SPECIAL COMMERCIAL LAWS

Commercial Credit

Commercial Credit

A letter of credit (LC) is a financial document that facilitates international as well as domestic trade. It substitutes
the bank credit for the credit of the customer. There are two basic types of letters of credit – commercial
and standby. The commercial LC is the primary mechanism of payment while the standby LC is a secondary
mechanism.

1. Concept

A letter of credit (LC) is an operative document or a letter of notification of a bank to one or more of its
correspondent banks, certifying that the person or firm whose name appears therein, is entitled to draw on its credit
up to a certain maximum amount under expressed terms and conditions.

Letters of credit (L/C) is a written instrument whereby the writer requests or authorizes the addressee to pay money
or deliver goods to a third person, and assumes responsibility for payment of debt therefor to the addressee.
[Transfield Philippines v. Luzon Hydro, G.R. No. 146717 (2004)]

A L/C is a financial device developed by merchants as a convenient and relatively safe mode of dealing with sales of
goods. The buyer is required to contract a bank to issue a L/C in favor of the seller so that, by virtue of the L/C, 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 L/C. [Bank of America v. CA, G.R. No. 105395 (1993)]

It is a letter of accommodation of a bank to a specific client and it is being conveyed to another bank. The terms of
accommodation are clearly stipulated in the said letter. It described the following:
(1) product being purchased;
(2) quantity;
(3) manner of packaging;
(4) pricing;
(5) mode of payment;
(6) documentary requirements to facilitate its shipment, etc.

From the point of view of the Opening Bank (Importer’s Bank), an LC is a contingent liability since the actual credit
has not been drawn until the exporter or its bank collects the payment through their account. Therefore, due to
the contingent liability factor, a client must first secure a credit line from its bank in order to open and negotiate
LC transactions.

LC dealings follow international standards. It is particularly covered by the International Chamber of Commerce –
Uniform Customs and Practices (ICC-UCP) and International Standards Banking Practices (ISBP). These rules
apply to any Documentary Credit unless modified or excluded. The latest revisions of the standards are incorporated
under UCP 600 and ISBP 2007. It became effective last July 2007 and will be the standard International rules for
the next 10 years.

Purpose:
Its purpose is to substitute for, and support, the agreement of the buyer-importer to pay money under a contract
or other arrangement, but does not necessarily constitute as a condition for the perfection of such arrangement.
[Reliance Commodities, Inc. v. Daewoo Industrial Co., Ltd., G.R. No. L-100831 (1993)]

Essential Conditions of Letters of Credit:

1. Issued in favor of a definite person and not to order.
2. Limited to a fixed and specified amount, or to one or more undetermined amounts, but within a
maximum the limits of which has to be stated exactly.

Those which do not have one of these conditions shall be mere letters of recommendation. [Art. 568, Code of
Commerce]

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SPECIAL COMMERCIAL LAWS
Commercial Credit

2. The Parties Involved in Letter of Credit (elements)

a. Importer/applicant/buyer
The buyer in the business transaction; one who procures the LC and obliges himself to reimburse the issuing
bank upon receipt of documents of title.

b. Issuing bank/opening bank/buyer’s or importer’s bank

The bank which is usually the buyer’s bank and actually issues the LC. [Lee v. CA, G.R. No. 117913 (2002)]

It undertakes:
1. To pay the seller upon receipt of the draft and proper documents of title; and
2. To surrender the documents to the buyer upon reimbursement.

The obligation of the issuing bank to pay the seller is direct, primary, absolute, definite and solidary with the
buyer, in the absence of stipulation in the letter of credit. [Metropolitan Waterworks and Sewerage System v.
Daway, G.R. No. 160732 (2004)]

An issuing bank that paid the beneficiary of an expired letter of credit can recover from the applicant-buyer,
who obtained goods from the beneficiary to prevent unjust enrichment. [Rodzssen Supply Co. v. Far East Bank
& Trust Co., G.R. No. 109087 (2001)]

The issuing bank provides an assurance to the beneficiary that the payment will be paid duly if all the documents
presented comply with the stipulations stated in the letter of credit. The issuing bank also needs to examine the
documents submitted by the beneficiary. It is absolutely liable to pay once all the terms and conditions in the
LC are complete.

c. Exporter/beneficiary/seller
One who ships the goods to the buyer in compliance with a contract of sale and delivers the documents of title
and draft to the issuing bank to recover payment.

