LETTERS OF CREDIT AND TRUST RECEIPTS
I. LETTERS OF CREDIT AND TRUST RECEIPTS
Definition and Nature
Letters of credit (L/C) are those issued by one merchant to
another, or for the purpose of attending to a commercial
transaction. (Art. 567, Code of Commerce)
A letter of credit is one whereby one person requests some
other person to advance money or give credit to a third
person, and promises that he will repay the same to the
person making the advancement, or accept the bills drawn
upon himself for the like amount. (Campos, Notes and
Selected Cases on Negotiable Instruments Law)
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, 2004).
An engagement by a bank or other person made at the
request of a customer that the issuer shall honor drafts or
other demands of payment upon compliance with the
conditions specified in the credit (Prudential Bank v.
Intermediate Appellate Court, 1992).
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., 1993)
ESSENTIAL REQUISITES 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)
NATURE
(1) Financial device – L/Cs are 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. (Bank of America, NT&SA v. Court of Appeals, 1993)
A letter of credit is one of the modes of payment, set out in
Sec. 8, Central Bank Circular No. 1389, "Consolidated
Foreign Exchange Rules and Regulations," dated 13 April
1993, by which commercial banks sell foreign exchange to
service payments for, e.g., commodity imports (Reliance
Commodities v. Daewoo, 1993).
(2) Composite of three distinct contracts – An L/C
transaction involves three distinct but intertwined
relationships:
(a) First Contract between the party applying for the
L/C (buyer/importer/account party) and the party
for whose benefit the L/C is issued
(seller/exporter/beneficiary).
(b) Second Contract between the buyer and the
issuing bank. This contract is sometimes called
the "Application and Agreement" or the
"Reimbursement Agreement".
(c) Third Contract between the issuing bank and the
seller, in order to support the contract, under (a)
above (Reliance Commodities v. Daewoo, 1993).
TYPES OF LETTERS OF CREDIT AS TO THE TYPE OF THE
MAIN CONTRACT:
(1) Commercial L/C – The main transaction involves a
contract of sale. The credit is payable upon the presentation
by the seller of documents that show he has taken
affirmative steps to comply with the sales agreement. The
beneficiary of a commercial credit must demonstrate by
documents that he has performed his contract (Transfield
Philippines v. Luzon Hydro, 2004).
(2) Standby L/C – Used in non-sale settings. The credit is
payable upon certification of a party's nonperformance of
the agreement. The creditor-beneficiary of the standby
credit must certify that the debtor-applicant has not
performed the principal obligation. (Transfield Philippines v.
Luzon Hydro, 2004).
AS TO REVOCABILITY:
(1) Revocable L/C – One which can be revoked by the
issuing bank without the consent of the buyer and
seller
(2) Irrevocable L/C – One which the issuing bank
cannot revoke without the consent of the buyer
and seller (Feati Bank and Trust Co. v. CA, 1991)
AS TO THE OBLIGATION ASSUMED BY CORRESPONDENT
BANK:
(1) Unconfirmed L/C – One which continues to be the
obligation of the issuing bank
(2) Confirmed L/C – One which is supported by the
absolute assurance to the beneficiary that the
confirming bank will undertake the issuing bank's
obligation as its own according to the terms and
conditions of the credit (Feati Bank and Trust Co.
v. CA, 1991)
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Parties to a Letter of Credit
RIGHTS AND OBLIGATIONS OF THE PARTIES
There are at least three parties to a letter of credit:
(1) Buyer/Exporter/Account Party – one who
procures the letter of credit and obliges himself
to reimburse the issuing bank upon receipt of
documents of title.
(2) Issuing Bank – the bank which undertakes:
(a) to pay the seller upon receipt of the draft and
proper documents of title; and
(b) 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 (MWSS v. Daway, 2004)
(3) Seller/Importer/Beneficiary – 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.
Depending on the transaction, the number of
parties to the letter of credit may be increased.
Thus, the different types of correspondent banks:
(4) Advising/Notifying Bank – 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.
A notifying bank is not a privy to the contract of
sale between the buyer and the seller, its
relationship is only with that of the issuing bank
and not with the beneficiary to whom he assumes
no liability. 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, 1991).
(5) Confirming Bank – the bank which lends credence
to the letter of credit issued by a lesser known
issuing bank.
The bank assumes a direct obligation to the seller
and its liability is a primary one as if the bank itself
had issued the letter of credit (Feati Bank and
Trust Co. v. CA, 1991).
(6) Negotiating Bank – the bank which discounts the
draft presented by the seller.
The bank buys or discounts a draft under the
letter of credit. Its liability is dependent upon the
stage of the negotiation. If before negotiation, it
has no liability with respect to the seller but after
negotiation, a contractual relationship will then
prevail between the negotiating bank and the
seller (Feati Bank and Trust Co. v. CA, 1991).
(7) Paying Bank – the bank which undertakes to
encash the drafts drawn by the seller.
Basic Principles of Letter of Credit
DOCTRINE OF INDEPENDENCE – The principle of
independence assures the seller or 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.
Under this principle, banks assume no liability or
responsibility for the form, sufficiency, accuracy,
genuineness, falsification or legal effect of any documents,
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 whomsoever
