COMMERCIAL LAW REVIEW CASE DIGESTS FROM CODE OF COMMERCE TO TRUST RECEIPTS A.

LETTERS OF CREDIT The Rule of Strict Compliance Feati Bank and Trust Co., (now Citytrust Banking Corp), Petitioner, vs. The Court of Appeals and Bernardo Villaluz, Respondents. GR NO. 94209 April 30, 1991 Gutierrez, Jr., J.: Facts: Respondent Bernardo Villaluz agreed to sell to the Axel Christiansen 2,000 cu.m. of lauan logs. On the arrangements made and upon instructions of the consignee, Hanmi Trade Devt., in the US, the Security Pacific National Bank of L.A., California, issued an irrevocable letter of credit in favor of Villaluz for the total purchase price of the logs. The letter of credit was mailed to petitioner Feati Bank with the instruction to the latter that it forward the enclosed letter of credit to the beneficiary. Under the letter of credit, one of the stipulations therein provided, was that Christiansen shall issue a certification that the logs have approved prior to shipment in accordance with the terms and conditions of the corresponding purchase order. The logs were thereafter loaded to a vessel. However, Christiansen refused to issue the certification as required in the letter of credit despite several requests made by Villaluz. Because of the absence of the certification by Christiansen, Feati Bank refused to advance the payment on the letter of credit. This prompted Villaluz to file an action for mandamus and specific performance against Christiansen and Feati Bank. However, while the case was pending Christiansen left the country and as such Villaluz made Feati Bank solidarily liable with Christiansen. The trial court ruled in favor of Villaluz and was affirmed by CA on appeal. Hence, this present petition for review. Issue: Whether or not a correspondent bank is to be held liable under the letter of credit despite the noncompliance by the beneficiary with the terms thereof. Held: No. The petition is impressed with merit. It is 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 of credit. 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. The bank may only negotiate, accept or pay, if the documents tendered on it are on their face in accordance with the terms and conditions of the documentary credit. And since a correspondent bank, like the petitioner, principally deals only with documents, the absence of any document require in the documentary credit justifies the refusal by the correspondent bank to negotiate, accept or pay the beneficiary, as it is not its obligation to look beyond the documents. It merely has to rely on the completeness of the documents tendered by the beneficiary.

Standy Letter of Credit Nature of the Liability of the Issuing Bank Metropolitan Waterworks and Sewerage System (MWSS), petitioner, vs. Hon. Reynaldo Daway, Judge-RTC,QC., and Maynilad Water Services, Inc., respondents. GR No. 160732 June 21, 2004 Azcuna, J.: Facts: Petitioner MWSS granted respondent Maynilad under a Concession Agreement a 20-year period to manage, operate, repair, decommission and refurbish the existing water MWSS water delivery and sewerage services in the West Zone Service area, for the Maynilad undertook to pay the corresponding concession fees which, among other things, consisted of payments of MWSSs foreign loans. As a security for the performance of its obligation, Maynilad opened with a number of foreign banks several irrevocable standby letters of credit in favor of MWSS amount to $120M. Due to the failure of the Maynilad to perform its obligations under the Concession Agreement, MWSS submitted a written notice to the participating banks that it was drawing on the Irrevocable Standby Letters of Credit and thereby demanded payment. Prior to this, however, Maynilad had filed a petition for rehabilitation before the RTC of Quezon City which resulted in the issuance of a Stay Order suspending enforcement of all claims, whether for money or otherwise and whether such enforcement is by court action or otherwise, against Maynilad, its guarantors and sureties not solidarily liable with the latter. The lower court likewise enjoined MWSS from seeking availment under the standby letters of credit because it is violative of the Interim Rules of Procedure on Corporate Rehabilitation. Thus, this present petition filed by MWSS assailing the legality of said order as having been issued without or in excess of the lower courts jurisdiction or that it acted with grave abuse of discretion. Issue: Did the rehabilitation court act in excess of its authority or jurisdiction when it enjoined MWSS from seeking the payment of consession fees from the banks that issued the Irrevocable Standby Letters of Credit in its favor and for the account of respondent Maynilad? Held: Yes. First, the claim is not one against the debtor but against an entity that respondent Maynilad has procured to answer for its non-performance of certain terms and conditions of the Concession Agreement, particularly the payment of concession fees. The financial records of Maynilad do not show that the Irrevocable Standby Letters of Credit are part of Maynilads assets or liabilities. In issuing the assailed order enjoining MWSS from claiming from an asset that did not belong to the debtor and over which it did not acquire jurisdiction, the rehabilitation court acted in excess of its jurisdiction. Second, as had been held previously by the Court, except when a letter of credit specifically stipulates otherwise, the obligation of the banks issuing letters of credit are solidary with that of the person or entity requesting for its issuance, the same being a direct, primary, absolute and definite undertaking to pay the beneficiary upon the presentation of the set of documents required therein. Thus, the prohibition under the Interim Rules does not apply to MWSS as the prohibition is on the enforcement of claims against guarantors or sureties of the debtors whose obligations are not solidary with the debtor. The participating banks obligation are solidary with respondent Maynilad in that it is primary, direct, definite and an absolute undertaking to pay and is not conditioned on the prior exhaustion of the debtors assets. These are the same characteristics of a surety or solidary obligor.

