LETTER OF CREDIT:

a letter issued by one merchant to another for the purpose of attending to a

commercial transaction.

In banking practice, it is a request by one bank to another bank to advance or

give money to a third person on the basis of the letter and on the credit of the
person issuing it.

A letter of credit is a letter issued by a banker to a person to whom credit is given authorizing drafts on the

issuing bank or on a bank in the person's country up to a certain sum and guaranteeing to accept the drafts

provided the drafts are appropriately made. A letter of credit may also be issued from a bank to a bank or

other party abroad authorizing payment of a specified amount of money to a person named in the letter. A

letter of credit is different from a bill of exchange. A letter of credit is not negotiable but is cashable only by

the paying bank. There are two types of letters of credit namely commercial and traveller’s letter of credit.

Commercial letters of credit are used mainly by exporters who seek a guarantee that they will be paid before

they ship goods. Traveller’s letters of credit are issued for the benefit of foreign travelers.

Pursuant to the Uniform Commercial Code, the term "Letter-of-credit right" means a right to payment or

performance under a letter of credit, whether or not the beneficiary has demanded or is at the time entitled

to demand payment or performance. However, the term does not include the right of a beneficiary to

demand payment or performance under a letter of credit.

PARTIES TO A LETTER OF CREDIT:

1. Buyer - who procures the letter of credit and obliges himself to reimburse the
issuing bank upon receipt of the document�s title;

2. Issuing bank - which undertakes to pay the seller upon receipt of the draft and
proper documents of titles and to surrender the documents to the buyer upon
reimbursement; and

3. Seller - who in compliance with the contract of sale ships the goods to the
buyer and delivers the documents of title and draft to the issuing bank to recover
payment.

The number of the parties may be increased and may include:

1. Advising (notifying) bank - may be utilized to convey to the seller the existence
of the credit.
2. Confirming bank - which will lend credence to the letter of credit issued by a
lesser known issuing bank; the confirming bank is directly liable to pay the seller-
beneficiary;
3. Paying bank - which undertakes to encash the drafts drawn by the
exporter/seller
4. Instead of going to the place of the issuing bank to claim payment, the buyer
may approach another bank, termed the negotiating bank to have the draft
discounted (Charles Lee v. CA, GR No. 117913 February 1, 2002)

ESSENTIAL CONDITIONS OF A LETTER OF CREDIT:

1. Issued in favor of a definite person and not to order. In effect, it is not a
negotiable instrument governed by the Negotiable Instruments Law.
2. Limited to fixed or specified amount, or to one or more amounts, but with
maximum stated limit. If any circumstance is missing, the letter is a mere letter of
recommendation (Article 568, Code of Commerce)

INDEPENDENCE PRINCIPLE:

INDEPENDENCE PRINCIPLE in a letter of credit transaction means that a bank, in

determining compliance with the terms of a letter of credit is required to examine
only the shipping documents presented by the seller and is precluded from
determining whether or not the main contract is actually accomplished or not.