What are Letters of Credit?
Those issued by one
merchant to another for the purpose of attending to a commercial transaction.
Kinds:
Common Letter of Credit—an
instrument by which a bank, for the account of a buyer of merchandise, gives
formal evidence to a seller, of its willingness to permit the seller to draw
bills against it, and stipulates in legal form that all such bills will be
honored.
Traveler’s Letter of Credit—a
letter from a bank addressed to its correspondents stating that drafts up to a
certain sum drawn by the beneficiary will be honored by the bank.
Essential Conditions:
1.)
Issued in favor of a definite person
and not to order; and
2.)
Amount is fixed and specified.
Duration:
1.)
Upon a period fixed by the
parties;
2.) If none is fixed, 6 months from its date
if used in the Philippines
or 1 year if used abroad.
LETTER
OF CREDIT
(Art. 567-572 Code of Commerce)
LETTER OF CREDIT
Letter of credit –
an arrangement by a bank or other person made at the request of a customer that
the issuer will honor drafts or other demands for payment upon compliance w/
the conditions specified in the credit.
Internationally
accepted definition of a LC as provided in the Uniform Customs and Practices
for Documentary Credit (UCPDC):
Letter of Credit –
any arrangement, however named or described, whereby a bank also known as the
issuing bank, acting upon the request or instruction of another(applicant or
customer) or on its own behalf, binds itself to:
- Pay to the order of a 3rd
person known as beneficiary OR
- Accepts and pay any draft that
may be drawn by the beneficiary, OR
- Authorize another bank to:
- Pay to the order of a 3rd person known as the
beneficiary.
- Accept and pay any draft by the
beneficiary, OR
4.
Authorize another bank to negotiate against the stipulated documents.
Note: We are bound by the UCPDC
issued by the International Chamber of Commerce. Sec. 2 of the Code of Commerce states that in
the absence of any particular provision in the code of Commerce, commercial
transactions shall be governed by the usages and customs generally observed
(BPI vs. Nery).
A
Letter of Credit is a special contract designed to answer two concerns:
Seller’s refusal to part with his goods
before being paid coupled with the Buyer’s want of ownership over the goods
before paying.
Note: The opening of a LC does not involve specific
appropriation of money in favor of the beneficiary. The correspondent bank does not receive in
advance the money form the buyer or issuing bank but pays the amount out of its
own funds and then later on seek reimbursement from the issuing bank. It does not convey the notion that a
particular sum of money has been specifically reserved or has been held in
trust.
Note: An LC is not a negotiable instrument. It does
Not conform w/ Section 1 of the Negotiable Instruments Law. This is because it does not contain an
unconditional promise to pay a sum certain in money. The LC is conditioned to the submission of
certain documents. Moreover, the LC is
issued in favor of a definite person and not to order. Therefore, it also lacks
the words of negotiability required.
LC is conditioned on –
- Submission
of stipulated documents
- Compliance
with the terms of the LC
Is LC a commercial transaction?
YES. Because it is governed by the Code of
Commerce.
PARTIES to the transaction:
Basic parties to a
letter of credit:
- Applicant/buyer/importer
– the one who procures the letter of credit and obliges himself to
reimburse the Issuing Bank (IB) upon the receipt of the documents of
title. He is the party who
initiates the operation of the Letter of Credit transaction as the buyer
of the merchandise and also of the credit instrument.
- Issuing
Bank – is usually the buyer’s bank; it
issues the letter of credit and undertakes to pay the seller upon receipt
of the draft and proper documents to the buyer upon reimbursement.
- Seller/beneficiary
– is the one who in compliance w/ the contract of sale ships the goods to
the buyer and delivers the documents of title and drafts to the issuing
bank to recover payment. He is the
beneficiary of the instrument because the instrument is addressed to him
and in his favor.
Additional
party/parties to the LC:
4. Correspondent Bank
TYPES OF
CORRESPONDENT BANK:
- Advising/Notifying
Bank – does not have any contractual
relations w/ the buyer but merely serves as an agent of the issuing
bank. Its only responsibility is to
transmit the LC. Thus, it could
validly refuse to negotiate or accept, even if the seller tenders all the
documents required under the LC and it does not become liable as the
beneficiary has no cause of action against the bank.
- Confirming
Bank – lends credence to the LC issued by a
lesser known bank. It assumes
direct obligation to the seller/beneficiary and becomes principally
liable.
A
notifying bank, who also assumes the role of a negotiating bank does not
include assuming the role of a confirming bank and is therefore not liable to
the beneficiary. To be liable, there
must be an absolute assurance that it will undertake the issuing bank’s
obligation as its own. If it does
confirm, the beneficiary become entitled to proceed against either or both
banks in case of breach.
- Paying
Bank – the bank w/c pays the
beneficiary. It may either be the
opening/issuing bank or any other bank in the place of the beneficiary.
