The person paying = shall have the right to demand the proof of identity of the person in whose favor the letter of credit was issued.

Transcription

1 CODE OF COMMERCE LETTERS OF CREDIT Pertinent Provisions under the Code of Commerce Arts. 567 to 572 Art. 567 Letters of credit are = those issued by one merchant to another = or for the purpose of attending to commercial transaction. This is considered obsolete = modern letters of credit are strictly bank-to-bank transactions 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. To those which do not have any of these last circumstances = shall be considered as mere letters of recommendation. Art 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. Letters of credit may = not be protested even should they not be paid, = nor shall the bearer thereof acquire any right of action by reason of such non-payment against the person who issued it. The person paying = shall have the right to demand the proof of identity of the person in whose favor the letter of credit was issued. Art 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 The holder of a letter of credit shall pay the amount received to the drawer without delay. Should he not do so, = an action involving execution may be brought to recover it, = with legal interest and the current exchange in the place where payment was made = on the place where it is repaid. Art 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,

2 = 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 = in Feati Bank vs. CA = the SC accepted the application in our jurisdiction of this international commercial credit regulatory set of rules. = In BPI vs. De Reny Fabric Industries = SC said that the observance of the UCP is justified by Art. 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. = 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. = In Bank of America, NT vs. Inter-Resin Industrial Corp = SC has sanctioned the application of Art. 18 of the UCP, which states: = Banks assume no liability or responsibility for the consequence arising out of the delay and/or loss in transit of any messages, letters or documents, = or for the delay, mutilation or other errors arising in the transmission of any telecommunication xxx, =and that an advising bank is bound only to check the apparent authenticity of the letter of credit. 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. Bank of America vs. Court of Appeals (228 SCRA 357, 1993) Transfield Philippines, Inc., vs. Luzon Hydro (443 SCRA 307, 2004) = a letter of credit is a financial devise developed by merchants = 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. = to break the impasse = the buyer may be required to contract with a bank to issue a letter of credit in favor of the seller, so that, by virtue thereof, = the issuing bank authorizes the seller to draw draft and engage to pay them upon their presentment, simultaneously with the tender of documents required by the letter of credit, which basically are the shipping documents of the goods purchased. = what characterizes letters of credit, as distinguished from other accessory contracts,

3 = is the engagement of the issuing bank to pay the seller once the draft and the required shipping documents are presented to it. Essential Conditions of a Letter of Credit: Art. 568 Code of Commerce The essential conditions of a letter of credit are the following: a. To be issued in favor of a definite person and not to order; and 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 = If any of these essential conditions is not present, =the instrument is merely considered as a letter of recommendation. Nature of the Letter of Credit = the primary purpose of a letter of credit is: = to substitute for, and therefore support, the agreement of the buyer importer to pay money under a contract or other arrangement; = but it does not necessarily constitute as a condition for the perfection of such arrangement. In a letter of credit arrangement, there are three distinct and independent contracts: a. Contract of Sale between buyer and seller b. Contract of buyer with issuing bank = in this contract, the bank agrees to issue the letter of credit in favor of the seller = subject to reimbursement or payment by the buyer of whatever is paid to the seller = plus proper consideration agreed upon by the parties c. Letter of credit proper = in which the bank promises to pay seller pursuant to the terms and conditions stated therein. = in the Letter of Credit proper = the bank obligates itself to pay the seller or to the order of the seller (that is, it will honor the bills or drafts drawn by the seller) = after presentation to the bank or tender documents stipulated upon, = which normally includes the document of title = 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. Feati Bank vs. Court of Appeals (196 SCRA 576, 1991) = mere opening of a letter of credit, = does not involve a specific appropriation of a sum of money in favor of the beneficiary. = it only signifies that the beneficiary may be able to draw funds upon the letter of credit up to the designated amount specified therein. = it does not convey the notion that a particular sum of money has been specifically reserved or has been held in trust. Kinds of Letters of Credit A. Clean LoC (according to Vitug Book)

