Special Commercial Laws

Letters of Credit
Context: Security Transactions
Credit: an individual's ability to borrow money by virtue of the
confidence or trust reposed by a lender that he will pay what he may
promise. (People v. Concepcion, 1922)
Definition and Nature
- insuring to a seller payment of a definite amount upon the
presentation of documents (De Leon, 2010)
- an instrument issued by one merchant to another, or for the
purpose of attending to a commercial transaction (Code of
Commerce, Art. 567)
- An original undertaking by the issuer to substitute its financial
strength for that of another (the applicant) with the undertaking to
be conditioned on the presentation of a draft or demand for
payment (by the beneficiary) (Dolan, 1991)
Is this definition still relevant?
- Articles 567 to 572 of the Code of Commerce on Letters of Credit
are obsolete. Modern Letters of Credit are strictly bank-to-bank
transactions. (Villanueva)
A letter
-

of credit is...
an instrument issued by a bank
that guarantees its client's ability to pay for... 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. (Villanueva)

Prudential Bank v. IAC (216 SCRA 257)

- A letter of credit is defined as 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 the conditions specified in the credit.
Through a letter of credit, the bank merely substitutes its own
promise to pay for 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.
Bank of America NT. & SA v. CA (G.R. No. 105395, December 10, 1993)
- 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. 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 latter 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.
MWSS v. Daway (G.R. No. 160732, June 21, 2004)
- A letter of credit as an engagement by a bank or other person made
at the request of a customer that the issuer shall honor drafts or
other demands of payment upon compliance with the conditions
specified in the credit.
Kinds of Letters of Credit
Commercial

Standby

Involve the payment of Does

not
involve
money under a contract payment of money.
of sale.
Payable
upon
the
presentation
by
the
seller-beneficiary
of
documents that show he
has
taken
affirmative
steps to comply with the
sales agreement.

the

Payable upon certification of

a partys non performance
of the agreement. The
documents that accompany
tend to show that the
applicant
has
not
performed.

Demonstrate that the Certify

that
the
beneficiary
has beneficiarys obligor has not
performed his contract.
performed the contract.
- An exporter sells goods to a foreign buyer who promises to pay within 60
days.
- A contractor agrees to complete a construction project within a
certain timeframe. When the deadline arrives, the project has not
been completed.
REVOCABLE
-

LOC that may be

revoked
or
modified for nay
reason, at any
time
by
the
issuing
bank
without
notification and
cannot
be
confirmed.

IRREVOCABLE
- May not be revoked or
amended without the
agreement of the issuing
bank,
the
confirming
bank and the beneficiary.

Confirmed (and Unconfirmed) Letters of Credit

- When a letter of credit is confirmed, another bank (presumably one
that the beneficiary trusts) guarantees that payment will be made.
Sight Letter of Credit
- Payment under a sight letter of credit occurs as soon as the
beneficiary submits acceptable documents to the appropriate bank.
The bank has a few days to review the documents and ensure that
they meet the requirements in the letter of credit. If the documents

are compliant, payment is made immediately.