- Negotiating
Bank – any bank in the place of the
beneficiary w/c buys or discounts the seller’s draft. Its liability depends on the stage of
negotiation. If BEFORE negotiation,
such that it suggests its willingness to negotiate, it has no liability w/
respect to the seller. But if AFTER
negotiation, a contractual relationship will then prevail between them.
Note: A bank does not become a negotiating bank
unless he pays the draft and becomes the holder of said document.
As such, the IB may
notify the seller of the opening of the LC either directly or through a
correspondent bank, w/c may either be a mere advising bank or a Confirming
Bank.
Note: The IB has the option to tap a correspondent
bank or not.
The
liability of a Correspondent Bank depends on what kind of function it plays in
the LC transaction.
RELATIONSHIP OF THE PARTIES is governed by-
- Issuing
bank and applicant – the relationship is governed by the terms of the
application and agreement for the issuance of the LC by the bank.
- Issuing
bank and the Beneficiary – the relationship is governed by the terms of
the LC issued by the bank
- Applicant
and beneficiary – the relationship is governed by the contract they
entered into. ex. Sales
INDEPENDENCE
PRINCIPLE-
The bank in determining compliance with the
terms of the LC is required only to examine the shipping document presented by
the seller and is precluded from determining whether the main contract is
accomplished or not
DOCTRINE OF STRICT COMPLIANCE-
The document tendered by the seller must
strictly conform to the terms of the LC . The correspondent bank which departs
from what has been stipulated under the LC, as when it accepts a faulty tender
, acts on his own risk and may not thereafter recover from the buyer or issuing
bank , the money paid to the benefic
In short, the
documents presented must comply w/ those stipulated on. In a LC, the banks only
deals w/ documents and not w/ goods.
Can a
breach of contract be invoked against the Issuing Bank?
NO. Because if all
the documents stipulated have been submitted and the IB finds that they conform
w/t the LC requires, then the IB must pay the seller. In a LC transaction the banks deal only w/
documents not goods, so banks pays if the documents are OK and gets reimbursed
by the buyer. This relationship is
independent so if ever the goods are in bad condition, the applicant still pays
the bank.
Note: A loan transaction may give rise to LC. An LC does not arise only because of sale or
importation. Example: Standby LC.
Standby Letter of
Credit (SLC) – it is a bank issued option on loan involving
3 parties: the bank issuing the credit,
the party requesting for such issuance (otherwise known as the account party)
and the beneficiary.
Under the terms of a SLC, the
beneficiary has the right to trigger the loan option (referred to as TAKING
DOWN THE LOAN) if the account party fails to meet its commitment, in w/c case
the issuing bank disburses a specified sum to the beneficiary and books an
equivalent loan to its customer.
SLC’s
may support non-financial obligations such as those of bidders, or financial
obligations such as those of borrowers. In
the latter case, the borrower purchases an SLC and names the lender as
beneficiary. Should the borrower
default, the beneficiary has the right to take down the SLC and receive the
principal balance from the issuing bank.
The borrower’s loan obligation is then passed to the bank.
When the Notifying
Bank (NB) may be held liable:
The NB is liable
if:
- It did not notify the seller of
the opening of the LC, or
- It did not determine the apparent
authenticity of the required documents.
Note: Only the APPARENT AUTHENTICITY is to be
determined. The NB does not warrant the
authenticity of the LC but only its apparent authenticity. So if the LC turns out to be spurious, NB is
not liable for damages unless obvious that it is not authentic.
Therefore,
Notifying Bank/Advising Bank is liable if it acts beyond the scope of its
authority.
When may
the Advising Bank (AB) be equally liable with the Issuing Bank (IB)?
Ordinarily, an AB, whose obligation
is merely to advise the seller/beneficiary of the opening of a LC has no
liability. The opening of a LC does not
make the IB liable at once because there is no liability. The liability is conditioned and dependent on
the tender or submission of the documents stipulated upon by the parties. If the beneficiary requires that the
obligation of the IB shall also be made the obligation of the AB to him, there
is what is known as a CONFIRMED COMMERCIAL CREDIT and the AB shall become a
Confirming Bank. In this situation, the
liability of the CB is primary and it is as if the credit were issued by the IB
and the CB jointly, thus giving the beneficiary or holder for value of the
drafts drawn under the credit, the right to proceed against either or both
banks, the moment the credit instrument has been breached.
The CB is liable only when the
documents are submitted and gets reimbursed by the IB because there is no
privity of contract with the applicant.
Thus, an AB becomes a CB when the
above mentioned conditions occur. In
such a case, the CB acquires the same liabilities as the Issuing Bank and is
bound by the same conditions as an IB.
Function of a
Negotiating Bank (NB):
It
accepts or gives value to the draft and w/c later on sells the draft to the
IB. The IB then reimburses the NB. What happens is that the NB buys the draft at
a discounted price and then sells it to the IB for its face value.
