LETTERS OF CREDIT ( LC)

Definition / Concept
That issued by one merchant to another for the purpose of
attending to a commercial transaction (Art. 567)
An instrument issued by a bank on behalf on one of its
customers, authorizing an individual or firm to draw on the
bank or one of its correspondents for its account under
certain conditions of the credit. (Commercial Law Review, C
Villanueva, 2004 ed.)
Letters of credit 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. (Metropolitan vs. Daway)
A letter of credit is a commercial transaction because it is
one of the contracts provided for by the Code of Commerce
not repealed by the Civil Code. (Bar Review Materials in
Commercial Law, Miravite, 2005 ed.)
There are at least 3 distinct and independent contracts involved
in a LC:
1. Contract of sale between the buyer and the
seller
2. Contract of the buyer with the issuing bank
3. LC Proper in which bank promises to pay
the seller pursuant to the terms and
conditions stated therein (with a pour
autrui stipulation in favor of the seller).
Governing Laws
1. Code of Commerce
2. Uniform Customs and Practice for Documentary Credits
Note: the Uniform Commercial Practice for Documentary Credits
allow Letters of Credit to be payable to order.
Nature: The LC is the financial devise (mode of payment)
developed 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.
Parties
1. Applicant/buyer/importer one who purchases the goods,
procures the LC, and obliges himself to reimburse the
issuing bank upon receipt of the documents of title.
2. Issuing/opening bank one which issues the LC, and
undertakes to pay the seller upon receipt of the draft and
proper documents of title from the seller and to surrender
them to the buyer upon reimbursement; and
3. Seller/exporter/beneficiary one who sells the goods to
the buyer, and who delivers the draft and documents to the
issuing bank to recover payment.
The number of parties may be increased. Modern letters
of credit are usually not made between natural persons.
They involve bank- to bank transactions.
4. Advertising/ Notifying Bank - the correspondent bank
(agent) of the opening bank through which it advises the
beneficiary of the LC.
5. Confirming Bank bank which, upon the request of the
beneficiary, confirms the LC issued.
6. Paying Bank bank on which the drafts are to be drawn,
which may be the opening bank or another bank not in the
city of the beneficiary.
7. Negotiating Bank bank in the city of the beneficiary which
buys or discounts the drafts contemplated by the LC, if such
draft is to be drawn on the opening bank or on another
designated bank not in the city of the beneficiary.
A mere advertising or notifying bank is not liable for
a breach of the letter of credit, while a confirming
bank is liable in case of breach thereof. An
advertising bank is bound only to check the apparent
authenticity of the letter of credit. (Bank of America
NT. & SA vs. CA, G.R. No. 105395, December 10,
1993)
Stages:
a) Contract of sale between the buyer and seller
b) Application for LC by the buyer with the bank

c) Issuance of LC by the bank

d) shipping of goods by the seller
e) Execution of draft and tender of documents by the
seller
f) Redemption of draft (payment)and obtaining of
documents by the issuing bank
g) reimbursement to the bank and obtaining of
documents by the buyer
Essential conditions:
1. Issued in favor of a definite person and not to order;
2. Amount fixed and specified. (Art. 568)
Note: If any of these essential conditions is not present, the
instrument is merely considered as a letter of recommendation.

is not among the essential requirements of

a contract of sale enumerated in arts.1305
and 1474 of the Civil Code. Therefore it
does not prevent the perfection of the
contract between the parties. (Johannes
vs. CA, 227 SCRA 717)
Other contracts maybe involved especially where additional parties
are present.
Independence Principle

The 3 basic contracts are distinct and independent, and the

undertakings of the respective parties in each are neither
subject to claims and defenses nor affected by the breach in
the others.

