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CASE OUTLINE IN MERCANTILE LAW Dean Nilo T. Divina I.
 
Letters of Credit
A.
 
Definition and Nature of Letter of Credit
 
Usage and customs apply in commercial transactions in the absence of any particular provision in the Code of Commerce, as provided in Article 2 of the same Code. Hence, the rule that all parties concerned in documentary credit operations deal in documents and not in goods bind the parties in a letter of credit transaction.
Bank of the Philippine Islands vs. De Reny Fabric Industries, Inc.,35 SCRA 253 (1970)
An order of the court releasing the proceeds of an irrevocable letter of credit to the applicant, which was issued to pay for tobacco purchased from the beneficiary of the letter of credit, violates the irrevocable nature of the letter of credit. An irrevocable letter of credit cannot, during its lifetime, be cancelled or modified without the express permission of the beneficiary.
Philippine Virginia Tobacco Administration vs. De Los Angeles, 164 SCRA 543 (1988)
An irrevocable letter of credit is not synonymous with a confirmed letter of credit. In an irrevocable letter of credit, the issuing bank may not, without the consent of the beneficiary and the applicant, revoke its undertaking under the letter, whereas, in a confirmed letter of credit, 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,
ibid
 Mere opening of a letter of credit does not involve a specific appropriation of a sum of money in favor of the beneficiary.
Feati Bank & Trust Company vs. Court of Appeals, 196 SCRA 576. 1991)
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 letters of credit plus credit or commitments fees mutually agreed
upon. Once the issuing bank shall have paid the beneficiary after the latter’s compliance
with the terms of the letter of credit, the issuing bank is entitled to reimbursement for the amount it paid under the letter of credit. Presentment for acceptance to the customer/ applicant of the drafts drawn by the beneficiary is not a condition sine qua non for reimbursement.
 Prudential Bank and Trust Company vs. IAC, 216 SCRA 257 (1992)
The primary purpose of the 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. Hence, the failure of a buyer/importer to open a letter of credit as stipulated amounts to a breach of contract which would entitle the seller/exporter to A letter of credit transaction is a composite of at least three distinct but intertwined relationships, each relationship being concretized in a contract:
 
a) One contract relationship links the party applying for the letter of credit (the account party or applicant or buyer or importer) and the party for whose benefit the letter of credit is issued (the beneficiary or seller or exporter). In this contract, the account party agrees, among other things, and subject to the terms and conditions of the contract, to pay money to the beneficiary b) A second contract relationship between the account party and the issuing bank. Under this contract,(sometimes called the Application and Agreement or the Reimbursement Agreement), the account party, among other things, applies to the Issuing Bank for a specified letter of credit and agrees to reimburse the bank for amounts paid by the bank pursuant to the letter of credit. c) The third contract relationship is established between the issuing bank and the beneficiary to, inter alia, pay certain monies to the latterclaim damages for such breach.
Reliance Commodities, Inc., vs. Daewoo Industrial Co., Ltd., 228 SCRA 545 (1993)
In a letter of credit transaction, there are three separate and distinct relationships: a) between the account party (buyer/importer) and the beneficiary (seller/exporter), which may be a contract of sale or non-sale; b) between the account party and the issuing bank, where the former applies to the latter for a specified L/C and agrees to reimburse the bank for amounts paid by it pursuant to the L/C; and c) between the issuing bank and the beneficiary where the former, upon presentation of stipulated documents, pays the latter the amount under the L/C. Such relationships are interrelated but independent of one another.
Rodzssen Supply Company, Inc.,vs. Far East Bank and Trust Company, 357 SCRA 618 (2001)
 Commercial letters of credit involve the payment of money under a contract of sale wherein the seller-beneficiary presents to the issuing bank documents that would show that he has taken affirmative steps to comply with the sales agreement. On the other hand, standby letters of credit are used in non-sale setting where the beneficiary presents documents that would show that the obligor has not complied with his obligation. Letters of credit are also used in non-sale setting where they serve to reduce the risk of nonperformance. Letters of credit in the non-sale settings are known as standby letters of credit. There are significant differences between commercial and standby letters of credit: (1) commercial credits involve the payment of money under a contract of sale. Such credits become payable upon presentation by the seller-beneficiary of documents that show he has taken affirmative steps to comply with the sales agreement. In the standby type, the credit is
payable upon certification of a party’s nonperformance of the agreement; (2) In standby letter of credit, the documents that accompany the beneficiary’s draft tend to show that the
applicant has not performed. The beneficiary of a commercial letter of credit demonstrates by documents that he has performed his contract. The beneficiary of a standby letter of credit must certify that his obligor has not performed the contract.
Transfield Philippines, Inc.,vs. Luzon Hydro Corp. 443 SCRA 307 (2004)
The concept of guarantee vis-à-vis the concept of an irrevocable letter of credit is
inconsistent with each other. The guarantee theory destroys the independence of the bank’s
responsibility from the contract upon which it was opened and the nature of both contracts
 
is mutually in conflict with each other. In contracts of guarantee, the guarantor’s obligation
is merely collateral and it arises only upon the default of the person primarily liable. On the other hand, in an irrevocable letter of credit, the bank undertakes a primary obligation. Letters of credit were developed for the purpose of insuring to a seller payment of a definite amount upon the presentation of documents and is thus a commitment by the issuer that the party in whose favor it is issued and who can collect upon it will have his credit against the applicant of the letter, duly paid in the amount specified in the letter. They are primary obligations and not accessory contracts and while they are security arrangements, they are not converted thereby into contracts of guaranty. What distinguishes letters of credit from other accessory contracts, is the engagement of the issuing bank presented to it. They are definite undertakings to pay once the documents stipulated therein are presented. The stay order issued by the rehabilitation court pursuant to the Interim Rules of Corporate Rehabilitation does not apply to the beneficiary of the letter of credit against the banks that issued it because the prohibition on the enforcement of claims against the debtor, guarantors or sureties of the debtors does not extend to the claims against the issuing bank in a letter of credit. Letters of credit are primary obligations and not accessory contracts and while they are security arrangements, they are not thereby converted into contracts of guaranty.
MWSS vs. Hon. Daway, 432 SCRA 559 (2004)
A letter of credit is a separate document from a trust receipt. While the trust receipt may have been executed as a security on the letter of credit, still the two documents involve different undertakings and obligations. A letter of credit is 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. By contrast, a trust receipt transaction is one where the entruster, who holds an absolute title or security interests over certain goods, documents or instruments, released the same to the entrustee, 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 to the entruster, or as appears in the trust receipt, or return the goods, documents or instruments themselves if they are unsold, or not otherwise disposed of, in accordance with the terms and conditions specified in the trust receipt.
 Bank of Commerce vs. Serrano, 451 SCRA 484. 2005)
B. Parties to a Letter of Credit
 
1.
 
Rights and Obligations of Parties
 
A buyer who applied for a letter of credit to pay for imported dyestuffs must reimburse the issuing bank which paid the beneficiary, even if the shipment contained colored chalks. Banks are not required to investigate if the contract underlying the letter of credit has been fulfilled or not because in a transaction involving letter of credit, banks deal only with documents and not with goods.
Bank of the Philippine Islands vs. De Reny Fabric Industries, Inc.,35 SCRA 253 (1970)

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