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A: Yes, the SC has held that the observance of the Uniform (b) Negotiating Bank – buys or discounts a draft under the L/C It was held that a L/C is drawable on its own terms, and
Customs and Practice in the Philippines, is justified by Art. 2 of the and its liability is dependent upon the stage of negotiation: if compliance therewith cannot be avoided because of pending
Code of Commerce, which enunciates that in the absence of any before negotiation, it has no liability with respect to the issues with respect to the main contract.
particular provision in the Code of Commerce, commercial seller but after negotiation, a contractual relationship will
transactions shall be governed by generally-observed usages and then prevail between the negotiating bank and the seller; (e) Independent Doctrine; Fraud as Proper Defense
customs (BPI v. De Reny Fabric Industries, Inc. v. G.R. No. L-24821, (c) Confirming Bank – the correspondent bank assumes a direct
October 16, 1970) obligation to the seller and its liability is a primary one as if Transfield Phil. Inc. v. Luzon Hydro Corp., (2004)
the correspondent bank itself had issued the L/C
1981 Bar, Q. III: “A” applies with Prime Bank for a letter of credit Facts:
(d) Obligations of Issuing Bank; Rights of Beneficiary (Seller)
in the amount of P50,000 in favor of Melmart Trading of
California, to cover “A’s” importation of 500 bales of cotton. 1. Transfield Phil. Inc. (TPI) as contractor under a turnkey
Insular Bank v. IAC, (1988). L/C constitutes the primary obligation, construction agreement, submitted to Luzon Hydro Corp.
and not merely an accessory contract, of the issuing bank (LHC) standby L/C to secure the performance of its (TPI)
After shipment, Melmart Trading presented all the pertinent
separate from the underlying the contract that it may support. obligations.
documents to Prime Bank’s correspondent Bank in San
Consequently, beneficiary of a L/C issued to secure payment of 2. Delays in the completion of the project resulted in the filing
Francisco, California, and obtained payment under the letter of
loan may collect on its entirety, even if the borrower claims it of arbitration proceedings on whether TPI could benefit
credit. Prime Bank now seeks payment from “A” who refuses to
made partial payments. from force majeure (storm) for non-completion of the
pay on the ground that Melmart Trading violated certain
conditions in their Contract of Sale and, therefore, should not project on due date.
Metropolitan Waterworks v. Daway, (2004). Obligations of the 3. While the arbitral proceedings were pending, and despite
have been paid under the letter of credit.
banks issuing the L/C is solidary with that of the person or entity TPI’s notice to the banks that LHC cannot call on the L/C until
requesting for its issuance, the same being a direct primary, final settlement of the issues, nevertheless the banks
Can the bank recover from “A”? Reasons.
absolute and definite undertaking to pay the beneficiary upon the notified TPI that they would pay on the L/C upon demand of
presentation of the set of documents required therein. LHC, based on the delay of completion
A: Yes, Prime bank can recover from “A”. Banks in providing
financing in international business transactions (such as that
Transfield Phil. Inc. v. Luzon Hydro Corp., (2004). Independent Issue:
entered into by “A” with Prime Bank) do not deal with the
Principle: The engagement of the issuing bank is to pay the seller
property to be exported or shipped to the importer (by Melmart
or beneficiary of the credit once the draft and the required (1) WON LHC call on the L/C despite the pendency of the
Trading), but deal only with documents. The custom in
documents are presented to it. The so-called "independence resolution of the issue on whether TPI has defaulted in its
international banking negates any duty on the part of the banks to
principle" assures the seller or the beneficiary of prompt payment obligations to complete the project on due date
verify whether what has been described in the letters of credit or
independent of any breach of the main contract and precludes the (2) WON only the issuing bank and not LHC can claim the
drafts or shipping documents actually tallies with what is loaded
issuing bank from determining whether the main contract is “independent principle
aboard ship. (BPI v. De Reny Fabric Industries, Inc., Oct. 16, 1970)
actually accomplished or not.
