VI.

LETTERS OF CREDIT
A. Definition and nature of letter of credit
Under Philippine banking law, particularly governed by the Uniform Customs
and Practice for Documentary Credits (UCP 600), a Letter of Credit (LC) is a
binding commitment by a bank, issued on behalf of a buyer (applicant),
ensuring that payment will be made to the seller (beneficiary) upon
presentation of specified documents, as long as they meet the LC’s
conditions. This mechanism is widely used in international trade for its
security and predictability in payment transactions.
In the Philippines, the LC is governed by the General Banking Law of 2000
(Republic Act No. 8791) and its implementing rules. Local regulations align
with international standards set by UCP 600, allowing for consistency and
reliability in trade transactions involving Philippine banks.
Types of Letters of Credit:
 Revocable and Irrevocable: Most LCs issued by banks in the Philippines
are irrevocable, meaning they cannot be amended or canceled without
the beneficiary's consent. This aligns with standard international
banking practice.
 Confirmed and Unconfirmed: A confirmed LC has an additional
guarantee from a second bank (confirming bank), which may be useful
for Philippine exporters needing added payment security.
 Standby and Commercial: In the Philippines, standby LCs function as a
backup to ensure performance, while commercial LCs are used directly
in the transaction to facilitate payment.
 Transferable and Non-transferable: Transferable LCs are allowed in the
Philippines, allowing the original beneficiary to transfer part or all of
the credit to another party, though these LCs may be subject to
specific conditions imposed by the issuing bank.

B. Parties to a letter of credit

 Applicant (Buyer): The buyer or importer who requests the issuance
of the LC.
 Issuing Bank: The bank (usually in the applicant’s country) that
issues the LC. Philippine banks often act as issuing banks for importers
in local transactions.
 Beneficiary (Seller): The seller or exporter entitled to receive
payment upon compliance with the LC terms.
  Confirming Bank: In cases where additional security is required, a
confirming bank, usually in the beneficiary's country, guarantees
payment alongside the issuing bank.
 Advising Bank: This bank, typically located in the beneficiary’s
country, communicates the LC terms to the beneficiary. In the
Philippines, this bank ensures transparency and clear communication
without bearing any payment obligation.
 Nominated Bank: The bank authorized by the issuing bank to pay or
negotiate the LC. This could be the advising bank or another
authorized bank in the beneficiary’s location.

C. Basic principles of letter of credit

1. Autonomy Principle: The LC is independent from the sales contract
between the buyer and seller. Philippine courts uphold this autonomy,
ensuring that banks are not liable for disputes on goods’ quality or
quantity.
2. Strict Compliance: The beneficiary must meet all terms and
conditions precisely for the bank to release funds. Philippine banks
follow the “doctrine of strict compliance,” meaning documents
presented must match the LC terms exactly.
3. Documentary Compliance: Philippine banks rely solely on
documentation to verify compliance. They are not responsible for
physically inspecting the goods, minimizing risks and focusing on
paper-based validation.
4. Irrevocability: In the Philippines, most LCs are irrevocable unless
stated otherwise, ensuring stability and predictability in international
and domestic trade.
5. Governing Standards (UCP 600 and BSP Circulars): Letters of
credit in the Philippines are regulated under UCP 600, with additional
oversight by the Bangko Sentral ng Pilipinas (BSP), the central bank,
which issues circulars to govern the conduct of banks issuing LCs.

D. Warehouseman’s Lien (Act No. 2137)

Under Act No. 2137, also known as the Warehouse Receipts Law, Philippine
law provides the warehouseman a lien on goods stored in their warehouse
for all lawful charges and expenses related to the goods’ storage, care, and
sale. This lien:
  Extends to expenses for maintaining or safeguarding the goods, giving
the warehouseman the right to retain the goods until payments are
settled.
 Remains enforceable against third parties if the goods are sold, unless
the warehouse receipt is transferred free of lien as stated in the
warehouse receipt.
The Warehouseman’s Lien is pivotal in securing interests in storage-related
transactions, aligning with banking laws by supporting collateralized lending
and financial security for banks and financial institutions when dealing with
stored goods.

i. Transfield Phils vs. Luzon Hydro Corp., November 22, 2004

Facts: Transfield Philippines and Luzon Hydro Corporation entered into a
contract where Transfield was to construct a hydroelectric plant for Luzon
Hydro. Disputes arose during the project, leading Transfield to claim
additional compensation for alleged variations in the work. Luzon Hydro,
however, denied Transfield’s claims and argued that the contract did not
support the additional compensation sought. The parties attempted to
resolve their disputes through arbitration as stipulated in their agreement,
but further issues arose regarding the scope of arbitration and the proper
venue.

Issue: Whether the disputes between Transfield and Luzon Hydro regarding
additional compensation and contract interpretation should be resolved
through arbitration.

