Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001

LETTERS OF CREDIT

What is a letter of credit?

 A letter of credit is one issued by one merchant to another, or for the purpose of attending
to a commercial transaction. (Art. 567, Code of Commerce)

 It is an engagement by a bank or other person made at the request of a customer that the
issue will honor drafts or other demands for payment upon compliance with the conditions
specified in the credit. (Prudential Bank v. IAC, 216 SCRA 257)

 It is an instrument issued by a bank at the request of an importer, in which the bank

promises to pay a beneficiary upon presentation of documents specified therein.

What is the nature of a letter of credit and what role does it play in resolving
the basic import / export dilemma?

 A letter of credit is a financial device developed by merchants as a convenient and

relatively safe mode of dealing with sales of goods to satisfy the seemingly irreconcilable
interests of a seller, who refuses to part with his goods before he is paid, and a buyer, who
wants to have control of the goods before paying. To break the impasse, the buyer may be
required to contract a bank to issue a letter of credit in favor of the seller so that, by virtue of
the letter of credit, the issuing bank can authorize the seller to draw drafts and engage to pay
them upon their presentment simultaneously with the tender of documents required by the
letter of credit. The buyer and the seller agree on what documents are to be presented for
payment, but ordinarily they are documents of title evidencing or attesting to the shipment of
the goods to the buyer.

Once the credit is established, the seller ships the goods to the buyer and in the process
secures the required shipping documents or documents of title. To get paid, the seller
executes a draft and presents it together with the required documents to the issuing bank.
The issuing bank redeems the draft and pays cash to the seller if it finds that the documents
submitted by the seller conform with what the letter of credit requires. The bank then
obtains possession of the documents upon paying the seller. The transaction is completed
when the buyer reimburses the issuing bank and acquires the documents entitling him to the
goods. (Bank of America NT & SA v. CA, 228 SCRA 357)

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

 Under this arrangement, the seller gets paid only if he delivers the documents of title over
the goods, while the buyer acquires the said documents and control over the goods only after
reimbursing the bank.

 A letter of credit is one of the modes of payment set out in Section 8 of Central Bank
Circular No. 1389 or the Consolidated Foreign Exchange Rules and Regulations, by which
commercial banks sell foreign exchange to service payments for, e.g., commodity exports.
The primary purpose of a 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. It
creates in the seller/exporter a secure expectation of payment. (Reliance Commodities, Inc,
v. Daewoo Industrial Co., Ltd.)

What are the essential conditions of letters of credit?

(1) They must be issued in favor of a definite person and not to order; and
(2) They must be limited to a fixed and specified amount, or to one or more
undetermined amounts, but within a maximum, the limits of which have to be stated
exactly. (Art. 568, Code of Commerce)

 NOTE: A letter of credit which does not have one of these conditions is
considered simply as a letter of recommendation.

Applicability of the Uniform Customs and Practice for Documentary Credits

(UCP) in transactions involving letters of credit

 Being a product of international commerce, the impact of letters of credit transcends

national boundaries, and it is thus not uncommon to find a dearth of national law that can
adequately provide for the governance of letters of credit.

 In the Philippine jurisdiction, the provisions of the Uniform Customs and Practice for
Documentary Credits have been applied in transactions involving letters of credit in the
case of Feati Bank v. Court of Appeals and BPI v. De Nery.

 Application of the UCP is made possible by Article 2 of the Code of Commerce which
expresses that, in the absence of any particular provision in the Code of Commerce,
commercial transactions shall be governed by usages and customs generally observed.

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

Who are the basic parties to a letter of credit?

1) the buyer, who procures the letter of credit and obliges himself to reimburse the issuing
bank upon receipt of the documents of title;

2) the bank issuing the letter of credit, which undertakes to pay the seller upon receipt of
the draft and proper documents of titles and to surrender the documents to the buyer upon
reimbursement; and

3) the seller, 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. (Bank
of America NT & SA v. Court of Appeals, supra)

How are their respective relationships governed?

1) Issuing bank and applicant / buyer / importer - Their relationship is governed by

the terms of the application and agreement for the issuance of the letter of credit by the
bank.
2) Issuing bank and beneficiary / seller / exporter - Their relationship is governed
by the terms of the letter of credit issued by the bank.
3) Applicant and beneficiary - Their relationship is governed by the sales contract.

Procedure re. letter of credit

1) The buyer and the seller agree on what documents are to be presented for payment, but
ordinarily they are documents of title evidencing or attesting to the shipment of the goods
to the buyer.

2) Once the credit is established, the seller ships the goods to the buyer and in the process
secures the required shipping documents or documents of title. To get paid, the seller
executes a draft and presents it together with the required documents to the issuing bank.

