Letters of CreditWhat areLETTERS OF CREDIT?Those issued by one merchant to another for the purpose of attending to a commercial transaction.Kinds:Common Letter of Creditan instrument by which a bank, for the account of a buyer of merchandise, gives formal evidence to a seller, of its willingness to permit the seller to draw bills against it, and stipulates in legal form that all such bills will be honored.Travelers Letter of Credita letter from a bank addressed to its correspondents stating that drafts up to a certain sum drawn by the beneficiary will be honored by the bank.Essential Conditions:1.)Issued in favor of a definite person and not to order; and2.)Amount is fixed and specified.Duration:1.)Upon a periodfixedby the parties;2.) Ifnone is fixed, 6 months from its date if used in thePhilippinesor 1 year if used abroad.LETTER OF CREDIT(Art. 567-572 Code of Commerce)LETTER OF CREDITLetter of credit an arrangement by a bank or other person made at the request of a customer that the issuer will honor drafts or other demands for payment upon compliance w/ the conditions specified in the credit.Internationally accepted definition of a LC as provided in the Uniform Customs and Practices for Documentary Credit (UCPDC):Letter of Credit any arrangement, however named or described, whereby a bank also known as the issuing bank, acting upon the request or instruction of another(applicant or customer) or on its own behalf, binds itself to:Pay to the order of a 3rdperson known as beneficiary ORAccepts and pay any draft that may be drawn by the beneficiary, ORAuthorize another bank to:Pay to the order of a 3rdperson known as the beneficiary.Accept and pay any draft by the beneficiary, OR 4. Authorize another bank to negotiate against the stipulated documentsNote: We are bound by the UCPDC issued by the International Chamber of Commerce. Sec. 2 of the Code of Commerce states that in the absence of any particular provision in the code of Commerce, commercial transactions shall be governed by the usages and customs generally observed (BPI vs. Nery)A Letter of Credit is a special contract designed to answer two concerns:Sellers refusal to part with his goods before being paid coupled with the Buyers want of ownership over the goods before paying.Note: The opening of a LC does not involve specific appropriation of money in favor of the beneficiary. The correspondent bank does not receive in advance the money form the buyer or issuing bank but pays the amount out of its own funds and then later on seek reimbursement from the issuing bank. It does not convey the notion that a particular sum of money has been specifically reserved or has been held in trust.Note: An LC is not a negotiable instrument. It doesNotconform w/ Section 1 of the Negotiable Instruments Law. This is because it does not contain an unconditional promise to pay a sum certain in money. The LC is conditioned to the submission of certain documents. Moreover, the LC is issued in favor of a definite person and not to order. Therefore, it also lacks the words of negotiability required.LC is conditioned on Submission of stipulated documentsCompliance with the terms of the LCIs LC a commercial transaction?YES. Because it is governed by the Code of Commerce.PARTIESTO THE TRANSACTION:Basic parties to a letter of credit:Applicant/buyer/importer the one who procures the letter of credit and obliges himself to reimburse the Issuing Bank (IB) upon the receipt of the documents of title. He is the party who initiates the operation of the Letter of Credit transaction as the buyer of the merchandise and also of the credit instrument.Issuing Bank is usually the buyers bank; it issues the letter of credit and undertakes to pay the seller upon receipt of the draft and proper documents to the buyer upon reimbursement.Seller/beneficiary is the one who in compliance w/ the contract of sale ships the goods to the buyer and delivers the documents of title and drafts to the issuing bank to recover payment. He is the beneficiary of the instrument because the instrument is addressed to him and in his favor.Additional party/parties to the LC:4. Correspondent BankTYPES OF CORRESPONDENT BANK:Advising/Notifying Bank does not have any contractual relations w/ the buyer but merely serves as an agent of the issuing bank. Its only responsibility is to transmit the LC. Thus, it could validly refuse to negotiate or accept, even if the seller tenders all the documents required under the LC and it does not become liable as the beneficiary has no cause of action against the bank.Confirming Bank lends credence to the LC issued by a lesser known bank. It assumes direct obligation to the seller/beneficiary and becomes principally liable.A notifying bank, who also assumes the role of a negotiating bank does not include assuming the role of a confirming bank and is therefore not liable to the beneficiary. To be liable, there must be an absolute assurance that it will undertake the issuing banks obligation as its own. If it does confirm, the beneficiary become entitled to proceed against either or both banks in case of breach.Paying Bank the bank w/c pays the beneficiary. It may either be the opening/issuing bank or any other bank in the place of the beneficiary.Negotiating Bank any bank in the place of the beneficiary w/c buys or discounts the sellers draft. Its liability depends on the stage of negotiation. If BEFORE negotiation, such that it suggests its willingness to negotiate, it has no liability