Ruling: The Supreme Court held that arbitration was the appropriate means
of resolving the disputes between Transfield and Luzon Hydro. The Court
emphasized the validity of the arbitration clause in their contract, which both
parties voluntarily agreed to as a mechanism for settling disagreements. It
ruled that the arbitration should cover all disputed claims regarding the
additional compensation and contract interpretation. The Court underscored
that arbitration clauses in contracts are to be respected to uphold parties’
autonomy in choosing how to settle their conflicts, affirming the
enforceability of arbitration agreements in contractual disputes.
ii. Feati Bank & Trust vs. CA, April 30, 1991
Facts: Feati Bank issued a letter of credit on behalf of a local buyer to pay for
goods from a foreign supplier. The buyer later instructed the bank to stop
payment due to issues with the goods' quality. However, the seller's bank,
relying on the letter of credit, sought payment from Feati Bank, which
refused. The seller’s bank argued that the letter of credit was an
independent obligation of Feati Bank and that it was entitled to payment
regardless of disputes between the buyer and seller.

Issue: Whether Feati Bank could refuse payment under the letter of credit
based on the buyer’s instruction to stop payment due to issues with the
goods.

Ruling: The Supreme Court ruled in favor of the seller's bank, affirming that a
letter of credit is an independent contract between the issuing bank and the
beneficiary. It serves to guarantee payment as long as the terms of the letter
are complied with, regardless of any disputes between the buyer and the
seller regarding the goods. The Court emphasized that the independence
principle is a cornerstone of the letter of credit system, meant to facilitate
smooth international transactions. Therefore, Feati Bank could not refuse
payment, as its obligation under the letter of credit was independent of the
buyer’s disputes with the seller.

iii. Landl & Co. vs. Metrobank, July 30, 2004

Facts: Landl & Co., an importer, secured a letter of credit from Metrobank to
facilitate payment for goods purchased from an international supplier. After
receiving the goods, Landl & Co. alleged that the shipment did not meet the
agreed quality standards and subsequently instructed Metrobank to withhold
payment under the letter of credit. Metrobank, however, proceeded with the
payment to the supplier, arguing that its obligation under the letter of credit
was independent and irrevocable, regardless of disputes about the goods'
quality.

Issue: Whether Metrobank, as the issuing bank, was obligated to pay under
the letter of credit despite Landl & Co.'s claim of non-compliance by the
supplier regarding the quality of goods.
Ruling: The Supreme Court ruled in favor of Metrobank, upholding the
independence principle of letters of credit. It emphasized that the bank’s
obligation under a letter of credit is separate from the underlying contract
between the buyer and the seller. As long as the seller complied with the
documentary requirements stipulated in the letter of credit, Metrobank was
bound to honor it, irrespective of any quality issues raised by Landl & Co.
The Court clarified that disputes over the quality of goods are matters
between the buyer and seller and do not affect the bank's duty to pay under
the letter of credit. Thus, Metrobank was correct in fulfilling its obligation.

iv. Metrobank vs. Ley Construction, December 3, 2014

Facts: Metrobank issued a letter of credit for Ley Construction, which was
used to pay a supplier for materials needed for a construction project. Upon
receipt of the goods, Ley Construction claimed that the materials delivered
did not meet the specifications required for the project. Consequently, Ley
Construction instructed Metrobank to withhold payment, arguing that the
supplier had breached the underlying contract due to non-compliance with
the agreed quality. Metrobank, however, insisted on fulfilling the payment
under the letter of credit terms, emphasizing the independence of its
obligation.

Issue: Whether Metrobank was obligated to proceed with payment under the
letter of credit despite Ley Construction’s claim that the goods did not meet
contractual specifications.

Ruling: The Supreme Court ruled in favor of Metrobank, reaffirming the

independence principle in letters of credit. The Court held that the bank’s
obligation to honor the letter of credit is independent of the buyer-supplier
contract. As long as the supplier complied with the documentary
requirements of the letter of credit, Metrobank was bound to make payment,
irrespective of any disputes regarding the quality or compliance of the
goods. The Court underscored those issues related to the quality of goods
must be resolved between the buyer and the supplier, separate from the
bank’s obligation under the letter of credit. Therefore, Metrobank acted
correctly in adhering to its independent contractual duty.
v. HSBC vs. National Steel Corp., February 24, 2016
Facts: HSBC issued a letter of credit in favor of National Steel Corporation
(NSC) to pay for machinery purchased from an international supplier. After
the machinery was shipped and documents were presented to HSBC for
payment, NSC alleged that the machinery did not meet the agreed
specifications and directed HSBC to stop payment. HSBC, however, argued
that its obligation under the letter of credit was independent of the
underlying sales contract and that, as long as the documents conformed to
the terms of the letter of credit, it was required to make the payment.

Issue: Whether HSBC was obligated to pay under the letter of credit despite
NSC’s claim of non-compliance with the specifications of the purchased
machinery.

