Letters of Credit

Accept and pay any draft by the

beneficiary, OR

What are LETTERS OF CREDIT?

Those issued by one merchant to another for the
purpose of attending to a commercial transaction.
Kinds:
Common Letter of Creditan instrument by which a
bank, for the account of a buyer of merchandise, gives
formal evidence to a seller, of its willingness to permit
the seller to draw bills against it, and stipulates in legal
form that all such bills will be honored.
Travelers Letter of Credita letter from a bank
addressed to its correspondents stating that drafts up to
a certain sum drawn by the beneficiary will be honored
by the bank.
Essential Conditions:
1.) Issued in favor of a definite person and not to order; and
2.) Amount is fixed and specified.
Duration:
1.) Upon a period fixed by the parties;
2.) If none is fixed, 6 months from its date if used in the
Philippines or 1 year if used abroad.
LETTER OF CREDIT
(Art. 567-572 Code of Commerce)
LETTER OF CREDIT
Letter of credit an arrangement 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 w/ the conditions specified in the credit.

4. Authorize another bank to negotiate against the

stipulated documents.
Note: We are bound by the UCPDC issued by the
International Chamber of Commerce. Sec. 2 of the Code of
Commerce states that in the absence of any particular
provision in the code of Commerce, commercial transactions
shall be governed by the usages and customs generally
observed (BPI vs. Nery).
A Letter of Credit is a special contract designed to
answer two concerns:
Sellers refusal to part with his goods before being paid
coupled with the Buyers want of ownership over the
goods before paying.
Note: The opening of a LC does not involve specific
appropriation of money in favor of the beneficiary. The
correspondent bank does not receive in advance the
money form the buyer or issuing bank but pays the
amount out of its own funds and then later on seek
reimbursement from the issuing bank. It does not
convey the notion that a particular sum of money has
been specifically reserved or has been held in trust.
Note: An LC is not a negotiable instrument. It does Not
conform w/ Section 1 of the Negotiable Instruments
Law. This is because it does not contain an
unconditional promise to pay a sum certain in money.
The LC is conditioned to the submission of certain
documents. Moreover, the LC is issued in favor of a
definite person and not to order. Therefore, it also lacks
the words of negotiability required.
LC is conditioned on
1. Submission of stipulated documents
2. Compliance with the terms of the LC

Internationally accepted definition of a LC as provided in

the Uniform Customs and Practices for Documentary
Credit (UCPDC):

Is LC a commercial transaction?
YES. Because it is governed by the Code of Commerce.

Letter of Credit any arrangement, however named or

described, whereby a bank also known as the issuing
bank, acting upon the request or instruction of
another(applicant or customer) or on its own behalf,
binds itself to:
1. Pay to the order of a 3 rd person known as
beneficiary OR
2. Accepts and pay any draft that may be drawn by
the beneficiary, OR

PARTIES TO THE TRANSACTION:

Basic parties to a letter of credit:
1. Applicant/buyer/importer the one who
procures the letter of credit and obliges himself
to reimburse the Issuing Bank (IB) upon the
receipt of the documents of title. He is the party
who initiates the operation of the Letter of Credit
transaction as the buyer of the merchandise and
also of the credit instrument.

3.

Authorize another bank to:

Pay to the order of

as the beneficiary.

a 3rd person known

2. Issuing Bank is usually the buyers bank; it

issues the letter of credit and undertakes to pay

the seller upon receipt of the draft and proper

documents to the buyer upon reimbursement.

3. Seller/beneficiary is the one who in

compliance w/ the contract of sale ships the
goods to the buyer and delivers the documents
of title and drafts to the issuing bank to recover
payment. He is the beneficiary of the instrument
because the instrument is addressed to him and
in his favor.

Additional party/parties to the LC:

4. Correspondent Bank
TYPES OF CORRESPONDENT BANK:

1. Advising/Notifying Bank does not have any

contractual relations w/ the buyer but merely
serves as an agent of the issuing bank. Its only
responsibility is to transmit the LC. Thus, it
could validly refuse to negotiate or accept, even
if the seller tenders all the documents required
under the LC and it does not become liable as
the beneficiary has no cause of action against
the bank.

Note: A bank does not become a negotiating bank

unless he pays the draft and becomes the holder of said
document.
As such, the IB may notify the seller of the opening of
the LC either directly or through a correspondent bank,
w/c may either be a mere advising bank or a Confirming
Bank.
Note: The IB has the option to tap a correspondent
bank or not.
The liability of a Correspondent Bank depends on what
kind of function it plays in the LC transaction.

