Transfield Philippines, Inc. v. Luzon Hydro Corp.

GR No. 146717 (22 November 2004)

Tinga J. kmd

SUBJECT MATTER: Special Laws; Letters of Credit; Independence Principle

CASE SUMMARY:
Transfield, as a contractor, undertook to construct a hydro-electric power station and complete the same on or before June 1,
2000. To secure the performance of its obligation. Transfield opened 2 letters of credits from ANZ Banking Group and Security
Bank in favor of Luzon. Nonetheless, Transfield was unable to complete the project on the target date allegedly due to force
majeure. Both Transfield and Luzon filed before separate arbitration tribunals, ICC and CIAC respectively, to determine whether
force majeure would justify the delay. Pending the arbitration proceeding, Transfield filed a complaint for preliminary injunction
against the respondent banks to restrain them from paying on the securities and also against Luzon to prevent it from calling on
the securities. RTC issued a TRO but denied the application for writ of preliminary injunction. CA affirmed RTC. N.B. When the
TRO expired, Luzon was able to withdraw from ANZ.
DOCTRINES:
Under the independence principle, banks assume no liability or responsibility for the form, sufficiency, accuracy, genuineness,
falsification or legal effect of any document, or for the general and/or particular conditions stipulated in the documents or
superimposed thereon, nor do they assume any liability or responsibility for the description, quantity, weight, quality, condition,
packing, delivery, value or existence of the goods represented by any documents, or for the good faith or acts and/or omissions,
solvency, performance or standing of the consignor, the carriers, or the insurers of the goods, or any other person.
The independence principle liberates the issuing bank from the duty of ascertaining compliance by the parties in the main
contract.
PARTIES:
Petitioner: Transfield Philippines, Inc. (Transfield)
Luzon Hydro Corporation (Luzon)
Respondents: Australia and New Zealand Banking Group Ltd. (ANZ)
Security Bank Corporation (SBC)
FACTS:
Transfield and Luzon entered into a Turnkey Contract whereby Transfield undertook, as a contractor, to construct a 70-
Megawatt hydro-electric power station at the Bakun River in Benguet and Ilocos Sur.
The contract provides that:
(1) the target completion date of the project is on June 1, 2000, or such date as may be agreed upon; and
(2) petitioner is entitled to claim extensions of time (EOT) for reasons enumerated in the contract e.g. variations, force
majeure, and delays caused by Luzon itself.
It was also agreed upon that in case of dispute, the parties are bound to settle their differences through mediation,
conciliation and such other means enumerated in the contract.
To secure the performance of the obligation, Transfield opened in favor of Luzon, 2 standby letters of credits with ANZ and SBC,
each in the amount of US$8.99M.
Nonetheless, in the course of construction, Transfield sought various EOT to complete the project. The request for extensions
were allegedly due to force majeure occasioned by typhoon Zeb, barricades, and demonstrations, which prevented the on-time
completion of the project.
Luzon denied Transfield’s requests for EOT.
Luzon filed a Request for Arbitration before the Construction Industry Arbitration Commission (CIAC), while Transfield filed a
Request for Arbitration before the International Chamber of Commerce (ICC). These arbitration proceedings would resolve the
issues: (1)WON the alleged forcemajeure would justify the EOT sought by Transfield, (2)WON Luzon had the right to terminate
the contract for Transfield’s failure to complete the project on target date.
Meanwhile, Transfield wrote letters to ANZ and SBC advising them of the arbitration proceedings. Transfield asserted that Luzon
had no right to call on the securities until the resolution of the issued before CIAC and ICC. Transfield also warned the banks that
any transfer, release, or disposition of the securities in favor of Luzon would constrain it to hold respondent banks liable for
liquidated damages.
Despite the Transfield’s letters, the banks informed Transfield that they would pay on the Securities if and when Luzon calls on
them.
Transfield filed a complaint for injunction with prayer for TRO and writ of preliminary injunction before the RTC. Transfield
sought to restraint banks from calling on the securities and the respondent banks from paying on the securities.
RTC –denied the application for writ of preliminary injunction. Applying the “Independent Contract” principle, Luzon should be
allowed to draw on the securities for liquidated damages. Banks were mere custodians of the funds and were obligated to
transfer the same to the beneficiary for as long as the latter could submit the required certification of its claims. Luzon, as the
ultimate beneficiary, may also invoke the “independent contract” principle.
CA - issued a TRO but failed to act on the application for preliminary injunction until the TRO expired.
N.B. As soon as the TRO expired, Luzon went to ANZ bank and withdrew US$ 4.9M.
- CA affirmed RTC decisions; Luzon could call on the securities pursuant to the first principle in credit law that the credit itself
is independent of the underlying transaction and that as long as the beneficiary complied with the credit.