w/ respect to the seller. But if AFTER negotiation, a contractual relationship will then prevail between them.Note: A bank does not become a negotiating bank unless he pays the draft and becomes the holder of said document.As such, the IB may notify the seller of the opening of the LC either directly or through a correspondent bank, w/c may either be a mere advising bank or a Confirming Bank.Note: The IB has the option to tap a correspondent bank or not.The liability of a Correspondent Bank depends on what kind of function it plays in the LC transaction.RELATIONSHIP OF THE PARTIES is governed by-Issuing bank and applicant the relationship is governed by the terms of the application and agreement for the issuance of the LC by the bank.Issuing bank and the Beneficiary the relationship is governed by the terms of the LC issued by the bankApplicant and beneficiary the relationship is governed by the contract they entered into. ex. SalesINDEPENDENCEPRINCIPLE-The bank in determining compliance with the terms of the LC is required only to examine the shipping document presented by the seller and is precluded from determining whether the main contract is accomplished or notDOCTRINE OF STRICT COMPLIANCE-The document tendered by the seller must strictly conform to the terms of the LC . The correspondent bank which departs from what has been stipulated under the LC, as when it accepts a faulty tender , acts on his own risk and may not thereafter recover from the buyer or issuing bank , the money paid to the beneficIn short, the documents presented must comply w/ those stipulated on. In a LC, the banks only deals w/ documents and not w/ goods.

Can a breach of contract be invoked against the Issuing Bank?NO. Because if all the documents stipulated have been submitted and the IB finds that they conform w/t the LC requires, then the IB must pay the seller. In a LC transaction the banks deal only w/ documents not goods, so banks pays if the documents are OK and gets reimbursed by the buyer. This relationship is independent so if ever the goods are in bad condition, the applicant still pays the bank.Note: A loan transaction may give rise to LC. An LC does not arise only because of sale or importation. Example: Standby LC.Standby Letter of Credit (SLC) it is a bank issued option on loan involving 3 parties: the bank issuing the credit, the party requesting for such issuance (otherwise known as the account party) and the beneficiary. Under the terms of a SLC, the beneficiary has the right to trigger the loan option (referred to as TAKING DOWN THE LOAN) if the account party fails to meet its commitment, in w/c case the issuing bank disburses a specified sum to the beneficiary and books an equivalent loan to its customer.SLCs may support non-financial obligations such as those of bidders, or financial obligations such as those of borrowers. In the latter case, the borrower purchases an SLC and names the lender as beneficiary. Should the borrower default, the beneficiary has the right to take down the SLC and receive the principal balance from the issuing bank. The borrowers loan obligation is then passed to the bank.When the Notifying Bank (NB) may be held liable:The NB is liable if:It did not notify the seller of the opening of the LC, orIt did not determine the apparent authenticity of the required documents.Note: Only the APPARENT AUTHENTICITY is to be determined. The NB does not warrant the authenticity of the LC but only its apparent authenticity. So if the LC turns out to be spurious, NB is not liable for damages unless obvious that it is not authentic.Therefore, Notifying Bank/Advising Bank is liable if it acts beyond the scope of its authority.When may the Advising Bank (AB) be equally liable with the Issuing Bank (IB)? Ordinarily, an AB, whose obligation is merely to advise the seller/beneficiary of the opening of a LC has no liability. The opening of a LC does not make the IB liable at once because there is no liability. The liability is conditioned and dependent on the tender or submission of the documents stipulated upon by the parties. If the beneficiary requires that the obligation of the IB shall also be made the obligation of the AB to him, there is what is known as a CONFIRMED COMMERCIAL CREDIT and the AB shall become a Confirming Bank. In this situation, the liability of the CB is primary and it is as if the credit were issued by the IB and the CB jointly, thus giving the beneficiary or holder for value of the drafts drawn under the credit, the right to proceed against either or both banks, the moment the credit instrument has been breached. The CB is liable only when the documents are submitted and gets reimbursed by the IB because there is no privity of contract with the applicant. Thus, an AB becomes a CB when the above mentioned conditions occur. In such a case, the CB acquires the same liabilities as the Issuing Bank and is bound by the same conditions as an IB.Function of a Negotiating Bank (NB):It accepts or gives value to the draft and w/c later on sells the draft to the IB. The IB then reimburses the NB. What happens is that the NB buys the draft at a discounted price and then sells it to the IB for its face value.If LC is disowned by the IB, can the Negotiating Bank ask reimbursement from the seller? Under what principle?YES. Seller is a drawer of the draft accepted and paid by the Negotiating Bank. Therefore, the seller has contingent liability on such draft.Can a Confirming Bank become a