RELATIONSHIP OF THE PARTIES is governed by1. Issuing bank and applicant the relationship is
governed by the terms of the application and
agreement for the issuance of the LC by the
bank.
2. Issuing bank and the Beneficiary the
relationship is governed by the terms of the LC
issued by the bank
3. Applicant and beneficiary the relationship is
governed by the contract they entered into. ex.
Sales

2. Confirming Bank lends credence to the LC

issued by a lesser known bank. It assumes
direct obligation to the seller/beneficiary and
becomes principally liable.

A notifying bank, who also assumes the role of a

negotiating bank does not include assuming the role of a
confirming bank and is therefore not liable to the
beneficiary. To be liable, there must be an absolute
assurance that it will undertake the issuing banks
obligation as its own. If it does confirm, the beneficiary
become entitled to proceed against either or both banks
in case of breach.

3. Paying Bank the bank w/c pays the

beneficiary. It may either be the opening/issuing
bank or any other bank in the place of the
beneficiary.

4. Negotiating Bank any bank in the place of the

beneficiary w/c buys or discounts the sellers
draft. Its liability depends on the stage of
negotiation. If BEFORE negotiation, such that it
suggests its willingness to negotiate, it has no
liability w/ respect to the seller. But if AFTER
negotiation, a contractual relationship will then
prevail between them.

INDEPENDENCE PRINCIPLEThe bank in determining compliance with the terms of

the LC is required only to examine the shipping
document presented by the seller and is precluded from
determining whether the main contract is accomplished
or not
DOCTRINE OF STRICT COMPLIANCEThe document tendered by the seller must strictly
conform to the terms of the LC . The correspondent bank
which departs from what has been stipulated under the
LC, as when it accepts a faulty tender , acts on his own
risk and may not thereafter recover from the buyer or
issuing bank , the money paid to the benefic
In short, the documents presented must comply w/ those
stipulated on. In a LC, the banks only deals w/
documents and not w/ goods.

Can a breach of contract be invoked against the Issuing

Bank?
NO. Because if all the documents stipulated have been
submitted and the IB finds that they conform w/t the LC
requires, then the IB must pay the seller. In a LC
transaction the banks deal only w/ documents not goods,
so banks pays if the documents are OK and gets
reimbursed by the buyer. This relationship is

independent so if ever the goods are in bad condition,

the applicant still pays the bank.
Note: A loan transaction may give rise to LC. An LC
does not arise only because of sale or importation.
Example: Standby LC.
Standby Letter of Credit (SLC) it is a bank issued
option on loan involving 3 parties: the bank issuing the
credit, the party requesting for such issuance (otherwise
known as the account party) and the beneficiary.
Under the terms of a SLC, the beneficiary has
the right to trigger the loan option (referred to as TAKING
DOWN THE LOAN) if the account party fails to meet its
commitment, in w/c case the issuing bank disburses a
specified sum to the beneficiary and books an equivalent
loan to its customer.
SLCs may support non-financial obligations
such as those of bidders, or financial obligations such as
those of borrowers. In the latter case, the borrower
purchases an SLC and names the lender as beneficiary.
Should the borrower default, the beneficiary has the right
to take down the SLC and receive the principal balance
from the issuing bank. The borrowers loan obligation is
then passed to the bank.
When the Notifying Bank (NB) may be held liable:
The NB is liable if:
1. It did not notify the seller of the opening of the
LC, or
2. It did not determine the apparent authenticity of
the required documents.

Note: Only the APPARENT AUTHENTICITY is to be

determined. The NB does not warrant the authenticity of
the LC but only its apparent authenticity. So if the LC
turns out to be spurious, NB is not liable for damages
unless obvious that it is not authentic.
Therefore, Notifying Bank/Advising Bank is liable if it
acts beyond the scope of its authority.

When may the Advising Bank (AB) be equally liable with

the Issuing Bank (IB)?
Ordinarily, an AB, whose obligation is merely to
advise the seller/beneficiary of the opening of a LC has
no liability. The opening of a LC does not make the IB
liable at once because there is no liability. The liability is
conditioned and dependent on the tender or submission
of the documents stipulated upon by the parties. If the
beneficiary requires that the obligation of the IB shall
also be made the obligation of the AB to him, there is
what is known as a CONFIRMED COMMERCIAL
CREDIT and the AB shall become a Confirming Bank.
In this situation, the liability of the CB is primary and it is
as if the credit were issued by the IB and the CB jointly,
thus giving the beneficiary or holder for value of the
drafts drawn under the credit, the right to proceed

against either or both banks, the moment the credit

instrument has been breached.
The CB is liable only when the documents are
submitted and gets reimbursed by the IB because there
is no privity of contract with the applicant.
Thus, an AB becomes a CB when the above
mentioned conditions occur. In such a case, the CB
acquires the same liabilities as the Issuing Bank and is
bound by the same conditions as an IB.
Function of a Negotiating Bank (NB):
It accepts or gives value to the draft and w/c
later on sells the draft to the IB. The IB then reimburses
the NB. What happens is that the NB buys the draft at a
discounted price and then sells it to the IB for its face
value.
If LC is disowned by the IB, can the Negotiating
Bank ask reimbursement from the seller? Under
what principle?
YES. Seller is a drawer of the draft accepted and paid by
the Negotiating Bank. Therefore, the seller has
contingent liability on such draft.

