​ ​

Letters of Credit
Letters of Credit is a document issued by a third party, such as a bank, that guarantees payment
for goods or services when the seller provides acceptable documentation.
​ ​it is an Official Letter Format used in banking. This document is generally
issued by a bank to assure that the beneficiary will receive payment according to the amount
mentioned in the letter of credit till the time the documentary delivery conditions will be
fulfilled.
​ ​a letter issued by one merchant to another for the purpose of attending to a
commercial transaction. (Article 567. Code of Commerce)

In banking practice, it is a request by one bank to another bank to advance or give

money to a third person on the basis of the letter and on the credit of the person issuing it.

Internationally accepted definition of a Letters of Credit as provided in the Uniform

Customs and Practices for Documentary Credit (UCPDC):
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 3rd person known as beneficiary OR
2. Accepts and pay any draft that may be drawn by the beneficiary, OR
3. Authorize another bank to:
-Pay to the order of a 3rd person known as the beneficiary.
-Accept and pay any draft by the beneficiary, OR
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.

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 bank merely substitutes its own promise for the promise to
pay of one of its customers who in turn promises to pay the bank the amount of funds mentioned
in the letter of credit plus credit or commitment fees mutually agreed upon. (Prudential vs IAC,
216 SCRA 257)

A Letter of Credit is a special contract designed to answer two concerns:

Seller’s refusal to part with his goods before being paid coupled with the Buyer’s 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 from 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 or bearer. 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

​Laws governing a Letter of Credit transaction

-Uniform Customs and Practice for Documentary Credits issued by the International Chamber of
Commerce (Metropolitan Waterworks vs Daway, GR No. 160723, July 21, 2004)
- Code of Commerce Article 567- 572
- Civil Code, Obligations and Contracts (Suppletory) (Transfield Phils Inc. Vs Luzon Hydro
Corporation, 443 SCRA 307, Nov 22, 2004)

Consequence of payment upon an expired Letter of Credit

An issuing bank which paid the beneficiary upon an expired L/C can recover the payment from
the applicant which obtained the goods from the beneficiary to prevent unjust enrichment
(Rodzssen Supply Co. v. Far East Bank and Trust Co, G.R. No. 109087, May 9, 2001)

Read the case of Metropolitan Waterworks and Sewerage System VS. Act Theater, Inc.,
432 SCRA 418)
Rehabilitation Court/ Stay Order/LC/ Local LC

​Duration of LC
1. Upon the period fixed by the parties, or
2. If none is fixed, one year from the date of issuance (if the LC is used outside the Philippine)
and 6 months from the date of issuance (if the LC is used in the Philippine)

SIGNIFICANCE OF LETTERS OF CREDIT

Roughly at least 85% of importations are financed by letters of credit. The underlying
idea of a letter of credit is to ensure certainty of payment. Seller is assured of payment because
the bank intervenes and makes the commitment to pay. The idea behind it is like your credit card.
You walk into a department store and they sell to you on credit although you’re a total stranger
because you show your credit card, which means that the bank which issued the credit card tells
the seller that it will pay the goods being bought.

ESSENTIAL CONDITIONS OF A LETTER OF CREDIT

1. Issued in favor of a definite person and not to order. In effect, it is not a negotiable
instrument governed by the Negotiable Instruments Law.
2. Limited to fixed or specified amount, or to one or more amounts, but with maximum
stated limit. If any circumstance is missing, the letter is a mere letter of recommendation (Article
568, Code of Commerce)

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.
2. Issuing bank - is usually the buyer’s bank, 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. Seller/Exporter/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 (Letters of
Credit) is addressed to him and in his favor.
The number of the parties may be increased and may include:
4. Correspondent Bank

TYPES OF CORRESPONDENT BANK:

1. Advising (notifying) bank - may be utilized to convey to the seller the existence of
the credit.
– 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.
2. Confirming bank - which will lend credence to the letter of credit issued by a lesser
known issuing bank. It assumes direct obligation to the seller/beneficiary and becomes
principally liable.
 Note: 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 bank’s 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 - which undertakes to encash the drafts drawn by the exporter/seller
– 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. Instead of going to the place of the issuing bank to claim payment, the buyer may
approach another bank, termed as the negotiating bank to have the draft discounted (Charles
Lee v. CA, GR No. 117913 February 1, 2002)
Negotiating Bank – any bank in the place of the beneficiary w/c buys or discounts the
seller’s 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.
Note: A bank does not become a negotiating bank unless he pays the draft and becomes
the holder of said document.
As such, the Issuing Bank 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 Issuing Bank 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
Letters of Credit transaction.