Notifying Bank?NEVER, because they have different liabilities. The CBs liability is primary while the NBs liability comes only after negotiation (Before negotiation, there is no liability).It is the application for the opening of a LC w/c governs the relationship between the buyer and the IB. This implies that the buyer/applicant is not concerned w/ the terms of the LC between the IB and the seller/beneficiary.As to the IB, it is not a guarantor because its liability is not subsidiary since the condition of the submission of the document is determinative of the liability not the nonpayment of the buyer.The IB opens a LC for a consideration w/c comes in the form of a commission.If the IB does not advance the payment in favor of the seller/beneficiary, may the buyer/applicant recover the commission paid?No More because this is the consideration. But he may recover the margin fee.What among other things, should be stipulated upon the application for a LC?The documents w/c the seller should submit to the IB.In LC transactions, the IB deals only w/ the documents, not w/ goods. The IB is not bound or required to examine the goods. For as long as the required documents are submitted by the seller, the IB pays the seller.If the goods turned out to be defective, is this a valid defense to avoid payment by the IB to the seller?NO. As long as the documents submitted by the seller are complete and in conformity w/ what the LC requires, the IB is bound to pay the seller. This is true even if the goods turned out to be defective.How about the buyer, is he still bound to reimburse the IB despite the defective goods received by him?YES. The buyer has no course of action against the IB. The buyer has a COA against the seller.If the documents submitted by the seller are incomplete and the IB still pays the seller, is the buyer still bound to pay the IB?NO. Because the IB should not have paid the seller knowing the documents to be incomplete. The IB deals only w/ documents.Can the beneficiary demand payment form the CB?YES. Since the CB is equally liable w/ the IB.If the beneficiary proceeds against the CB, the CB may ask reimbursement from the IB. But if the beneficiary proceeds directly against the CB; it has no right to collect from the IB. The beneficiary may compel the CB to accept drafts it has drawn.How is payment made by the Issuing Bank?Payment by the IB is done through:Direct payment or wire transfer or credit in the account of the beneficiaryDrawing of a draft by the beneficiary against the IB pay to my orderIB may authorize the Confirming Bank to payAuthorize Correspondent Bank to accept and pay any draft drawnAuthorize the negotiation of any draft drawn by the beneficiary.Note: If the drawee doesnt pay, go to the drawer who is secondarily liable.Apart form the bill of lading, what additional documents may be needed as a condition of the LC for honoring a draft?Commercial invoice it is a document signed and issued by the seller and contains a precise description of the merchandise and the terms of the sale such as unit prices, amount due form the buyer and shipping conditions related to charges such as FOB (Free on Board), FAS (Free Alongside), C and F (Cost and Freight) or CIF (Cost, Insurance, Freight).Consular invoice document issued by the consulate of the importing country to provide customs information and statistics for that country and to help prevent false declaration of value.Certificate of analysis may be required to ascertain that certain specifications of weight, purity, sanitation, etc., have been met. These specifications may be required by health or other officials of the importing country, or they may be insisted by the importer as assurance that it is receiving what it ordered.Export declaration it is a document prepared by the exporter to assist the government to prepare export statistics.Note: Documents to be passed are not unilaterally determined by the bank but agreed upon by the buyer and seller.Document of Title(Bill of Lading) given to the seller upon shipment of goods. This is to be given to the IB to be able for the seller to get payment.Is there a scheme where the IB may release the documents of title to the buyer w/o being reimbursed first by the buyer?YES. By the IB letting the buyer execute a trust receipt.Failure of the buyer to open the Letter of Contract does not prevent the birth of the Sales Contract.The opening of the letter of credit is only a mode of payment. The letter of the credit is not an essential requisite to the contract of sale.A CONCISE DEFINITION: DEMAND GUARANTEES> Undertaking given for payment of a stated or maximum sum of money on presentation to the party giving the undertaking of a demand or payment and such other documents as may be specified in the guarantee within the period and in conformity with the other conditions of the guarantee> Procured by the seller in favor of the buyer for the latter to be paid in case the seller doesnt comply with contract provisions. The economic burder is upon the party who breaches the contract> Employed typically in construction contracts and contracts for international sale of goods> Demand guarantees are intended to safeguard the other party against non-performance or late or defective performance by the supplier or contractorGUARANTEE STRUCTURES AND TERMINOLOGY: DIRECT (3RD PARTY) GUARANTEES> Involves a minimum of three parties1. Account party/principalparty to the underlying contract whose performance is required to be