Bar Q and A #48

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1.) Is the Uniform Customs and Practice for Documentary Credits of the International Chamber of Commerce applicable to commercial letters of credit issued by a domestic bank even if not expressly mentioned in such letters of credit? What is the basis for your answer?

YES, the Supreme Court held that the observance of the Uniform Customs and Practice in the Philippines is justified by Article 2 of the Code of Commerce which enunciates that in the absence of any particular provision in the Code of Commerce, commercial transaction shall be governed by usage and customs generally observed.(Bank of the Philippine Islands v. De Reny Fabric Industries, Inc. 35 SCRA 253)

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2.) Explain what is a “Letter of Credit” as a financial device and a “Trust Receipt” as a security to the Letter of Credit.

A letter of credit is any arrangement however named or described whereby a bank acting upon the request of its client or on its behalf agrees to pay another against stipulated documents provided that the terms of the credit are complied with (Section 2 of the Uniform Customs and Practices for Documentary Credit). A trust receipt is an arrangement whereby the issuing bank (referred to as the entruster under the trust receipt) releases the imported goods to the importer (referred to as the entrustee) but that the latter in case of sale must deliver the proceeds thereof to the entruster up to the extent of the amount owing to the entruster or to return the goods in case of non-sale.

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3.) Explain the three (3) distinct but intertwined contract relationships that are indispensable in a letter of credit transaction.

The following are the three (3) distinct relationships arising from a letter of credit:

1. Issuing Bank and the Applicant/ Buyer/ Importer – The applicant has the obligation to pay what the issuing bank has paid to the beneficiary with the cost and interest on the letter of credit. Their relationship is governed by the terms of the application and agreement for the issuance of letter of credit by the bank.

2. Issuing Bank and the Beneficiary/ Seller/ Exporter – The issuing bank is the one who undertakes to pay the beneficiary upon strict compliance of the latter to the requirements set forth in the letter of credit.

3. Applicant and Beneficiary – The applicant is the one who procures the letter of credit and obliges himself to reimburse the issuing bank upon receipt of the documents of title while the beneficiary is the one 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 for the goods. The relationship between them is governed by the law on sales if it is a commercial letter of credit but if it is a stand-by letter of credit it is governed by the law on obligations and contract.

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4.) Ricardo mortgaged his fishpond to AC Bank to secure a P1M loan. In a separate transaction, he opened a letter of credit with the same bank for $500,000 in his favor of HS Bank, a foreign bank, to purchase outboard motors. Likewise, Ricardo executed a Surety Agreement in favor of AC Bank. The outboard motors arrived and were delivered to Ricardo, but he was not able to pay the purchase price thereof. a. Can AC Bank take possession of the outboard motors? Why? b. Can AC Bank also foreclose the mortgage over the fishpond? Explain.

a. If what Ricardo executed is a trust receipt, AC Bank can take possession of the outboard motors so that it can exercise its lien and sell them. If what Ricardo executed is a Surety Agreement, AC Bank cannot take possession of the outboard motors, because it has no lien on them.

b. AC Bank can also foreclose the mortgage over the fishpond if Ricardo fails to pay the loan of P1M.

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5.) In letters of credit in banking transactions, distinguish the liability of a confirming bank from a notifying bank.

In case anything wrong happens to the letter of credit, a confirming bank incurs liability for the amount of the letter of credit, while a notifying bank does not incur any liability.

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6.) Yeti Export Corporation {YEC), thru its President, negotiated for Yahoo Bank of Manila {YBM) to issue a letter of credit to course the importation of electronic parts from China to be sold and distributed to various electronic manufacturing companies in Manila. YBM issued the letter of credit and forwarded it to its correspondent bank, Yunan Bank (YB) of Beijing, to notify the Chinese exporters to submit the bill of lading in the name of YBM covering the goods to be exported to Manila and to pay the Chinese exporters the purchase price upon verification of the authenticity of the shipping documents. The electronic parts arrived in the Port of Manila, and YBM released them to the custody of YEC as an entrustee under a trust receipt. When YEC unpacked the imported parts in its warehouse, it found that they were not only of inferior quality but also did not fit the descriptions contained in the bill of lading. YEC refused to pay YBM the amount owed under the trust receipt. YBM thereafter commenced the following: Civil suit to hold YB liable for failure to ensure that the electronic parts loaded for exportation in China corresponded with those described in the bill of lading. Is there any merit in the case against YB?

There is no merit in the case against YB. YB only acted as an advising bank whose only obligation after determining the apparent authenticity of the letter of credit is to transmit a copy thereof to the beneficiary of the letter of credit. It has no obligation to ensure that the goods loaded for exportation corresponded with those described in the bill of lading (Bank of America v. Court of Appeals, G..R No. 105395, Dec. 10, 1993).