Incidents in the life of a Letter of Credit

1. Contract of Sale between the buyer and the seller
2. Application for letter of credit by the buyer with the bank
3. Issuance of letter of credit by the bank
4. Shipping of the goods by the seller
5. Execution of draft and tender of documents by the seller
6. Redemption of draft (payment) and obtaining of document by the issuing bank
7. Reimbursement to the bank and obtaining of documents by the buyer

INDEPENDENCE PRINCIPLE – in a letter of credit transaction means that a bank, in

determining compliance with the terms of a letter of credit is required to examine only the
shipping documents presented by the seller and is precluded from determining whether or not the
main contract is actually accomplished or not.
RULE OF STRICT COMPLIANCE – in a letter of credit transaction means that the
documents tendered by the seller or beneficiary must strictly conform to the terms of the letters
of credit, i.e., they must include all documents required by the letter of credit. Thus, 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 risk and 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
(Feati Bank vs. CA, G.R. No. 94209, April 30, 1991)
​
A Demand Draft is a negotiable instrument similar to a bill of exchange. A bank issues a
demand draft to a client (drawer), directing another bank (drawee) or one of its own branches to
pay a certain sum to the specified party (payee). (aka sight drafts)

​ ​- used synonymously with bill of exchange although it normally refers to a bill of

exchange used in documentary exchange like letters of credit transactions.
a. Time Draft- draft that is payable at aa fixed date
b. Sight or demand draft- draft that is payable when the holder presents it for payment.
(Reviewer on Commercial Law review By Sundiang, Sr. and Aquino)

Theory of Manifestation: Mercantile contracts are perfected from the moment the acceptance is
sent, even if it has not yet been received by the offeror.

Offeror can no longer withdraw the offer or change the terms and
conditions.

Theory of Cognition: Contracts governed by civil law such as partnerships, agencies, deposits,
loans, sales and guaranties will be perfected only upon receipt by the offeror of the unconditional
acceptance by the offeree.

RELATIONSHIP OF THE PARTIES is governed by-

1. 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
INDEPENDENCE PRINCIPLE-
The 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 COMPLIANCE-
The 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 beneficiary.
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 Issuing Bank finds that
they conform w/t the LC requires, then the Issuing Bank must pay the seller. In a LC transaction
the banks deal only w/ documents not goods, so banks pay 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.
SLC’s 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 borrower’s loan obligation is
then passed to the bank.
When the can 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 (Confirming Bank) 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 (Confirming Bank) 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 (Negotiating Bank) 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 CB’s liability is primary while the NB’s
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.

What among other things, should be stipulated upon the application for a LC?
The documents w/c the seller should submit to the Issuing Bank.

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. (Independence Principle of LC)

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 course of action 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.

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. Issuing Bank 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 doesn’t pay, go to the drawer who is secondarily liable.

Apart from 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.

N.B: The opening of letter of credit is only a mode of payment. The letter of credit is not an
essential requisite to the contract of sale.

Kinds of Letters of Credit

1. Confirmed Letters of Credit
2. Irrevocable Letters of Credit
3. Revolving Letters of Credit
4. Back-to-Back Letters of Credit
5. Standby Letters of Credit

COMMERCIAL LETTERS OF CREDIT

>Involve contracts of sale.
>Payable upon presentation by the seller/beneficiary of documents that show he has performed h
is contract.
STANDBY LETTERS OF CREDIT
>Involve non‐sale transaction
> Payable upon certification by the beneficiary of the applicant’s NON
performance of the agreement. (Transfield v. Luzon Hydro Corp., G.R. No. 146717, Nov. 22,
2004)

DISTINGUISH AN IRREVOCABLE LETTER OF CREDIT FROM A CONFIRMED

LETTER OF CREDIT.
Answer: an irrevocable letter of credit is one that constitutes a definite undertaking of the issuing
bank, provided that the stipulated documents are presented and that the terms and conditions are
complied with (Article 10, UCP). In other words, the issuing bank cannot revoke its undertaking
without the consent of the applicant (buyer/importer) and the beneficiary (seller/exporter),
whereas, a confirmed letter of credit is one whereby the correspondent bank assumes the
obligation of giving an absolute assurance to the beneficiary (seller/exporter) that it will
undertake the obligation of the issuing bank as its own.
Hence, an irrevocable letter of credit does not necessarily mean that the correspondents bank has
confirmed the letter of credit when it accepts the instructions of the issuing bank.
Problem:
Juan Tamad opened a letter of credit with X Bank for the importation of dyestuffs. When the
shipment arrived, the goods turned out to be mere colored chalks instead of dyestuffs. Juan
Tamad refused to reimburse X Bank on the ground that he did not receive the goods as ordered
from the seller.
Is the refusal of Juan Tamad to reimburse X Bank Tenable? Explain.
Ans: No, the refusal of Juan Tamad to reimburse X Bank is not tenable. Under a letter of credit,
the bank deals only with the necessary documents. It has nothing to do with any discrepancy or
defect in the goods. (BPI vs. De Reny Fabric Industries, Inc., 35 SCRA 253)
Assume the same facts, except that the bills of lading submitted by the seller to collect on
the letter of credit are falsified. May Juan Tamad refuse to reimburse X Bank? Explain.
Ans: No, Juan Tamad cannot refuse to reimburse X Bank. If the seller was paid by the bank in
good faith without knowledge of the falsity of the bills of lading, the buyer must reimburse the
issuing bank because the latter assumes no responsibility for the genuineness of the document of
title over the goods.
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