4 = the draft need not be accompanied by any stated documents 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. = pertains to the kind of obligation assumed by the correspondent bank, = which means that the correspondent bank gives an absolute assurance to the beneficiary that it will undertake the issuing bank s obligation as its own according to the terms and conditions of the credit 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. = issuing bank waives revocation = when the letter of credit is irrevocable, it cannot, without the consent of the beneficiary, be cancelled or modified during the lifetime thereof. = it refers to the duration of the letter of credit, = and simple means that the issuing bank may not without the consent of the beneficiary (seller) and the applicant (buyer) revoke his undertaking under the letter, because the issuing bank does not reserve the right to revoke the credit. An irrevocable letter of credit is not synonymous with a confirmed letter of credit. Hence, the mere fact that a letter of credit is irrevocable = does not necessarily imply that the correspondent bank in accepting the instructions of the issuing bank = has also confirmed the letter of credit. 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.

5 = it may be issued in lieu of performance bond Thus, this should be distinguished from ordinary commercial credit = where the beneficiary will recover if can show that he performed his obligation (delivery of the purchased goods) 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. Letters of Credit Distinguished from Other Contracts and Arrangement As distinguished from guarantee a. Unlike in guarantee = the settlement of dispute between the parties is not a pre-requisite for the release of funds under a letter of credit b. The guarantee theory = destroys the independence of the bank s responsibility from the contract upon which it was opened While in a letter of credit, under the Independent Principle = it liberates the issuing bank from the duty of ascertaining compliance by the parties in the main contract = the obligation under the letter of credit is independent of the related and originating contract = the letter of credit is separate and distinct from the underlying transaction. = letter of credit is not a contract of suretyship or guarantee, = because it entails a primary liability on the part of the Issuer following a default. 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 While in irrecovable credit, = the bank undertakes a primary obligation Distinguishing Commercial Credits from Standby Credits There are three: Commercial Credits 1. involve the payment of money under a contract of sale = such credits become payable upon the presentation by the seller-beneficiary of documents = that show that he has taken affirmative steps to comply with the sales agreement Standby Credits 1. In the standby type = the credit payable upon certification of a party s non-performance of the agreement 2. the beneficiary of a commercial credit = must demonstrate by documents that he has performed his contract. 2. the documents that accompany a beneficiary s draft = tend to show that the applicant has not performed 3. the beneficiary of the standby credit = must certify that his obligor has not performed the contract

6 Perfection of the Letter of Credit Belman, Inc. vs. Central Bank (104 Phil. 877, 1958) = a letter of credit is perfected = the moment when the correspondent bank = pays to the person in whose favor the letter of credit has been opened. Illustration: (Note illustration din ito ng Letter of Credit-Trust Receipt Transactions) 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 = A letter of credit is made not between natural persons; = it is a bank to bank transaction. = Between Merchant s Bank (Issuing Bank) = and Chemical Bank (the Correspondent Bank) = there is an element of trust. = The correspondence is a mutual arrangement whereby = Merchant s Bank can ask Chemical Bank in New York to pay Seller B in New York $10,000 = Chemical Bank will pay because it trusts Merchant s Bank = In other words, the credit of Merchant s Bank is good with Chemical Bank. [It works both ways, = thus, if the Seller in Manila has sugar which he offers to sell = and which Buyer in New York agrees to buy = Chemical Bank can request Merchant s Bank to pay seller in Manila. = the credit of either bank is good with each other.] 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. But because Buyer A still owes Merchant s Bank $1,000, = the bill of lading covering the goods will be delivered to Merchant s Bank and not to Buyer A, = so as to protect the bank against Buyer A. = when the goods arrive in Manila, = Merchant s Bank will advise Buyer A; = but Buyer A must first pay $1,000 before he can take possession of the goods But if Buyer A does not have the money yet, = Merchant s Bank may release the goods to Buyer A = under a Trust Receipt,