YB cannot be considered a confirming bank, because to be one it must have assumed a direct obligation to the seller as if it has issued the letter of credit (Marphil Export Corporation v. Allied Banking Corporation, (G.R. No. 187922, September 21, 2016). YB not a negotiating bank either, because it did not buy the draft of the beneficiary of the letter of credit. Even if, however, YB acted as a confirming or negotiating bank, such kind of correspondent bank has no similar obligation to ensure that the goods shipped match with those described merely an alternative recourse and does not in any way prevent the beneficiary from directly claiming from the applicant. (Transfield Phils. Inc. v. Luzon Hydro Corporation, G.R. No. 146717, Nov 22, 2004)

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7.) ABC Company filed a Petition for Rehabilitation with the Court. An Order was issued by the Court, (1) staying enforcement of all claims, whether money or otherwise against ABC Company, its guarantors and sureties not solidarily liable with the company; and (2) prohibiting ABC Company from making payments of its liabilities, outstanding as of the date of the filing of the Petition. XYC Company is a holder of an irrevocable Standby Letter of Credit which was previously procured by ABC Company in favor of XYC Company to secure performance of certain obligations. In the light of the Order issued by the Court, can XYC Company still be able to draw on their irrevocable Standby Letter of Credit when due? Explain your answer.

XYC Company, the beneficiary of the standby letter of credit, can draw on the letter of credit despite filing of petition for corporate rehabilitation. The liability of the bank that issued the letter of credit is primary and solidary. Being solidary, the claims against them can be pursued separately from and independently of the rehabilitation case. (MWSS v. Daway G.R. No. 142381. October 15, 2003)

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8.) A standby letter of credit was issued by ABC Bank to secure the obligation of X Company to Y Company. Under the standby letter of credit, if there is failure on the part of X Company to perform its obligation, then Y Company will submit to ABC Bank a certificate of default (in the form prescribed under the standby letter of credit) and ABC Bank will have to pay Y Company the defaulted amount. Subsequently, Y Company submitted to ABC Bank a certificate of default notwithstanding the fact that X Company was not in default. Can ABC Bank refuse to honor the certificate of default? Explain.

NO. Under the doctrine of independence in a letter of credit, the obligation of the issuing bank to pay the beneficiary is distinct and independent from the main and originating contract underlying the letter of credit. Such obligation to pay does not depend on the fulfillment or non-fulfillment of the originating contract. It arises upon tender of the stipulated documents under the letter of credit. In the present case, the tender of the certificate of default entitles Y to payment under the standby letter of credit notwithstanding the fact that X Company was not in default. This is without prejudice to the right of X Company to proceed against Y Company under the law on contracts and damages. (Insular Bank of Asia and America v. IAC, 167 SCRA 450)

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9.) The Supreme Court has held that fraud is an exception to the “independence principle” governing letters of credit. Explain this principle and give an example of how fraud can be an exception.

The “independence principle” posits that the obligations of the parties to a letter of credit are independent of the obligations of the parties to the underlying transaction. Thus, the beneficiary of the letter of credit, which is able to comply with the documentary requirements under the letter of credit, must be paid by the issuing or confirming bank, notwithstanding the existence of a dispute between the parties to the underlying transaction, say a contract of sale of goods where the buyer is not satisfied with the quality of the goods delivered by the seller. The Supreme Court in Transfield Philippines, Inc. v. Luzon Hydro Corporation, 443 SCRA 307 (2004) for the first time declared that fraud is an exception to the independence principle. For instance, if the beneficiary fraudulently presents to the issuing or confirming bank documents that contain material facts that, to his knowledge, are untrue, then payment under the letter of credit may be prevented through court injunction.

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10.) BV agreed to sell to AC, a Ship and Merchandise Broker, 2500 cubic meters of logs at $27 per cubic meter FOB. After inspecting the logs, CD issued a purchase order. On the arrangements made upon instruction of the consignee, H &T Corporation of LA, California, the SP Bank of LA issued an irrevocable letter of credit available at sight in favor for the total purchase price of the logs. The letter of credit was mailed to FE Bank with the instruction “to forward it to the beneficiary”. The letter of credit provided that the draft to be drawn is on SP Bank and that it be accompanied by, among other things, a certification from AC, stating that the logs have been approved prior shipment in accordance with the terms and conditions of the purchase order. Before loading on the vessel chartered by AC, the logs were inspected by custom inspectors and representatives of the Bureau of Forestry, who certified to the good condition and exportability of the logs. After loading was completed, the Chief Mate of the vessel issued a mate receipt of the cargo which stated that the logs are in good condition. However, AC refused to issue the required certification in the letter of credit. Because of the absence of certification, FE Bank refused to advance payment on the letter of credit. a. May FE Bank be held liable under the letter of credit? Explain. b. Under the facts above, the seller, BV, argued that FE Bank, by accepting the obligation to notify him that the irrevocable letter of credit has been transmitted to it on his behalf, has confirmed the letter of credit. Consequently, FE Bank is liable under the letter of credit. Is the argument tenable? Explain.

a. FE Bank cannot be held liable under the letter of credit since the certificate is not issued by BV. 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 by the letter. 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 thereafter be able to recover from the buyer or the issuing bank, as the case may be, the money thus paid to the beneficiary. Thus the rule of strict compliance. (Feati Bank and Trust Company v. Court of Appeals, G.R. No. 94209, April 30, 1991)

b. The argument made by BV is untenable. The FE Bank in this case is only a notifying bank and not a confirming bank. It is tasked only to notify and/or transmit the required documents and its obligation ends there. It is not privy to the contract between the parties, its relationship is only with that of the issuing bank and not with the beneficiary to whom he assumes no liability.

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