Stages/Perfection
Belman Inc. v. Central Bank (104 Phil. 877)
- An irrevocable letter of credit granted by a bank, which authorizes a
creditor in a foreign country to draw upon a debtor of another and
to negotiate the draft through the agent or correspondent bank or
any bank in the country of the creditor, is a consummated contract,
when the agent or correspondent bank or any bank in the
country of the creditor pays or delivers to the latter the
amount in foreign currency, as authorized by the bank in the
country of the debtor in compliance with the letter of credit
granted by it.
Johannes Schuback & Sons v. CA (227 SCRA 717)
- The opening of a letter of credit in favor of a vendor is only a mode
of payment. It is not among the essential requirements of a
contract of sale enumerated in Article 1305 and 1474 of the Civil
Code, the absence of any of which will prevent the perfection of the
contract from taking place.
Independent Contracts involved in a Letter of Credit
Keng Hua Paper Products v. CA (286 SCRA 257)
- In a letter of credit, there are three distinct and independent
contracts: (1) the contract of sale between the buyer and the
seller, (2) the contract of the buyer with the issuing bank,
and
(3) the letter of credit proper in which the bank
promises to pay the seller pursuant to the terms and
conditions stated therein.
- The contract of carriage, as stipulated in the bill of lading in the
present case, must be treated independently of the contract of sale
between the seller and the buyer, and the contract for the issuance
of a letter of credit between the buyer and the issuing bank.
Feati Bank v. CA (196SCRA 576)
- It is a fundamental rule that an irrevocable credit is independent
not only of the contract between the buyer and the seller but also of
the credit agreement between the issuing bank and the buyer. The
relationship between the buyer and the issuing bank is
entirely independent from the letter of credit issued by the
latter. The contract between the two has no bearing as to the noncompliance by the buyer with the agreement between the latter and
the seller.
Doctrine of Strict Compliance
- Under this rule, the documents tendered by the beneficiary must
strictly conform to the terms of the letter of credit.
- If the letter of credit requires a certification from a beneficiary,
issuing bank cannot be compelled to pay when no such
certification is issued.
- If an honoring entity accepts a faulty tender, it acts on its own
risk and may not thereafter recover from the applicant or
issuer the money paid to the beneficiary.
Transfield Philippines, Inc. v. Luzon Hydro Corporation Australia, et. al.
Doctrine of Independence

The letter of credit is separate and distinct from the underlying or

principal obligation.
The settlement of a dispute between the parties is not a prerequisite for the release of funds. 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.

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.

Fraud Exception Principle

- The untruthfulness of a certificate may qualify as fraud, sufficient to
support an injunction against payment.
However, injunction should not be granted unless:
1) There is clear proof of fraud
2) The fraud constitutes fraudulent abuse of the independent purpose of the
letter of credit and not only fraud under the underlying obligation; and
3) Irreparable injury might follow if injunction is not granted or the recovery
of damages would be seriously affected.
Parties
Bank of America NT. & SA v. CA
(G.R. No. 105395, December 10, 1993)

There would at least be three (3) parties:

1. Buyer (Applicant)
2. Issuing bank (Buyer's Bank)
3. Seller (Beneficiary)
How does it work?
- Most common in international transactions.
- Let's assume that Pinoy Company sells furniture in the Philippines
and Italiano Company manufactures furniture in Italy. Pinoy
Company wants to import $100,000 worth of furniture
manufactured by Italiano Company , but Italiano Company is
concerned about Pinoy Company's ability to pay for them.
Who applies for the letter of credit?
Pinoy Company from -Its bank, ABC Bank. Indicating that
Pinoy Company will make good on the $100,000 payment in the number
of days agreed or ABC Bank will pay the bill itself.
ABC Bank will then send the letter of credit to Italiano Company which

then ships the furniture.

After shipment, Italiano Company or Italiano Companys Bank will then
ask for payment of its $100,000 by --Presenting a written draft (also known as a bill of exchange) to
ABC Bank.
Who is protected/benefited in a letter of credit? Seller or the buyer?
Both.
Seller: guarantee of payment.
Buyer: protection of payment.
Italiano Company must present ABC Bank with written proof the
shipment in order to get paid.
Proof: commercial invoice, bill of lading or airway bill.
After ABC Bank pays Italiano Company, it turns to Pinoy Company for
reimbursement.
Debit of account, usually with pledge of securities or cash collateral.
Whats in it for the bank?
Additional Parties
1. Advising (notifying) bank
- conveys to the seller the existence of the credit.
2. Confirming bank
- lends credence to the letter of credit issued by a lesser known issuing
bank.
3. Paying bank
- undertakes to encash the drafts drawn by the exporter.
4. Negotiating bank
- discounts the draft instead of going to the place of the issuing bank to
claim payment
Rights and Obligations of Parties in Letter of Credit
Bank of Philippine Islands v. De Reny Fabric Industries, Inc. (35 SCRA 256)
- The buyer-applicant cannot shift the burden of loss to the
correspondent bank on account of the violation by the sellerbeneficiary of its obligation.
- Banks do not deal with the property to be exported or shipped to
the importer, but deal only with the documents.
Insular Bank v. IAC (167 SCRA 450)
- Letter of credit constitutes the primary obligation, and not merely
an accessory contract of the issuing bank separate 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.
Phil. Virginia Tobacco Adm. v. De los Angeles (164 SCRA 543)
- An irrevocable letter of credit during its lifetime cannot be cancelled
or modified without the express permission of the beneficiary.
Obligations of Correspondent Bank
Depending on the functions assumed:
Advising or Notifying Bank no liability except to notify and transmit

