LETTERS OF CREDIT Atty. Myra-Diwata R.

ARTICLE 567-572, Caroy

Professor

CODE OF COMMERCE
 LETTER OF CREDIT (ART. 567)

In a perfect example of a non-definition, the Code of

Commerce describe letters of credit as “ Those issued by one
merchant to another or for the purpose of attending to a
commercial transaction.” More helpful to an understanding of
what a letter of credit is are these statements made by the
Supreme Court:
LETTER OF CREDIT (ART. 567)

• Prudential Bank vs. IAC, et al., G.R. 74886, December 8, 1992 –

A letter of credit is an engagement by a bank or other person
made at request of a customer that the issuer will honor drafts
or other demands for payment upon compliance with the
conditions specified in the credit. Through a letter of credit, the
bank merely substitutes its own promise to pay for the promise
to pay of one of its customer who in return promises to pay the
bank the amount of funds mentioned in the letter of credit plus
credit or commitment fees mutually agreed upon.
LETTER OF CREDIT (ART. 567)
* Bank of America NT & SA vs. CA. et al., G.R. No. 105395, December
10, 1993 – 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. To
break the impasse, the buyer may be required to contract a bank to
issue a letter of credit in favor of the seller so that, by virtue of the
letter of credit, the issuing bank can authorized the seller to draw
drafts and engage to pay them upon their presentment
simultaneously with the tender of documents required by the letter of
credit. The buyer and the seller agree on what documents are to be
presented for payment, but ordinarily they are documents of title
evidencing or attesting to shipment of the goods to the buyer.
Once the credit is established, the seller ships the goods to the
buyer and in the process secures the required shipping
documents of title. To get paid, seller executes a drafts and
present it together with the required documents to the issuing
bank. The issuing bank redeems the draft and pays cash to
the seller if it finds that the documents submitted by the seller
conform with what letter of credit requires. The bank then
obtains possession of the documents upon paying the seller.
LETTER OF CREDIT (ART. 567)

It is an instrument issued by a bank that guarantees its client’s ability

to pay for imported goods or services, by authorizing a person to
draw drafts on the bank or its correspondents for the bank’s account,
under conditions specified in the letter of credit.

It is a bank’s written engagement made at the clients’s request that the

banks will honor draft or other demands for payment in compliance
with the conditions specified in the letter of credit.
 GOVERNING LAWS ON LETTER OF
CREDIT
a) Articles 567 – 572 of the Code of Commerce, which provides a skeletal
introduction to the subject of letters of credit;
b) The Uniform Customs and Practice for Documentary Credits issued by the
International Chamber of Commerce, which reflects accepted commercial
usage and practice on the subject of letters of credit and application of
which in the Philippines has been acknowledge by the Supreme Court
based on Article 2 of the Code of Commerce which provides that in the
absence of any applicable provision in the Code of Commerce, commercial
transaction shall be governed by the usages generally observed.
 THE ESSENTIAL CONDITIONS OF A
LETTER OF CREDIT (ART. 568)

a) It be issued in favor of definite person and not to order; and

b) It be limited to afixed and specified amount, or to one more undetermined
amounts, but within a maximum the limits of which has to be stated exactly.
WHEN A LETTER OF CREDIT
BECOMES VOID (ART. 572)

A letter of credit becomes void if the bearer of a letter of credit does

not make use thereof within the period agreed upon with the drawer,
or, in default of a period fixed, within 6 months, counted from its date,
in any point in the Philippines, and within 12 months any where outside
thereof, it shall be void in fact and in law.
THE BASIC PARTIES TO A LETTER
OF CREDIT
a) The buyer (applicant/importer), who procures the
letter of credit and obliges himself to reimburse the
issuing bank upon receipt of the documents of titles;
b) The bank issuing the letter of credit, 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
c) The seller (beneficiary/exporter), who is 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.
HOW ARE THEIR REPRESENTATIVE
RELATIONSHIPS GOVERNED?

a) Issuing bank and applicant/ buyer/ importer – Their relationships

is governed by the terms of the application and agreement for
the issuance of the letter of credit by the bank.
b) Issuing bank and beneficiary/ seller/ exporter – Their
relationship is governed by the terms of the letter of credit issued
by the bank.
c) Applicant and beneficiary – Their relationship is governed by the
sales contract.
CONTRACTS IN A LETTER OF
CREDIT ARRANGEMENT
1. CONTRACT OF SALE between the buyer and the seller whereby
the seller binds himself to ship the goods to the buyer and deliver the
documents of title and draft to the issuing bank to recover payment.
2. CONTRACT OF BUYER WITH ISSUING BANK (usually
accompanied by a Trust Receipt over the goods purchased/imported)
whereby the buyer obliges himself to reimburse the bank upon receipt
of the documents of title.
3. LETTER OF CREDIT PROPER where the issuing bank promises to
pay the seller pursuant to terms and conditions stated therein.
 HOW DOES IT WORK?

Foreign Seller

Contract of Sale Letter of Credit Proper

Importer Bank

Reimbursement
Agreement
Trust Receipt Agreement
THE INDEPENDENCE PRINCIPLE
IN A LETTER OF CREDIT
TRANSACTION

The 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 the main contract is actually
accomplished or not.
THE RULE OF STRICT CONFORMITY IN
A LETTER OF CREDIT TRANSACTION

The documents tendered by the seller or beneficiary must

strictly conform to the terms of the letter of credit, i.e.,
they must include all documents required by the letter of
credit. Thus 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 risk and
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.
THE STANDBY LETTER OF CREDIT

A standby letter of credit is a bank – issued option on

loan involving three parties: the bank issuing the credit,
the party requesting for such issuance (otherwise known
as the account party) and the beneficiary.
Beneficiary has the right to trigger the loan option
(referred to as taking down loan) if the account party
fails to meet its commitment, in which case the issuing
bank disburses a specified sum to the beneficiary and
books an equivalent loan to its customer.
 SOME COMMON TYPES OF LETTERS OF CREDIT:
a) Irrevocable vs. revocable
 Irrevocable letter of credit – obligates the issuing bank
to honor drafts drawn in the compliance with the credit
and can be neither cancelled nor modified without the
consent of all parties, including in particular the
beneficiary / exporter.
 Revocable letter of credit – can be cancelled or
amended at any time before payment; it is intended to
serve as a means of arranging payment but not as
guarantee of payment.
b.) Confirmed vs. unconfirmed
Confirmed letter of credit – both banks are obligated to
honor drafts drawn in compliance with the credit.
Unconfirmed letter of credit– is the obligation only of the
issuing bank.
c.) Revolving vs. non-revolving
Non-revolving letter – one that is valid for one
transaction only.
Revolving – one that valid for several transactions over
a given period of time such as a week or a month.
d.) Cumulative and non-cumulative
 Non-cumulative – any amount not used by the
beneficiary during the specified period may not be
drawn against in a later period.
 Cumulative – undrawn amounts carry over to the
future periods.
Draft – sometimes called a bill of exchange, is an
order written by an exporter/seller instructing an
importer/buyer or its agent to pay a specified
amount of money at a specified time.
END OF LECTURE. THANK YOU 