In commercial transactions, 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.[1]
The use of credits in commercial transactions serves to reduce the risk of
nonpayment of the purchase price under the contract for the sale of goods.
However, credits are also used in non-sale settings where they serve to reduce
the risk of nonperformance. Generally, credits in the non-sale settings have
come to be known as standby credits.[2] (Transfield Philippines, Inc. vs. Luzon Hydro
Corporation, et al., G.R. No. 146717, November 22, 2004, [Tinga])
Definition and Nature of Letter of Credit
By
definition, a letter of credit is 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.[3] (Transfield Philippines, Inc. vs. Luzon Hydro
Corporation, et al., G.R. No. 146717, November 22, 2004, [Tinga])
In Metropolitan Waterworks and Sewerage System
vs. Daway[4],
we
have also defined a letter of credit as 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.[5]
The
letter of credit evolved as a mercantile specialty, and the only way to
understand all its facets is to recognize that it is an entity unto itself. The
relationship between the beneficiary and the issuer of a letter of credit is
not strictly contractual, because both privity and a meeting of the minds are
lacking, yet strict compliance with its terms is an enforceable right. Nor is
it a third-party beneficiary contract, because the issuer must honor drafts
drawn against a letter regardless of problems subsequently arising in the
underlying contract. Since the bank's customer cannot draw on the letter, it
does not function as an assignment by the customer to the beneficiary. Nor, if
properly used, is it a contract of suretyship or guarantee, because it entails
a primary liability following a default. Finally, it is not in itself a
negotiable instrument, because it is not payable to order or bearer and is
generally conditional, yet the draft presented under it is often negotiable.[6] (supra)
Letters of credit were developed for the
purpose of insuring to a seller payment of a definite amount upon the
presentation of documents[7]
and is thus a commitment by the issuer that the party in whose favor it is
issued and who can collect upon it will have his credit against the applicant
of the letter, duly paid in the amount specified in the letter.[8]
They are in effect absolute undertakings to pay the money advanced or
the amount for which credit is given on the faith of the instrument. They are
primary obligations and not accessory contracts and while they are security
arrangements, they are not converted thereby into contracts of guaranty.[9]
What distinguishes letters of credit from other accessory contracts, is the
engagement of the issuing bank to pay the seller once the draft and other
required shipping documents are presented to it.[10]
They are definite undertakings to pay at sight once the documents stipulated
therein are presented. (Metropolitan
Waterworks and Sewerage System vs. Daway, G.R. No. 160732, June 21, 2004
[Azcuna])
[1] Bank of America v. Court of Appeals, G.R. No. 105395, 10 December
1993, 228 SCRA 357 citing William S. Shaterian, Export-Import Banking: The
Instruments and Operations Utilized by American Exporters and Importers and
Their Banks in Financing Foreign Trade, 284-374 (1947).
[2] E&H Partners v. Broadway Nat'l Bank, 39 F. Supp. 2d 275,
(United States Circuit Court, S.D. New York) No. 96 Civ. 7098 (RLC), 19 October
1998 <http://www.westlaw.com>.
[3] 24 A Words and Phrases 590, Permanent Edition.
[4] G.R. No. 160732, June 21, 2004
[Azcuna]
[5] Prudential Bank v. Intermediate Appellate Court, 216 SCRA
257 (1992).
[6] Joseph, Letters of Credit: The Developing Concepts and Financing
Functions, 94 Banking Law Journal 850-851 [1977] cited in M. Kurkela, Letters
of Credit under International Trade Law, 321 (1985).
[7] Ibid, p. 270.
[8] Isidro Climaco v. Central Bank of the Philippines, 63 O.G.
No. 6, p. 1348.
[9] Insular Bank of Asia & America v. Intermediate Appellate
Court, 167 SCRA 450 (1988).
[10] Bank of America, NT & SA v. Court of Appeals, 228 SCRA
357 (1993).
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