LETTERS OF CREDIT

What are letters of credit?

 A letter of credit is basically an open letter of request whereby one person requests another to
advance money or give credit to a third person for a certain amount and promises to repay the
person advancing the money.
 They are intended generally to facilitate the purchase and sale of goods by providing assurance to
the seller of prompt payment upon compliance with specified conditions or presentation of
stipulated documents without the seller having to rely upon the solvency and good faith of the buyer.

Standby Letter of Credit

- involves non-sale transactions
- Payable upon certification by the beneficiary of the applicant’s non-performance of the agreement.
The documents that accompany the beneficiary's draft must show that the applicant has not
performed the undertaking (Transfield Philippines, Inc. v. Luzon Hydro Corp., supra).
- it is governed by the law on obligations and contract
- In a standby letter of credit securing a loan obligation, any payment of the debtor to the creditor
should not be deducted from the total obligation of the issuing bank to the beneficiary. The issuing
bank, after payment of the full amount, is entitled to full reimbursement from the debtor. But the
debtor may recover excess payment from the creditor to prevent unjust enrichment.

Who are the parties to a letter of credit?

1. The Buyer
 he is the one who procures the letter of credit and obliges himself to reimburse the issuing bank
upon receipt of the documents of title

2. The Issuing Bank

 is the bank from whom the letter of credit is procured and which undertakes to pay the seller upon
receipt of the draft and proper documents of titles which are surrendered the buyer upon
reimbursement, and

3. The Seller
 who in compliance with the contract of sale, ships the goods to the buyer and deliver the
documents of title and draft to the issuing bank to recover payment.

The three contracts

(a) The contract of sale
(b) The application and agreement to issue the letter of credit
(c) The letter of credit

 These contracts must be maintained in a state of perpetual separation.

RIGHTS AND OBLIGATIONS OF PARTIES

Three (3) distinct but intertwined contracts in a Letter of Credit transaction (2002, 2008 Bar)

1. Between the applicant/buyer/importer/account party and the beneficiary/seller/exporter

- The applicant is the one who procures the letter of credit and obliges himself to reimburse the
issuing bank upon receipt of the documents of title while the beneficiary is the one 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 for the goods. The relationship between them
is governed by the law on sales if it is a commercial L/C but if it is a stand-by letter of credit it is
governed by the law on obligations and contract.

2. Between the issuing bank and the beneficiary/ seller/exporter

- The issuing bank is the one that issues the letter of credit and undertakes to pay the beneficiary
upon strict compliance of the latter to the requirements set forth in the letter of credit. On the other
hand, the beneficiary surrenders document of title to the bank in compliance with the terms of the
L/C. Their relationship is governed by the terms of the L/C.

3. Between the issuing bank and the applicant/ buyer/importer

- The applicant obliges himself to reimburse the issuing bank upon receipt of the documents of title.
Their relationship is governed by the terms of the application and agreement for the issuance of
the L/C by the bank.

NOTE: By the Doctrine of Independence, the relationship among:

a) the issuing bank and the beneficiary;

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b) the issuing bank and the applicant; and
c) the beneficiary and the applicant while interrelated are separate, distinct and independent of one another.

An Issuing Bank is not a guarantor

 The concept of guarantee vis-a-vis the concept of irrevocable L/C is inconsistent with each other.
 L/Cs are primary obligations and not security contracts and while they are security arrangements,
they are not converted thereby into contracts of guaranty (MWSS v. Hon. Daway, G.R. No.160732,
June 21, 2004).
 The liability of issuing bank is primary and solidary. Neither is the issuing bank entitled to the
benefit of excussion.

Entitlement of a bank to reimbursement

 Once the issuing bank shall have paid the beneficiary after the latter’s compliance with the terms of the
L/C, the bank is entitled to reimbursement. Presentment for acceptance to the customer/applicant is
not a condition sine qua non for reimbursement (Prudential Bank v. IAC, G.R. No. 74886, December
8, 1992).

What is the participation of a confirming and advising bank?

 The Advising Bank

– is the bank in the country of the beneficiary which communicates to the beneficiary the notice of
the credit issued by the issuing bank

 The Confirming Bank

– is the bank that undertakes that the letter of credit will be fully paid.
– Usually the confirming bank is also the advising bank, otherwise it is utilized to lend credence to
the letter of credit issued by a lesser known issuing bank and is directly liable to the beneficiary.

THREE THINGS TO CONSIDER

1. What is the independence principle?

 The 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 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.

2. What is the strict compliance rule?

 The strict compliance rule in a letter of credit transaction means that the documents tendered by
the seller or beneficiary must strictly conform to the terms of the letter of credit, i.e., they must
include all documents required by the letter of credit.