(Transfield Philippines v. Luzon Hydro, 2004; Bank of
America, NT&SA v. Court of Appeals, 1993).
The concept of guarantee vis-a-vis the concept of an
irrevocable credit are inconsistent with each other. In the
first place, the guarantee theory destroys the
independence of the bank's responsibility from the contract
upon which it was opened. In the second place, the nature
of both contracts is mutually in conflict with each other. In
contracts of guarantee, the guarantor's obligation is merely
collateral and it arises only upon the default of the person
primarily liable. On the other hand, in an irrevocable credit
the bank undertakes a primary obligation. (Feati v. CA,
1991)
The independent nature of the letter of credit may be:
(1) Independent in toto - the credit is independent
from the justification aspect and is a separate
obligation from the underlying agreement;
(2) 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.
(Transfield Philippines v. Luzon Hydro, 2004; Bank
of America, NT&SA v. Court of Appeals, 1993).
FRAUD EXCEPTION PRINCIPLE – The principle that limits the
application of the independence principle only to instances
where it would serve the commercial function of the credit
and not when fraud attends the transaction.
In the case of Transfield Philippines v. Luzon Hydro, 2004,
the petitioner alleged misrepresentation as constituting
fraud. The Court, however, made no ruling as to whether
the same indeed constitutes fraud.
The case asserts that the "fraud exception" exists when the
beneficiary, for the purpose of drawing on the credit,
fraudulently presents to the confirming bank, documents
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that contain, expressly or by implication, material
representations of fact that to his knowledge are untrue. In
such a situation, petitioner insists, injunction is recognized
as a remedy available to it.
Citing Dolan's treatise on letters of credit, petitioner argues
that the independence principle is not without limits and it
is important to fashion those limits in light of the principle's
purpose, which is to serve the commercial function of the
credit. If it does not serve those functions, application of the
principle is not warranted, and the common law principles
of contract should apply. (Transfield Phils. v. Luzon Hydro,
2004)
DOCTRINE OF STRICT COMPLIANCE – The settled rule in
commercial transactions involving letters of credit requires
that the documents tendered by the seller must strictly
conform to the terms of the letter of credit.
Otherwise, the issuing bank or the concerned
correspondent bank is not obliged to perform its
undertaking under the contract.
The tender of documents by the beneficiary (seller) must
include all documents required by the letter. A
correspondent bank which departs from what has been
stipulated under the letter of credit, as when it accepts a
faulty tender, acts on its own risks and it may not thereafter
be able to recover from the buyer or the issuing bank, as
the case may be, the money thus paid to the beneficiary
(Feati v. CA, 1991).
Concept of Trust Receipt Transaction
A Trust Receipt Transaction is any transaction by and
between an entruster and another person as entrustee,
whereby the entruster, who owns or holds absolute title or
security interests over certain specified goods, documents
or instruments, releases the same to the possession of the
entrustee upon the latter's execution and delivery to the
entruster of a signed document called a trust receipt [Sec.
4, PD 115 (Trust Receipts Law)].
A Trust Receipt is a written or printed document signed by
the entruster wherein the entrustee binds himself:
(1) to hold the designated goods, documents or
instruments in trust for the entruster; and
(2) to sell or otherwise dispose of the goods,
documents or instruments with the obligation to
turn over to the entruster the proceeds thereof to
the extent of the amount owing to the entruster
or as appears in the trust receipt or the goods,
documents or instruments themselves if they are
unsold or not otherwise disposed of, in
accordance with the terms and conditions
specified in the trust receipt (Sec. 4)
LOAN/SECURITY FEATURE
A letter of credit-trust receipt arrangement is endowed
with its own distinctive features and characteristics. Under
that set-up, a bank extends a loan covered by the letter of
credit, with the trust receipt as a security for the loan. In
other words, the transaction involves a loan feature
represented by the letter of credit, and a security feature
which is in the covering trust receipt. A trust receipt,
therefore, is a security agreement, pursuant to which a
bank acquires a "security interest" in the goods (Vintola v.
IBAA, 1987)
A trust receipt arrangement does not involve a simple loan
transaction between a creditor and debtor-importer. Apart
from a loan feature, the trust receipt arrangement has a
security feature that is covered by the trust receipt itself.
That second feature is what provides the much needed
financial assistance to our traders in the importation or
purchase of goods or merchandise through the use of those
goods or merchandise as collateral for the advancements
made by a bank. The title of the bank to the security is the
one sought to be protected and not the loan which is a
separate and distinct agreement (People v. Nitafan, 1992)
OWNERSHIP OF THE GOODS, DOCUMENTS AND
INSTRUMENTS UNDER A TRUST RECEIPT
Entrustee is the factual owner of the goods, documents and
instruments (Prudential Bank v. NLRC). Entruster is the real
owner of the goods, documents and instruments “A trust
receipt transaction, within the meaning of this Decree, is
any transaction…whereby the entruster, who owns or holds
absolute title or security interests over certain specified