3) The issuing bank redeems the draft and pays cash to the seller if it finds that the
documents submitted by the seller conform with what the letter of credit requires. The
bank then obtains possession of the documents upon paying the seller.

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

4) The transaction is completed when the buyer reimburses the issuing bank and acquires
the documents entitling him to the goods.

Other parties to a letter of credit

In commercial transactions involving letters of credit, correspondent banks are also parties to
such transactions. The functions assumed by a correspondent bank are classified according to
the obligations taken by it.

The correspondent bank may be called:

1) a notifying bank, which conveys to the seller the existence of the credit. In this
case, the correspondent bank assumes no liability except to notify and/or transmit
to the beneficiary the existence of the letter of credit.

2) a confirming bank, which will lend credence to the letter of credit issued by a
lesser known issuing bank. In this case, the correspondent bank assumes a direct
obligation to the seller and its liability is a primary one as if the correspondent
bank itself had issued the letter of credit (solidary liability with issuing bank).

3) a paying bank, which undertakes to encash the drafts drawn by the exporter; or

4) a negotiating bank, which buys or discounts a draft under the letter of credit.
Its liability is dependent upon the stage of the negotiation: if before negotiation,
it has no liability with respect to the seller. However, after negotiation, a
contractual relationship will then prevail between the negotiating bank and the
seller.

Requirements for opening a letter of credit

 All letters of credit must be opened on or before the date of shipment with maximum
validity of one (1) year. Likewise, only one letter of credit should be opened for each
import transaction. For purposes of opening a letter of credit, importers shall submit to
the commercial bank the following documents:

a) the duly accomplished letter of credit application;

b) firm offer / pro forma invoice which shall contain information on the specific
quantity of the importation, unit cost and total cost, complete

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

description/specification of the commodity and the Philippine Standard

Commodity Classification statistical code;

c) permits/clearances from the appropriate government agencies, whenever

applicable; and

d) duly accomplished Import Entry Declaration form which shall serve as basis for
payment of advance duties as required under PD 1853. (CB Circular No. 1389 or
Consolidated Foreign Exchange Rules and Regulations)

When does a letter of credit become void?

A letter of credit becomes void if the bearer does not make use of it within the period agreed upon
with the drawer. In default of a period fixed, 6 months, counted from its date, in any point in the
Philippines (domestic L/Cs), and within 12 months outside thereof (international L/Cs). (Art.
572)

What is the “independence principle”?

The independent principle provides that once a seller presents the draft and required documents to
the issuing bank, said bank must pay the seller. The issuing bank is precluded from determining
whether the main contract is actually accomplished or not. This arrangement assures the seller of
prompt payment, independent of any breach of the main sales contract. (See BPI v. De Reny
Fabric Industries, Inc., 35 SCRA 256)

What is the rule of strict conformity?

The rule of strict conformity provides that in commercial transactions involving letters of credit,
the documents tendered must strictly conform to the terms of the L/C. The tender of documents
by the beneficiary (seller) must include all documents required by the L/C. A correspondent bank
which departs from what has been stipulated under the L/C (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 the money paid to the beneficiary. (Feati Bank v. CA, 196 SCRA 576)

In other words, there is no such thing as substantial compliance as far as letters of credit are
concerned!

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

Irrevocable credit v. confirmed credit

 An irrevocable credit is not synonymous with a confirmed credit. These types of credit
have different meanings and the legal relations arising from there varies.

 A credit may be an irrevocable credit and at the same time a confirmed credit or vice-
versa.

 An irrevocable credit refers to the duration of the letter of credit. What it simply means is
that the issuing bank may not, without the consent of the beneficiary (seller) and the
applicant (buyer), revoke his undertaking under the letter.

 A confirmed letter of credit pertains to the kind of obligation assumed by the

correspondent bank. In this case, 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.

 Hence, the mere fact that a letter of credit is irrevocable does not necessarily imply that
the correspondent bank in accepting the instructions of the issuing bank has also
confirmed the letter of credit. (Feati Bank v. CA, 196 SCRA 576)

What is a sight draft?

Sight drafts are drafts which do not require presentment for acceptance. (Prudential Bank v. IAC,
216 SCRA 257)

What is a standby letter of credit and is it another type of letter of credit?

A standby letter of credit is a bank-issued option on a loan involving three (3) parties: the bank
issuing the credit, the party requesting for such issuance (otherwise known as the account party)
and the beneficiary. It is NOT another type of letter of credit.

Under the terms of a standby letter of credit (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 which case the issuing bank disburses a specified sum to the beneficiary and
books an equivalent loan to its customer. In effect, the SLC operates as if another loan had been

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

extended by the bank to the obligor. But instead of the money going to the obligor, it goes to the
beneficiary. This is to prevent interception by other creditors.