3. What is the fraud exception?

 The fraud exception maintains that despite the bank’s unconditional obligation to pay the seller
upon presentation of the required documents, the issuing bank is not bound to pay when there
has been fraud by the seller.
 The test is whether, standing in the shoes of the paying bank at the time of payment, the fraud
was clear and obvious.
 If [the] fraud was clear and obvious, the bank pays the beneficiary at its own peril and it is not
entitled to reimbursement. But if [the] fraud is not clear and obvious, then it is not for a bank to
question why the parties involved had chosen to conduct their business in any particular way.

Transfield Philippines, Inc. vs. Luzon Hydro Corp.

GR. No. 146717, November 22, 2004
443 SCRA 307

Purpose of L/C
 The use of credits in commercial transactions serve to reduce the risk of non-payment of the
purchase price under the contract for the sale of goods. However, letters of credit are also used in
non-sale settings where they serve to reduce the risk of non-performance. Generally, credits in the
non-sale settings have come to be known as “standard credits”.

Nature of Letters of Credit as a Financial Device

 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 in control of the
goods before paying. The use of credits in commercial transactions serves to reduce the risk of

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 nonpayment of the purchase price under the contract of sale of the goods and to reduce the risk of
non-performance of an obligation in a non-sale setting.

Non-payment of the buyer of its obligation under the Letter of Credit does not give the bank the
right to take possession of the goods covered by the Letter of Credit
 The opening of a L/C does not vest ownership of the goods in the bank in the absence of a trust
receipt agreement.

Two-Fold nature of the Independence Principle

1. Independence in toto where the credit is independent from the justification aspect and is a separate
obligation from the underlying agreement. This principle is illustrated by standby L/C; or
2. Independence only as to the justification aspect which is identical with the same obligations under the
underlying agreement. This principle is illustrated by a commercial L/C or repayment standby.

The Exception to the Independence Principle (2010 Bar)

 The “Fraud Exception Principle” is the exception to the Independence Principle. It provides that the
untruthfulness of a certificate accompanying a demand for payment under a standby letter of credit
may qualify as fraud sufficient to support an injunction against payment.
 Under the fraud exception principle, the beneficiary may be enjoined from collecting on the letter of
credit if the beneficiary committed fraud by substituting fraudulent documents even if on their face
the documents complied with the requirements.
 This principle refers to fraud in relation with the independent purpose or character of the L/C and
not only fraud in the performance of the obligation or contract supporting the letter of credit

What is the effect of a stay order on beneficiary?

 In the case of MWSS v. Hon. Daway, 432 SCRA 599, it was held that the beneficiary of a stand-by
letter of credit can draw on the letter of credit even if the obligor is under a corporate rehabilitation
stay order because the prohibition under the rules is on the enforcement of claims against the
debtor, guarantors or sureties of the debtor whose obligations are not solidary with the debtor.

What is the effect of payment on an expired letter of credit?

 In the case of Rodzssen Company Inc. v. Far East Bank and Trust Company, 357 SCRA 618 it
was held that an issuing bank which paid the beneficiary of an expired letter of credit can recover
payment from the applicant who obtained the goods from the beneficiary to prevent unjust
enrichment.

Q: Can LC be accompanied by Trust Receipt? A: YES.

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TRUST RECEIPT
What is a trust receipt transaction?
 A trust receipt transaction is a transaction between parties known as an entruster and an entrustee
whereby the entruster, who owns or hold absolute title or security interests over certain specified
goods, documents or instruments, releases the same to the possession of the entrustee upon the
latter’s execution and delivery to the entruster of a trust receipt wherein the entrustee binds himself
to hold the specified goods, documents or instruments in trust for the entruster and to sell or
otherwise dispose of the goods, documents or instruments with the obligation to turn over to the
entruster the proceeds thereof to the extent of the amount owing to the entruster, or the goods,
documents or instruments themselves if they are unsold or not otherwise disposed of.

Two views regarding Trust Receipts

1. As a commercial document - the entrustee binds himself to hold the designated GDI in trust for
the entruster and to sell or otherwise dispose of GDI with the obligation to turn over to the entruster
the proceeds if they are unsold or not otherwise disposed of, in accordance with the terms and
conditions specified in the TR (P.D. 115, Sec. 4).
2. As a commercial transaction – It is a separate and independent security transaction intended to
aid in financing importers and retail dealers who do not have sufficient funds (Nacu v. CA, G.R. No.
108638, March 11, 1994).

PARTIES TO A TRUST RECEIPT TRANSACTION

1. Entruster - A lender, financer or creditor. Person holding title over the GDI subject of a TR
transaction; releases possession of the goods upon execution of TR (P.D. 115, Sec. 3[c]).
2. Entrustee - A borrower, buyer, importer or debtor. He is the person to whom the goods are
delivered for sale or processing in trust, with the obligation to return the proceeds of sale of the
goods or the goods to the entruster (P.D. 115, Sec. 3[b]).

What are the two basic obligations?