The seller of the goods and services and the ultimate recipient of payment in the business transaction. The
beneficiary needs to provide all the required documents for the letter of credit to be processed.

d. Advising or notifying bank/the reimbursing or paying bank

The advising bank advises the beneficiary and helps him to use the letter of credit. It pays the beneficiary once
the issuing bank makes the payment. It also has the responsibility to send the required documents to the issuing
bank. The advising bank has no obligation to pay if the issuing bank is unable to pay the beneficiary.

The bank which conveys to the seller the existence of the credit.

The bank assumes no liability except to notify and/or transmit to the seller the existence of the letter of credit.
It is not privy to the contract of sale between the buyer and the seller. Its relationship is only with that of the
issuing bank.

The bank may suggest to the seller its willingness to negotiate, but this fact alone does not imply that the
notifying bank promises to accept the draft drawn under the documentary credit. [FEATI Bank and Trust Co.
v. CA, G.R. No. 94209 (1991)]

The services of the notifying bank must always be utilized if the letter of credit is to be advised to the beneficiary
through cable. [Lee v. CA, G.R. No. 117913 (2002)]

e. Government agencies and other related instrumentalities e.g. Bureau of Customs, Society of General
Surveillance (SGS), Shipping Lines, Airlines, Customs’ Broker, Banking Institutions, etc.

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SPECIAL COMMERCIAL LAWS
Commercial Credit

Import-Export Cycle

(1) The importer and exporter sign an agreement or finalize their international contract. The terms and
conditions are clearly stipulated and translated into a Purchase Order (PO), Sales Contract (SC), Sales
Invoice (SI), or Commercial Invoice (CI).
(2) The importer approaches its bank and applies for the opening of the LC.
(3) Assuming the credit line or a case to case facility was approved for the said purpose, and is in order,
the importer’s bank opens the LC and notifies its correspondent bank which can either be the exporter’s
bank or the reimbursing bank.
(4) The exporter’s bank will notify/advise the exporter that an LC was issued in its favor. Usually, the advising
bank is also the negotiating bank. But the exporter may opt to negotiate the LC with another bank.
(5) Upon receipt of the advise, the exporter starts manufacturing the goods or products ordered.
(6)
a. The finishing goods will then be transported and loaded on board the vessel or aircraft; and
b. Simultaneous with the loading, the original documents are secured from the shipping or airline
company or other relevant institutions to be forwarded to the Exporter’s Bank (Bill of Lading, Packing
List, Consular Invoice, Insurance, etc.).
(7)
a. Goods are transported from point of origin to point of destination;
b. Exporter’s bank sends the export documents to the importer’s bank for collection; and
c. Upon arrival of goods at point of destination (wharf/dock/pier) these are transferred and stored in a
warehouse.
(8) Upon receipt of the documents, the importer’s bank informs the importer about the arrival of said
documents. It is ministerial upon the importer’s bank to review the documents and identify if there are any
major or minor discrepancies. This will facilitate the decision making of the importer on whether to pay or
reject the documents. Under the new rules, the decision to accept or reject the documents can be made
within 5 banking days from receipt of said documents. Otherwise, it will be deemed accepted and therefore
should be paid.
(9) Once payment is made, the documents are released to the importer by the importer’s bank.
(10)Importer pays the remaining balance of the duties and taxes.
(11) Once duties and taxes have been cleared and all documents submitted and presented to the shipping/airline
company, the goods will now be released in favor of the importer.

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SPECIAL COMMERCIAL LAWS
Commercial Credit

3. Usual Charges of LCs

(1) Opening commissions

(2) Cable or postage
(3) Marginal deposit
(4) Import duties/tariffs (Import Entry Declaration or IED)
(5) Transit interest
(6) Commitment fees
(7) Swap charges

4. How LCs and Non-LCs are Communicated

The LCs and Non-LC businesses are transmitted and received by the parties through the expertise of their respective
banking institutions. Banks oftentimes avail of the services of Society of Worldwide Interbank Financial
Telecommunication (SWIFT), which provides a network that enables financial institutions worldwide to send and
receive information about financial transactions in a secure, standardized and reliable environment.

Information under LC and Non-LC transactions are verified and authenticated by the contracting banks through
the signatures of authorized bank officers of their respective international departments. Test keys or codes
intimately shared by the parties due to their existing correspondent banking relationship are likewise verified and
authenticated. Customarily, the documents under LC and Non-LC transactions are sent through ship or airplane as
they are circumspectly handled by global couriers or package delivery companies.

