3. Transfield vs. Luzon Hyrdo Corp.

Applicability of the independence principle and fraud exception rule in letters of credit.
What the LoC is NOT:
- The relationship between the beneficiary and the issuer of a letter of credit is not strictly
contractual, because both privity and a meeting of the minds are lacking, yet strict
compliance with its terms is an enforceable right.
- Nor is it a third-party beneficiary contract, because the issuer must honor drafts drawn
against a letter regardless of problems subsequently arising in the underlying contract.
- Since the banks customer cannot draw on the letter, it does not function as an assignment
by the customer to the beneficiary.
- Nor, if properly used, is it a contract of suretyship or guarantee, because it entails a primary
liability following a default.
- Finally, it is not in itself a negotiable instrument, because it is not payable to order or bearer
and is generally conditional, yet the draft presented under it is often negotiable.

As defined 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.[30] 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.

Standby Credits - 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

3 difference between Commercial and Stanby Credits:

1. Payment:
a. Commercial credits involve the payment of money under a contract of sale.

2. Standby type, the credit is payable upon certification of a party's nonperformance of the
agreement.

3. Effects of documents involved

a. Commercial credits become payable upon the presentation by the seller-beneficiary of
documents that show he has taken affirmative steps to comply with the sales
agreement.
b. The documents that accompany the beneficiary's draft tend to show that the applicant
has not performed

4. Beneficiary:
a. Commercial credit must demonstrate by documents that he has performed his contract.
b. standby credit must certify that his obligor has not performed the contract

Definition: a letter of credit 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

Change of nature: A letter of credit, however, changes its nature as different transactions occur
and if carried through to completion ends up as a binding contract between the issuing and
 honoring banks without any regard or relation to the underlying contract or disputes between
the parties thereto.

Mode of international trade transaction: Since letters of credit have gained general
acceptability in international trade transactions, the ICC has published from time to time
updates on the Uniform Customs and Practice (UCP) for Documentary Credits to standardize
practices in the letter of credit area. the observance of the UCP is justified by Article 2 of the
Code of Commerce which provides that in the absence of any particular provision in the Code of
Commerce, commercial transactions shall be governed by usages and customs generally
observed.

Types of independent nature of LoC:

1. independence in toto where the credit is independent from the justification aspect and is a
separate obligation from the underlying agreement like for instance a typical standby; or
2. Independence may be only as to the justification aspect like in a commercial letter of credit
or repayment standby, which is identical with the same obligations under the underlying
agreement.

In both cases the payment may be enjoined if in the light of the purpose of the credit the
payment of the credit would constitute fraudulent abuse of the credit

Effect of when credit is stipulated as irrevocable, there is a definite undertaking by the issuing
bank to pay the beneficiary provided that the stipulated documents are presented and the
conditions of the credit are complied with.[41] Precisely, the independence principle liberates the
issuing bank from the duty of ascertaining compliance by the parties in the main contract. As the
principles nomenclature clearly suggests, the obligation under the letter of credit is independent
of the related and originating contract. In brief, the letter of credit is separate and distinct from
the underlying transaction.

While it is the bank which is bound to honor the credit, it is the beneficiary who has the right to
ask the bank to honor the credit by allowing him to draw thereon