SLCs may support non-financial obligations such as those of bidders, or financial obligations. 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 borrower’s loan obligation is then passed on to the bank.
(Prof. Catindig)

It must be noted that SLCs are “in effect an absolute undertaking to pay the money advanced or
the amount for which credit is given on the faith of the instrument. They are primary obligations
and not accessory contracts.” (IBAA v. IAC, 167 SCRA 450) Thus, in a case where a SLC is taken
out to secure a loan, partial payments made by the principal obligors on the loan do not reduce the
liability of the issuing bank under such SLC since the loan agreement and SLC are separate and
independent agreements. (IBAA v. IAC, supra)

CASES

FEATI BANK & TRUST CO. V. COURT OF APPEALS

196 SCRA 576

In this case, Bernardo Villaluz agreed to sell to Axel Christiansen 2,000 cubic meters of
lauan logs at $27.00 per cubic meter FOB. On the arrangements made and upon the instructions
of consignee, Hanmi Trade Development, Ltd., the Security Pacific National Bank of Los
Angeles, California issued an irrevocable letter of credit available at sight in favor of Villaluz for
the sum of $54,000.00, the total purchase price of the lauan logs.

The letter of credit was mailed to the Feati Bank and Trust Company (now Citytrust) with
the instruction to the latter that it “forward the enclosed letter of credit to the beneficiary.” The
letter of credit also provided that the draft to be drawn is on Security Pacific National Bank and
that it be accompanied by certain documents.

The logs were thereafter loaded on a vessel but Christiansen refused to issue the
certification required in paragraph 4 of the letter of credit, despite repeated requests by the private
respondent. The logs however were still shipped and received by consignee, to whom
Christiansen sold the logs.

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

Because of the absence of the certification by Christiansen, the Feati Bank and Trust
company refused to advance the payment on the letter of credit until such credit lapsed.

Since the demands by Villaluz for Christiansen to execute the certification proved futile,
he filed an action for mandamus and specific performance against Christiansen and Feati Bank
and Trust Company before the Court of First Instance of Rizal. Christiansen however left the
Philippines and Villaluz filed an amended complaint making Feati Bank and Trust Company
solidarily liable with Christiansen.

Trial court held that Christiansen and Feati Bank were liable, the latter for refusing to
negotiate the letter of credit in the absence of Christiansen’s certification considering that the
letter of credit is irrevocable. Trial court said that Security Pacific National Bank, the issuing
bank, undertook by the terms of the letter of credit that the same shall be honored upon
presentment. On the other hand, the notifying bank, Feati Bank, by accepting the instructions
from the issuing bank, itself assumed the very same undertaking as the issuing bank under the
terms of the letter of credit.

The Court of Appeals affirmed the decision of the trial court thus this petition for review.

The principal issue in this case is whether or not a correspondent bank is to be held liable
under the letter of credit despite non-compliance by the beneficiary with the terms thereof.

The Supreme Court held that Feati Bank is not liable.

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.

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.

We have heretofore held that these letters of credit are to be strictly complied with, which
documents and shipping documents must be followed as stated in the letter. There is no discretion
in the bank or trust company to waive any requirements. The terms of the letter constitutes an
agreement between the purchaser and the bank.

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

In the absence of any specific provision governing the legal complexities arising from
transactions involving letters of credit in the Philippines, the Supreme Court applied the Uniform
Customs and Practice for Documentary Credit (UCP) in lieu of Article 2 of the Code of
Commerce 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.

Under the UCP, an irrevocable credit is a definite undertaking on the part of the issuing
bank and constitutes the engagement of that bank to the beneficiary and bona fide holders of
drafts drawn and/or documents presented thereunder, that the provisions for payment, acceptance
or negotiation contained in the credit will be duly fulfilled, provided that all the terms and
conditions of the credit are complied with.

An irrevocable credit may be advised to a beneficiary through another bank (the advising
bank) without engagement on the part of that bank, but when an issuing bank authorizes or
requests another bank to confirm its irrevocable credit and the latter does so, such confirmation
constitutes a definite undertaking of the confirming bank.

Under the foregoing provisions, the bank may only negotiate, accept or pay, if the
documents tendered to it are on their face in accordance with the terms and conditions of the
documentary credit. And since a correspondent bank, like Feati Bank, principally deals only with
documents, the absence of any document required 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.

SC also ruled out the contentions that Feati Bank is a “trustee” and “guarantor.”