5. Significant Points to Consider

There are two prerequisites to issuing an LC:

1. The importer should secure an approved credit line from its bank which can accommodate any LC openings
under a Letter of Credit – Trust Receipt (LC-TR) facility,
2. The accommodating bank should have a framework agreement or correspondent banking relationship with
the exporter’s bank. This will simplify the transaction inasmuch as the two banks can directly negotiate with
one another, It should be noted that the main element of correspondent banking relationship is the
maintenance of depositary accounts (nostro-vostro accounts). These accounts will facilitate the settlement of
international transactions between the contracting parties.

In case the bank nominated by the exporter has no correspondent banking relationship with the issuing bank,
the immediate solution then is to locate the reimbursing bank. The latter will serve as the conduit between
the importer’s bank and exporter’s bank as they are similarly situated in terms of correspondent banking
relationship. Both the importer and exporter banks should maintain an account with the reimbursing bank. All
settlement and communications should be coursed through the reimbursing bank. The importer and exporter
should understand that passing through a reimbursing bank entails additional cost. It is logical for the
reimbursing bank to collect the cost of reimbursement which may be tucked in to the LC or paid separately by
either party.

6. Importance of Letter of Credit

Letter of credit advantages for the seller

1. The seller has the obligation of buyer’s banks to pay for the shipped goods;
2. Reducing the production risk, if the buyer cancels or changes his order
3. The opportunity to get financing in the period between the shipment of the goods and receipt of payment
(especially, in case of deferred payment).
4. The seller is able to calculate the payment date for the goods.
5. The buyer will not be able to refuse to pay due to a complaint about the goods

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SPECIAL COMMERCIAL LAWS
Commercial Credit

Letter of credit advantages for the buyer

1. The bank will pay the seller for the goods, on condition that the latter presents to the bank the determined
documents in line with the terms of the letter of credit;
2. The buyer can control the time period for shipping of the goods;
3. By a letter of credit, the buyer demonstrates his solvency;
4. In the case of issuing a letter of credit providing for delayed payment, the seller grants a credit to the buyer.
5. Providing a letter of credit allows the buyer to avoid or reduce pre-payment.

Reference:
https://www.mondaq.com/turkey/international-trade-investment/100456/advantages-of-using-letter-of-
credit-in-international-transactions (Retrieved 13 September 2021)

7. Important Features

1. Confirmed
If it is confirmed, it simply means that the issuing bank or the advising bank or both, adds their guarantee to
the LC transaction. Confirmation eliminates the risk of non-delivery and non-payment of goods.

2. Unconfirmed
No guarantee is added to the instrument, thus making it vulnerable for credit risk factors.

3. Revocable
An LC can be cancelled or withdrawn by any of the contracting parties without the consent of either.

4. Irrevocable
An LC can only be cancelled or withdrawn with the consent of the contracting parties of the bank.

Under the Revised Uniform Customs and Practices for Documentary Credits 2007—ICC Publication No. 600, all
Letters of Credit must be confirmed and irrevocable.

8. Kinds of LCs

1. Sight LC
The LC must be settled or paid by the importer upon sight of the documents from the importer bank’s counter.

2. Usance LC
The settlement of the LC will be based on the actual Bill of Lading or loading date, e.g., 60 days, 90 days or 180
days from the Bill of Lading date.

3. Deferred LC
The settlement of the LC is on installment basis, for example 3 months, 4 months, 12 months to pay from date
of opening, bill of lading date or upon arrival of goods. Payments can be made equally or based on an agreed
repayment schedule.

4. Domestic LC
In this case, the buyer and the seller are both situated in the local market. Seller can simply negotiate and collect
payment by proceeding directly to the opening bank or buyer’s bank and present the required documents
(usually the Sales Contract/Commercial/Sales Invoice, Delivery Receipt, Official or Acknowledgement Receipt).

5. Stand-by LC
This is a mode of performance guarantee issued by the bank for and in behalf of its client in favor of another
entity (e.g. supplier, service provider, technology transfer, etc.) for the satisfaction and fulfillment of a given
obligation under a specific agreement or contract.

It is a contingency liability of the bank. Actual liability only happens when the client fails to perform its
contractual obligation thus, allowing the aggrieved party to enforce its right and collect against the SBLC.