A direct consequence of the independence principle is the

rule that banks deal only which documents and not with
goods,services or obligation to which they relate. By this socalled independence principle, the bank determines
compliance with the letter of credit only by examining the
shipping documents presented; it is precluded from
determining whether the main contract is actually
accomplished or not. (Bank of America, NT. & SA vs. CA,
G.R. No. 105395, December 10, 1993)

Duration:
a. Upon the period fixed by the parties: or
b. If none is fixed, 6 months from its date if used in the
Philippines, or 12 months if used abroad. (Art. 572)
Note: The LC becomes void if it is not used within the period
applicable.
Perfection: LC are perfected from the moment the correspondent
bank makes payment to persons in whose favor the LC has
been opened. (Belman, Inc. vs. Central Bank, 104 Phil. 887)
How their respective relationships are governed
a. Issuing bank and applicant/buyer/importer
governed by the terms of the application and
agreement for the issuance of the letter of the credit
by the bank.
b. Issuing bank and Beneficiary/seller/exporter
governed by the terms of the letter of the credit
issued by the bank.
c. Applicant and beneficiary governed by the sales of
contract (Bar Review Materials in Commercial Law,
J. MIravite, 2005 ed.)
The opening of the letter of credit in favor
of a vendor is only a mode of payment; it

Rule of Strict compliance

It espouses that the documents tendered by the
seller/beneficiary must strictly conform to terms of the LC.
(Feati bank vs. CA 196 SCRA 576)
Thus, a correspondent bank which departs from what has
been stipulated under the letter of credit acts on its own risk
and may not thereafter be able to recover from the buyer
or the issuing bank the money thus paid to the
beneficiary.(Feati Bank vs. CA)
WAREHOUSE RECEIPTS LAW (Act 2137)

Coverage: Seeks to encourage transactions on negotiable

warehouse receipts, which may only be issued by a
warehouseman who is engaged in the business of receiving
commodities on deposits for storage.
Purposes of the Law:
a. to prescribe the rights and duties of a warehouseman ;
b. to regulate the relationship between a warehouse man and
1. the depositor of goods, or
2. the holder of a warehouse receipt for the goods, or
3. the person lawfully entitled to the possession of
the good, or
4. other persons.
Definitions:
Warehouseman - A person lawfully engaged in the business of
storing goods for profit.
Warehouseman Receipt - A written acknowledgement by a
warehouseman that he has received and holds certain goods therein
described in store for the person to whom it is issued.
Function of Warehouse Receipt:
The negotiation of a warehouse receipt carries with it the transfer of
title over the commodity covered by the receipt, so also with a
negotiable bill of lading.
Exception: Where a negotiable warehouse receipt is
indorsed and delivered to a creditor as collateral for a loan.
Note: in case of loss of the commodity covered by the receipt
through a fortuitous event, it will be the debtor who will bear the
loss as the true intent to the parties is not the negotiation of the
warehouse receipt with its consequent transfer of title but merely as
security.
Kinds of Warehouse Receipt
1. Negotiable one which states that the goods received by the
warehouse will be delivered:
a. to the bearer or
b. to the order of any person named in such receipt.
2. Non-Negotiable one which states that the goods received by

the warehouseman will be delivered to the depositor or to any

other specified person.

Distinctions between a Negotiable Instrument and a Negotiable

Warehouse Receipt

As to:

Negotiable Instrument

Subject
Money
Object of
Instrument itself
value
Liability of
intermediate Secondary liability
parties
Effect of
deliberate
Null and void
alteration
An originally bearer
Conversion
instrument will always be
from bearer
such
to order
Significance
of a HIDC

May obtain a better title

instrument into an order instrument

Negotiable Warehouse
Receipt
Money
Goods deposited
None for failure to deliver the
goods
Valid but enforceable only in
accordance with its original tenor
Can be converted to an order
warehouse receipt if specifically
endorsed
Obtains only the title which the
party negotiating had over the
goods