Transfield Phil., Inc. v. Luzon Hydro Corp., (2004). While the bank Held:
Under this principle, banks assume no liability or responsibility for
is bound to honor the credit, it is the beneficiary who has the right the form, sufficiency, accuracy, genuineness, falsification or legal
to ask bank to honor the credit by allowing him to draw thereon, WON LHC can call on the L/C
effect of any documents, or for the general and/or particular
and not the buyer-applicant. conditions stipulated in the documents or superimposed thereon, 1. Precisely, the independence principle liberates the issuing
nor do they assume any liability or responsibility for the bank from the duty of ascertaining compliance by the parties
Feati Bank v. CA, (1991). In commercial transactions involving L/C, description, quantity, weight, quality, condition, packing, delivery,
the functions assumed by a correspondent bank are classified in the main contract.
value or existence of the goods represented by any documents, or 2. As the principle's nomenclature clearly suggests, the
according to the obligations taken up by it: whether as a notifying for the good faith or acts and/or omissions, solvency,
bank, a negotiation bank or as a confirming bank: obligation under the L/C is independent of the related and
performance or standing of the consignor, the carriers, or the
insurers of the goods, or any other person whomsoever.
originating contract. In brief, the L/C is separate and distinct A: No. Under the doctrine of independence in a letter of credit, under the L/C, must be paid by the issuing or confirming bank,
from the underlying transaction. the obligation of the issuing bank to pay the beneficiary is distinct notwithstanding the existence of a dispute between the parties to
3. The argument that any dispute must first be resolved by the and independent from the main and originating contract the underlying transaction, say a contract of sale of goods where
parties through negotiations or arbitration before the underlying the letter of credit. Such obligation to pay does not the buyer is not satisfied with the quality of the goods delivered
beneficiary is entitled to call on the L/C in essence would depend on the fulfillment or non-fulfillment of the originating by the seller.
convert the L/C into a mere guarantee. contract. It arises upon tender of the stipulated documents under
the letter of credit. In the present case, the tender of the The SC in Transfield Philippines, Inc. v. Luzon Hydro Corp. (2004)
WON the Independent Principle can be invoked by LHC certificate of default entitles Y to payment under the standby for the first time declared that fraud is an exception to the
letter of credit, notwithstanding the fact that X Company was not independence principle. For instance, if the beneficiary
4. To say that the independence principle may only be invoked in default. This is without prejudice to the right of X Company to fraudulently presents to the issuing or confirming bank
by the issuing banks would render nugatory the purpose for proceed against Y Company under the law on contracts and documents that contain material facts that, to his knowledge, are
which the L/C are used in commercial transactions. damages (Insular Bank of Asia and America v. IAC, G.R. No. 74834, untrue, then payment under the L/C may be prevented through a
5. As it is, the independence doctrine works to the benefit of November 17, 1988) court injunction.
both the issuing bank and the beneficiary.
Alternative: Under the fraud exception principle, the beneficiary 2008 Bar, Q. I: X corporation entered into a contract with PT
Transfield Phil. Inc. v. Luzon Hydro Corp., (2004). The may be enjoined from collecting on the letter of credit in case of Construction Corp. for the latter to construct and build a sugar
independent nature of the letter of credit may be: fraudulent abuse of credit. The issuance of a certificate of default, mill within six (6) months. They agreed that in case of delay, PT
despite the fact that X Company is not in default, constitutes Construction Corp. will pay X Corporation P100,000 for every day
(a) Independence in toto where the credit is independent from fraudulent abuse of credit (Transfield Philippines v. Luzon Hydro of delay. To ensure payment of the agreed amount of damages,
the justification aspect and is a separate obligation from the Corp., G.R. No. 146717, November 22, 2004) PT Construction Corp. secured from Atlantic Bank a confirmed
underlying agreement like for instance a typical standby; or 2012 Bar, Q. 4 (MCQ): AAA Carmakers opened an irrevocable and irrevocable letter of credit which was accepted by X
(b) Independence may be only as to the justification aspect like Letter of Credit with BBB Banking Corporation with CCC Cars Corporation in due time. One week before the expiration of the
in a commercial letter of credit or repayment standby, which Corporation as beneficiary. The, irrevocable Letter of Credit was six (6) month period, PT Construction Corp. requested for an
is identical with the same obligations under the underlying opened to pay for the importation of ten (1 0) units of Mercedes extension of time to deliver claiming that the delay was due to
agreement. Benz S class. Upon arrival of the cars, AAA Carmakers found out the fault of X Corporation. A controversy as to the cause of the
that the cars were all not in running condition and some parts delay which involved the workmanship of the building ensued.
