Principles Involving Issuance of Letters of Credit

What is the nature of Letters of Credit? In commercial transactions, 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. The use of credits in commercial transactions serves to reduce the risk of nonpayment of the purchase price under the contract for the sale of goods. However, credits are also used in non-sale settings where they serve to reduce the risk of nonperformance. Generally, credits in the non-sale settings have come to be known as standby credits. [1] What are the three transactions involving issuance of Letter of Credit? [2] 1. Buyer and seller enter into a contract of sale with a requirement that the buyer obtain a letter of credit from a third party acceptable to the seller. 2. The buyer requests the issuing bank to issue a letter of credit naming the seller as the beneficiary. 3. The issuing bank issues the letter of credit for the benefit of the seller. How do the various transactions that give rise to a letter of credit proceed and operate? [3] 1. Once the seller ships the goods, he or she obtains the documents required under the letter of credit. 2. He or she shall then present these documents to the issuing bank which must then pay the amount identified under the letter of credit after it ascertains that the documents are complete. 3. The issuing bank then holds on to these documents which the buyer needs in order to claim the goods shipped. 4. The buyer reimburses the issuing bank for its payment at which point the issuing bank releases the documents to the buyer. 5. The buyer is then able to present these documents in order to claim the goods. At this point, all the transactions are completed. The seller received payment for his or her performance of his obligation to deliver the goods. The issuing bank is reimbursed for the payment it made to the seller. The buyer received the goods purchased. What is the “Independence Principle”? The so-called "independence principle" assures the seller or the beneficiary of prompt payment independent of any breach of the main contract and precludes the issuing bank from determining whether the main contract is actually accomplished or not.

Under this principle, banks assume no liability or responsibility for the form, sufficiency, accuracy, genuineness, falsification or legal effect of any documents, or for the general and/or particular conditions stipulated in the documents or superimposed thereon, nor do they assume any liability or responsibility for the description, quantity, weight, quality, condition, packing, delivery, value or existence of the goods represented by any documents, or for the good faith or acts and/or omissions, solvency, performance or standing of the consignor, the carriers, or the insurers of the goods, or any other person whomsoever. [4] What is the “Fraud Exception Rule” as an exception to the “Independence Principle”? Most writers agree that fraud is an exception to the independence principle. Professor Dolan opines that 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. The remedy for fraudulent abuse is an injunction.

However, injunction should not be granted unless: (a) there is clear proof of fraud; (b) the fraud constitutes fraudulent abuse of the independent purpose of the letter of credit and not only fraud under the main agreement; and (c) irreparable injury might follow if injunction is not granted or the recovery of damages would be seriously damaged. [5] What is the “Doctrine of Strict Compliance”? It is a 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. 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 constitute an agreement between the purchaser and the bank. [6] [1] Transfield Philippines Inc. vs. Luzon Hydro Corp., G.R. No. 146717 (November 22, 2004) [2] The Hongkong Shanghai Banking Corp. vs National Steel Corp., G.R. No. 183486 (February 24, 2016) [3] Id. [4] Supra note 1. [5] Id. [6] Feati Bank & Trust Co. vs. CA G.R. No. 94209 (April 30, 1991)

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