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. 1305 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) Johannes Schuback & Sons Phil. Trading Corp., petitioner, vs. Hon. Court of Appeals, Ramon San Jose (Philippine SJ Industrial Trading), respondents. GR No. 105387 November 11, 1993 Romero, J.; Facts: Sometime in 1981, respondent Ramon San Jose, submitted to Schuback Philippines a list of MAN bus spare parts he wanted to purchase from its counterpart in the Hamburg, Germany. San Jose informed Schuback that he preferred genuine parts and requested a discount thereon. Schuback submitted its formal offer. San Jose immediately ordered the items from Schuback Hamburg, which thereafter ordered the same from a supplier in Germany. Thereafter, Shcuback Hamburg sent San Jose a proforma invoice to used by the latter in applying for letter of credit. Said invoice required that the letter of credit be opened in favor of Schuback Hamburg. But for some reason or another, San Jose failed to open the letter of credit in favor of Schuback Hamburg. For several times, Schuback reminded San Jose of his order and demanded payment from him. However, San Jose replied that there was no definite contract between him and Schuback. This prompted Schuback to file a complaint against San Jose for recovery of actual and compensatory damages. The trial court ruled in favor of Schuback but was eventually reversed on appeal since there was no perfection of the contract. Hence, this present for review on certiorari. Issue: Whether or not a contract of sale has been perfected betw een the parties despite the non-opening of a letter of credit by private respondent. Held: Yes. The situation reveals that San Jose failed to open an irrevocable letter of credit without recourse in favor of Johannes Schuback of Hamburg, Germany. This omission, however, does not prevent the perfection of the contract between the parties, for the opening of the letter of credit is not deemed to be a suspensive condition. The facts herein do not show that Schuback reserved title to the goods until private respondent had opened a letter of credit. Schuback, in the course of its dealings with private respondent, did not incorporate any provision declaring their contract of sale without effect until after the fulfillment of the act of opening a letter of credit. 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 Art. 1305 and 1474 of the Civil Code, the absence of any of which will prevent the perfection of the contract from taking place.

Letters of Credit; Presentment of Draft drawn against the letter of credit. Prudential Bank, petitioner, vs. IAC, Philippine Rayon Mills,Inc., and Anacleto Chi, respondents. GR No. 74886 December 8, 1992 Davide, Jr., J.: Facts: Respondent Philippine Rayon Mills Inc., (PRMI) entered into a contract with Nissho Co., of Japan for the importation of textile machineries under a five-year deferred payment plan. To effect the payment of said machineries, PRMI applied for a commercial letter of credit with the petitioner Prudential Bank in favor of the Nissho and by of which Prudential open the letter of credit. Against this letter of credit, 12 drafts were drawn and issued by Nissho which were all paid by Prudential Bank through its correspondent bank in Japan. Two of these drafts were accepted by PRMI through its president, Anacleto Chi. The machineries eventually arrived and Prudential Bank immediately indorsed the shipping documents to PRMI. However, before the latter could take the delivery of the machineries, it executed a trust receipt in favor of Prudential Bank which was signed by Anacleto Chi. Unfortunately, several years later, PRMI ceased its business operation and its factory was eventually sold to AIV Corporation. At this point, the obligation of PRMI arising from the letter of credit and trust receipt remained unpaid and unliquidated. Formal demands were made by Prudental Bank, yet it yielded no result. Hence, Prudential filed an action for collection of the principal amount of the obligation. The trial court, and on appeal, the IAC ruled that Philippine Rayon could only be held liable for the two drafts because only these appear to have been accepted by the latter after presentment. The liability for the remaining ten drafts did not arise because the same were not presented for acceptance. Hence, this present petition for review. Issue: Whether or not presentment for acceptance of the drafts drawn against the letter of credit was indispensible to make Philippine Rayon liable thereon. Held: No. 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 commitment fees mutually agreed upon. In the instant case then, the drawee was the petitioner Prudential bank. It was to the latter that the drafts were presented for payment. In fact, there was no need for acceptance as the issued drafts are sight drafts. Presentment for acceptance is necessary only in the cases expressly provided for in Section 143 of the NIL.* The Court further ruled, that even if the drafts were not sight drafts, thereby necessitating acceptance, it would be Prudential Bank - and not Philippine Rayon which had to accept the same for the latter was not the drawee. Therefore, the trial court and the appellate court erred in ruling that presentment for acceptance was an indispensable requisite for Philippine Rayons liability on the drafts to attach. Contrary to both courts pronouncements, Philippine Rayon immediately became liable thereon upon Prudential Banks payment thereof. Such is the essence of the letter of credit issued by the petitioner Prudential Bank.