Kinds of Negotiation:
1. Negotiation by delivery:
a. Where, by terms of the receipt, the
warehouseman undertakes to deliver the goods
to the bearer; or
b. Where, by the terms of the receipt, the
warehouseman undertakes to deliver the goods
to the order of a specified person, and such
person or a subsequent indorsee of the receipt
has indorsed it in blank or to bearer.
Note: A bearer document of title is not always a bearer document. A
special indorsement has the effect of converting the bearer

2. Indorsement coupled with delivery

1. A negotiable receipt may be negotiated by the
indorsement of the person to whose order the
goods are, by the terms of the receipt,
deliverable.
2. Such indorsement may be in blank, to bearer or
to a specified person. If indorsed to a specified
person, it may be again negotiated by the
indorsement of such person in blank, to bearer
or to another specified person. Subsequent
negotiation may be made in like manner.
Effect of delivery without indorsement: (ANT)
The transferee acquires title against the transferor;

There is no direct obligation of the warehouseman; and

The transferee can compel the transferor to complete
the negotiation by indorsing the instrument.
Note: The negotiation takes effect on the date of indorsement only.

Effects of Negotiation:
1. Warranties on sale of receipt: A person who, for value, negotiates
or transfers a receipt by indorsement or delivery, including one who
assigns for value a claim secured by a receipt, unless a contrary
intention appears, warrants: (GRIT)
a. that the receipt is genuine;
b. that he has legal right to negotiate or transfer it;
c. that he has knowledge of no fact which would impair the
validity or worth of the receipt; and
d. that he has a right to transfer title to the goods and that the
goods are merchantable.
Note: Sec. 44 (warranties on sale of receipt) is similar to Sec. 65 of
NIL on warranties of a qualified indorser.
2. Indorser not a guarantor - The indorsement of a receipt shall not
make the indorser liable for any failure on the part of the
warehouseman or previous indorsers of the receipt to fulfill their
respective obligations.
3. Negotiation defeats vendor's lien - Where a negotiable receipt has
been issued for goods, no seller's lien or right of stoppage in transitu
shall defeat the rights of any purchaser for value in good faith to
whom such receipt has been negotiated, whether such negotiation
be prior or subsequent to the notification to the warehouseman who
issued such receipt of the seller's claim to a lien or right of stoppage
in transitu. Nor shall the warehouseman be obliged to deliver or
justified in delivering the goods to an unpaid seller unless the receipt
is first surrendered for cancellation.
Warehousemans Obligation To Deliver The Goods
upon demand made either:
a. by the holder of a receipt for the goods;
b. by the depositor, provided that such demand is
accompanied by:
i. an offer to satisfy the warehousemans lien;

ii.

an offer to surrender the receipt if it is

negotiable; and
iii. a readiness and willingness to sign an
acknowledgment, when such goods are
delivered, that they have been delivered if such
is requested by the warehouseman.
Commingling of Goods
General Rule: Warehouseman must keep the goods of a depositor
from the goods of other depositors, or from the goods of the same
depositor for which a separate receipt has been issued.
Exception: Commingling of goods is allowed if:
a. the goods are fungible; and
b. the commingling is authorized by agreement or by
custom.
What The Warehouseman Can Do In Case Of Several Claims:
a. He can refuse to deliver the goods to anyone of them until
he has had reasonable time to ascertain the validity of the
various claims;
b. He can require all claimants to interplead, either as a
defense to an action brought against him for non-delivery of
the goods, or as an original suit, whichever is appropriate.
When Justified In Delivering The Goods:
The person lawfully entitled to the possession of the goods:
1. the person who is himself entitled to delivery of goods by the
terms of a non-negotiable receipt or who has been authorized to
take delivery of the goods by the person entitled to such
delivery;
2. the person in possession of a negotiable instrument receipt
by the person to whom delivery was promised by the terms of
the receipt by immediate endorsee.
When Liable For Misdelivery:
1. if he delivers the goods to one who is not in fact lawfully entitled
to the possession of the goods;
2. If he delivers to a person holding a non-negotiable receipt or a
negotiable receipt, if prior to the delivery he had either:
a. been requested not to make such delivery by the

