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).