SCL I.

Letters of Credit | 1 Letters of Credit (LC)

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: o o o Pay to the order of a 3rd person known as beneficiary OR Accepts and pay any draft that may be drawn by the beneficiary, OR Authorize another bank to: o Pay to the order of beneficiary. Accept and pay any draft by the beneficiary, OR Authorize another bank to negotiate against the stipulated documents. Note: This is the internationally accepted definition of a LC as provided in the Uniform Customs and Practices for Documentary Credit (UCPDC). We are bound by the UCPDC issued by the International Chamber of Commerce. Sec. 2 of the Code of Commerce states that in the absence of any particular provision in the code of Commerce, commercial transactions shall be governed by the usages and customs generally observed (BPI vs. Nery). In effect, are absolute undertakings 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, and while they are security arrangements, they are not converted thereby into contracts of guaranty (MWSS v. Daway) Purpose: to insure to a seller payment of a definite upon presentation of documents (Prudential Bank v. IAC, GR. No. 74886, Dec. 8, 1992) Essential conditions (absence of any makes the instrument merely as a letter of recommendation): o Issued in favour of a definite person (and not to order) o The UCPDC allows LC to be payable to order Limited to a fixed or specified amount, or to one or more amounts, but with a maximum stated limit (Art. 568, UCPDC) Duration: o o Period fixed by the parties; or If none is fixed o o 6 months from its date if used in the Phil 12 months - if used abroad (Art. 572, UCPDC) o o A letter of credit is a financial device developed by merchant s as a convenient and relatively safe mode of dealing with sales of goods to satisfy the seemingly irreconcilable interests of the 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 LC; 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 LC. o The buyer and seller agree on what documents are to be presented for payments, but ordinarily, they are documents of title evidencing or attesting to the shipment of the goods to the buyer Once the letter of credit is established, the seller ships the g oods to the buyer and in the process secures the required shipping documents and documents of title. o 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 th e seller if it finds that the documents submitted by the seller conform with what the LC 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. a 3rd person known as the A: YES it is governed by the Code of Commerce Q: is an LC a negotiable instrument under the Negotiable Instruments Law? A: NO it does not conform to Sec. 1 of said law. it does not contain an unconditional promise to pay a sum certain in money it is issued in favour of a definite person (not to order)

Q: is an LC transaction a commercial transaction?

Governing laws
1. 2. Code of Commerce Uniform Customs and Practices for Documentary Credits (UCPDC) (Bank of America NT & SA v. CA, GR. No. 105395, Dec. 10, 1993)

Nature of LC

Conditioned on: Submission of stipulated documents; and Compliance with the term of the LC

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o 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 Seller/ exporter/ beneficiary

Parties to a LC
1. Buyer/ applicant/ importer one who purchases the goods, procures the LC, and obliges himself to reimburse the issuing bank upon receipts of the documents of title. 2. Issuing or opening bank one which, whether a paying bank or not, 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. 3. Seller/ exporter/ beneficiary one who sells the goods to the buyer, and who delivers the drafts and documents of title to the issuing bank to recover payment 4. 5. Correspondent or advising bank the agent of the opening bank through which it advises the beneficiary of the LC Other parties: a. b. Confirming bank one which, upon the request of the beneficiary, confirms the LC issued Paying bank one which the drafts are to be drawn, which may be the opening bank or another bank not in the city of the beneficiary c. Negotiating bank one in the city of the beneficiary which buys or discounts the drafts contemplated by the LC, if such drafts are to be drawn on the opening bank or on another designated bank not in the city of the beneficiary 7. Note: The number of parties may be increased. Modern LCs are usually not made between natural persons but involve bank-to-bank transactions. 1. 2. 3. 4. 5. 6. Contract of sale between buyer and seller Application for LC by buyer with the bank Issuance of LC by the bank Shipment of goods by the seller Execution of draft and tender of documents by the seller Redemption of draft (payment) and obtaining of documents by issuing bank Reimbursement to the bank and obtaining of documents by buyer Note: an LC does not arise only because of sale or importation see Standby LC Correspondent or advising bank

Stages of a LC transaction:

Rights and obligations of the parties Rights Buyer/ applicant/ importer Acquires the documents of title and control over goods Obligations Purchases the goods Procures the LC Reimburses the IB upon receipt of document of title Illustration: B (buyer/applicant) enters into a contract (sale, loan, lease, etc.) with S (seller/beneficiary). S prefers to be afforded certainty Issuing or opening bank Receives reimbursement from B of payment by B. B thus applies to XYZ Bank (issuer; may be a commercial bank or any person or entity) for a LC. XYZ Bank issues a LC and thus adds its own credit to B. If S presents the documents required by the LC to XYZ Bank, the latter will promptly pay S.

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Independent contracts involved in LC transaction: 1. 2. 3. Contract of sale - buyer and seller Contract of buyer with issuing bank LC proper in which the bank promises to pay the seller pursuant to the terms and conditions stated therein (issuing bank and seller) Injunction as remedy when: o o There is clear proof of fraud; Fraudulent abuse of the independent purpose of the LC and not only fraud in the main agreement Note: Pursuant to the Independent principle, irreparable injury might follow if injunction is not granted or the recovery of damages would be seriously damaged (Transfield Phil. v. Luzon Hydro Corp.) How the parties relationships are governed: 1. 2. 3. IB and B by the terms of the application and agreement for the issuance of the LC by the bank IB and S by the terms of the LC B and S by the sales contract

Doctrine of Strict Compliance

The document tendered by the seller must strictly conform to the terms of the LC. o The correspondent bank which departs from what has been stipulated in the LC (e.g. when it accepts a faulty tender) acts on his own risk and may not thereafter recover from the