 There are two basic obligations that define a trust receipt transaction.
(a) The first is covered by a provision that refers to money under the obligation to deliver it
(entregarla) to the owner of the merchandise sold. (if not to sell, not a trust receipt)
(b) The second is covered by the provision referring to the merchandise received under the
obligation to return it (devolvera) to the owner.

 Thus, under the Trust Receipts Law, intent to defraud is presumed when:
(1) the entrustee fails to turn over the proceeds of the sale of the goods covered by the trust receipt;
(2) when the entrustee fails to return the goods under trust, if they are not disposed of in accordance
with the terms of the trust receipt.

What is the effect of the absence of an obligation?

 In the case of Land Bank of the Philippines v. Lamberto C. Perez, et.al., G.R. No. 166884, 672
SCRA 117, June 13, 2012, in all trust receipt transactions, both obligations on the part of the
(en)trustee exist in the alternative - the return of the proceeds of the sale or the return or recovery
of the goods, whether raw or processed. When both parties enter into an agreement knowing that
the return of the goods subject of the trust receipt is not possible even without any fault on the part
of the trustee, it is not a trust receipt transaction; the only obligation actually agreed upon by the
parties would be the return of the proceeds of the sale transaction. This transaction becomes a
mere loan (cannot be liable for estafa), where the borrower is obligated to pay the bank the amount
spent for the purchase of the goods.

What are the loan and security features of a trust receipt?

1) The loan feature of a trust receipt transaction lies in the manner it facilitates the importation or
purchase of merchandise by the extension of credit.
2) The security feature of a trust receipt lies in the fact that the imported or purchased merchandise
will serve as collateral for the credit extended and that the obligation of the entrustee is to deliver
the proceeds of their sale or return them if not sold.

What is meant by “security interest”?

 A Security Interest means a property interest in goods, documents or instruments to secure
performance of some obligations of the entrustee or of some third persons to the entruster and
includes title, whether or not expressed to be absolute, whenever such title is in substance taken
or retained for security only.

RIGHTS OF THE ENTRUSTER

1. To be entitled to the Proceeds from the sale of the GDI to the extent of the amount owing to him.

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 2. To the Return of the GDI in case of non-sale and enforcement of all other rights conferred to him
in the TR.
3. May Cancel the trust and take possession of the goods, upon default or failure of the entrustee to
comply with any of the terms and conditions of the TR (P.D. 115, Sec. 7).
4. To Sell the goods with at least five day notice to the entrustee and apply the proceeds in payment
of the obligation. Entrustee liable to pay deficiency, if any.

Obligations and Liabilitites of the Entrustee

1. To Hold GDI in trust for the entruster and to dispose of them strictly in accordance with the terms
of TR;
2. To Receive the proceeds of the sale for the entruster and to turn over the same to the entruster to
the extent of amount owing to the latter;
3. To Insure GDI against loss from fire, theft, pilferage or other casualties;
4. To Keep GDI or the proceeds thereof, whether in money or whatever form, separate and capable
of identification as property of the entruster;
5. To Return GDI to the entruster in case they could not be sold or upon demand of the entruster; and
6. To Observe all other conditions of the TR (P.D. 115, Sec. 9)

ELEMENTS ESTAFA IN TRUST RECEIPT

In order that the entrustee may be validly prosecuted for estafa under Art. 315, paragraph 1(b) of the RPC,
in relation with Sec. 13 of PD 115, the following elements must be established:
1. The entrustee Received the subject goods in trust or under the obligation to sell the same and to
remit the proceeds thereof to the entruster, or to return the goods if not sold;
2. The entrustee Misappropriated or converted the goods and/or the proceeds of the sale;
3. The entrustee performed such acts with Abuse of confidence to the damage and prejudice of
entruster; and
4. A Demand was made on the entrustee by entruster for the remittance of the proceeds or the return
of the unsold goods (Land Bank of the Philippines vs. Perez, GR No. 166884, June 13, 2012).

PENAL SANCTION WHEN THE OFFENDER IS A CORPORATION

 Though the entrustee is a corporation, nevertheless, the law specifically makes the officers,
employees or other officers or persons responsible for the offense, without prejudice to the civil
liabilities of such corporation and/or board of directors, officers, or other officials or employees
responsible for the offense.
 If the crime is committed by a corporation or other juridical entity, the directors, officers, employees
or other officers thereof responsible for the offense rshall be charged and penalized for the crime,
precisely because of the nature of the crime and the penalty therefor. A corporation cannot be
arrested and imprisoned; hence, cannot be penalized for a crime punishable by imprisonment
(Ching vs. Secretary of Justice, supra).

