special commercial law full cases

8/12/2019 Special Commercial Law full cases

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G.R. No. 94209 April 30, 1991

FEATI BANK & TRUST COMPANY (now CITYTRUST BANKING CORPORATION), petitioner,vs.THE COURT OF APPEALS, and BERNARDO E. VILLALUZ, respondents.

Pelaez, Adriano & Gregorio for petitioner.

Ezequiel S. Consulta for private respondent.

GUTIERREZ, JR., J .:p

This is a petition for review seeking the reversal of the decision of the Court of Appeals dated June 29, 1990 whichaffirmed the decision of the Regional Trial Court of Rizal dated October 20, 1986 ordering the defendants Christiansenand the petitioner, to pay various sums to respondent Villaluz, jointly and severally.

The facts of the case are as follows:

On June 3, 1971, Bernardo E. Villaluz agreed to sell to the then defendant Axel Christiansen 2,000 cubic meters of lauan

logs at $27.00 per cubic meter FOB.

After inspecting the logs, Christiansen issued purchase order No. 76171.

On the arrangements made and upon the instructions of the consignee, Hanmi Trade Development, Ltd., de Santa Ana,California, the Security Pacific National Bank of Los Angeles, California issued Irrevocable Letter of Credit No. IC-46268available at sight in favor of Villaluz for the sum of $54,000.00, the total purchase price of the lauan logs.

The letter of credit was mailed to the Feati Bank and Trust Company (now Citytrust) with the instruction to the latter that it"forward the enclosed letter of credit to the beneficiary." (Records, Vol. I, p. 11)

The letter of credit further provided that the draft to be drawn is on Security Pacific National Bank and that it beaccompanied by the following documents:

1. Signed Commercial Invoice in four copies showing the number of the purchase order and certifying that

a. All terms and conditions of the purchase order have been complied with and that alllogs are fresh cut and quality equal to or better than that described in H.A. Christiansen'stelex #201 of May 1, 1970, and that all logs have been marked "BEV-EX."

b. One complete set of documents, including 1/3 original bills of lading was airmailed toConsignee and Parties to be advised by Hans-Axel Christiansen, Ship and MerchandiseBroker.

c. One set of non-negotiable documents was airmailed to Han Mi Trade DevelopmentCompany and one set to Consignee and Parties to be advised by Hans-AxelChristiansen, Ship and Merchandise Broker.

2. Tally sheets in quadruplicate.

3. 2/3 Original Clean on Board Ocean Bills of Lading with Consignee and Parties to be advised by HansAxel Christiansen, showing Freight Prepaid and marked Notify:

Han Mi Trade Development Company, Ltd., Santa Ana, California.

Letter of Credit No. 46268 dated June 7, 1971


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Han Mi Trade Development Company, Ltd., P.O. Box 10480, Santa Ana, California 92711 and Han MiTrade Development Company, Ltd., Seoul, Korea.

4. Certification from Han-Axel Christiansen, Ship and Merchandise Broker, stating that logs have beenapproved prior to shipment in accordance with terms and conditions of corresponding purchase Order.(Record, Vol. 1 pp. 11-12)

Also incorporated by reference in the letter of credit is the Uniform Customs and Practice for Documentary Credits (1962Revision).

The logs were thereafter loaded on the vessel "Zenlin Glory" which was chartered by Christiansen. Before its loading, thelogs were inspected by custom inspectors Nelo Laurente, Alejandro Cabiao, Estanislao Edera from the Bureau ofCustoms (Records, Vol. I, p. 124) and representatives Rogelio Cantuba and Jesus Tadena of the Bureau of Forestry(Records, Vol. I, pp. 16-17) all of whom certified to the good condition and exportability of the logs.

After the loading of the logs was completed, the Chief Mate, Shao Shu Wang issued a mate receipt of the cargo whichstated the same are in good condition (Records, Vol. I, p. 363). However, Christiansen refused to issue the certification asrequired in paragraph 4 of the letter of credit, despite several requests made by the private respondent.

Because of the absence of the certification by Christiansen, the Feati Bank and Trust Company refused to advance thepayment on the letter of credit.

The letter of credit lapsed on June 30, 1971, (extended, however up to July 31, 1971) without the private respondentreceiving any certification from Christiansen.