* Section 143, NIL Presentment for acceptance must be made: a. where the bill is payable after sight, or in any other case, where presentment for acceptance is necessary in order to fix the maturity of the instrument; or b. where the bill expressly stipulates that it shall be presented for acceptance; or c. where the bill is drawn payable elsewhere than at the residence or place of business of the drawee. In no other case is presentment is necessary in order to render any party to the bill liable.

Fraud as an exception to Independence Principle Transfield Philippines, Inc., petitioner, vs. Luzon Hydro Corporation, etal., respondents. GR No. 146717 November 22, 2004 Tinga, J.: Facts: Petitioner Transfield Phil., Inc., (TPI) and respondent Luzon Hydro Corp., (LHC) entered into a Trunkey Contract whereby TPI undertook to construct on a turnkey basis a hydro electric power plant station in the provinces of Benguet and Ilocos Sur. The contract provides for a period for which the project is to be completed and also allows for the extension of the period provided that the extension is based on justifiable grounds such as fortuitous event. To secure the performance of TPIs obligation on or before the target completion date, TPI opened in favor the LHC Two standby letters of credit. During the construction of the hydro power plant, TPI sought various extensions of time to complete the project due to fortuitous events brought about by typhoon. LHC denied the requests and was eventually referred to the arbitration committee. In the meanwhile, foreseeing the LHC would call on the standby letters of credit, it advised the issuing banks not to release any funds in favor of LHC because there is a pending arbitration proceeding on their request for extension of time. LHC did serve a notice that it would call on the standby letters of credit for the payment of liquidated damages for the delay. Despite TPIs advise, the issuing banks informed TPI that they would pay on the standby letters of credit. This prompted TPI to file a complaint for injunction with a prayer for TRO against LHC and the issuing banks. However, the trial court denied TPIs application for a writ of preliminary injunction. On appeal, the denial was appealed. In this present petition, TPI invoked the fraud exception principle. It avers that LHCs call on the standby letters of credit is wrongful because it fraudulently misrepresented the two issuing banks that there is already a breach in the Turnkey Contract knowing fully well that this is yet to be determined by the arbitral tribunals. On the other hand LHC and the respondent banks invoke independence rule. Issue: Whether or not LHC deliberately misrepresented the supposed existence of delay despite its knowledge that the issue was still pending arbitration, hence the case falls squarely within the fraud exception rule. Held: No. It is recognized that fraud is an exception to the independence of contracts involving letters of credit. Fraud exception exists when the beneficiary, for the purpose of drawing on the credit, fraudulently presents to the confirming bank, documents that contain, express or by implication, material representations of fact that to his knowledge are untrue. In this situation, demand for payment under a standby credit may qualify as fraud sufficient to support an injunction against payment. However, the Court held and agreed with the finding of the lower court that the fraud exception rule does not apply in this case. The pendency of the arbitration proceedings would not per se make LHCs draws on the Securities wrongful of fraudulent for there was nothing in the Contract which would indicate that the parties intended that all disputes regarding delay should first be settled through arbitration before LHC would be allowed to call upon the Securities. It is therefore premature and absurd to conclude that the draws on the Securities were outright fraudulent given the fact the arbitration committee had not ruled with finality on the existence of default. The Court reiterates that pursuant to the independence principle the banks were under no obligation to determine the veracity of the LHCs certification that default has occurred. Neither were they bound by TPIs declaration that LHCs call thereon was wrongful. To repeat, respondent banks undertaking was simply to pay once the required documents are presented by the beneficiary.