DEFENSES AVAILABLE TO NEGATE CRIMINAL LIABILITY OF THE ENTRUSTEE

1. Compliance with the terms of the TR either by payment, return of the proceeds or return of the
goods (P.D. 115, Sec. 13).
2. Consignment.
3. Cancellation of the TR agreement and taking into possession of the goods by the entruster.
NOTE: Repossession of the goods will extinguish only the criminal liability.
4. Compromise by parties before filing of information in court. Compromise of estafa case arising from
TR transaction, after the case has been filed in court does not amount to novation and does not
erase the criminal liability of the accused (Ong vs. CA, G.R. No. L-58476, September 2, 1983).
5. Non-receipt of the goods by the entrustee or where proof of delivery of goods to the accused is
insufficient. (Ramos vs. CA, supra).
6. Loss of goods without fault of the entrustee.
7. The transaction does not fall under PD 115 (Colinares vs. CA, G.R. No. 90828, September 5, 2000,
Consolidated Bank and Trust Corporation vs. CA, G.R. No. 114286, April 19, 2001).

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BANKING LAWS
REPUBLIC ACT NO. 7653
THE NEW CENTRAL BANK ACT
Declaration of Policy
— The State shall maintain a central monetary authority that shall function and operate as an
independent and accountable body corporate in the discharge of its mandated responsibilities concerning
money, banking and credit. In line with this policy, and considering its unique functions and
responsibilities, the central monetary authority established under this Act, while being a government-
owned corporation, shall enjoy fiscal and administrative autonomy.

Responsibility and Primary Objective

— The Bangko Sentral shall provide policy directions in the areas of money, banking, and credit. It shall
have supervision over the operations of banks and exercise such regulatory powers as provided in this
Act and other pertinent laws over the operations of finance companies and non-bank financial institutions
performing quasibanking functions, hereafter referred to as quasi-banks, and institutions performing
similar functions.

— The primary objective of the Bangko Sentral is to maintain price stability conducive to a
balanced and sustainable growth of the economy. It shall also promote and maintain monetary stability
and the convertibility of the peso.

Composition of the Monetary Board

— The powers and functions of the Bangko Sentral shall be exercised by the Bangko Sentral Monetary
Board, hereafter referred to as the Monetary Board, composed of seven (7) members appointed by the
President of the Philippines for a term of six (6) years.

— The seven (7) members are:

a) the Governor of the Bangko Sentral, who shall be the Chairman of the Monetary Board.
b) a member of the Cabinet to be designated by the President of the Philippines.
c) five (5) members who shall come from the private sector, all of whom shall serve full-time:

— Provided, however, That of the members first appointed under the provisions of this subsection, three
(3) shall have a term of six (6) years, and the other two (2), three (3) years.

— No member of the Monetary Board may be reappointed more than once.

Qualifications
— The members of the Monetary Board must be natural-born citizens of the Philippines, at least thirty-five
(35) years of age, with the exception of the Governor who should at least be forty (40) years of age, of
good moral character, of unquestionable integrity, of known probity and patriotism, and with recognized
competence in social and economic disciplines.

When does conservatorship occur?

Conservatorship takes place whenever a bank or quasi-bank is in a state of continuing inability or
unwillingness to maintain a condition of liquidity deemed adequate to protect the interest of depositors
and creditors.
It is an attempt to save the bank from bankruptcy and ultimate liquidation. It is helping the bank by
introducing effective management reforms and/or the infusion of capital.
A conservator may take over a bank or quasi-bank without the need of first declaring the bank insolvent
nor is the designation of a conservator a precondition to the designation of a receiver.
The period is 1 year.

When does receivership occur?

Receivership is defined as the summary closure of a bank without prior notice and hearing after a
finding that the continuance in business will involve probable loss to its depositors and creditors.
Prior notice and hearing is not required before placement of a bank under receivership.
The bank as a corporation is not deemed dissolved by a receivership nor does it interfere with the
exercise of corporate rights. It retains its corporate personality and can sue and be sued, but in any case
suit is to be initiated and prosecuted through the liquidator.

How are banks distinguished from quasi-banks?

Quasi-banks are entities engaged in the borrowing of funds through the issuance, endorsement or
assignment with recourse or acceptance of deposit substitutes for purposes of relending or purchasing of
receivables and other obligations.

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 Deposit substitutes is an alternative form of obtaining funds from the public, other than deposits,
through the issuance, endorsement, or acceptance of debt instruments from the borrower’s own account,
for the purpose of relending or purchasing receivables, and other obligations.
The distinction is that they do not accept deposits.

What is the nature of deposits?

As to nature, all kinds of deposits whether fixed or current are to be treated as loans and are to be
covered by the law on loan.
They are also considered in the nature of irregular deposits as they are really loans because they earn
interest. Considering a deposit involves the delivery of a thing for safekeeping with the obligation to return
the very same thing upon demand and a loan is a contract whereby one of the parties delivers to another
money or other consumable thing upon the condition that the same amount of the same kind and quality
shall be paid.

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