In both cases the payment may be enjoined if in the light of the were missing. As a consequence, AAA Carmakers instructed BBB The controversy remained unresolved. Despite the controversy,
purpose of the credit the payment of the credit would constitute Banking Corporation not to allow drawdown on the Letter of X Corporation presented a claim against Atlantic Bank by
fraudulent abuse of the credit. Credit. Is this legally possible? executing a draft against the letter of credit.
Most writers agree that fraud is an exception to the independence a. No, because under the "Independence Principle", (a) Can Atlantic Bank refuse payment due to the unresolved
principle. Professor Dolan opines that the untruthfulness of a conditions for the drawdown on the Letters of Credit are controversy? Explain.
certificate accompanying a demand for payment under a standby based only on documents, like shipping documents, and (b) Can X Corporation claim directly from PT Construction
credit may qualify as fraud sufficient to support an injunction not with the condition of the goods subject of the Corp.? Explain.
against payment. The remedy for fraudulent abuse is an importation. A:
injunction. However, injunction should not be granted unless: b. Yes, because the acceptance by the importer of the goods
subject of importation is material for the drawdown of the (a) Atlantic Bank cannot refuse to pay because in a letter of
(a) There is clear proof of fraud; Letter of Credit. credit, where the credit is stipulated as irrevocable, there is
(b) The fraud constitutes fraudulent abuse of the independent c. Yes, because under the "Independence Principle", the seller a definite undertaking by the issuing bank to pay the
purpose of the letter of credit and not only fraud under the or the beneficiary is always assured of prompt payment if beneficiary, provided that the stipulated documents are
main agreement; and there is no breach in the contract between the seller and the presented and the conditions of the credit are complied
(c) Irreparable injury might follow if injunction is not granted or buyer. with. Under the “independence principle”, the issuing bank
the recovery of damages would be seriously damaged. d. No, because what was opened was an irrevocable letter of is not obligated to ascertain compliance by the parties in the
credit and not a confirmed letter of credit. main contact. In other words, where the legal relation arises
2015 Bar, Q. V(A): A standby letter of credit was issued by ABC from a letter of credit, such letter of credit contains the
Bank to secure the obligation of X Company to Y Company. 2010 Bar, Q. XVII: The Supreme Court has held that fraud is an entire contact of the parties and the resulting obligations
Under the standby letter of credit, if there is failure on the part exception to the "independence principle" governing letters of should be measured by its provisions. It is unaffected by any
of X Company to perform its obligation, then Y Company will credit. Explain this principle and give an example of how fraud breach of contract on the part of one of the parties or by any
submit to ABC Bank a certificate of default (in the form can be an exception. controversy which may arise between them (Transfield
prescribed under the standby letter of credit) and ABC Bank will Philippines, Inc. v. Luzon Hydro Corp., 2004)
have to pay Y Company the defaulted amount. Subsequently, Y A: The “independence principle” posits that the obligation of the (b) Yes, X Corp. can claim directly from PT Construction Corp.
Company submitted to ABC Bank a certificate of default parties to a L/C are independent of the obligations of the parties The call upon the letter of credit is not exclusive; it is merely
notwithstanding the fact that X Company was not in default. Can to the underlying transaction. Thus, the beneficiary of the L/C, an alternative remedy in case of delay due to the fault of PT
ABC Bank refuse to honor the certificate of default? Explain. which is able to comply with the documentary requirements
Construction Corp. (Transfield Philippines, Inc. v. Luzon (1) Being a product of international commerce, it is not BUYER in Manila agrees to SELLER in New York offers to
Hydro Corp., 2004) uncommon to find a dearth of national law that can buy sell merchandise worth
adequately provide for the governance of the L/C, and $10,000 FOB N.Y.