Basic Principles
o

buyer or issuing bank, the money paid to the beneficiary The documents presented must comply with those stipulated (in a LC, the banks only deals with documents and not with the goods)

Doctrine of Independence
A letter accommodation is an entirely distinct and separate agreement. o It is not supposed to be affected by the main contract upon which it rests. Purpose(s): o o assures the seller/beneficiary of prompt payment independent of any breach of the main contract precludes the issuing bank from determining whether the main contract is actually accomplished Independence nature of LC may be: o Independence in toto where the credit is independent from the justification aspect and is a separate obligation form the underlying agreement (e.g. a typical standby); or o Independence as only to the justification aspect identical with the same obligations under the underlying agreement (e.g. commercial LC or repayment standby) Note: This principle liberates the issuing bank from the duty of ascertaining compliance by the parties in the main contract. o The obligation under the LC is independent of the related and originating contract (it is separate and distinct from the underlying transaction) Who may invoke this principle? o o Beneficiary and the seller Issuing bank

Q: Can breach of contract be invoked against issuing bank? A: NO independence principle

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

Fraud Exception Principle

The untruthfulness of a certificate accompanying a demand for payment under a standby credit may qualify as fraud sufficient to support an injunction against payment

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2. It did not determine the apparent authenticity of the required documents Note: Only the APPARENT AUTHENTICITY is to be 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. Therefore, Notifying Bank/Advising Bank is liable if it acts beyond the scope of its authority. Q: When may the Advising Bank (AB) be equally liable with the Issuing Bank (IB)? A: Ordinarily, an AB, whose obligation is merely to advise the seller/beneficiary of the opening of a LC has no liability. The opening of a LC does not make the IB liable at once because there is no liability. The liability is conditioned and dependent on the tender or submission of the documents stipulated upon by the parties. If the beneficiary requires that the obligation of the IB shall also be made the obligation of the AB to him, there is what is known as a CONFIRMED COMMERCIAL CREDIT and the AB shall become a Confirming Bank. In this situation, the liability of the CB is primary and it is as if the credit were issued by the IB and the CB jointly, thus giving the beneficiary or holder for value of the drafts drawn under the credit, the right to proceed against either or both banks, the moment the credit instrument has been breached. The CB is liable only when the documents are submitted and gets reimbursed by the IB because there is no privity of contract with the applicant. Thus, an AB becomes a CB when the above mentioned conditions occur. In such a case, the CB acquires the same liabilities as the Issuing Bank and is bound by the same conditions as an IB. How about the buyer, is he still bound to reimburse the IB Function of a Negotiating Bank (NB): It accepts or gives value to the draft and w/c later on sells the draft to the IB. The IB then reimburses the NB. What happens is that the NB buys the draft at a discounted price and then sells it to the IB for its face value. Q: If LC is disowned by the IB, can the Negotiating Bank ask reimbursement from the seller? Under what principle? A: YES. Seller is a drawer of the draft accepted and paid by the Negotiating Bank. Therefore, the seller has contingent liability on such draft. Q: Can a Confirming Bank become a Notifying Bank? A: NEVER, because they have different liabilities. The CBs liability is primary while the NBs liability comes only after negotiation (Before negotiation, there is no liability). It is the application for the opening of a LC w/c governs the relationship between the buyer and the IB. This implies that How is payment made by the Issuing Bank? Payment by the IB is done through: Can the beneficiary demand payment form the CB? YES. Since the CB is equally liable w/ the IB. If the beneficiary proceeds against the CB, the CB may ask reimbursement from the IB. But if the beneficiary proceeds directly against the CB; it has no right to collect from the IB. The beneficiary may compel the CB to accept drafts it has drawn. 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. despite the defective goods received by him? YES. The buyer has no course of action against the IB. The buyer has a COA against the seller. If the 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. In LC transactions, the IB deals only w/ the documents, not w/ goods. The IB is not bound or required to examine the goods. For as long as the required documents are submitted by the seller, the IB pays the seller. What among other things, should be stipulated upon the application for a LC? The documents w/c the seller should submit to the IB. If the IB does not advance the payment in favor of the seller/beneficiary, may the buyer/applicant recover the commission paid? No More because this is the consideration. But he may recover the margin fee.

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.

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1. Direct payment or wire transfer or credit in the account of The opening of the letter of credit is only a mode of payment. The letter of the credit is not an essential requisite to the contract of sale.

the beneficiary 2. my order 3. 4. drawn 5. Authorize the negotiation of any draft drawn by the IB may authorize the Confirming Bank to pay Authorize Correspondent Bank to accept and pay any draft Drawing of a draft by the beneficiary against the IB pay to

beneficiary.

Note: If the drawee doesnt pay, go to the drawer who is secondarily liable. Apart form the bill of lading, what additional documents may be needed as a condition of the LC for honoring a draft? 1. Commercial invoice it is a document signed and issued

by the seller and contains a precise description of the merchandise and the terms of the sale such as unit prices, amount due form the buyer and shipping conditions related to charges such as FOB (Free on Board), FAS (Free Alongside), C and F (Cost and Freight) or CIF (Cost, Insurance, Freight).

2.

Consular invoice document issued by the consulate of

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

3.

Certificate of analysis may be required to ascertain that

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

4.

Export declaration it is a document prepared by the

exporter to assist the government to prepare export statistics.

Note: Documents to be passed are not unilaterally determined by the bank but agreed upon by the buyer and seller. Document of Title (Bill of Lading) given to the seller upon shipment of goods. This is to be given to the IB to be able for the seller to get payment.

Is there a scheme where the IB may release the documents of title to the buyer w/o being reimbursed first by the buyer? YES. By the IB letting the buyer execute a trust receipt. Failure of the buyer to open the Letter of Contract does not prevent the birth of the Sales Contract.