the issuing the obligations assumed. 77 A notifying bank undertakes to inform
bank to issue a letter of credit naming the seller as the beneficiary. the seller-beneficiary that a letter of credit exists. It may also have
In this transaction, the issuing bank undertakes to pay the seller the duty of transmitting the letter of credit. As its obligation is
upon presentation of the documents identified in the letter of limited to this duty, it assumes no liability to pay under the letter
credit. The buyer, on the other hand, obliges himself or herself to of credit. 78 A negotiating bank, on the other hand, purchases
reimburse the issuing bank for the payment made. In addition, this drafts at a discount from the seller-beneficiary and presents them
transaction may also include a fee for the issuing bank's to the issuing bank for payment. 79 Prior to negotiation, a
services. 68 This transaction constitutes an obligation on the part negotiating bank has no obligation. A contractual relationship
of the issuing bank to perform a service in consideration of the between the negotiating bank and the seller-beneficiary arises
buyer's payment. The obligations of the parties and their remedies only after the negotiating bank purchases or discounts the
in cases of breach are governed by the letter of credit itself and by drafts. 80 Meanwhile, a confirming bank may honor the letter of
our general law on obligations, as our civil law finds suppletory credit issued by another bank or confirms that the letter of credit
application in commercial documents. 69 will be honored by the issuing bank. 81 A confirming bank
essentially insures that the credit will be paid in accordance with
The third transaction takes place between the seller and the
the terms of the letter of credit.82 It therefore assumes a direct
issuing bank. The issuing bank issues the letter of credit for the
obligation to the seller-beneficiary. 83
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 Types of Letter Credit
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. 70 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.71 Neither can it be
considered as an assignment by the buyer to the seller-beneficiary
as the buyer himself cannot draw on the letter. 72 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. 73
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.

In simpler terms, the various transactions that give rise to a letter

of credit proceed as follows:
1. 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.
2. The issuing bank then holds on to these documents
which the buyer needs in order to claim the goods
shipped.
3. The buyer reimburses the issuing bank for its payment at
which point the issuing bank releases the documents to
the buyer.
4. The buyer is then able to present these documents in
order to claim the goods.
5. 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 a notifying bank, a

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