goods, documents or instruments...” (Sec. 4)
Note: “Security Interest” means a property interest in
goods, documents or instruments to secure performance of
some obligations of the entrustee or of some third persons
to the entruster and includes title, whether or not
expressed to be absolute, whenever such title is in
substance taken or retained for security only.
“Accordingly, in order to secure that the banker shall be
repaid at the critical point — that is, when the imported
goods finally reach the hands of the intended vendee — the
banker takes the full title to the goods at the very beginning;
he takes it as soon as the goods are bought and settled for
by his payments or acceptances in the foreign country, and
he continues to hold that title as his indispensable security
until the goods are sold.”
“[I]n a certain manner, (trust receipt contracts) partake of
the nature of a conditional sale as provided by the Chattel
Mortgage Law, that is, the importer becomes absolute
owner of the imported merchandise as soon as he has paid
its price. The ownership of the merchandise continues to be
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vested in the owner thereof or in the person who has
advanced payment, until he has been paid in full, or if the
merchandise has already been sold, the proceeds of the
sale should be turned over to him by the importer or by his
representative or successor in interest.” (Prudential Bank v.
NLRC, 1995)
Note: In the earlier cases of Vintola v. IBAA (1987) and Abad
v. Court of Appeals (1990), the Supreme Court held that the
entrustee becomes the absolute owner of the goods,
documents and instruments, the entruster being a mere
security holder.
Rights of the Entruster
VALIDITY OF THE SECURITY INTEREST AS AGAINST THE
CREDITORS OF THE ENTRUSTEE/ INNOCENT PURCHASERS
FOR VALUE
The entruster shall have the following rights:
(1) Right to the proceeds from the sale of the goods,
documents or instruments released under a trust
receipt to the entrustee to the extent of the
amount owing to the entruster or as appears in
the trust receipt; OR Right to the return of the
goods, documents or instruments in case of non-
sale; AND
(2) Right to the enforcement of all other rights
conferred on him in the trust receipt provided
such are not contrary to the provisions of the TRL.
(3) Right to cancel the trust and take possession of
the goods, documents or instruments subject of
the trust or of the proceeds realized therefrom at
any time upon default or failure of the entrustee
to comply with any of the terms and conditions of
the trust receipt or any other agreement between
the entruster and the entrustee.
(4) Right to sell the goods, documents or instruments
at public or private sale at least five days notice to
the defaulting entrustee of the intention to sell.
(5) Right to purchase the goods, documents or
instruments at a public sale.
(6) Right to recover the deficiency from the entrustee
should the proceeds of the sale not be sufficient
(Sec. 7)
Obligation and Liability of the Entrustee
OBLIGATIONS OF THE ENTRUSTEE
(1) To hold the goods, documents or instruments in
trust for the entruster and shall dispose of them
strictly in accordance with the terms and
conditions of the trust receipt;
(2) To receive the proceeds in trust for the entruster
and turn over the same to the entruster to the
extent of the amount owing to the entruster or as
appears on the trust receipt;
(3) To insure the goods for their total value against
loss from fire, theft, pilferage or other casualties;
(4) To keep said goods or proceeds thereof whether
in money or whatever form, separate and capable
of identification as property of the entruster;
(5) To return the goods, documents or instruments in
the event of non-sale or upon demand of the
entruster; and
(6) To observe all other terms and conditions of the
trust receipt not contrary to the provisions of the
TRL. (Sec. 9)
LIABILITIES OF THE ENTRUSTEE
(1) Liability for Loss - The risk of loss shall be borne by
the entrustee. Loss of goods, documents or
instruments which are the subject of a trust
receipt, pending their disposition, irrespective of
whether or not it was due to the fault or
negligence of the entrustee, shall not extinguish
his obligation to the entruster for the value
thereof (Sec. 10)
(2) Liability for failure to turn over proceeds of sale or
to return – The failure shall constitute the crime
of estafa, punishable under Art. 315 (b) of the
Revised Penal Code (Sec. 13)
Note: Penal sanction if offender is a corporation: If the
violation or offense is committed by a corporation,
partnership, association or other juridical entities, the
penalty shall be imposed upon the directors, officers,
employees or other officials or persons therein responsible
for the offense, without prejudice to the civil liabilities
arising from the criminal offense (Sec. 13)
Remedies Available:
(1) In case of default or failure of the entrustee to
comply with the trust receipt agreement -
Entruster may cancel the trust receipt agreement,
take possession of the goods, documents,
instruments, and sell the same at any private or
public sale at least five days from notice of
intention to sell to the entrustee.
The proceeds of any such sale, whether public or
private, shall be applied (a) to the payment of the
expenses thereof; (b) to the payment of the
expenses of re-taking, keeping and storing the
goods, documents or instruments; (c) to the
satisfaction of the entrustee's indebtedness to
the entruster (Sec. 7)
(2) In case of loss of the goods, documents,
instruments - Entruster may claim damages from
the entrustee (Sec.10)
(3) In case of failure to turn over proceeds of the sale
of the goods, documents or instruments or to
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return the same in case of non-sale - Entruster