The persistent refusal of Christiansen to issue the certification prompted the private respondent to bring the matter beforethe Central Bank. In a memorandum dated August 16, 1971, the Central Bank ruled that:

. . . pursuant to the Monetary Board Resolution No. 1230 dated August 3, 1971, in all log exports, thecertification of the lumber inspectors of the Bureau of Forestry . . . shall be considered final for purposesof negotiating documents. Any provision in any letter of credit covering log exports requiring certificationof buyer's agent or representative that said logs have been approved for shipment as a conditionprecedent to negotiation of shipping documents shall not be allowed. (Records, Vol. I, p. 367)

Meanwhile, the logs arrived at Inchon, Korea and were received by the consignee, Hanmi Trade Development Company,to whom Christiansen sold the logs for the amount of $37.50 per cubic meter, for a net profit of $10 per cubic meter.Hanmi Trade Development Company, on the other hand sold the logs to Taisung Lumber Company at Inchon, Korea.(Rollo, p. 39)

Since the demands by the private respondent for Christiansen to execute the certification proved futile, Villaluz, onSeptember 1, 1971, instituted an action for mandamusand specific performance against Christiansen and the Feati Bankand Trust Company (now Citytrust) before the then Court of First Instance of Rizal. The petitioner was impleaded asdefendant before the lower court only to afford complete relief should the court a quoorder Christiansen to execute therequired certification.

The complaint prayed for the following:

1. Christiansen be ordered to issue the certification required of him under the Letter of Credit;

2. Upon issuance of such certification, or, if the court should find it unnecessary, FEATI BANK be orderedto accept negotiation of the Letter of Credit and make payment thereon to Villaluz;

3. Order Christiansen to pay damages to the plaintiff. (Rollo, p. 39)

On or about 1979, while the case was still pending trial, Christiansen left the Philippines without informing the Court andhis counsel. Hence, Villaluz, filed an amended complaint to make the petitioner solidarily liable with Christiansen.

The trial court, in its order dated August 29, 1979, admitted the amended complaint.


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After trial, the lower court found:

The liability of the defendant CHRISTIANSEN is beyond dispute, and the plaintiffs right to demandpayment is absolute. Defendant CHRISTIANSEN having accepted delivery of the logs by having themloaded in his chartered vessel the "Zenlin Glory" and shipping them to the consignee, his buyer Han MiTrade in Inchon, South Korea (Art. 1585, Civil Code), his obligation to pay the purchase order had clearlyarisen and the plaintiff may sue and recover the price of the goods (Art. 1595, Id).

The Court believes that the defendant CHRISTIANSEN acted in bad faith and deceit and with intent to

defraud the plaintiff, reflected in and aggravated by, not only his refusal to issue the certification thatwould have enabled without question the plaintiff to negotiate the letter of credit, but his accusing theplaintiff in his answer of fraud, intimidation, violence and deceit. These accusations said defendant did notattempt to prove, as in fact he left the country without even notifying his own lawyer. It was to the Court'smind a pure swindle.

The defendant Feati Bank and Trust Company, on the other hand, must be held liable together with his(sic) co-defendant for having, by its wrongful act, i.e., its refusal to negotiate the letter of credit in theabsence of CHRISTIANSEN's certification (in spite of the Central Bank's ruling that the requirement wasillegal), prevented payment to the plaintiff. The said letter of credit, as may be seen on its face,is irrevocableand the issuingbank, the Security Pacific National Bank in Los Angeles, California,undertook by its terms that the same shall be honored upon its presentment. On the other hand, thenotifying bank, the defendant Feati Bank and Trust Company, by accepting the instructions from the

issuing bank, itself assumed the very same undertaking as the issuing bank under the terms of the letterof credit.

xxx xxx xxx

The Court likewise agrees with the plaintiff that the defendant BANK may also be held liable under theprinciples and laws on both trust and estoppel. When the defendant BANK accepted its role as thenotifying and negotiating bank for and in behalf of the issuing bank, it in effect accepted a trust reposedon it, and became a trustee in relation to plaintiff as the beneficiary of the letter of credit. As trustee, it wasthen duty bound to protect the interests of the plaintiff under the terms of the letter of credit, and must beheld liable for damages and loss resulting to the plaintiff from its failure to perform that obligation.

Furthermore, when the defendant BANK assumed the role of a notifying and negotiating BANK it in effect

represented to the plaintiff that, if the plaintiff complied with the terms and conditions of the letter of creditand presents the same to the BANK together with the documents mentioned therein the said BANK willpay the plaintiff the amount of the letter of credit. The Court is convinced that it was upon the strength ofthis letter of credit and this implied representation of the defendant BANK that the plaintiff delivered thelogs to defendant CHRISTIANSEN, considering that the issuing bank is a foreign bank with whom plaintiffhad no business connections and CHRISTIANSEN had not offered any other Security for the payment ofthe logs. Defendant BANK cannot now be allowed to deny its commitment and liability under the letter ofcredit:

A holder of a promissory note given because of gambling who indorses the same to aninnocent holder for value and who assures said party that the note has no legal defect, isin estoppel from asserting that there had been an illegal consideration for the note, andso, he has to pay its value. (Rodriguez v. Martinez, 5 Phil. 67).