BANK OF AMERICA, NT V. COURT OF APPEALS

228 SCRA 357

Bank of America received by registered mail an irrevocable letter of credit purportedly

issued by Bank of Ayudhya Samyek Branch, for the account of General Chemicals, Ltd., of
Thailand in the amount of $2,782,000.00 to cover the sale of plastic ropes and agricultural files,
with Bank of America as the advising bank and Inter-Resin Industrial Corporation as beneficiary.

Bank of America notified Inter-Resin of the letter of credit. Upon request by Inter-Resin
for Bank of America to confirm the letter of credit, latter refused although one of its employee
explained to Inter-Resin that there was no need for confirmation because the letter of credit is
genuine.

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

Inter-Resin therefore twice sought availment under the letter of credit. Bank of America
issued P10,219,093 in the first availment upon being satisfied of the documents submitted by
Inter-Resin.

However, Bank of America stopped the processing of the second availment upon being
informed by Bank of Ayudhya that the letter of credit was fraudulent. Further, upon conducting an
examination of the vans sent by Inter-Resin, it found out that they contain not ropes but plastic
strips, wrappers, rags and waste materials.

Bank of America sued Inter-Resin for recovery of the money it gave under the first
availment, considering the letter of credit has been disowned by Bank of Ayudhya. However, the
trial court ruled in favor of Inter-Resin which was affirmed by the Court of Appeals.

Supreme Court reversed the decision of the lower courts. It ruled that the crucial point of
dispute in this case is whether, under the “letter of credit,” Bank of America has incurred any
liability to the “beneficiary” thereof, an issue that largely is dependent on the bank’s participation
in that transaction: as a mere advising or notifying bank, it would not be liable, but as a
confirming bank, had this been the case, it could be considered as having incurred that liability.

It cannot seriously be disputed, looking at this case, that Bank of America has, in fact,
only been an advising, not confirming, bank, and this much is clearly evident, among other
things, by the provisions of the letter of credit itself, the petitioner bank’s letter of advice, its
request for payment of advising fee, and the admission of Inter-Resin that it has paid the same.
That Bank of America has asked Inter-Resin to submit documents required by the letter of credit
and eventually has paid the proceeds thereof, did not obviously make it a confirming bank.

As an advising or notifying bank, Bank of America did not incur any obligation more
than just notifying Inter-Resin of the letter of credit issued in its favor, let alone to confirm the
letter of credit.

Bringing the letter of credit to the attention of the seller is the primordial obligation of an
advising bank. The view that Bank of America should have first checked the authenticity of the
letter of credit with Bank of Ayudhya, by using advanced mode of business communications,
before dispatching the same to Inter-Resin finds no real support in the UCP.

As advising bank, Bank of America is bound only to check the “apparent authenticity” of
the letter of credit, which it did. Websters explains that the word “apparent” suggests appearance

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

to unaided senses that is not or may not be borne out by more rigorous examination or greater
knowledge.

May Bank of America then recover what it has paid under the letter of credit when the
corresponding draft for partial availment thereunder and the required documents therefore were
later negotiated with it by Inter-Resin? The answer is yes.

This kind of transaction is what is commonly referred to as a discounting arrangement.

This time, Bank of America, has acted independently as a negotiating bank, thus saving Inter-
Resin from the hardship of presenting the documents directly to Bank of Ayudhya to recover
payment. As a negotiating bank, Bank of America has a right of recourse against the issuer bank
and until reimbursement is obtained, Inter-Resin, as the drawer of the draft, continues to assume a
contingent liability thereon.

SC noted that the additional ground raised by Bank of America, i.e. that Inter-Resin sent
waste instead of its products, is really of no consequence. In the operation of a letter of credit, the
involved banks deal only with documents and not on goods described in those documents.

RELIANCE COMMODITIES, INC. V. DAEWOO INDUSTRIAL CO., LTD.

228 SCRA 545

Reliance Commodities, Inc. and Daewoo entered into a contract of sale where latter
undertook to ship and deliver to former several tons of foundry pig iron.

First contract was consummated and completed but Daewoo fell short of 135.655 metric
tons. Second contract for 2,000 metric tons was also perfected.

However, Reliance’s application for a letter of credit was denied by the China Banking
Corporation, and it was shown later that the reason for this is that it has exceeded its foreign
exchange allocation.

Because of the failure of Reliance to comply with its undertaking under the contract,
Daewoo was forced to sell the foundry pig irons to another buyer at a lower price.

Reliance filed an action for damages against Daewoo for the recovery of P226,370.48
representing the value of the short delivery of 135.655 metric tons of foundry pig iron under the
first contract. Daewoo filed a counterclaim, contending that Reliance was guilty of breach of
contract when it failed to open a letter of credit as required in the second contract.