to the beneficiary the existence of the letter of credit.

Negotiating Bank depends on the stage of negotiation. Before: no
liability. After: contractual relation will exist.
Confirming Bank direct obligation to the seller and its liability is
primary one as if the correspondent bank itself issued the letter of
credit.
Letter of Credit-Trust Receipt Transaction
Bank extends a loan covered by the letter of credit with trust receipt as
security for the loan.
The two are separate and involve different undertakings and obligations.
Trust Receipts Law
(P.D. No. 115)

Origin of Trust Receipts

- The device first came into general use in importing transactions,
where goods were consigned directly to a bank which paid a draft
for the price on the credit of the intended buyer who engaged to
repay the banks advances
Policy Objectives/Purpose
- To encourage and promote the use of trust receipts.
- To provide for the regulation of trust receipt transactions
- To penalize violations as a criminal offense (Sec. 2)
Definition
What is a Trust Receipt?
- It is a written or printed document signed by the entrustee in
favor of the entruster containing terms and conditions
substantially complying with the provisions of this Decree.
(Sec. 3, cf. Sec. 4)
South City Homes v. BA Finance
- 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 through utilization, as collateral, of
the merchandise imported or purchased.
Ching v. CA
- A trust receipt is a document in which is expressed a security
transaction where under the lender, having no prior title in
the goods on which the lien is to be given and not having
possession which remains in the borrower, lends his money
to the borrower on security of the goods which the borrower
is privileged to sell clear of the lien with an agreement to
pay all or part of the proceeds of the sale to the lender.
- It is a security agreement pursuant to which a bank acquires a
"security interest" in the goods. It secures an indebtedness and
there can be no such thing as security interest that secures no

obligation.
Form of
-

TR
Formal Contract
Written or Printed
No other formality of execution or authentication shall be necessary
for the validity of a TR.
Contents
(1) description of the goods, documents or instruments
(2) the total invoice value of the goods and the amount of the draft to
be paid by the entrustee;
(3) an undertaking or a commitment of the entrustee:
(a) to hold in trust for the entruster the goods, documents or
instruments
(b) to dispose of them in the manner provided for in the trust
receipt
(c) to turn over the proceeds of the sale to the entruster to the
extent of the amount owing or as appears in the trust receipt or to
return the goods, documents or instruments in the event of their
non-sale within the period specified
Parties
Rwants to buy ingredients and supplies for her new restaurant.
But she doesn't have enough money as she is only starting.
Her friend T tells her: "You can borrow money from the bank!
Rapplies for a letter of credit the bank.
The bank finance Rs purchases of supplies.
R receives the ingredients.
R executes a Trust receipt in favor of the bank.
How does it work?