The defendant BANK, in insisting upon the certification of defendant CHRISTIANSEN as a conditionprecedent to negotiating the letter of credit, likewise in the Court's opinion acted in bad faith, not onlybecause of the clear declaration of the Central Bank that such a requirement was illegal, but because theBANK, with all the legal counsel available to it must have known that the condition was void since itdepended on the sole will of the debtor, the defendant CHRISTIANSEN. (Art. 1182, Civil Code) (Rollo,pp. 29-31)

On the basis of the foregoing the trial court on October 20, 1986, ruled in favor of the private respondent. The dispositiveportion of its decision reads:


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WHEREFORE, judgment is hereby rendered for the plaintiff, ordering the defendants to pay the plaintiff,jointly and severally, the following sums:

a) $54,000.00 (US), or its peso equivalent at the prevailing rate as of the time payment is actually made,representing the purchase price of the logs;

b) P17,340.00, representing government fees and charges paid by plaintiff in connection with the logsshipment in question;

c) P10,000.00 as temperate damages (for trips made to Bacolod and Korea).

All three foregoing sums shall be with interest thereon at 12% per annumfrom September 1, 1971, whenthe complaint was filed, until fully paid:

d) P70,000.00 as moral damages;

e) P30,000.00 as exemplary damages; and

f) P30,000.00 as attorney's fees and litigation expense.

(Rollo, p. 28)

The petitioner received a copy of the decision on November 3, 1986. Two days thereafter, or on November 5, 1986, it fileda notice of appeal.

On November 10, 1986, the private respondent filed a motion for the immediate execution of the judgment on the groundthat the appeal of the petitioner was frivolous and dilatory.

The trial court ordered the immediate execution of its judgment upon the private respondent's filing of a bond.

The petitioner then filed a motion for reconsideration and a motion to suspend the implementation of the writ of execution.Both motions were, however, denied. Thus, petitioner filed before the Court of Appeals a petition forcertiorariandprohibition with preliminary injunction to enjoin the immediate execution of the judgment.

The Court of Appeals in a decision dated April 9, 1987 granted the petition and nullified the order of execution, thedispositive portion of the decision states:

WHEREFORE, the petition for certiorariis granted. Respondent Judge's order of execution datedDecember 29, 1986, as well as his order dated January 14, 1987 denying the petitioner's urgent motion tosuspend the writ of execution against its properties are hereby annulled and set aside insofar as they aresought to be enforced and implemented against the petitioner Feati Bank & Trust Company, now CitytrustBanking Corporation, during the pendency of its appeal from the adverse decision in Civil Case No.15121. However, the execution of the same decision against defendant Axel Christiansen did not appealsaid decision may proceed unimpeded. The Sheriff s levy on the petitioner's properties, and the notice ofsale dated January 13, 1987 (Annex M), are hereby annulled and set aside. Rollop. 44)

A motion for reconsideration was thereafter filed by the private respondent. The Court of Appeals, in a resolution datedJune 29, 1987 denied the motion for reconsideration.

In the meantime, the appeal filed by the petitioner before the Court of Appeals was given due course. In its decision datedJune 29, 1990, the Court of Appeals affirmed the decision of the lower court dated October 20, 1986 and ruled that:

1. Feati Bank admitted in the "special and negative defenses" section of its answer that it was the bank tonegotiate the letter of credit issued by the Security Pacific National Bank of Los Angeles, California.(Record, pp. 156, 157). Feati Bank did notify Villaluz of such letter of credit. In fact, as such negotiatingbank, even before the letter of credit was presented for payment, Feati Bank had already made anadvance payment of P75,000.00 to Villaluz in anticipation of such presentment. As the negotiating bank,Feati Bank, by notifying Villaluz of the letter of credit in behalf of the issuing bank (Security Pacific),


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confirmed such letter of credit and made the same also its own obligation. This ruling finds support in theauthority cited by Villaluz:

A confirmed letter of credit is one in which the notifying bank gives its assurance also that the openingbank's obligation will be performed. In such a case, the notifying bank will not simply transmit but willconfirm the opening bank's obligation by making it also its own undertaking, or commitment, or guarantyor obligation. (Ward & Hatfield, 28-29, cited in Agbayani, Commercial Laws, 1978 edition, p. 77).