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

Trial court ruled that Reliance is entitled to short delivery price and ordered Daewoo to
pay the amount. However, it also held that Reliance is liable for breach of contract for its failure
to open a letter of credit. Thus, it also awarded damages to Daewoo.

Court of Appeals denied the appeal of Reliance. Supreme Court affirmed the decision.

SC agreed with the Court of Appeals that Reliance and Daewoo had a perfected contract.
The failure of Reliance to open the appropriate letter of credit did not prevent the birth of the
contract, and neither did such failure extinguish the contract. The opening of the letter of credit in
favor of Daewoo was an obligation of Reliance and the performance of that obligation by
Reliance was a condition for enforcement of the reciprocal obligation of Daewoo to ship the
subject matter of the contract – the foundry pig iron – to Reliance. But the contract itself between
Reliance and Daewoo had already sprung into legal existence and was enforceable.

The letter of credit provided for in that contract was the mode or mechanism by which
payment was to be effected by Reliance of the price of the pig iron.

We believe and so hold that failure of a buyer seasonably to furnish an agreed letter of
credit is a breach of the contract between buyer and seller. Where the buyer fails to open a letter
of credit as stipulated, the seller or exporter is entitled to claim damages for such breach.
Damages for failure to open a commercial credit may, in appropriate cases, include the loss of
profit which the seller would seasonably have made had the transaction been carried out.

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

TRUST RECEIPTS LAW

Presidential Decree No. 115

Providing for the regulation of Trust Receipts Transactions
29 January 1973

What are the purposes of the law?

1. to encourage and promote the use of trust receipts as an additional and

convenient aid to commerce and trade;

2. to provide for the regulation of trust receipt transactions in order to assure

protection of the rights and the enforcement of obligations of the persons
involved therein; and

3. to declare the misuse and/or misappropriation of goods or proceeds realized from

the sale or goods, documents or instruments release under trust receipts as a
criminal offense punishable under Article 315 of the Revised Penal Code.

What is a trust receipt transaction, and who are the parties to such a
transaction?

A trust receipt transaction is any transaction by and between the entruster (usually a bank;
hereinafter ER) and the entrustee (usually a buyer; hereinafter EE), whereby the ER, who owns or
holds absolute title or security interest over certain specified goods 1, documents2 or instruments3,
releases the same to the possession of the EE upon the latter’s execution and delivery to the ER of
a signed document called a “trust receipt” wherein the EE binds himself to hold the designated

1 Goods shall include chattels and personal property other than money, things in action, or thins
so affixed to land as to become a part thereof.

2 Document means written or printed evidence of title to goods.

3 Instrument means any negotiable instrument, any certificate of stock, or bond or

debenture for the
payment of money issued by a public or private corporation, or any certificate of deposit,
participation certificate or receipt, any credit or investment instrument of a sort marketed in the
ordinary course of business or finance, whereby the EE, after the issuance of the trust receipt,
appears by virtue of possession and the face of the instrument to be the owner.

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

goods, documents or instruments (GDI) in trust for the ER and to sell or otherwise dispose of the
GDI with the obligation to turn over to the ER the proceeds thereof to the extent of the amount
owing to the ER or as appears in the trust receipt, or 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. (Sec. 4)

It must be noted that a trust receipt transaction is a tripartite transaction. It necessarily

involves three (3) parties, namely: the exporter / seller, the importer / buyer / EE, and the
financer / bank / ER.

What is the nature of a trust receipt transaction?

 A trust receipt is an accessory contract of the Letter of Credit. The set-up is like this: a
bank extends a loan covered by the Letter of Credit, with the trust receipt as a security for the
loan.

 A trust receipt is a security agreement, pursuant to which a bank acquires a “security

interest” in the goods.4 A trust receipt is considered as a security transaction intended to aid
in financing importers and retail dealers who do not have sufficient funds or resources to
finance the importation or purchase of merchandise, and who may not be able to acquire
credit except through utilization, as collateral of the merchandise imported or purchased.
(Vintola v. IBAA, 150 SCRA 578) The purpose of the Trust Receipts Law is to sell goods or
procure their sale, because it is out of the sale of these goods that the obligation will be paid.
(Comment of Sir Catindig)

 The trust receipt arrangement does not convert the ER (bank) into an investor; neither
does it make the ER into the real owner of the goods. The ER (bank)remains a lender and
creditor. “The bank has previously extended a loan for which the L/C represents to the
importer (EE), and by that loan, the importer should be the real owner of the goods. If under
the trust receipt, the bank is made to appear as the owner, it is but an artificial expedient,
more of a legal fiction than fact, for if it were so, it could dispose of the goods in any manner
it wants, which it cannot do, just to give consistency with the purpose of the trust receipt of

4 Security interest means a property interest in goods, documents or instruments to secure

performance of some obligations of the EE or of some third persons to the ER and includes title,
whether or not expressed to be absolute, whenever such titles is in substance taken or retained for
security only. (Sec. 3)

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

giving a stronger security for the loan obtained by the importer. To consider the bank as the
true owner from the inception of the transaction would be to disregard the loan feature
thereof.” (Sia v. People, 121 SCRA 655 as cited in Vintola v. IBAA, 150 SCRA 582)

Distinguish a trust receipt transaction from pledge, conditional sale, chattel

mortgage, and consignment.