may file a criminal complaint for estafa (Art. 315
(b) of the Revised Penal Code) against the
entrustee (Sec. 13)

Warehouseman’s Lien

A warehouseman shall have a lien on goods deposited or on

the proceeds thereof in his hands:

(1) For all lawful charges for storage and

preservation of the goods;
(2) For all lawful claims for money advanced, interest,
insurance, transportation, labor, weighing,
coopering and other charges and expenses in
relation to such goods;
(3) For all reasonable charges and expenses for
notice, and advertisements of sale; and
(4) For sale of the goods where default had been
made in satisfying the warehouseman's lien (Sec.
27)
Notes:
(1) General rule: A warehouseman shall have lien
only for charges for storage of goods subsequent
to the date of the receipt.
(2) Exception: When the receipt expressly
enumerated other charges provided under Sec.
27 even though the amounts thereof are not
stated in the receipt. (Sec. 30)

However, whether a warehouseman has or has not a lien

upon the goods, he is entitled to all remedies allowed by law
to a creditor against a debtor for the collection from the
depositor of all charges and advances which the depositor
has expressly or impliedly contracted with the
warehouseman to pay (Sec. 32).

(1) Against what property the lien may be enforced:

(a) Against all goods, whenever deposited,
belonging to the person who is liable as debtor for
the claims in regard to which the lien is asserted,
and (b) Against all goods belonging to others
which have been deposited at any time by the
person who is liable as debtor for the claims in
regard to which the lien is asserted if such person
had been so entrusted with the possession of
goods that a pledge of the same by him at the
time of the deposit to one who took the goods in
good faith for value would have been valid (Sec.
28)
(2) Satisfaction of the lien by sale: In accordance with
the terms of a notice so given, a sale of the goods
by auction may be had to satisfy any valid claim
of the warehouseman for which he has a lien on
the goods.