If LC is disowned
by the IB, can the Negotiating Bank ask reimbursement from the seller? Under what principle?
YES. Seller is a
drawer of the draft accepted and paid by the Negotiating Bank. Therefore, the seller has contingent
liability on such draft.
Can a
Confirming Bank become a Notifying Bank?
NEVER, because they
have different liabilities. The CB’s
liability is primary while the NB’s liability comes only after negotiation (Before
negotiation, there is no liability).
- It is the application for the
opening of a LC w/c governs the relationship between the buyer and the
IB. This implies that the
buyer/applicant is not concerned w/ the terms of the LC between the IB and
the seller/beneficiary.
- As to the IB, it is not a
guarantor because its liability is not subsidiary since the condition of
the submission of the document is determinative of the liability not the
nonpayment of the buyer.
- The IB opens a LC for a
consideration w/c comes in the form of a commission.
If the IB does
not advance the payment in favor of the seller/beneficiary, may the
buyer/applicant recover the commission paid?
No More because
this is the consideration. But he may
recover the margin fee.
What
among other things, should be stipulated upon the application for a LC?
The documents w/c
the seller should submit to the IB.
In LC transactions,
the IB deals only w/ the documents, not w/ goods. The IB is not bound or required to examine
the goods. For as long as the required
documents are submitted by the seller, the IB pays the seller.
If the goods turned
out to be defective, is this a valid defense to avoid payment by the IB to the
seller?
NO. As long as the documents submitted by the
seller are complete and in conformity w/ what the LC requires, the IB is bound
to pay the seller. This is true even if
the goods turned out to be defective.
How about the
buyer, is he still bound to reimburse the IB despite the defective goods
received by him?
YES. The buyer has
no course of action against the IB. The
buyer has a COA against the seller.
If the documents
submitted by the seller are incomplete and the IB still pays the seller, is the
buyer still bound to pay the IB?
NO. Because the IB should not have paid the
seller knowing the documents to be incomplete.
The IB deals only w/ documents.
Can the
beneficiary demand payment form the CB?
YES. Since the CB is equally liable w/ the
IB.
If the beneficiary
proceeds against the CB, the CB may ask reimbursement from the IB. But if the beneficiary proceeds directly
against the CB; it has no right to collect from the IB. The beneficiary may compel the CB to accept
drafts it has drawn.
How is
payment made by the Issuing Bank?
Payment by the IB
is done through:
- Direct payment or wire transfer
or credit in the account of the beneficiary
- Drawing of a draft by the
beneficiary against the IB – pay to my order
- IB may authorize the Confirming
Bank to pay
- Authorize Correspondent Bank to
accept and pay any draft drawn
- Authorize the negotiation of any
draft drawn by the beneficiary.
Note: If the drawee doesn’t pay, go to the drawer
who is secondarily liable.
Apart form the bill
of lading, what additional documents may be needed as a condition of the LC for
honoring a draft?
- Commercial
invoice – it is a document signed and issued by
the seller and contains a precise description of the merchandise and the
terms of the sale such as unit prices, amount due form the buyer and
shipping conditions related to charges such as FOB (Free on Board), FAS
(Free Alongside), C and F (Cost and Freight) or CIF (Cost, Insurance,
Freight).
- Consular
invoice – document issued by the consulate of
the importing country to provide customs information and statistics for
that country and to help prevent false declaration of value.
- Certificate
of analysis – may be required to ascertain
that certain specifications of weight, purity, sanitation, etc., have been
met. These specifications may be
required by health or other officials of the importing country, or they
may be insisted by the importer as assurance that it is receiving what it
ordered.
- Export
declaration – it is a document prepared by
the exporter to assist the government to prepare export statistics.
Note: Documents to be passed are not unilaterally
determined by the bank but agreed upon by the buyer and seller.
Document of Title (Bill of Lading) –
given to the seller upon shipment of goods.
This is to be given to the IB to be able for the seller to get payment.
Is there a scheme
where the IB may release the documents of title to the buyer w/o being
reimbursed first by the buyer?
YES. By the IB letting the buyer execute a trust
receipt.
Failure of the buyer to open the Letter of
Contract does not prevent the birth of the Sales Contract.
The opening of the letter of credit is only a
mode of payment. The letter of the credit is not an essential requisite to the
contract of sale.
We are authorized Financial consulting firm that work directly with
ReplyDeleteA rated banks eg Lloyds Bank,Barclays Bank,hsbc bank etc
We provide BG, SBLC, LC, LOAN and lots more for client all over the world.
Equally,we are ready to work with Brokers and financial
consultants/consulting firms in their respective countries.
We are equally ready to pay commission to those Brokers and financial
consultants/consulting firms.
Awaiting a favourable response from you.
Best regards
WALSH SMITH, ROBERT
email : info.iqfinanceplc@gmail.com
skype: cpt_young1