7 = which is a document issued by the bank in favor of Buyer A = whereby Buyer A admits that the goods still belong to Merchant s Bank, = and which authorizes to sell the goods and apply the proceeds thereof = to the payment of his debt with Merchant s Bank Note: The procedure whereby the Merchant s Bank liquidates its obligation with Chemical Bank is called = Forward Exchange 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 and 1475 of the Civil Code = that is, consent, object or subject matter, and cause or consideration = 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) Parties to Letter of Credit There are at least 3 parties in a letter of credit a. The Buyer = who procures the letter of credit = and obliges himself to reimburse the issuing bank upon receipt of the documents of title; b. The Issuing Bank = the bank issuing the letter of credit is known as Issuing Bank, = which 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. Unless the contrary is expressly provided for, = the liability of the Issuing Bank is solidary with the buyer-applicant 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. The number of parties may be increased and may include: Feati Bank vs. CA, (196 SCRA 576, 1991) 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

8 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 It is a correspondent bank, acting as an Advising or Notifying Bank: Obligations: = it assumes no liability, = except: = to notify and/or transmit to the beneficiary the existence of the letter of credit, thus: 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. = which buys or discounts a draft under a letter of credit = and whose liability depends on the stage of the negotiation; Obligations: = if before negotiation, = it has no liability with respect to the seller the seller. = but if after negotiation = a contractual relationship will then prevail between the negotiating bank and Summary Rules Pertaining to Letters of Credit Bank of America vs. CA (228 SCRA 357, 1993) The following rules apply to letters of credit: A. Being a product of international commerce = it is not uncommon to find a dearth (shortage, lack) of national law that can adequately provide for the governance of the letters of credit, = and therefore, = the observance of the Uniform Customs and Practice (UCP)

9 = is justified in the absence of any particular provision in the Code of Commerce, = commercial transactions shall be governed by usages and customs generally observed; B. An Advising or Notifying Bank = does not incur any obligation by such notification = and is only bound to check the apparent authenticity of the letter of credit 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. D. Between Seller and the Negotiating Bank = there is the usual relationship existing between a drawer and the purchaser of drafts; = the involved bank deals only with the documents and not on the goods described in the documents Rights and Obligations of Parties a. Obligations of the Applicant; Obligation of Correspondent Bank b. Obligations of the Issuing Bank; Rights of the Beneficiary (Seller) A. Special Relations Created; Special Rules Applicable 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: a. Relationship between Beneficiary-Seller and the Issuer (Issuing Bank) = is not strictly contractual = because both privity and a meeting of the minds are lacking = yet strict compliance with its terms is an enforceable right 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 c. Since the bank s customer (Applicant-Buyer), cannot draw on the letter, = it does not function as an assignment by the customer to the Beneficiary 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; e. A letter of credit is not a negotiable instrument = because it is not payable to order or bearer, = and is generally conditional = yet, the draft presented under it is often negotiable Feati Bank vs. Court of Appeals (196 SCRA 576, 1991) 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)

10 = but also of the credit agreement between the Issuing Bank and the Buyer-Applicant. = the non-compliance by buyer with its contract with Issuing Bank = has no bearing with the agreement between the buyer and the seller. = On the other hand, = the relationship between the Issuing Bank and the Notifying Bank = is more similar to that of an agency and not that of a guarantee, = since the latter is merely to follow the instructions of the Issuing bank which is to notify or to transmit the letter of credit to the beneficiary. The Rule of Strict Compliance = 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 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 B. Obligations of the Applicant; Obligations of the Correspondent Bank BPI vs. De Reny Fabrics (35 SCRA 256, 1971) 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. A custom in international banking and financing = negates any duty on the part of a bank to verify whether what is described in the letters of credit of shipping documents actually tally with what is loaded aboard a ship. 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. **While the bank is bound to honor the credit,

11 = it is the beneficiary who has the right to ask bank to honor the credit by allowing him to draw thereon, = and not the buyer-applicant. C. Obligations of the Issuing Bank; Rights of the Beneficiary (Seller) Letter of credit constitute the primary obligation, = and not merely an accessory contract, of the issuing bank from the underlying contract that it may support. = Consequently, Beneficiary of a letter of credit issued to secure payment of a loan, = may collect on its entirety, even if borrower claims it made partial payments already. Obligation of the banks issuing letters of credit = is solidary with that of the person or entity requesting for its issuance, (Applicant-Buyer) = the same being a direct primary, absolute and definite undertaking to pay the beneficiary upon the presentation of the set of documents required therein. 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. = the so-called Independent 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 the independent principle = banks assumes 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 whatsoever. 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

12 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. D. Independent Doctrine; Fraud as Proper Defense Transfield Phils. Vs. Luzon Hydro (443 SCRA 307, 2004) 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. Transfield Phils. Vs. Luzon Hydro (443 SCRA 307, 2004) Fraud as Proper Defense Under the Independence Principle 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.

