Letter of Credit; Doctrine of Independence

               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.[1] (Transfield Philippines, Inc. vs. Luzon Hydro Corporation, et al., G.R. No. 146717, November 22, 2004, [Tinga])

            The so-called "independence principle" 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. (supra)

            The independent nature of the letter of credit may be: (a) independence in toto where the credit is independent from the justification aspect and is a separate obligation from the underlying agreement like for instance a typical standby; or (b) independence may be 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. In both cases the payment may be enjoined if in the light of the purpose of the credit the payment of the credit would constitute fraudulent abuse of the credit.[2] (supra)

            As discussed above, in a letter of credit transaction, such as in this case, where the credit is stipulated as irrevocable, there is a definite undertaking by the issuing bank to pay the beneficiary provided that the stipulated documents are presented and the conditions of the credit are complied with.[3] Precisely, the independence principle liberates the issuing bank from the duty of ascertaining compliance by the parties in the main contract. As the principle's nomenclature clearly suggests, the obligation under the letter of credit is independent of the related and originating contract. In brief, the letter of credit is separate and distinct from the underlying transaction.

            Given the nature of letters of credit, petitioner's argument—that it is only the issuing bank that may invoke the independence principle on letters of credit—does not impress this Court. To say that the independence principle may only be invoked by the issuing banks would render nugatory the purpose for which the letters of credit are used in commercial transactions. As it is, the independence doctrine works to the benefit of both the issuing bank and the beneficiary.

            Letters of credit are employed by the parties desiring to enter into commercial transactions, not for the benefit of the issuing bank but mainly for the benefit of the parties to the original transactions. With the letter of credit from the issuing bank, the party who applied for and obtained it may confidently present the letter of credit to the beneficiary as a security to convince the beneficiary to enter into the business transaction. On the other hand, the other party to the business transaction, i.e., the beneficiary of the letter of credit, can be rest assured of being empowered to call on the letter of credit as a security in case the commercial transaction does not push through, or the applicant fails to perform his part of the transaction. It is for this reason that the party who is entitled to the proceeds of the letter of credit is appropriately called "beneficiary." (supra)

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[1] Article 15, UCP.

[2] Kurkela, Letters of Credit Under International Trade Law, 286-287 (1985).

[3] Art. 10, UCP.

Letter of Credit; Parties to a Letter of Credit; Rights and Obligations of the Parties

              Letters of credit are employed by the parties desiring to enter into commercial transactions, not for the benefit of the issuing bank but mainly for the benefit of the parties to the original transactions. With the letter of credit from the issuing bank, the party who applied for and obtained it may confidently present the letter of credit to the beneficiary as a security to convince the beneficiary to enter into the business transaction. On the other hand, the other party to the business transaction, i.e., the beneficiary of the letter of credit, can be rest assured of being empowered to call on the letter of credit as a security in case the commercial transaction does not push through, or the applicant fails to perform his part of the transaction. It is for this reason that the party who is entitled to the proceeds of the letter of credit is appropriately called "beneficiary." (Transfield Philippines, Inc. vs. Luzon Hydro Corporation, et al., G.R. No. 146717, November 22, 2004, [Tinga])

            In commercial transactions involving letters of credit, the functions assumed by a correspondent bank are classified according to the obligations taken up by it. The correspondent bank may be called a notifying bank, a negotiating bank, or a confirming bank. (Feati Bank & Trust Company vs. CA, G.R. No. 94209, April 30, 1991, [Gutierrez, Jr.])

            In case of a notifying bank, the correspondent bank assumes no liability except to notify and/or transmit to the beneficiary the existence of the letter of credit. (Kronman and Co., Inc. v. Public National Bank of New York, 218 N.Y.S. 616 [1926]; Shaterian, Export-Import Banking, p. 292, cited in Agbayani, Commercial Laws of the Philippines, Vol. 1, p. 76). A negotiating bank, on the other hand, is a correspondent bank which 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. (Scanlon v. First National Bank of Mexico, 162 N.E. 567 [1928]; Shaterian, Export-Import Banking, p. 293, cited in Agbayani, Commercial Laws of the Philippines, Vol. 1, p. 76)

            In the case of a confirming bank, the correspondent bank assumes a direct obligation to the seller and its liability is a primary one as if the correspondent bank itself had issued the letter of credit. (Shaterian, Export-Import Banking, p. 294, cited in Agbayani Commercial Laws of the Philippines, Vol. 1, p. 77)

            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. It follows therefore that when the petitioner refused to negotiate with the private respondent, the latter has no cause of action against the petitioner for the enforcement of his rights under the letter. (See Kronman and Co., Inc. v. Public National Bank of New York, supra)

            As earlier stated, there must have been an absolute assurance on the part of the petitioner that it will undertake the issuing bank's obligation as its own. Verily, the loan agreement it entered into cannot be categorized as an emphatic assurance that it will carry out the issuing bank's obligation as its own. (supra)

            The case of Scanlon v. First National Bank (supra) perspicuously explained the relationship between the seller and the negotiating bank, viz:

            It may buy or refuse to buy as it chooses. Equally, it must be true that it owes no contractual duty toward the person for whose benefit the letter is written to discount or purchase any draft drawn against the credit. No relationship of agent and principal, or of trustee and cestui, between the receiving bank and the beneficiary of the letter is established. (P.568)

            Whether therefore the petitioner is a notifying bank or a negotiating bank, it cannot be held liable. Absent any definitive proof that it has confirmed the letter of credit or has actually negotiated with the private respondent, the refusal by the petitioner to accept the tender of the private respondent is justified. (supra)

            The relationship between the issuing bank and the notifying bank, on the contrary, is more similar to that of an agency and not that of a guarantee. It may be observed that the notifying bank is merely to follow the instructions of the issuing bank which is to notify or to transmit the letter of credit to the beneficiary. (See Kronman v. Public National Bank of New York, supra). Its commitment is only to notify the beneficiary. It does not undertake any assurance that the issuing bank will perform what has been mandated to or expected of it. As an agent of the issuing bank, it has only to follow the instructions of the issuing bank and to it alone is it obligated and not to buyer with whom it has no contractual relationship.

            In fact the notifying bank, even if the seller tenders all the documents required under the letter of credit, may refuse to negotiate or accept the drafts drawn thereunder and it will still not be held liable for its only engagement is to notify and/or transmit to the seller the letter of credit.

            Finally, even if we assume that the petitioner is a confirming bank, the petitioner cannot be forced to pay the amount under the letter. As we have previously explained, there was a failure on the part of the private respondent to comply with the terms of the letter of credit. (Feati Bank & Trust Company vs. CA, G.R. No. 94209, April 30, 1991, [Gutierrez, Jr.])

Letter of Credit; 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.[1] (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[2], 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.[3]

            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.[4] (supra)

            Letters of credit were developed for the purpose of insuring to a seller payment of a definite amount upon the presentation of documents[5] 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.[6] 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.[7] 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.[8] 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])

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[1] 24 A Words and Phrases 590, Permanent Edition.

[2] G.R. No. 160732, June 21, 2004 [Azcuna]

[3] Prudential Bank v. Intermediate Appellate Court, 216 SCRA 257 (1992).

[4] 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).

[5] Ibid, p. 270.

[6] Isidro Climaco v. Central Bank of the Philippines, 63 O.G. No. 6, p. 1348.

[7] Insular Bank of Asia & America v. Intermediate Appellate Court, 167 SCRA 450 (1988).

[8] Bank of America, NT & SA v. Court of Appeals, 228 SCRA 357 (1993).