Ruling: The Supreme Court ruled in favor of HSBC, emphasizing the

independence principle governing letters of credit. The Court held that
HSBC’s duty to honor the letter of credit was separate from the underlying
sales contract between NSC and the supplier. As long as the documents
presented were in strict compliance with the terms of the letter of credit,
HSBC was required to make the payment. The Court reiterated that disputes
regarding the quality or specifications of the goods do not affect the bank's
independent obligation under the letter of credit, and any issues regarding
the performance of the sales contract should be resolved directly between
the buyer and the seller. Thus, HSBC was justified in fulfilling its payment
obligation.

vi. PNB vs. San Miguel, January 15, 2014

Facts: Philippine National Bank (PNB) issued a letter of credit in favor of a
supplier on behalf of San Miguel Corporation (SMC) for the purchase of
materials. SMC later found that the goods delivered by the supplier did not
meet the specifications agreed upon in the sales contract. SMC instructed
PNB to withhold payment, arguing that the supplier had breached the
contract by failing to deliver conforming goods. PNB maintained that it was
bound to honor the letter of credit as long as the documents presented
complied with its terms, regardless of the quality issues raised by SMC.
Issue: Whether PNB was required to make payment under the letter of credit
despite SMC’s claim that the goods did not meet contractual specifications.

Ruling: The Supreme Court ruled in favor of PNB, upholding the principle of
independence in letters of credit. The Court held that PNB’s obligation to pay
under the letter of credit was separate and distinct from the underlying sales
contract between SMC and the supplier. Since the documents submitted
complied strictly with the requirements of the letter of credit, PNB was
obligated to honor it, irrespective of any dispute about the quality or
conformity of the goods. The Court reaffirmed that issues related to product
quality or compliance must be resolved directly between the buyer and the
seller, and do not affect the bank's independent obligation under the letter of
credit. Thus, PNB was correct in proceeding with the payment.

vii. Bangayan vs. RCBC, 04 April 2011

Facts: Bangayan opened a letter of credit with Rizal Commercial Banking
Corporation (RCBC) to facilitate payment for imported goods. When the
goods arrived, Bangayan claimed they were defective and did not conform to
the agreed quality specifications. He then instructed RCBC to withhold
payment under the letter of credit, arguing that the goods’ quality issues
constituted a breach of contract by the supplier. RCBC, however, insisted on
its obligation to honor the letter of credit, emphasizing that it was
independent of the underlying sales agreement.

Issue: Whether RCBC was obligated to proceed with payment under the
letter of credit despite Bangayan’s claim of defective goods.

Ruling: The Supreme Court ruled in favor of RCBC, affirming the

independence principle of letters of credit. The Court held that RCBC’s
obligation to honor the letter of credit was separate from any disputes
concerning the goods between Bangayan and the supplier. Since the
documents presented were in strict compliance with the letter of credit's
terms, RCBC was required to make the payment. The Court emphasized that
issues regarding the quality or condition of goods are matters between the
buyer and the seller and do not affect the bank's independent obligation to
pay under the letter of credit. Thus, RCBC was justified in honoring its
payment obligation despite Bangayan's complaints about the goods.
viii. Land Bank vs. Monet’s Export, 10 March 2005
Facts: Monet’s Export secured a loan from Land Bank, using its future export
proceeds as collateral, and a letter of credit was issued in favor of Monet’s
Export for the importation of goods. Upon arrival, Monet’s Export alleged that
the goods were substandard and instructed Land Bank not to release
payment to the supplier, claiming breach of contract due to non-conforming
goods. Land Bank argued that under the independence principle of letters of
credit, it was obligated to pay once the required documents, strictly
complying with the letter of credit terms, were presented.

Issue: Whether Land Bank was required to release payment under the letter
of credit despite the alleged non-conformity of goods.

Ruling: The Supreme Court ruled in favor of Land Bank, underscoring the
independence principle governing letters of credit. The Court held that Land
Bank’s obligation to pay was distinct from the underlying transaction
between Monet’s Export and the supplier. Since the documents submitted by
the supplier met the requirements stipulated in the letter of credit, Land
Bank was bound to make the payment, regardless of any disputes over the
goods' quality. The Court emphasized that quality or compliance disputes
should be resolved between the buyer and the supplier and do not impact
the bank’s obligation to honor the letter of credit. Thus, Land Bank was
correct in proceeding with the payment.

ix. Bank of America vs. Court of Appeals, 10 December 1993

Facts: A letter of credit was issued by Bank of America on behalf of a
Philippine company to facilitate the importation of goods. Upon presentation
of the required documents, Bank of America made payment to the foreign
supplier. However, the Philippine company later contested the transaction,
claiming the goods were defective and did not comply with their contractual
specifications. They argued that Bank of America should have withheld
payment due to these defects in the goods. Bank of America, however,
asserted that its obligation under the letter of credit was independent of the
underlying sales contract and that it was bound to honor the letter as long as
the documents strictly conformed to its terms.
Issue: Whether Bank of America was required to make payment under the
letter of credit despite the alleged defects in the goods.

Ruling: The Supreme Court ruled in favor of Bank of America, reaffirming the
independence principle that governs letters of credit. The Court held that the
bank's obligation to honor a letter of credit is independent of the underlying
contract between the buyer and seller. Since the supplier’s documents met
the strict compliance requirements of the letter of credit, Bank of America
was obligated to proceed with payment. The Court emphasized that any
disputes regarding the goods' quality or conformity are matters between the
buyer and the seller, which do not affect the bank’s duty to honor the letter
of credit. Consequently, Bank of America was correct in fulfilling its payment
obligation under the letter of credit.