(f) Effect of Applicant Being under Rehabilitation Proceedings therefore the observance of the Uniform Customs and
Practice is justified in the absence of any particular provision (a) Since the Buyer has no facilities with which to transmit
Metropolitan Waterworks v. Daway, (2004). The effects of the in the Code of Commerce, commercial transactions shall be dollars to the U.S., he contacts Merchant’s Bank of Manila,
stay order under Rule 4, Sec. 6(b) of the Interim Rules of governed by usages and customs generally observed. which has a correspondent bank in New York, the Chemical
Procedure for Corporate Rehabilitation which enjoins the (2) An advising or notifying bank does not incur any obligation Bank of New York.
enforcement of all claims against guarantors and sureties “who by such notification and is only bound to check the apparent (b) A L/C is made not between the two (2) banks: between
are not solidarily liable with the debtor”, cannot apply to the L/C authenticity of the L/C Merchant’s Bank and its correspondent bank, the Chemical
issued in behalf of the debtor-applicant since the obligation of the (3) Negotiating bank has a right of recourse against the issuer Bank of New York, there is an element of trust. The
issuing banks under the L/C is primary and solidary. bank and, until reimbursement is obtained, the drawer correspondence is a mutual agreement whereby Merchant’s
continues to assume a contingent liability thereon Bank can ask Chemical Bank in New York to pay Seller in
2013 Bar, Q. XIV (MCQ): Muebles Classico, Inc. (MC), a Manila- (4) Between seller and the negotiation bank there is the usual New York $10,000. Chemical Bank will pay because it trusts
based furniture shop, purchased hardwood lumber from Surigao relationship existing between a drawer and the purchaser of Merchant’s Bank, i.e. the credit of Merchant’s Bank is good
Timber, Inc. (STI), a Mindanao-based logging company. MC was drafts; the involved bank deals only the documents and not with Chemical Bank
to pay STI the amount of P5.0 million for 50 tons of lumber. To on the goods described in those documents (c) It works both ways; thus: if Seller in Manila has sugar which
pay STI, MC opened a letter of credit with Banco de Plata (BDP). he offers to sell and which Buyer in New York agrees to buy,
BOP duly informed STI of the opening of a letter of credit in its (h) Margin Fee Chemical Bank can request Merchant’s Bank to pay Seller in
favor. Manila. The credits of either bank is good with each other.
Pacific Oxygen Co. v. Central Bank, (1968). Margin fee is a tax on (d) Buyer will be required to deposit with Merchant’s Bank 90%
In the meantime, MC- which had been undergoing financial the sale of foreign exchange and sale being consensual, it falls due (marginal deposit) of the amount of the transaction, so that
reverses- filed a petition for corporate rehabilitation. The as soon as the local bank opens the L/C. Buyer would still owe Merchant’s Bank $1,000. Buyer having
rehabilitation court issued a Stay Order to stay the enforcement deposited said amount, Merchant’s Bank cables Chemical
of all claims against MC. Abad v. CA, (1990). The marginal deposit requirement is a Central Bank in New York: “Open an irrevocable letter of credit for
Bank (now BSP) measure to cut off excess currency liquidity which $10,000”. Chemical Bank will require Seller to produce
After shipping the lumber, STJ went to BDP, presented the would create inflationary pressure. It is a collateral security given genuine shipping papers, such as the packing list, before
shipping documents, and demanded payment of the letter of by the debtor, and is supposed to be returned to him upon paying him. Chemical Bank will not debit Merchant’s Bank
credit opened in its favor. MC, on the other hand, informed the compliance with his obligation. The applicant for a L/C is entitled account the sum of $10,000.
