2008

X corporation entered into a contract with

PT Contruction Corp. for the latter to construct
and build a sugar mill within six (6) months.
They agreed that in case of delay, PT Construction Corp.
will pay X Corporation P100,000 for every day of delay.
To ensure payment of the agreed amount of damages, PT Construction Corp.
secured from Atlantic Bank a confirmed and irrevocable letter of
credit which was accepted by X Corporation in due time.

One week before the expiration of the six (6) month period,
PT Construction Corp. requested for an extension of time to
deliver claiming that the delay was due to the fault of X
Corporation. A controversy as to the cause of the delay which
involved the workmanship of the building ensued. T
he controversy remained unresolved. Despite the controversy,
X Corporation presented a claim against Atlantic Bank by
executing a draft against the letter of
credit.

a. Can Atlantic Bank refuse payment due to the

unresolved controversy? Explain. (3%)

b. Can X Corporation claim directly from PT Construction Corp.?

Explain. (3%)

http://sc.judiciary.gov.ph/jurisprudence/2004/nov2004/146717.htm

Can the beneficiary invoke the independence principle?

Petitioner insists that the independence principle does not apply to the instant
case and assuming it is so, it is a defense available only to respondent banks.
LHC, on the other hand, contends that it would be contrary to common sense to deny
the benefit of an independent contract to the very party for whom the benefit is
intended. As beneficiary of the letter of credit, LHC asserts it is entitled to
invoke the principle.

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.[41] 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.�

Petitioner�s argument that any dispute must first be resolved by the parties,
whether through negotiations or arbitration, before the beneficiary is entitled to
call on the letter of credit in essence would convert the letter of credit into a
mere guarantee. Jurisprudence has laid down a clear distinction between a letter of
credit and a guarantee in that the settlement of a dispute between the parties is
not a pre-requisite for the release of funds under a letter of credit. In other
words, the argument is incompatible with the very nature of the letter of credit.
If a letter of credit is drawable only after settlement of the dispute on the
contract entered into by the applicant and the beneficiary, there would be no
practical and beneficial use for letters of credit in commercial transactions.

Professor John F. Dolan, the noted authority on letters of credit, sheds more light
on the issue:

The standby credit is an attractive commercial device for many of the same reasons
that commercial credits are attractive. Essentially, these credits are inexpensive
and efficient. Often they replace surety contracts, which tend to generate higher
costs than credits do and are usually triggered by a factual determination rather
than by the examination of documents.

Because parties and courts should not confuse the different functions of the surety
contract on the one hand and the standby credit on the other, the distinction
between surety contracts and credits merits some reflection. The two commercial
devices share a common purpose. Both ensure against the obligor�s nonperformance.
They function, however, in distinctly different ways.

Traditionally, upon the obligor�s default, the surety undertakes to complete the
obligor�s performance, usually by hiring someone to complete that performance.
Surety contracts, then, often involve costs of determining whether the obligor
defaulted (a matter over which the surety and the beneficiary often litigate) plus
the cost of performance. The benefit of the surety contract to the beneficiary is
obvious. He knows that the surety, often an insurance company, is a strong
financial institution that will perform if the obligor does not. The beneficiary
also should understand that such performance must await the sometimes lengthy and
costly determination that the obligor has defaulted. In addition, the surety�s
performance takes time.

The standby credit has different expectations. He reasonably expects that he will
receive cash in the event of nonperformance, that he will receive it promptly, and
that he will receive it before any litigation with the obligor (the applicant) over
the nature of the applicant�s performance takes place. The standby credit has this
opposite effect of the surety contract: it reverses the financial burden of parties
during litigation.

In the surety contract setting, there is no duty to indemnify the beneficiary until
the beneficiary establishes the fact of the obligor�s performance. The beneficiary
may have to establish that fact in litigation. During the litigation, the surety
holds the money and the beneficiary bears most of the cost of delay in performance.

In the standby credit case, however, the beneficiary avoids that litigation burden
and receives his money promptly upon presentation of the required documents. It
may be that the applicant has, in fact, performed and that the beneficiary�s
presentation of those documents is not rightful. In that case, the applicant may
sue the beneficiary in tort, in contract, or in breach of warranty; but, during the
litigation to determine whether the applicant has in fact breached the obligation
to perform, the beneficiary, not the applicant, holds the money. Parties that use
a standby credit and courts construing such a credit should understand this
allocation of burdens. There is a tendency in some quarters to overlook this
distinction between surety contracts and standby credits and to reallocate burdens
by permitting the obligor or the issuer to litigate the performance question before
payment to the beneficiary.[42]

While it is the bank which is bound to honor the credit, it is the beneficiary who
has the right to ask the bank to honor the credit by allowing him to draw thereon.
The situation itself emasculates petitioner�s posture that LHC cannot invoke the
independence principle and highlights its puerility, more so in this case where the
banks concerned were impleaded as parties by petitioner itself.

Respondent banks had squarely raised the independence principle to justify their
releases of the amounts due under the Securities. Owing to the nature and purpose
of the standby letters of credit, this Court rules that the respondent banks were
left with little or no alternative but to honor the credit and both of them in fact
submitted that it was �ministerial� for them to honor the call for payment.[43]

Furthermore, LHC has a right rooted in the Contract to call on the Securities. The
relevant provisions of the Contract read, thus:

4.2.1. In order to secure the performance of its obligations under this Contract,
the Contractor at its cost shall on the Commencement Date provide security to the
Employer in the form of two irrevocable and confirmed standby letters of credit
(the �Securities�), each in the amount of US$8,988,907, issued and confirmed by
banks or financial institutions acceptable to the Employer. Each of the Securities
must be in form and substance acceptable to the Employer and may be provided on an
annually renewable basis.[44]

8.7.1 If the Contractor fails to comply with Clause 8.2, the Contractor shall pay
to the Employer by way of liquidated damages (�Liquidated Damages for Delay�) the
amount of US$75,000 for each and every day or part of a day that shall elapse
between the Target Completion Date and the Completion Date, provided that
Liquidated Damages for Delay payable by the Contractor shall in the aggregate not
exceed 20% of the Contract Price. The Contractor shall pay Liquidated Damages for
Delay for each day of the delay on the following day without need of demand from
the Employer.

8.7.2 The Employer may, without prejudice to any other method of recovery, deduct
the amount of such damages from any monies due, or to become due to the Contractor
and/or by drawing on the Security.�[45]

A contract once perfected, binds the parties not only to the fulfillment of what
has been expressly stipulated but also to all the consequences which according to
their nature, may be in keeping with good faith, usage, and law.[46] A careful
perusal of the Turnkey Contract reveals the intention of the parties to make the
Securities answerable for the liquidated damages occasioned by any delay on the
part of petitioner. The call upon the Securities, while not an exclusive remedy on
the part of LHC, is certainly an alternative recourse available to it upon the
happening of the contingency for which the Securities have been proffered. Thus,
even without the use of the �independence principle,� the Turnkey Contract itself
bestows upon LHC the right to call on the Securities in the event of default.