covered by the guarantee and who gives instruction for its2. Issuer/guarantorthe bank or other party issuing the guarantee on behalf of the customer the principal3. The beneficiarythe other party to the underlying contract, in whose favor the guarantee is issued> Usually the guarantee in the 3-party structure is the principals bank and carries on business in the same country as the principal, whilst the beneficiary carries on business in a foreign country> Known as direct guarantees because the guarantee is issued to directly by the principals bank, not by the local bank in the beneficiarys countryPRINCIPAL TYPES OF DEMAND GUARANTEES1. Tender or bid guaranteea. Where tenders are invited it is often a condition of consideration of the tender that the tenderer undertakes to sign the contract if its awarded to him, to procure the issue of any performance or other guarantee required by the guarantee and not to modify or withdraw his tender in the meantimeb. Purposesafeguard the beneficiary against breach of such an undertakingc. If the tenderer is successful and fails to sign the contract and to furnish the requisite performance or other guarantee, or withdraws his tender before its expiry, the beneficiary can call upon the guarantor to pay a specified sum designed to compensate him for the trouble andexpense he suffered in reawarding the contract, as well as any additional cost of the contract2. Performance guaranteea. Guarantee of the central performance of the contract from commencement to completionb. Given for a specified percentage of the contract sumc. But there are stages in the relationship between the parties which precede and follow the central performance, and there may be distinct segments of liability to be covered within that performance3. Advance payment or repayment guaranteea. Underlying contract may entitle the principal to payment of stated sums in advance of performanceb. The advance payment guarantee is designed to secure the beneficiarys right to repayment of the advance if the performance to which it relates is not furnished4. Retention guaranteea. Construction contracts usually provide for stage payments against architects or engineers certificate and for a specified percentage of the amount certified in each certificate to be retained by the employer for a specified period of time as safeguard against defectsb. The employer may be willing to release such retention moneys against a retention guarantee securing repayment of the released retention moneys if defects are later found or if the contractor fails to complete the contract5. Maintenance or warranty guaranteea. Construction contracts usually provide that on completion part of the retention moneys are to be retained for a specified period to cover the cost of any defects or malfunction which become manifest during that periodGUARANTEES NOT GUARANTEED BY UNDERLYING CONTRACT> Not all guarantees are meant to be in favor of a party in the underlying contract> For example are customs guarantees which are issued to the customs to cover any duty that may become payable when imported goods which would be exempt from duty if re-exported within a specified time are not in fact re-exported within that timeTHE LEGAL NATURE OF A DEMAND GUARANTEE> A demand guarantee is an abstract payment undertaking that is, a promise of payment which, though intended to preserve the beneficiary from loss in connection with the underlying transaction is detached from the underlying contract between principal and beneficiary and is in form a primary undertaking between the guarantor and beneficiary which becomes binding solely by virtue of its issue> A secondary guarantee is both secondary in form and intent. The intention of the parties is that the guarantor will be called upon to pay only if the principal defaults in performance, and then only to the extent of the principals liability and subject to any defenses available to the principal> A documentary credit is both primary in intent and form. The parties to the underlying contract intend that the bank issuing the credit is a to be the first port of call for payment, and this is the effect of the agreement between them. Whereas in the case of a surety ship guarantee, the beneficiary cannot look to the guarantor without establishing default by the principal, the reverse is true of the documentary credit. The parties have designated payment by the bank as the primary payment method and only if it fails without fault on the part of the beneficiary is entitled to > DEMAND GUARANTEE STANDS BETWEEN THE SURETYSHIP GUARANTEE AND THE DOCUMENTARY CREDITSECONDARY IN INTENT AND PRIMARY IN FORM. Performance is due in the first instance from the principal, and the guarantee is intended to be resorted to only if the principal has failed to perform. But though this is the intent of the parties, the guarantee isnt in form linked to default under the underlying contract, nor there is any question of performance to hold the beneficiary harmless up to the agreed maximum; and the sole condition of the guarantors payment liability is the presentation of a demand and other documents specified in the guarantee in the manner of and within the period of the guarantee> THE GUARANTOR HAS NO CONCERN WITH THE UNDERLYING CONTRACT AND IF DEMAND IS DULY PRESENTED, PAYMENT MUST BE MADE DESPITE ALLEGATIONS BY THE PRINCIPAL HAS FULLY PERFORMED THE CONTRACTIN THE ABSENCE OF ESTABLISHED FRAUD OR OTHER EVENT CONSTITUTING GROUND FOR NON-PAYMENT