bank of the Stay Order and instructed it to deny payment to STI to have the marginal deposit first deducted from the principal (e) Buyer still owes Merchant’s Bank $1,000, and the bill of
because of the Stay Order. BDP comes to you for advice. Your obligation under the L/C and for interest to accrue only on the lading covering the goods will be delivered to Merchant’s
best advice is to __________. balance, and such deposit is supposed to be returned upon the Bank and not to Buyer, so as to protect the bank against
buyer’s compliance with his obligation, since compensation takes Buyer. When the goods arrive in Manila, Merchant’s Bank
(a) grant STI's claim. Under the "Independence Principle," the effect by operation of law. will advise Buyer; but Buyer must first pay $1,000 before he
bank deals only with the documents and not the underlying can take possession of the goods.
circumstances; hence, the presentation of the letter of credit 6. Letters of Credit – Trust Receipt Transactions (f) If Buyer does not have money yet, Merchant’s Bank may
is sufficient. release the goods to Buyer under a trust receipt, which is a
(b) deny STI's claim. The Stay Order covers all claims against the RCBC v. Alfa RTW Manufacturing Corp., (2001). Under a “letter of document issued by the bank in favor of Buyer whereby the
debtor and binds all its creditors. The letter of credit is a credit – trust receipt transaction, a bank extends to a borrower a latter admits that the goods still belong to Merchant’s Bank,
claim against the debtor that is covered by the Stay Order. loan covered by the letter of credit, with the trust receipt as and which authorizes to sell the goods and apply the
(c) grant STI's claim. The letter of credit is not a claim against security of the loan. A trust receipt is "a security transaction proceeds thereof to the payment of his debt with
the debtor under rehabilitation, but against the bank which intended to aid in financing importers and retail dealers who do Merchant’s Bank.
has assumed a solidary obligation. (MWSS v. Daway, G.R. not have sufficient funds or resources to finance the importation (g) The procedure whereby the Merchant’s Bank liquidates its
No. 160732, June 21, 2004) or purchase of merchandise, and who may not be able to acquire obligation with Chemical Bank is called “Forward Exchange”
(d) deny STI's claim. If the bank disregards the Stay Order, it credit except thru utilization, as collateral, of the merchandise
may be subject to contempt by the rehabilitation court. STI imported or purchased.” Bank of Commerce v. Serrano, (2005). A L/C is a separate
should file its claim with the rehabilitation court. document from a trust receipt. While the trust receipt may have
(e) file an action for inter pleader to resolve the parties' In contracts contained in trust receipts, the contracting parties been executed as a security on the letter of credit, still the two
competing claims. may establish agreements, terms and conditions they may deem documents involve different undertakings and obligations.
advisable, provided that they are not contrary to law, morals or Consequently, a clause in the L/C making a party solidarily liable
(g) Summary Rules Pertaining to L/C public order therein cannot be extended to apply to the trust receipt.
Bank of America v. CA, (1993). The following rules apply to L/C: Illustration: 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. Through a letter of credit, the Feati Bank v. CA, (1991). The concept of guarantee vis-à-vis the letter of credit with the same bank for $500,000.00 in favor of HS
bank merely substitutes its own promise to pay for the promise to concept of an irrevocable credit are inconsistent with each other. Bank, a foreign bank, to purchase outboard motors. Likewise,
pay of one of its customers who in return promises to pay the Ricardo executed a Surety Agreement in favor of AC Bank.
bank the amount of funds mentioned in the letter of credit plus (a) Firstly, the guarantee theory destroys the independence of
credit or commitment fees mutually agreed upon. the bank’s responsibility from the contract upon which it The outboard motors arrived and were delivered to Ricardo, but
was opened. he was not able to pay the purchase price thereof.