TRUST RECEIPTS Landl & Company (Phil.) Inc., etal., petitioners, vs. Metropolitan Bank & Trust Company, respondent. GR No. 159622 July 30, 2004 Ynare-Santiago, J.: Facts: Petitioner Landl & Co. is a corporation engaged in the business of selling imported welding rods and alloys. It opened a letter of credit with respondent Metrobank to purchase various welding rods and electrodes from the US. Landl put up a marginal deposit from the proceeds of a separate loan. To ensure the indebtedness of Landl, Metrobank required the execution of a Trust Receipt in an amount equivalent to the letter of credit on the condition the Landl would hold the goods in trust for respondent bank, with the right to sell the goods and the obligation to turn over to respondent bank the proceeds of the sale, if any. If the goods remained unsold, Landl had the further obligation to return them to Metrobank. Petitioner corporation defaulted in the payment of its obligation and failed to turn over the goods to the latter. In compliance with Metrobanks demand, petitioner, as entrustee, turned over the goods subject of the trust receipt to Metrobank. The goods were eventually sold at a public auction and the goods were sold to Metrobank as the highest bidder. However, the proceeds of the auction sale were insufficient to completely satisfy petitioners outstanding obligation. Accordingly, Metrobank demanded that petitioner pay the remaining balance of their obligation. Since petitioner still failed to do, Metrobank instituted an action to collect said deficiency. The lower court rendered judgment in favor of Metrobank and was affirmed by the CA on appeal. Hence, this instant case. Issue: Whether or not, in a trust receipt transaction, an entruster which had taken actual and juridical possession of the goods covered by trust receipt may subsequently avail of the right to demand from the entrustee the deficiency of the amount covered by the trust receipt. Held: Yes. A trust receipt is inextricably linked with the primary agreement between the parties. Time and again, it has been emphasized that a trust receipt agreement is merely a collateral agreement, the purpose of which is to serve as a security for a loan. The initial repossession by the bank of the goods subject of the trust receipt did not result in the full satisfaction of the petitioners loan obligation. Petitioners are apparently laboring under the mistaken impression that the full turn-over of the goods suffices to divest them of their obligation to repay the principal amount of their loan obligation. The second paragraph of Section 7 expressly provides that the entrustee shall be liable to the entruster for any deficiency after the proceeds of the sale have been applied to the payment of the expenses of the sale, the payment of re-taking, keeping and storing the goods, and the satisfaction of the entrustees indebtedness to the entruster. In the case at bar, the proceeds of the auction sale were insufficient to satisfy entirely petitioner corporations indebtedness to the respondent bank. Respondent bank was thus well within its rights to institute the instant case to collect the deficiency.

Development Bank of the Philippines, petitioner, vs. Prudential Bank, respondent. GR No. 143772 November 22, 2005 Corona, J.: Facts: In connection with its importation of spindles including parts and accessories for spinning machinery, Lirag Textile Mills, Inc., (Litex) opened an irrevocable commercial letter of credit with respondent Prudential Bank. These goods were release to Litex under covering trust receipts it executed in favor of Prudential. The items were installed and used by Litex in its textile mill. Several years later, DBP granted a foreign currency loan to Litex. To secure the loan, Litex executed a real estate and chattel mortgage on its plant site, including buildings and other improvements, machineries and equipment there. Among the machineries and equipment mortgaged in favor of DBP were the article covered by the trust receipts. Prudential notified DBP of its claim over the various items covered by the trust receipts. For failure of Litex to pay its obligations, DBP extrajudicially foreclosed on the real and chattel mortgages including the articles claimed by Prudential Bank. During the foreclosure sale, DBP acquired the foreclosed properties. However, despite the claim of Prudential Bank over the items covered by the trust receipts and not to include them in the auction and to turn over the articles to it or pay for their value, DBP proceeded with the public auction. Eventually, without the knowledge of Prudential Bank, DBP sold Litex as well as the machineries and equipment therein, to Lyon Textile Mills. This prompted Prudential Bank to file a complaint for a sum of money with damages against DBP. Judgment was rendered against DBP. Issue: Whether or not the contract of mortgage entered into by Litex and DBP, the subject of which includes the items covered by the trust receipts, is valid. Held: No. The article were owned by Prudential Bank and they were held in trust by Litex. While it was allowed to sell the items, Litex had no authority to dispose of them or any part thereof or their proceeds through conditional sale, pledge or any other means. Article 2085(2) of the Civil Code requires that, in a conduct of pledge or mortgage, it is essential that the pledgor or mortgagor should be the absolute owner of the thing pledged or mortgaged. Article 2085(3) further mandates that the person constituting the pledge or mortgage must have the free disposal of his property, and in the absence thereof, that he be legally authorized for the purpose. Litex had neither absolute ownership, free disposal nor the authority to freely dispose of the article. Litex could not have subjected them to a chattel mortgage. Their inclusion in the mortgage was void and had no legal effect. There being no valid mortgage, there could also be no valid foreclosure or valid auction sale. Thus, DBP could not be considered either as a mortgagee or as a purchaser in good faith. No one can transfer a right to another greater than what he himself has. Corollarily, DBP could not acquire a right greater than what its predecessor in interest had. DBP merely stepped into the shoes of Lites as trustee of the imported articles with an obligation to pay their value or to return them on Prudential Banks demand. By failure to pay or return them despite Prudential Banks repeated demands, and by selling them to Lyon without Prudential Banks knowledge and conformity, DBO became a trustee ex maleficio.