Trust receipt v. pledge

In a pledge, the person doing the financing (the pledgee) has possession of the property.
However, in a trust receipt transaction, the property is in the possession of the person financed.

Trust receipt v. conditional sale

A conditional sale necessarily involves a sale by the financer to the person being financed. On
the other hand, in a trust receipt transaction, the EE acquires the goods through advances made by
the ER, not through a sale.

Trust receipt v. chattel mortgage

A chattel mortgage involves the passing of a defeasible title to, or a lien upon, the property from
the mortgagor directly to the mortgagee. In a trust receipt transaction, the entruster takes the full
title to the goods at the very beginning of the transaction, and continues to hold that title as his
indispensable security until the vendee (EE) is called upon to pay for them. No lien is created.

Trust receipt v. consignment

In consignment, the title of the bailor / consignor is not retained to secure the indebtedness due
from the bailee or consignee. In a trust receipt transaction, the ER retains the full title to the
goods as his indispensable security until the vendee (EE) is called upon to pay for them.

What is a trust receipt?

Trust receipt shall refer to the written or printed document signed by the EE in favor of the ER
containing terms and conditions substantially complying with the provisions of this Decree. No
further formality of execution or authentication shall be necessary for the validity of a trust
receipt. (Sec. 5)

Form of trust receipts

 A trust receipt need not be in any particular form, but every such receipt must
substantially contain:

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

1. a description of the goods, documents, or instruments subject of the trust receipt;

2. the total invoice value of the goods and the amount of the draft to be paid by the
EE;

3. an undertaking of a commitment of the EE:

a. to hold in trust for the ER the goods, documents or instruments therein

described;

b. to dispose of them in the manner provided for in the trust receipt; and

c. to turn over the proceeds of the sale of the goods, documents or

instruments to the ER to the extent of the amount owing to the ER or as
appears in the trust receipt or to return the goods, documents or
instruments in the event of their non-sale within the specified period.
(Sec. 5)

Can a trust receipt be denominated in foreign currency? (Sec. 6)

YES, for as long as such currency is acceptable and eligible as part of the Philippines’
international reserves.

If the trust receipt is denominated in foreign currency, payment shall be made in equivalent
Philippine currency computed on prevailing exchange rate on the date the proceeds of the sale are
turned over to the ER, or on such other date as may be stipulated in the trust receipt or other
agreements executed between the ER and the EE.

What are the rights of the entruster? (Sec. 7)

 The ER is entitled to the proceeds from the sale of the goods / documents /
instruments (GDI).

 In case of non-sale, he is entitled to the return of the GDI.

 Upon default or failure of the EE to comply with any other agreement between
them, the ER may cancel the trust and take possession of the GDI or the proceeds at any
time. The GDI may then be sold at either a public or a private sale (after proper notice to
the EE, and not less than 5 days after serving or sending notice), with the proceeds to be

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

applied to payment of expenses for retaking, keeping, storing, and the satisfaction of the
EE’s indebtedness.5

It must be noted that the ER is not limited to such course of action. As held in the case of
Prudential Bank v. NLRC (251 SCRA 421), the ER has the discretion to avail of the right
to cancel the trust, or to seek any alternative action such as a third-party claim or a
separate civil action which it deems best to protect its right at any time upon default or
failure of the EE to comply with any of the terms and conditions of the trust agreement.

 The ER holding a security interest shall not, merely by virtue of such interest or
having given the EE the liberty of sale or other disposition of the goods, documents or
instruments under the terms of the trust receipt transaction, be responsible as principal or
as vendor under any sale or contract to sell made by the EE. (Sec. 8) Thus, in a case
where Mr. X suffers food poisoning from seafood sold by Mr. Y covered under a trust
receipt with ABC Bank, Mr. X cannot sue ABC Bank. He can only go after the EE Mr. Y.

 The ER’s security interest in the GDI shall be valid as against all creditors of the
EE for the duration of the trust receipt agreement. (Sec. 12)

Exception: When the properties are in the hands of an innocent purchaser for value and
in good faith. (Prudential Bank v. NLRC, 251 SCRA 421)

What are the obligations of the entrustee? (Sec. 9)

(1) The ER must hold the GDI in trust for the ER and dispose of them strictly in
accordance with the terms and conditions of the trust receipt.