Can a Confirming Bank become a Notifying Bank?

NEVER, because they have different liabilities. The
CBs liability is primary while the NBs liability comes only
after negotiation (Before negotiation, there is no liability).
It is the application for the opening of a LC w/c
governs the relationship between the buyer and
the IB. This implies that the buyer/applicant is
not concerned w/ the terms of the LC between
the IB and the seller/beneficiary.
As to the IB, it is not a guarantor because its
liability is not subsidiary since the condition of
the submission of the document is determinative
of the liability not the nonpayment of the buyer.

The IB opens a LC for a consideration w/c

comes in the form of a commission.

If the IB does not advance the payment in favor of

the seller/beneficiary, may the buyer/applicant
recover the commission paid?
No More because this is the consideration. But he may
recover the margin fee.

What among other things, should be stipulated upon the

application for a LC?
The documents w/c the seller should submit to the IB.
In LC transactions, the IB deals only w/ the documents,
not w/ goods. The IB is not bound or required to
examine the goods. For as long as the required
documents are submitted by the seller, the IB pays the
seller.

If the goods turned out to be defective, is this a valid

defense to avoid payment by the IB to the seller?
NO. As long as the documents submitted by the seller
are complete and in conformity w/ what the LC requires,
the IB is bound to pay the seller. This is true even if the
goods turned out to be defective.

How about the buyer, is he still bound to reimburse

the IB despite the defective goods received by him?
YES. The buyer has no course of action against the IB.
The buyer has a COA against the seller.
If the documents submitted by the seller are
incomplete and the IB still pays the seller, is the
buyer still bound to pay the IB?
NO. Because the IB should not have paid the seller
knowing the documents to be incomplete. The IB deals
only w/ documents.

Can the beneficiary demand payment form the CB?

YES. Since the CB is equally liable w/ the IB.
If the beneficiary proceeds against the CB, the CB may
ask reimbursement from the IB. But if the beneficiary
proceeds directly against the CB; it has no right to collect
from the IB. The beneficiary may compel the CB to
accept drafts it has drawn.

How is payment made by the Issuing Bank?

Payment by the IB is done through:
1. Direct payment or wire transfer or credit in the
account of the beneficiary
2. Drawing of a draft by the beneficiary against the
IB pay to my order
3. IB may authorize the Confirming Bank to pay
4. Authorize Correspondent Bank to accept and
pay any draft drawn
5. Authorize the negotiation of any draft drawn by
the beneficiary.

Note: If the drawee doesnt pay, go to the drawer who is

secondarily liable.
Apart form the bill of lading, what additional
documents may be needed as a condition of the LC
for honoring a draft?

1. Commercial invoice it is a document signed

and issued by the seller and contains a precise
description of the merchandise and the terms of
the sale such as unit prices, amount due form

the buyer and shipping conditions related to

charges such as FOB (Free on Board), FAS
(Free Alongside), C and F (Cost and Freight) or
CIF (Cost, Insurance, Freight).

2. Consular invoice document issued by the

consulate of the importing country to provide
customs information and statistics for that
country and to help prevent false declaration of
value.

3. Certificate of analysis may be required to

ascertain that certain specifications of weight,
purity, sanitation, etc., have been met. These
specifications may be required by health or other
officials of the importing country, or they may be
insisted by the importer as assurance that it is
receiving what it ordered.

4. Export declaration it is a document prepared

by the exporter to assist the government to
prepare export statistics.

Note: Documents to be passed are not unilaterally

determined by the bank but agreed upon by the buyer
and seller.
Document of Title (Bill of Lading) given to the seller
upon shipment of goods. This is to be given to the IB to
be able for the seller to get payment.
Is there a scheme where the IB may release the
documents of title to the buyer w/o being
reimbursed first by the buyer?
YES. By the IB letting the buyer execute a trust receipt.
Failure of the buyer to open the Letter of Contract does
not prevent the birth of the Sales Contract.
The opening of the letter of credit is only a mode of
payment. The letter of the credit is not an essential
requisite to the contract of sale.