Alfredo Ching, petitioner, vs. The Secretary of Justice, etal., respondents. GR No. 164317 February 6, 2006 Callejo, Jr., J.: Facts: Petitioner Alfredo Ching was the SVP of Philippine Blooming Mills, Inc., (PBMI). PBMI through Ching, applied with respondent RCBC for the issuance of commercial letters of credit to finance the importation of assorted goods. RCBC approved the application and issued an irrevocable letters of credit in favor of Alfredo Ching. The goods were purchased and delivered in trust to PBMI. Ching signed 13 trust receipts

as surety, acknowledging delivery of the goods. Under the receipts, Ching agreed to hold the goods in trust for the bank, with authority to sell xxx; and in case such goods were sold, to turn over the proceeds thereof as soon as received, to apply against the relative acceptances and payment of other indebtedness to RCBC. In case the goods remained unsold within the specified period, the goods were to be returned to RCBC without any need of demand. Thus, said goods, manufactured products or proceeds thereof, whether in the form of money, bills, receivables, or accounts separate and capable of identification were RCBCs property. When the trust receipts matured, petitioner failed to return the goods to RCBC, or to return their value despite demand. This prompted RCBC to file a criminal action for estafa against petitioner for violation of PD 115 of Trust Receipt Law. Petitioner posits that, except for his being the SVP of PBMI, he cannot be held criminally liable as the transaction sued upon were clearly entered into in his capacity as an officer of the corporation and that he never received the goods as an entrustee for PBMI as he never took possession of the goods. Issue: Whether or not the officers of the corporation can be held criminally and civilly liable of estafa for violation of the trust receipts law. Held: Yes. Though the entrustee is a corporation, nevertheless, the law specifically makes officers, employees or other officers or persons responsible for the offense, without prejudice to the civil liabilities of such corporation and/or board of directors, officers, or other officials or employees responsible for the offense. The rationale is that such officers of employees are vested with the authority and responsibility to devise means necessary to ensure compliance with law and, if they fail to do so, are held criminally accountable; thus, they have a reasonable share in the violations of the law. If the crime is committed by a corporation or other juridical entity, the directors, employees or other officers thereof responsible for the offense, shall be charged and penalized for the crime, precisely because of the nature of the crime and the penalty thereof. A corporation cannot be arrested and imprisoned; hence, cannot be penalized for a crime punishable by imprisonment. However, a corporation may be charged and prosecuted for a crime if the imposable penalty is fine. Even if the statute prescribes both fine and imprisonment as penalty, a corporation may be prosecuted and, if found guilty, may be fined. In this case, petitioner Ching signed the trust receipts in question. He cannot, thus, hide behind the cloak of separate corporate entity of PBMI. A corporate office cannot protect himself behind a corporation where he is the actual, present and efficient actor.