13 Exception: = is when there is fraud or forgery in the underlying transaction or the tender documents. The independent nature of the letter of credit may be: a. independent 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 LoC b. independence may only be 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 credit. Fraud is an exception to the Independence Principle = it has been opined 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. 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 Effect of Applicant Being under Rehabilitation Proceedings Metropolitan Waterworks vs. Daway (432 SCRA 559, 2004) = 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 the Marginal Deposit requirement of the BSP measure to cut off excess currency liquidity which would create inflationary pressure it is a collateral security given by the debtor, = and is supposed to be returned to him upon compliance with his obligation the applicant for a letter of credit = is entitled to have the marginal deposit first deducted from the principal obligation under the letter of credit and for interest to accrue only on the balance, = and such deposit is supposed to be returned upon the buyer s compliance with his obligation, = since compensation takes effect by operation of law Letter of Credit Trust Receipt Transactions Under a letter of credit trust receipt transaction = a bank extends to a borrower a loan covered by a letter of credit

14 = with the trust receipt as security of the loan. 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. In contracts contained in trust receipts = the contracting parties may establish agreements, terms and conditions they may deem advisable, = provided they are not contrary to law, morals or public order. Letter of Credit and Trust Receipt Distinguished A letter of credit is a separate document from a trust receipt. = a trust receipt may have been executed as security on the letter of credit, = still the two documents involve different undertakings and obligations. = 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. = Through a letter of credit, = the bank merely substitutes its own promise to pay = for the promise to pay of one of its customers = who in return promises to pay the bank the amount of funds mentioned in the letter of credit = plus credit or commitment fees mutually agreed upon. By contrast, a Trust Receipt = is one where Entruster, = who holds an absolute title or security interest over certain goods, documents or instruments, = released the same to the Entrustee = 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

15 = so, Merchant Bank here is the Issuing Bank = and the Chemical Bank is the Correspondent or the Notifying Bank = A letter of credit is made not between natural persons; = it is a bank to bank transaction. = Between Merchant s Bank (Issuing Bank) = and Chemical Bank (the Correspondent Bank) = there is an element of trust. = The correspondence is a mutual arrangement whereby = Merchant s Bank can ask Chemical Bank in New York to pay Seller B in New York $10,000 = Chemical Bank will pay because it trusts Merchant s Bank = In other words, the credit of Merchant s Bank is good with Chemical Bank. [It works both ways, = thus, if the Seller in Manila has sugar which he offers to sell = and which Buyer in New York agrees to buy = Chemical Bank can request Merchant s Bank to pay seller in Manila. = the credit of either bank is good with each other.] 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. But because Buyer A still owes Merchant s Bank $1,000, = the bill of lading covering the goods will be delivered to Merchant s Bank and not to Buyer A, = so as to protect the bank against Buyer A. = when the goods arrive in Manila, = Merchant s Bank will advise Buyer A; = but Buyer A must first pay $1,000 before he can take possession of the goods But if Buyer A does not have the money yet, = Merchant s Bank may release the goods to Buyer A = under a Trust Receipt, = which is a document issued by the bank in favor of Buyer A = whereby Buyer A admits that the goods still belong to Merchant s Bank, = and which authorizes to sell the goods and apply the proceeds thereof = to the payment of his debt with Merchant s Bank Note: The procedure whereby the Merchant s Bank liquidates its obligation with Chemical Bank is called = Forward Exchange

16 Bar Questions: Code of Commerce a. What do you understand by the term commercial transaction? = Is it essential that at least one party to a contract be a merchant in order to consider such a commercial transaction?