ISSUE/S:
1. WON the “Independence Principle” on Letter of Credit may be invoked by a beneficiary. (YES)
2. WON injunction is the proper remedy to restrain the allegedly wrongful draws on the securities. (NO)
Petitioner’s argument:
 RTC and CA improperly relied on the “independence principle” on the letters of credit when this case falls within the
“fraud exception rule”.
 Luzon knowing misinterpreted the existence of delay despite its knowledge that the issue was still pending arbitration
to be able to draw against the securities.
 Luzon should be ordered to return proceeds of the securities.
 Injunction was the appropriate remedy obtainable from the local courts.
Respondent SBC’s argument:
 Invoking the independence principle, it was under no obligation to look into the validity or accuracy of the certification
submitted by Luzon or into the latter’s capacity or entitlement to so certify.
Respondent ANZ’s argument:
 Its actions could not be regarded as unjustified in the view of the prevailing independence principle under which it had
no obligation to ascertain the truth of Luzon’s allegations (Similar to SBC)

HOLDING/RATIO:
1. Yes, the beneficiary can invoke the independence principle.

In a letter of credit transaction where the 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, and particularly, the independence principle liberates the issuing bank from the duty of
ascertaining compliance by the parties of the main contract. As it is, the independence doctrine works for the benefit
of both issuing bank and the beneficiary.

To say that the independence principle may only be invoked by the issuing banks would render nugatory the
purpose for which the letters of credit are used in commercial transactions. Letters of credit are employed by the
parties desiring to enter into commercial transactions, not for the benefit of the issuing bank but mainly for the benefit
of the parties of the original transaction. With the letter of credit, the party who obtained the letter of credit may
present it to the beneficiary as a security to convince the latter to enter into the business transaction. On the other
hand, the beneficiary can be rest assured of being empowered to call on the letter of credit as a security in case the
commercial transaction does not push through, or the party who presented the letter of credit fails to perform his part.

Prior resolution of any dispute before beneficiary is entitled to call on the letter of credit would convert it into a mere
guarantee.

In this case, the Court ruled that ANZ and SBC banks were left with little or no alternative but to honor the credit and
that it was “ministerial for them to honor the call for payment. Also, Luzon’s right to call on the securities was rooted
on the following provisions of the contract:
… provide security to the Employer in the form of 2 irrevocable and confirmed standby letters of credit …
… if the contractor fails to comply, the contractor shall pay the Employer by way of liquidated damages …
 … Employer may deduct the amount of such damages by drawing on the security …

2. No, injunction is not a remedy in this case.

Fraud is an exception to the independence principle and the remedy for fraudulent abuse is injunction. However,
injunction should not be granted unless: (a) there is a clear proof of fraud; (b) the fraud constitutes fraudulent abuse of
the independent purpose of the letter of credit and not only fraud under the main agreement; and (c) irreparable injury
might follow if injunction is not granted or the recovery of damages would be seriously damaged.

In this case, Transfield failed to show that it has a clear and unmistakable right to restrain Luzon’s call on the securities.
The contract was plain and unequivocal in that it conferred upon Luzon the right to draw upon the securities in case of
default. Also, nothing in the contract would indicate that all disputes regarding delay should first be settled through
arbitration before Luzon would be allowed to call upon the securities.

WHEREFORE, the instant petition is DENIED, with costs against petitioner.

Notes:
 Letter of Credit is:
o Not strictly contractual because privity and meeting of the minds are lacking.
o Not a contract of suretyship or guaranty because it entails a primary liability following a default.
o Not a negotiable instrument because it is not payable to order or bearer, and is generally conditional.
o 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.
Commercial credits Standby Credits
Involve payment of money under a contract of sale
Becomes payable upon presentation by the seller- Payable upon certification of a party’s nonperformance of
beneficiary of the documents that show he has taken the agreement;
affirmative steps to comply with the sales agreement. Documents that accompany the beneficiary’s draft tend to
show that the applicant has not performed.
Beneficiary of commercial credit must demonstrate by Beneficiary of the standby credit must certify that his
documents that he has performed his contract. obligor has not performed the contract.
 In a standby type of letter of credit, the credit is payable upon certification of a party’s nonperformance of the agreement.
 The independence principle assures the beneficiary of prompt payment independent of any breach of the main contract
and precludes the issuing bank from determining whether the main contract is actually accomplished or not.
o Bank assumes no liability or responsibility for the form, sufficiency, accuracy, genuineness, falsification or legal
effect of any documents, or for the generals and/or particular conditions stipulates in the documents.
 Independent nature maybe:
o Independence in toto – credit is independent from the underlying agreement (e.g. standby letter of credit).
o Independence as to the justification aspect only – e.g in a commercial letter of credit or repayment standby,
which is identical with the same obligations under the underlying agreement.