(2) The EE must receipt the proceeds in trust for the ER and turn over the same to
the ER to the extent of the amount owing to the ER or as appears in the trust receipt.

(1) The EE must insure the goods for their total value against loss from fire, theft,
pilferage or other casualties.

(2) The EE must keep said goods and proceeds thereof (whether in money or
whatever form) separate and capable of identification as property of the ER.

(3) The EE must return the GDI in the event of non-sale or upon demand of the ER.

5 Note that the EE shall receive any surplus from the sale, but shall not be liable to the ER for
any deficiency. (Sec. 7)

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

(4) The EE must observe all other terms and conditions of the trust receipt not
contrary to the provisions of the Trust Receipts Law.

Liability of EE for loss (Sec. 10)

 The risk of loss shall be borne by the EE.

 Loss of goods, documents or instruments which are the subject of a trust receipt pending
their disposition shall not extinguish the EE’s obligation to the ER for the value thereof.
This is irrespective of whether or not such loss was due to the fault or negligence of the
EE (Sec. 10). Thus, in a case where ABC Bank releases to Mr. X 500 crates of grapes
under a trust receipt, and the grapes are stolen while they are in a warehouse, Mr. X is
still obliged to pay his obligation to ABC Bank notwithstanding the loss of the grapes.

What are the rights of a purchaser for value and in good faith?

 Any purchaser of goods from an EE with right to sell, or of documents or instruments

through their customary form of transfer, who buys the goods, documents, or instruments
for value and in good faith from the EE, acquires said goods, documents or instruments
free from the ER’s security interest. (Sec. 11)

Liability for estafa (Sec. 13)

 The failure of an EE to turn over the proceeds of the sale of the goods, documents or
instruments covered by a trust receipt to the extent of the amount owing to the ER or as
appears in the trust receipt or to return said goods, documents or instruments if they were
not sold or disposed of in accordance with the terms of the trust receipt shall constitute
the crime of estafa punishable under Article 315 of the Revised Penal Code.

 If the violation or offense is committed by a corporation, partnership or association, or

other juridical entities, the penalty provided for shall be imposed upon the directors,
officers, employees or other officials or persons therein responsible for the offense,
without prejudice to the civil liabilities arising from the criminal offense.

CASES

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

I. VIOLATION OF TRUST RECEIPTS LAW IS AN OFFENSE AGAINST PUBLIC ORDER.

PEOPLE V. NITAFAN
207 SCRA 726

Petitioner Allied Banking Corporation filed an information for estafa against Betty Sia
Ang. It was alleged that the accused, proprietess of Eckart Enterprises, received from the bank
Goardon plastics, plastic sheeting and Hook Chromed, amounting to P398,000 specified in a trust
receipt and covered by a Domestic Letter of Credit. She had the obligation to sell the goods and
to account for the proceeds, if sold, or to return the goods, if not sold, on or before 16 October
1980, or upon demand. Despite repeated demands, Ang paid only P283,115. It was alleged that
she misappropriated, misapplied and converted the balance to her own personal use and benefit.
The accused filed a motion to quash the information, alleging that violation of the trust receipt
constitutes only a civil liability. The respondent judge granted the motion.

The Supreme Court held that acts involving the violation of a trust receipt agreement
after 29 January 1973 (the date of enactment of PD 115) would make the accused criminally
liable for estafa under Article 315(b) of the Revised Penal Code.

Section 13 of PD 115 provides that failure of the EE to turn over the proceeds of the sale
of the goods, documents or instruments covered by a trust receipt or to return said goods,
documents or instruments if they are not sold or disposed of constitute the crime of estafa,
punishable under Article 315 paragraph 1(b) of the Revised Penal Code.

Section 1(b) of Article 315 states that one of the means by which to commit estafa is “by
misappropriating or converting, to the prejudice of another, money, goods … received by the
offender in trust … or under any other obligation involving the duty to make delivery of or to
return the same…”

It is the failure of Ang to account for the balance that makes her liable for estafa.

NOTE:

The courts in the cases of People v. Cuevo and Sia v. CA, which were relied upon by the
respondent judge and the accused in the case above, adopted the view that a violation of
obligations under a trust receipt gave rise only to a civil liability because the two cases occurred
before the effectivity of PD 115.

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

Trust receipt arrangements do not involve a simple loan transaction. Apart from a loan
feature, the trust receipt arrangement has a security feature covered by the trust receipt itself. The
second feature provides needed financial assistance to traders in the importation or purchase of
goods through the use of the goods as collateral for the advancements made by the bank. The title
of the bank to the security is the one sought to be protected and not the loan which is a separate
and distinct agreement.