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SPECIAL COMMERCIAL LAWS
Commercial Credit

9. Related Transactions

a. Trust Receipt (TR)

An importer may settle his obligation with the exporter through any of the following:
(1) Allow its bank to debit its account;
(2) Book a loan and use the proceeds for the said purpose; or
(3) Enter into a TR agreement with the bank.

The latter means that the importer is allowed to take physical possession of the imported merchandise
although the legal title or ownership of the goods remain with the bank. The nature of the agreement is in the
form of a consignor-consignee relationship. At the time of opening, the LC provides that the owner of the goods
or the consignee will be the importer’s bank. This practice assures the importer’s bank that in case the importer
fails to comply with the LC, refuses to pay or simply abandons the goods, the bank as the real owner may assume
physical possession and monetize it through actual sale and disposition of the items. Thereafter, the bank will
hand to the importer the proceeds if the sale of the items, net of their projected income.

b. Bank Guarantee
A Bank Guarantee (BG) is issued by the importer’s bank in such instance wherein the imported goods arrive in
advance, prior to the prescribed documents such as the bill of lading/airway bill, packing list, commercial
invoice, etc. With a bank guarantee, the importer can have the goods released in the absence of the original
documents. The bank then issues a Ship Side Bond (SSB) or BG in favor of the shipping company.

c. Export Transactions
Exporters always want to get paid upon delivery. Negotiation commences when all export documents specified
under the LC have been collated and submitted to the exporter’s bank, which in turn, reviews the documents
before sending it for collection to the importer’s bank. All discrepancies are communicated to the exporter for
purposes of correction. Even if the exporter fails to rectify the reported discrepancies, the documents will be
sent for collection anyway. From then on, the exporter waits for the payment to be credited to his account.

d. Export Financing

i. Buyer’s Credit
This occurs when the importer is in dire need of the exporter’s commodities to the point that they are willing
to advance the payment to the exporter. The amount of financing the importation depends on the degree of
necessity for the commodities/items/goods.

ii. Back to Back Facility

Subject to the exporter’s bank’s flexibility in its credit accommodation procedure, the following documents
are accepted as collaterals:
 Purchase Orders (POs)
 Sales Contracts (SCs)
 Commercial Invoice (CI)
 Import Letters of Credit (ILCs)

This allows the exporter to open its own ILC to procure raw materials to manufacture the goods.

iii. Packing Credit Loan/Pre-Shipment Facility

The exporter bank advances the funds to finance the manufacturing of the products order of the importer.
This is called pre-shipment loan. This can also be secured by POs, SCs, CI and ILCs.

iv. Post Shipment/Rediscounting Facility

This accommodation is applicable after the goods are shipped/delivered to the importer. It can be sent for
collection or purchased outright by the exporter bank (export bills purchase) or the exporter can use the
export documents and have it rediscounted under the BSP rediscounting window. Initially the commercial
banks will do the advance payment to the exporter and then forward the documents to BSP for rediscounting
purposes. This facility is in sync with the objective of the government to boost the morale of the exporters

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SPECIAL COMMERCIAL LAWS
Commercial Credit

and encourage them to generate more business for the benefit of our economy. Since the booking originates
from private banks, the loan will be priced based on commercial rates. But once rediscounted with BSP, the
interest rates will be reduced by using the BSP pass on rate plus a minimal spread allowed for
conduit banks to generate a reasonable income.

10. Non-LC Transactions

Non-LC transactions are those which are not guaranteed or confirmed by the banks. Yet, these still pass through
the international department of the banks. Hence, there arises the risk of non-payment or non-delivery.

a. Open Account/Direct Remittances

Direct remittances or payments are made to the exporter prior to the delivery of goods/commodities. This non-
LC transaction is usually practiced by companies or individuals affiliated with each other, e.g. sister companies
or affiliates doing business with one another.

b. Documents against Payment

This transaction is similar to a Sight LC. The importer is under obligation to pay the exporter upon sight of the
documents. The importer’s bank will only release the documents upon receipt of payment. In case of default or
non-delivery/discrepancy in the delivery by the exporter, the importer’s bank is under no obligation to
reimburse since it is not a related party in interest.

c. Documents against Acceptance

This transaction is similar to a usance LC. The ministerial function of the importer’s bank is to release the
documents to the importer against his acceptance of liability to pay the exporter upon maturity, based on the
agreed terms and conditions of their contract. Again, in case of nonpayment or delay on the part of the importer,
the bank cannot be held primarily nor secondarily liable since they are not a related party in interest in the said
transaction.

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