LETTER OF CREDIT (LC) It is any arrangement, however named or described, whereby a bank (issuing bank), acting at the request and on th...

It is any arrangement, however named or described, whereby a bank (issuing bank), acting at the request and on the instructions of a customer (applicant) or on its own behalf, binds itself to:
1. Pay to the order of, or accept and pay drafts drawn by a third party (Beneficiary), or
2. Authorize another bank to pay or to accept and pay such drafts, or
3. Authorizes another bank to negotiate, against stipulated document(s),

Provided, the terms and conditions of the credit are complied with. (Art. 2, Uniform Customs & Practice for Documentary Credits.)

They are in effect absolute undertakings to pay the money advanced or for the amount for which the credit is given on the faith of the instrument.

To ensure certainty of payment. The seller is assured of payment because the bank intervenes and makes the commitment to pay. This addresses problems arising from seller’s refusal to part with his goods before being paid and the buyer’s refusal to part with his money before acquiring the goods, thus, facilitating commercial transactions.

1. Issued in favor of a definite person and not to order.

The Uniform Commercial Practice for Documentary Credits allows letters of credit to be payable to order.

2. Limited to a fixed or specified amount, or to one or more amounts, but with a maximum stated limit. (Article 568, Ibid)

If any of these essential conditions is not present, the instrument is merely considered as a letter of recommendation.

In case the buyer was not able to pay its obligation under the letter of credit, can the bank cannot take possession over the goods covered by the said letter of credit.
       The opening of a Letter of Credit did not vest ownership of the goods in the bank in the absence of a trust receipt agreement. A letter of credit is a mere financial device developed by merchants as a convenient and relatively safe mode of dealing with the 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. (Transfield Philippines, Inc. v. Luzon Hydro Corporation, G.R. No. 146717, Nov. 22, 2004)

1. Between the applicant/buyer/importer and the beneficiary/seller/exporter – 
The applicant/buyer/importer is the one who procures the letter of credit while the beneficiary/seller/exporter is the one who in compliance with the contract of sale ships the goods to the buyer and delivers the documents of title and draft to the issuing bank to recover payment for the goods. Their relationship is governed by the contract of sale.

2. Between the issuing bank and the beneficiary/seller/exporter – 
The issuing bank is the one that issues the letter of credit and undertakes to pay the seller upon receipt of the draft and proper documents of title. On the other hand, the beneficiary/seller/exporter surrenders document of title to the bank in compliance with the terms of the LC. Their relationship is governed by the terms of the LC.

3. Between the issuing bank and the applicant/buyer/importer – 
The applicant/buyer/importer obliges himself to reimburse the issuing bank upon receipt of the documents of title. Their relationship is governed by the terms of the application for the issuance of the letter of credit by the bank. 

1. Contract of sale between the buyer and seller
2. Application for LC by the buyer with the bank
3. Issuance of LC by the bank
4. Shipping of goods by the seller
5. Execution of draft and tender of documents by the seller
6. Redemption of draft (payment) and obtaining of documents by the issuing bank
7. Reimbursement to the bank and obtaining of documents by the buyer

Issuing bank is not a guarantor:
The concept of guarantee vis‐a‐vis the concept of irrevocable LC is inconsistent with each other. LCs are primary obligations and not security contracts and while they are security arrangements, they are not converted thereby into contracts of guaranty. (MWSS v. Hon. Daway, G.R. No. 160732, June 21, 2004)

Once the issuing bank shall have paid the beneficiary after the latter’s compliance with the terms of the LC. Presentment for acceptance to the customer/applicant is not a condition sine qua non for reimbursement. (Prudential Bank v. IAC, G.R. No. 74886, Dec. 8, 1992)

Consequence of payment upon an expired LC:
An issuing bank which paid the beneficiary of an expired letter of credit can recover the payment from the applicant which obtained the goods from the beneficiary to prevent unjust enrichment. (Rodzssen Supply Co. v. Far East Bank and Trust Co, G.R. No. 109087, May 9, 2001)

DISCLAIMER: The author is not lawyer nor an authority on this topic. It is a product of humble research and study of law. The information provided is not a legal advice and it should not be used  as a substitute for a competent legal advice from a licensed lawyer.

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