Letters of Credit Notes

A.
Letters of Credit
1. Definition/Concept
That issued by one merchant to another for the purpose of attending to a

commercial transaction.1
An instrument issued by a bank on behalf of one of its customers, authorizing an

individual or a firm to draw drafts on the bank or one of its correspondents for its
account under certain conditions of the credit.2
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.3 Through it, the bank merely substitutes its own
promise to pay for the promise to pay of one of its customers who in return promises to
pay the bank the amount of funds mentioned in the letter of credit plus credit or
commitment fees mutually agreed upon.
2. Governing laws
a. Code of Commerce
b. Uniform Customs and Practice for Documentary Credits4
3. Nature of letter of credit
The LC is a financial device5developed 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.
4. Parties to a letter of credit
There are at least 3 basic parties:
1
Art. 567
2
Commercial Law Review, C. Villanueva, 2004 ed.
3
Prudential Bank vs. CA, 216 SCRA 257
4
The Uniform Commercial Practice for Documentary Credits allow Letters of Credit to be payable to order.
5
mode of payment
1. Applicant/buyer/importer – one who purchases the goods, procures the LC, and
obliges himself to reimburse the issuing bank upon receipt of the documents of
title.
2. Issuing/opening bank – one which issues the LC, and undertakes to pay the
seller upon receipt of the draft and proper documents of title from the seller and
to surrender them to the buyer upon reimbursement; and
3. Seller/exporter/beneficiary – one who sells the goods to the buyer, and who
delivers the draft and documents to the issuing bank to recover payment.
The number of parties may be increased. Modern letters of credit are usually not
made between natural persons. They involve bank-to-bank transactions.
4. Advising/notifying bank – the correspondent bank6of the opening bank through

which it advises the beneficiary of the LC.
5. Confirming bank – bank which, upon the request of the beneficiary, confirms the
LC issued.
6. Paying bank – bank on which the drafts are to be drawn, which may be the
opening bank or another bank not in the city of the beneficiary.
7. Negotiating bank – bank in the city of the beneficiary which buys or discounts the
drafts contemplated by the LC, if such draft is to be drawn on the opening bank
or on another designated bank not in the city of the beneficiary.
a. Rights and obligations of parties
1. Drawer is liable to person on whom it was issued provided identity proven, for
the amount paid within fixed maximum.
2. Bearer has no right of action if not paid by person who issued it.
3. Drawer may annul the letter of credit, informing the bearer and to
whom it is addressed.
4. Bearer shall pay the amount received to drawer, otherwise action for
6
agent
execution may be filed with interest and current exchange in place where payment
made on place where repaid.
5. If a bearer does not make use of letter of credit within agreed period, or if
none, within 6 months from date if in the Philippines, and 12 months if outside the
Philippines, it shall be void.7
5. Basic Principles of letter of credit
a. Doctrine of independence
The 3 basic contracts are distinct and independent, and the undertakings of the
respective parties in each are neither subject to claims and defenses nor affected by the
breach in the others.
b. Fraud exception principle
Exists when the beneficiary, for the purpose of drawing on the credit, fraudulently
presents to the confirming bank, documents that contain, expressly or by implication,
material representations of fact that to his knowledge are untrue.8
c. Doctrine of strict compliance
It espouses that the documents tendered by the seller/beneficiary must strictly

conform to the terms of the LC, i.e. they must include all the documents required by the
LC.9
7
Articles 569-572, Code of Commerce
8
TransfieldPhils, Inc. vs. Luzon Hydro Corporation, Australia and New Zealand Banking Group Limited and Security
Bank Corp., G.R. No. 146717, November 22, 2004
9
Feati Bank vs. CA

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A.

That issued by one merchant to another for the purpose of attending to a

An instrument issued by a bank on behalf of one of its customers, authorizing an

An engagement by a bank or other person made at the request of a customer

3. Nature of letter of credit

The LC is a financial device5developed as a convenient and relatively safe mode

4. Parties to a letter of credit

There are at least 3 basic parties:

4. Advising/notifying bank – the correspondent bank6of the opening bank through

a. Rights and obligations of parties

5. Basic Principles of letter of credit

b. Fraud exception principle

c. Doctrine of strict compliance

It espouses that the documents tendered by the seller/beneficiary must strictly

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