Melvin Colinares and Lordino Veloso, petitioners, vs. Hon. Court of Appeals, and the People of the Philippines, respondents. GR No. 90828 September 5, 2000 Davide, Jr., C.J.: Facts: Petitioners Melvin Colinares and Lordino Veloso were contracted for a consideration by the Carmelite Sisters to renovate the latters convent. On October 30, 1979, petitioners obtained from CM Builders various construction materials for the construction project. The following day, petitioners applied for a commercial letter of credit with Philippine Banking Corporation (PBC) in favor of CM Builders to cover the full invoice value of the goods. Petitioners likewise signed a trust receipt as security. Because of petitioners failure to pay their obligation, PBC demanded payment from them. Instead of complying with PBCs demand, petitioner Veloso confessed that they incurred losses in the construction project and proposed that the terms of payment of the loan be modified. Pending approval thereof, petitioners made several partial payments of the loan. However, petitioners were charged with violation of Trust Receipts Law (PD 115) in relation to Art. 315 of the RPC in an information filed with RTC-CDO. Despite of their insistence that the transaction was a clean loan, they were convicted of estafa for violating PD 115. On appeal, the CA affirmed the decision of the trial court but increased the penalty imposed upon the petitioners. Hence, the instant case. Issue: Whether or not the contract between the petitioners and PBC is a trust receipt agreement under the Trust Receipt Law. Held: No. There are two situations in a trust receipt transaction. The first is covered by the provision which refers to money received under the obligation involving the duty to deliver it (entregarla) to the owner of the merchandise sold. The second is covered by the provision which refers to merchandise received under the obligation to return it (devolvera) to the owner. Failure of the entrustee to turn over the proceeds of the sale of goods, covered by the trust receipt to the entruster or to return said goods if they were not disposed of in accordance with the terms of the trust receipt shall punishable as estafa under Art. 315(1) of the RPC, without need of proving intent to defraud. A thorough examination of the facts obtaining in the case at bar reveals that the transaction intended by the parties was simple loan, not a trust receipt agreement.

Petitioners received the merchandise from CM Builders on October 30, 1979. On that day ownership over the merchandise was already transferred to petitioners who were to use the materials for their construction project. It was only a day later that they went to the bank to apply for a loan to pay for the merchandise. This situation belies what normally obtains in a pure trust receipt transaction were goods are owned by the bank and only released to the importer in trust subsequent to the grant of the loan. In this case, petitioners are not importers acquiring goods for re-sale, contrary to the express provision embodied in the trust receipt. They are contractors who obtained the fungible goods for their construction project. At no time did the title over the construction materials pass to the bank, but directly to the petitioners from CM Builders. This impresses upon the trust receipt in question vagueness and ambiguity, which should not be the basis for criminal prosecution in the event of violation of its provisions.

Pilipinas Bank, petitioner, vs. Alfredo T. Ong and Leoncia Lim, respondents. GR No. 133176 August 8, 2002 Sandoval-Gutierrez, J.: Facts: In 1991, Baliwag Mahogany Corporation (BMC), through its president, respondent Alfredo Ong, applied for a letter of domestic letter of credit with petitioner Pilipinas Bank (the Bank) to finance the purchase of air dried, dark red lauan sawn lumber. The Bank approved the application and accordingly issued the letter of credit. To secure the payment of the amount of the letter of credit, BMC, through Mr. Ong, executed 2 trust receipts providing that the proceeds of the goods shall be turned over to the bank, if sold, or return the goods, if unsold upon maturity of the trust receipts. However, BMC failed to comply with the trusts receipt agreement. Later on, BMC filed with the SEC a Petition for Rehabilitation and Suspension of Payments. BMC informed its creditors including the Bank of the filing of the petition and consequently a creditors meeting was held. Thereafter, BMC and a consortium of 14 of its creditor banks entered into a MOA rescheduling the payment of BMCs existing debts. Neverthless, BMC and respondent Ong defaulted the payment of their obligations under the rescheduled payment scheme. Thus, the Bank filed with the Makati Prosecutors Office a complaint charging the respondents with violation of Trust Receipts Law for having failed to pay their obligations under the trust receipts. The complaint was, however, dismissed. The Bank appealed and the resolution of the prosecution dismissing the complaint was set aside. However, the decision of the CA was reconsidered upon motion of the respondents holding that the execution of the MOA constitutes novation and bars the petitioner bank to file any criminal information for violation of the Trust Receipt Law. Issue: Did the MOA entered into by the respondent and the Bank novate the trust agreement between the parties. Held: Yes. There are two ways which could indicate the presence of novation thereby producing the effect of extinguishing an obligation by another which substitute the same. The first is when novation has been stated and declared unequivocal. The seconds is when the old and the new obligations are incompatible on every point. The test of incompatibility is whether or not the two obligations can stand together. If they cannot, they are incompatible and the latter obligation novates the first. The incompatibility must take place in any of the essential elements of the obligation, such as its object, cause or principal conditions. In the case at bar, the MOA did not only reschedule BMCs debts, but more importantly, it provided principal obligations which are incompatible with the trust receipt agreement and it can be safely concluded that the MOA novated and effectively extinguished BMCs obligations under the trust receipt. Such is the case, the BMCs liability if any, would only be civil in nature since the trust receipts were transformed into mere loan documents after the execution of the MOA.