1. HK and SHANGHAI BAKING CORP. vs.

NSC and BPI

The nature of a letter of credit

Definition: A letter of credit is a commercial instrument developed to address the unique needs
of certain commercial transactions. Sanctioned in jurisprudence and rticle 56763 of the Code of
Commerce
" ... 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."

When does it arises: generally arises out of a separate contract requiring the assurance of
payment of a third party.

3 transactions and 3 parties involved:

1. Contract of sale between buyer and seller - may require that the buyer obtain a letter of
credit from a third party acceptable to the seller. The obligations of the parties under this
contract are governed by our law on sales

2. Issuance of Letter of Credit between buyer and issuing bank - The buyer requests the issuing
bank to issue a letter of credit naming the seller as the beneficiary. the issuing bank
undertakes to pay the seller upon presentation of the documents identified in the letter of
credit. The buyer, on the other hand, obliges himself or herself to reimburse the issuing
bank for the payment made.

3. Issuance of Issuing bank of Letter of Credit to benefit of seller - not strictly contractual since
there is no privity of contract nor meeting of the minds between them, not constitute a
stipulation pour autrui in favor of the seller since the issuing bank must honor the drafts
drawn against the letter of credit regardless of any defect in the underlying contract, neither
is it assignment by the buyer to the seller-beneficiary as the buyer himself cannot draw on
the letter. not a contract of suretyship or guaranty since it involves primary liability in the
event of default

Its 2 legal underpinnings:

a. letters of credit, as will be further explained, are governed by recognized international
norms which dictate strict compliance with its terms; and
b. the issuing bank has an existing agreement with the buyer to pay the seller upon proper
presentation of documents.

Step-by-step transaction:
a) Once the seller ships the goods,

b) He or she obtains the documents required under the letter of credit.

c) 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.

d) The issuing bank then holds on to these documents which the buyer needs in order to claim the
goods shipped.
e) The buyer reimburses the issuing bank for its payment at which point the issuing bank releases
the documents to the buyer.

f) The buyer is then able to present these documents in order to claim the goods. At this point, all
the transactions are completed.
g) The seller received payment for his or her performance of his obligation to deliver the goods.
h) The issuing bank is reimbursed for the payment it made to the seller. The buyer received the
goods purchased.

Kinds of correspondent bank- which facilitates the ease of completing the transactions
1. A notifying bank undertakes to inform the seller-beneficiary that a letter of credit exists. It
may also have the duty of transmitting the letter of credit. As its obligation is limited to this
duty, it assumes no liability to pay under the letter of credit;
2. A negotiating bank, on the other hand, purchases drafts at a discount from the seller-
beneficiary and presents them to the issuing bank for payment. 79 Prior to negotiation, a
negotiating bank has no obligation. A contractual relationship between the negotiating bank
and the seller-beneficiary arises only after the negotiating bank purchases or discounts the
drafts; and
3. a confirming bank may honor the letter of credit issued by another bank or confirms that
the letter of credit will be honored by the issuing bank. 81 A confirming bank essentially
insures that the credit will be paid in accordance with the terms of the letter of credit.82 It
therefore assumes a direct obligation to the seller-beneficiary.

the standard of care imposed on banks engaged in business imbued with public interest applies
to them. Banks have the duty to act with the highest degree of diligence in dealing with clients.

Through a letter of credit, a seller-beneficiary is assured of payment regardless of the status of

the underlying transaction

issuing banks respect their obligation to pay, and that seller-beneficiaries may reasonably expect
payment, in accordance with the terms of a letter of credit.