person lawfully entitled to a right of property or

possession in the goods; or
b. had information that delivery about to be made was
to one not lawfully entitled to the possession of the
goods.
When May Delivery Be Legally Refused: (SHAPE-L)
1. where the goods have already been lawfully sold to third
persons to satisfy the warehousemans lien or disposed of
because of their perishable nature;
2. When the holder of the receipt does not satisfy the conditions
prescribed in Section 8 of the Act;
3. In case of adverse claimants;
4. Prior to delivery:
a. if he has been requested by a person lawfully
entitled to a right of property or possession in
the goods not to make delivery to any person;
b. if he had information that the delivery to be
made was to one not lawfully entitled to the
passion of the goods.
5. In the valid exercise of the warehousemans lien;and
6. When the warehouseman has a legal title in himself on the
goods such title or right being derived directly or indirectly from
the transfer made by the depositor at the time or subsequent to
the deposit for storage or from the warehousemans lien.
Warehousemans Lien
Extent:
1. lawful charges for storage and preservation of the goods;
2. lawful claims for money advanced; and
3. reasonable charges and expenses for notice and
advertisement of the sale, and the sale of goods.
Remedies available to warehouseman to enforce his lien: (SOR)
1. To refuse to deliver the goods until his lien is satisfied;
2. To sell the goods and apply the proceeds to the value of the
lien;
3. By other means allowed by law to a creditor against his
debtor, for the collection from the depositor of all charges
and advances which the depositor contracted with the

warehouseman to pay, or such other remedies allowed by

law for the enforcement of a lien against personal property.
Against what property may Lien be enforced:
1. All deposited goods of the person liable for the lien; and
2. All goods belonging to others deposited by the person liable for
the lien.
How Lien May Be Lost:
1. By surrendering possession thereof; or
2. By refusing to deliver the goods when a demand is made with
which he is bound to comply.
TRUST RECEIPTS LAW (PD 115)
Definition: A commercial document whereby the bank releases the
goods in the possession of the entrustee but retains ownership
thereof while the entrustee shall sell the goods and apply the
proceeds for the full payment of his liability with the bank.
It is a written / printed document signed by the entrustee;
in favor of the entrustor;
whereby the latter releases the goods, documents or
instruments to the possession of the former upon the
entrustees promise:
c. to hold said goods in trust for the entrustor;
d. to sell the goods;
e. turn over the proceeds thereof to the extent of
what is owing to the entruster; or
f. to return the goods if unsold or for other purposes.
The Trust Receipt Law does not seek to enforce the payment of
loans. Thus, there can be no violation of the right against
imprisonment for non-payment of a debt. It is not an offense against
property but an offense against public order. (People vs. Nitafan,
207 SCRA 726)
Parties:
Entrustee person having or taking possession o
goods, documents or instruments under a trust
receipt transaction, and any successor in interest of

such person for the purpose or purposes specified in

the trust receipt agreement.
Entrustor person holding title over the goods,
documents, or instruments subject of a trust receipt
transaction, and any successor in interest of such
person; not the owner of the goods, but merely a
holder of security interest
Seller of the goods Not strictly and actually a
party to the trust receipt transaction; but merely a
party to the contract of sale with the buyer/importer
(entrustee).
Note: On issuing trust receipts, the bank, if not paid what is due it,
will be preferred over other creditors of the entrustee. He is not liable
to the buyer of the goods as vendor.
Rights of the Entruster: (PROCN)
1. Entitled to the proceeds from the sale of
goods, documents or instruments;
2. Entitled to the return of goods , etc. in
case of non-sale;
3. Enforce all other rights conferred on him
under the trust receipts;
4. May cancel the trust and take
possession of goods, etc. on case of
breach of trust agreement; and
5. Give at least 5 days notice to the entrustee
of the intention to sell the goods, etc.; he
may purchase at a public sale.
4. The entrusters security interest shall be
valid as against all creditors of the entrustee
for the duration of the trust receipt
agreement. Security interest of the
entrusters advances will have to be settled
first before the entrustee can consolidate his

ownership over the goods.