Trust Receipts
bank releases the goods
to the entrustee, who
promises to deliver the
proceeds or return the
goods to the bank

Letters of Credit
bank substitutes its promise
to pay for the promise of a
customer who in turn
promises to pay the bank

Concept of Trust Receipt Transaction

- a real security transaction where a person who owns or holds
absolute title or security interests over certain specified goods,
documents or instruments releases the same to the possession of
another person who binds himself to hold the goods etc in trust and

to sell or otherwise dispose of the same with the obligation to turn

over the proceeds thereof (Sec 4)
Nacu v. CA
- A letter of credit-trust receipt arrangement is endowed with its own
distinctive features and characteristics. Under that set-up, a bank
extends a loan covered by the letter of credit, with the trust receipt
as a security for the loan. In other words, the transaction
involved a loan feature represented by the letter of credit,
and security feature which is in the covering trust receipt. .
Ownership of the Goods, Documents and Instruments under a Trust Receipt
Who holds title?
- The entruster takes the full title to the goods at the very beginning
as soon as goods are bought and paid by him.
Who owns the goods?

The goods remain the importers property. Entrustee is factual owner.

The bank does not become real owner of the goods. It remains a lender
and creditor. Entrusters ownership is merely legal fiction. (Abad vs. CA)

Robles v. CA

In the case at bar, the acts of petitioner which were complained of were
committed between 19 November 1976 and 9 March 1977, that is, long
after the beginning date of effectivity of Presidential Decree No. 115. In
accordance with the provisions of Section 13, Presidential Decree No.
115, quoted above, the failure of petitioner Damian Robles to turnover to
the entruster Paramount the proceeds of the sale of goods covered by
the delivery trust receipts and to return the said goods, constituted
estafa punishable under Article 315 (1) (b) of the Revised Penal Code.

Allied v. Ordonez

Does the penal provision of PD 115 (Trust Receipts Law) apply when the
goods covered by a Trust Receipt do not form part of the finished
products which are ultimately sold but are instead, utilized/used up in
the operation of the equipment and machineries of the entrusteemanufacturer?

Nature of Trust Receipts

In a certain manner, a trust receipt partakes of the nature of a

conditional sale as provided in the Chattel Mortgage Law, i.e., the
importer becomes absolute owner of the imported merchandise as soon
as he has paid its price.

TR vs. Chattel Mortgage

It is not a chattel mortgage because:

it does not require the formalities set forth in the Chattel Mortgage Law,
such as the affidavit and oath (Secs. 3(j) and 5, cf. Sec. 5, Act 1508)
it does not have to be registered with the Register of Deeds (Sec. 3(j),
cf. Sec. 198, Admin. Code)

TR vs. Conditional Sale

It is not a conditional sale per se because:

the entruster is not a seller as contemplated by law. He does not take on
the obligations and warranties of a seller (Sec. 8, cf. Arts. 1495-1581,
Civil Code)

the transaction between the entruster and the entrustee is more akin to
a credit transaction than a sale.

TR vs. Pledge

It is not a pledge because:

the entrustee/debtor is not the absolute owner of the goods (cf. Art.
2085)
the entrustee/debtor does not deliver the possession of the goods to the
entruster/creditor (cf. Art. 2093)

TR vs. Consignment

It is different from consignment because the entrustee is the real owner

of the goods and not a mere dealer/agent
Note: But if the consignment is evidenced by a delivery trust receipt, it
will fall under the Trust Receipts Law (Robles vs. CA)

Rights of the Entruster

The entruster shall be entitled:
Proceeds
Return
Enforce all other rights
Cancel and take possession upon default
Obligations of the Entrustee
hold the goods in trust
dispose of them strictly in accordance with TR's terms and

conditions
receive the proceeds in trust
turn over the proceeds to enstruster
insure the goods for their total value against fire, theft, pilferage
or other casualties
keep the goods or proceeds separate and capable of
identification as property of entruster
return in the event of non-sale or upon demand
observe all other terms and conditions of the TR
Remedies Available
Entrustee always bound to pay loan.

Sec. 7, PD 115 expressly provides that entrustee shall be liable to

entruster for any deficiency.

No Option to Abandon Goods to Set-off Loan

Entrustee-borrower cannot be relieved of his obligation to pay the

loan simply by abandoning property with bank.