By contrast, a trust receipt transaction is one where the entruster, (b) Secondly, in a contract of guarantee, the guarantor’s
who holds an absolute title or security interests over certain obligation is merely collateral and it arises only upon the a. Can AC Bank take possession of the outboard motors?
goods, documents or instruments, released the same to the default of the person primarily liable; while in an irrevocable Why?
entrustee, who executes a trust receipt binding himself to hold credit the bank undertakes a primary obligation b. Can AC Bank also foreclose the mortgage over the
the goods, documents or instruments in trust for the entruster fishpond? Explain.
and to sell or otherwise dispose of the goods, documents and Distinguishing Commercial Credits from Standby Credits
instruments with the obligation to turn over to the entruster the A:
proceeds thereof to the extent of the amount owing to the Transfield Phil. Inc. v. Luzon Hydro Corp., (2004). A letter of
entruster, or as appears in the trust receipt, or return the goods, credit is a financial device developed by merchants as a a. If what Ricardo executed is a trust receipt, AC Bank can take
documents or instruments themselves if they are unsold, or not convenient and relatively safe mode of dealing with sales of goods possession of the outboard motors so that it can exercise its
otherwise disposed of, in accordance with the terms and to satisfy the seemingly irreconcilable interests of a seller, who lien and sell them (Sec. 7, Trust Receipts Law). If what
conditions specified in the trust receipt. refuses to part with his goods before he is paid, and a buyer, who Ricardo executed is a Surety Agreement, AC Bank cannot
2016 Bar, Q. XVII(a): Explain what is a "Letter of Credit" as a wants to have control of the goods before paying. The use of take possession of the outboard motors, because it has no
financial device and a "Trust Receipt" as a security to the Letter credits in commercial transactions serves to reduce the risk of lien on them.
of Credit. nonpayment of the purchase price under the contract for the sale
of goods. However, credits are also used in non-sale settings Alternative: No. The opening of a L/C did not vest ownership of
where they serve to reduce the risk of nonperformance. the outboard motors in the bank in the absence of a trust receipt
2016 Bar, Q. XVII(b): PJ Corporation (PJ) obtained a loan from
Generally, credits in the non-sale settings have come to be known agreement. A letter of credit is a mere financial device developed
ABC Bank (ABC) in the amount of P10 million for the purchase of
as standby credits. by merchants as a convenient and relatively safe mode of dealing
100 pieces of ecodoors. Thereafter, a Letter of Credit was
with the sales of goods to satisfy the seemingly irreconcilable
obtained by PJ against such loan. The beneficiary of the Letter of
There are three significant differences between commercial and interests of a seller, who refuses to part with his goods before he
Credit is Scrap Metal Corp. (Scrap Metal) in Beijing, China. Upon
standby credits: is paid, and a buyer, who wants to have control of the goods
arrival of 100 pieces of ecodoors, PJ executed a Trust Receipt in
before paying (Transfield Philippines, Inc. v. Luzon Hydro
favor of ABC to cover for the value of the ecodoors for its release
(a) First, commercial credits involve the payment of money Corporation, 2004)
to PJ. The terms of the Trust Receipt is that any proceeds from
under a contract of sale. Such credits become payable upon
the sale of the ecodoors will be delivered to ABC as payment.
the presentation by the seller-beneficiary of documents that b. AC Bank can also foreclose the mortgage over the fishpond if
After the ecodoors were sold, PJ, instead of paying ABC, used the
show he has taken affirmative steps to comply with the sales Ricardo fails to pay the loan of P1M.
proceeds of the sale to order from Scrap Metal another 100
agreement.
pieces of ecodoors but using another bank to issue a new Letter
(b) In the standby type, the credit is payable upon certification
of Credit fully covered by such proceeds.
of a party's nonperformance of the agreement.
(c) The documents that accompany the beneficiary's draft tend
PJ refused to pay the proceeds of the sale of the first set of
to show that the applicant has not performed. The
ecodoors to ABC, claiming that the ecodoors that were delivered
beneficiary of a commercial credit must demonstrate by
were defective. It then instructed ABC not to negotiate the
documents that he has performed his contract.
Letter of Credit that was issued in favor of Scrap Metal.
(d) The beneficiary of the standby credit must certify that his
obligor has not performed the contract.
As counsel of ABC, you are asked for advice on whether or not to
grant the instruction of PJ. What will be your advice?
2012 Bar, Q. 2(MCQ): Letter of Credit which is used in non-sale
transaction, where it serves to reduce the risk of non-
7. Distinguished from Other Contracts and Agreements performance is called -