5. He is not liable as principal or vendor
under any sale or contract to sell made by
the entrustee.
6. No agency relationship is established in
Trust Receipts Law.
Obligations of Entrustee: (RTIDS-ROH)
Receive the proceeds in trust for the entruster;
Turn over the proceeds to the entruster to the extent of the
amount owing to the entruster or as appears on the trust
receipt;
Insure the goods for their total value against loss from fire,
theft, pilferage or other casualties;
Dispose the goods, etc. strictly in accordance with the
terms and conditions of the trust receipt;
Keep said goods or proceeds thereof separate and capable
of identification as property of the entruster;
Return the goods, etc. in the event of non-sale or upon
demand of the entruster;
Observe all other terms and conditions of the trust receipt
not contrary to law. and
Hold the goods, etc. in trust for the entruster.

The risk of loss shall be borne by the entrustee. Loss of

goods, etc. pending disposition, whether due to the fault or
negligence of the entrustee, shall not extinguish his
obligation to the entruster for the value thereof.
It is assumed that the title and possession is turned over
to the entrustee. The law does not cover sales on credit
with the title or other interest being retained by the seller as
security thereof.
A purchaser for value and in good faith acquires said goods,
etc. free from the entrusters security interest.

Civil Law Concepts

Where there is a contract of sale, the buyer is
to acquire only whatever title the seller had at
the time the sale was perfected. (Art. 1505)
Owner will bear the risk of loss of the object.

Trust Receipts Law Concept

Although the trustee is not the owner of the goods
under a trust receipt (ownership is retained by the
entrustor), anyone who acquires the goods from the
entrustee acquires good title over the goods.
Although the entrustee is not the owner of the goods
covered by a trust receipt, he bears the risk of loss.

Effects of breach of obligation:

1. Acts involving the violation of trust receipts agreement, such as failure to turn over the goods or the proceeds realized from the sale
thereof, shall render the offender LIABLE FOR ESTAFA UNDER ARTICLE 315, PAR. 1-B OF THE REVISED PENAL CODE.
2. If the violation or offense is committed by a corporation, the penalty shall be imposed upon the directors, officers, employees or other
officials or persons therein responsible for the offense, without prejudice to the civil liabilities arising from the criminal offense. (Pilipinas
Bank vs. Ong, G.R. No. 133176)
3. In the event of default by the entrustee the entruster need not demand the return of the unsold goods to be able to enforce his rights
under the trust receipt.
4. Fraud and deceit need not be proven for the offense is punished as malum prohibitum regardless of intent or malice.
5. Surrender of the goods to the bank, if unsold merely extinguishes the entrustees criminal liability but is not relieved of its obligation to pay
for the money borrowed.
Note: Mere failure to deliver the proceeds of the sale or the goods, if not sold, constitutes violation of PD No. 115. However, what is being
punished by the law is the dishonesty and abuse of confidence in the handling of money or goods to the prejudice of another regardless of
whether the latter is the owner. The mala prohibita nature of the offense notwithstanding, intent to misuse or misappropriate the goods or their
proceeds has to be established by the records. (Pilipinas Bank vs. Ong, G.R. No. 133176)
Trust Receipt
The property is in the possession of the person
financed.
There is no sale of the property from the entruster to
the entrustee.
Does not involve the creation of a lien.
The seller does not retain title to the property but
transfers such title to the entruster.

Pledge
The person doing the financing has possession
of the property.
Conditional Sale
There is a sale of the property from the seller to
the buyer.
Chattel Mortgage
Involves the creation of a lien upon the property.
Consignment
The consignor retains title to the property to
secure the indebtedness due form the
consignee.