Penalty for Breach of Entrustee

Entrustor may File Estafa Charges Against Entrustee

Art. 315 Revised Penal Code
With unfaithfulness or abuse of confidence, namely:

(b) By misappropriating or converting, to the prejudice of another,

money, goods, or any other personal property received by the offender
in trust or on commission, or for administration, or under any other
obligation involving the duty to make delivery of or to return the same,
even though such obligation be totally or partially guaranteed by a
bond; or by denying having received such money, goods, or other
property.
Prudential v. IAC
Although it is true that the petitioner commenced a criminal action for
the violation of the Trust Receipts Law, no legal obstacle prevented it
from enforcing the civil liability arising out of the trust receipt in a
separate civil action.
Under Section 13 of the Trust Receipts Law, the failure of an entrustee to
turn over the proceeds of the sale of goods, documents or instruments
covered by a trust receipt to the extent of the amount owing to the
entruster or as appear in the trust receipt or to return said goods,
documents or instruments if they were not sold or disposed of in
accordance with the terms of the trust receipt shall constitute the crime
of estafa, punishable under the provisions of Article 315, paragraph 1(b)
of the Revised Penal Code. Under Article 33 of the Civil Code, a civil
action for damages, entirely separate and distinct from the criminal
action, may be brought by the injured party in cases of defamation,
fraud and physical injuries. Estafa falls under fraud.
Colinares v. CA and People

A thorough examination of the facts obtaining in the case at bar reveals

that the transaction intended by the parties was a simple loan, not a
trust receipt agreement .
The Trust Receipts Law does not seek to enforce payment of the loan,
rather it punishes the dishonesty and abuse of confidence in the
handling of money or goods to the prejudice of another regardless of
whether the latter is the owner.
Tiomico v. CA
The Court has repeatedly upheld the validity of the Trust Receipts Law
and consistently declared that the said law does not violate the
constitutional proscription against imprisonment for non-payment of
debts.
PD 115 is a declaration by the legislative authority that, as a matter of
public policy, the failure of a person to turn over the proceeds of the sale
of goods covered by a trust receipt or to return said goods if not sold is a
public nuisance to be abated by the imposition of penal sanctions.
Phil. Blooming v. CA
The entruster may cancel the trust and take possession of the
goods, documents or instruments subject of the trust or of the
proceeds realized therefrom at any time upon default or failure
of the entrustee to comply with any of the terms and conditions
of the trust receipt or any other agreement between the
entruster and the entrustee, and the entruster in possession of the
goods, documents or instruments may, on or after default, give notice to
the entrustee of the intention to sell, and may, not less than five days
after serving or sending of such notice, sell the goods, documents or
instruments at public or private sale, and the entruster may, at a public
sale, become a purchaser.
Thus, even though TRB took possession of the goods covered by the
trust receipts, PBM and Ching remained liable for the entire amount of
the loans covered by the trust receipts.
Sarmiento Jr. v. CA
The entrusters complaint against entrustee was based on the failure of
the latter to comply with their obligation as spelled out in the Trust
Receipt executed by them.
This breach of obligation is separate and distinct from any criminal
liability for misuse and/or misappropriation of goods or proceeds
realized from the sale of goods, documents or instruments released
under trust receipts, punishable under Section 13 of the Trust Receipts
Law(P.D. 115) in relation to Article 315(1), (b) of the Revised Penal Code.
Being based on an obligation ex contractu and not ex delicto , the civil
action may proceed independently of the criminal proceedings instituted
against petitioners regardless of the result of the latter.
Rizal Commercial Banking Corporation v. Alfa RTW Manufacturing Corp.
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. In the
case at bar, there are specific amounts of interest, service charges and
penalties agreed upon by the parties.
Exception to: Nemo Dat Quod Non Habet

Although the entrustee is not the owner of the goods, anyone who
acquires the goods from the entrustee acquires good title over the
goods.

Exception to: Res Perit Domino

Although the entrustee is not the owner of the goods covered by a

trust receipt, should the goods be lost while in his possession,
entrustee will bear the loss.