The Trust Receipts Law punishes the dishonesty and abuse of confidence in the handling
of money or goods to the prejudice of another, regardless of whether or not the latter is the owner.
The law does not seek to enforce payment of the loan. There is thus no violation of the
Constitutional right imprisonment for non-payment of debts.

Like BP 22, PD 115 punishes the act as an offense against public order, not against
property. The offense is punished as a mala prohibitum regardless of the existence of intent or
malice. A mere failure to deliver the proceeds of the sale or the goods constitute a criminal
offense that causes prejudice to another and, more importantly, to the public interest.

II. THE TRUST RECEIPTS LAW IS DEEMED TO COVER GOODS NOT INTENDED FOR SALE.

ALLIED BANKING CORPORATION V. ORDOÑEZ

192 SCRA 246 (1990)

Philippine Blooming Mills (PBM), a steel manufacturer, through its duly authorized
officer, private respondent Alfredo Ching, applied for the issuance of commercial letters of credit
with petitioner bank to finance the purchase of 500 M/t Magtar Branch Dolomites and one Lot
High Fired Refractory Sliding Noozle Bricks. Petitioner bank issued an irrevocable letter of credit
in favor of Nikko Industry Co. Ltd. (Nikko) by virtue of which the latter drew four drafts which
were accepted by PBM and duly honored and paid by the petitioner bank.

To secure payment of the amount covered by the Drafts, and in consideration of the
transfer of the goods to PBM, the latter as EE, through private respondent, executed four Trust
Receipt Agreements acknowledging petitioner’s ownership of the goods and its obligation to turn
over the proceeds of the sale of the goods, if sold, or to return the same, if unsold, within the
stated period.

Out of the said obligation resulted an overdue amount of P1,475,274. Despite repeated
demands, PBM failed and refused to either turn over the proceeds of the sale of the goods or to
return the same.

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

Allied Bank filed a criminal complaint against private respondent for violation of PD
115.

PBM contents that PD 115 does not cover the transaction he entered into because the said
law only refers to goods which are ultimately intended for sale. In this case, the dolomites and
nuzzle bricks are not part of the steel products that they make. Rather, they are used in the
operation of PBM’s equipment. Furthermore, they are not engaged in the sale of dolomites and
nozzle bricks.

The issue here is whether the penal provision of PD 115 apply or not when the goods
covered by a Trust Receipt do not form part of the finished products which are ultimately sold but
are, instead, utilized or used up in the operation of the equipment and machineries of the EE
/manufacturer.

SC held that PD 115 applies. The penal provision of PD 115 encompasses any act
violative of an obligation covered by the trust receipt; it is not limited to transactions in goods
which are to be sold, reshipped, stored or processed as a component of a product ultimately sold.

In an attempt to escape criminal liability, PBM claims PD 115 covers goods which are
ultimately destined for sale and not goods for use in manufacture. But the wording of Section 13
of PD 115 covers failure to turn over the proceeds of the sale of entrusted goods, or to return said
goods if unsold or disposed of in accordance with the terms of the trust receipts.

And even assuming the absence of a clear provision in the trust receipt agreement, Lee v.
Rodil and Sia v. CA have held: Acts involving the violation of trust receipt agreements occurring
after 29 January 1973 (when PD 115 was enacted) would render the accused criminal liable for
estafa under par. 1(b), Article 315 of the Revised Penal Code, pursuant to the explicit provision in
Section 13 of PD 115. The act punishable is malum prohibitum.

NOTE:

Prof. Follosco and Prof. Catindig do not agree with the decision which did not actually
address the issue raised by PBM: how could PBM return goods which were used up in its
operations and which are not integrated in the processed and finished product of the company?
According to Prof. Catindig, the Trust Receipts Law is not contemplated to cover capital
goods. Even a cursory reading of sec. 4 will show that the intent of the law is to cover goods that
are meant to be sold. (The provisions speak of “ultimate sale.”)

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops
Primer on Letters of Credit and Trust Receipts
UP Bar Ops 2001

ACKNOWLEDGMENTS:

This primer is based on Prof. Tristan Catindig’s

syllabus, outline of bar review lecture, and class
lectures. Many thanks, Sir, for your generosity
with your time, your resources, and your
insights! Our thanks, too, to Prof. Rachel
Follosco whose comments and insights likewise
found their way into this primer via her lectures
in Banking and Finance.

Thank you to Dan Calica and Tanya Lat who

collaborated on this primer.

Excellence. Not just a tradition.

It’s a commitment.
- UP LSG Bar Ops