Feati Bank argues further that it would be considered as the negotiating bank only upon negotiation of the

letter of credit. This stance is untenable. Assurance, commitments or guaranties supposed to be made bynotifying banks to the beneficiary of a letter of credit, as defined above, can be relevant or meaningfulonly with respect to a future transaction, that is, negotiation. Hence, even before actual negotiation, thenotifying bank, by the mere act of notifying the beneficiary of the letter of credit, assumes as of thatmoment the obligation of the issuing bank.

2. Since Feati Bank acted as guarantor of the issuing bank, and in effect also of the latter's principal orclient, i.e. Hans Axel-Christiansen. (sic) Such being the case, when Christiansen refused to issue thecertification, it was as though refusal was made by Feati Bank itself. Feati Bank should have taken stepsto secure the certification from Christiansen; and, if the latter should still refuse to comply, to hale him tocourt. In short, Feati Bank should have honored Villaluz's demand for payment of his logs by virtue of theirrevocable letter of credit issued in Villaluz's favor and guaranteed by Feati Bank.

3. The decision promulgated by this Court in CA-G.R. Sp No. 11051, which contained the statement"Since Villaluz" draft was not drawn strictly in compliance with the terms of the letter of credit, FeatiBank's refusal to negotiate it was justified," did not dispose of this question on the merits. In that case, thequestion involved was jurisdiction or discretion, and not judgment. The quoted pronouncement should notbe taken as a preemptive judgment on the merits of the present case on appeal.

4. The original action was for "Mandamusand/or specific performance." Feati Bank may not be a party tothe transaction between Christiansen and Security Pacific National Bank on the one hand, and Villaluz onthe other hand; still, being guarantor or agent of Christiansen and/or Security Pacific National Bank whichhad directly dealt with Villaluz, Feati Bank may be sued properly on specific performance as a proceduralmeans by which the relief sought by Villaluz may be entertained. ( Rollo, pp. 32-33)

The dispositive portion of the decision of the Court of Appeals reads:

WHEREFORE, the decision appealed from is affirmed; and accordingly, the appeal is hereby dismissed.Costs against the petitioner. (Rollo, p. 33)

Hence, this petition for review.

The petitioner interposes the following reasons for the allowance of the petition.

First Reason

THE RESPONDENT COURT ERRONEOUSLY CONCLUDED FROM THE ESTABLISHED FACTS ANDINDEED, WENT AGAINST THE EVIDENCE AND DECISION OF THIS HONORABLE COURT, THAT

PETITIONER BANK IS LIABLE ON THE LETTER OF CREDIT DESPITE PRIVATE RESPONDENTSNON-COMPLIANCE WITH THE TERMS THEREOF,

Second Reason

THE RESPONDENT COURT COMMITTED AN ERROR OF LAW WHEN IT HELD THAT PETITIONERBANK, BY NOTIFYING PRIVATE RESPONDENT OF THE LETTER OF CREDIT, CONFIRMED SUCHCREDIT AND MADE THE SAME ALSO ITS OBLIGATION AS GUARANTOR OF THE ISSUING BANK.

Third Reason


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THE RESPONDENT COURT LIKEWISE COMMITTED AN ERROR OF LAW WHEN IT AFFIRMED THETRIAL COURT'S DECISION. (Rollo, p. 12)

The principal issue in this case is whether or not a correspondent bank is to be held liable under the letter of credit despitenon-compliance by the beneficiary with the terms thereof?

The petition is impressed with merit.

It is a settled rule in commercial transactions involving letters of credit that the documents tendered must strictly conform

to the terms of the letter of credit. The tender of documents by the beneficiary (seller) must include all documents requiredby the letter. A correspondent bank which departs from what has been stipulated under the letter of credit, as when itaccepts a faulty tender, acts on its own risks and it may not thereafter be able to recover from the buyer or the issuingbank, as the case may be, the money thus paid to the beneficiary Thus the rule of strict compliance.

In the United States, commercial transactions involving letters of credit are governed by the rule of strict compliance. Inthe Philippines, the same holds true. The same rule must also be followed.

The case ofAnglo-South America Trust Co.v.Uhe et al. (184 N.E. 741 [1933]) expounded clearly on the rule of strictcompliance.

We have heretofore held that these letters of credit are to be strictly complied with which documents, andshipping documents must be followed as stated in the letter. There is no discretion in the bank or trustcompany to waive any requirements. The terms of the letter constitutes an agreement between thepurchaser and the bank. (p. 743)

Although in some American decisions, banks are granted a little discretion to accept a faulty tender as when the otherdocuments may be considered immaterial or superfluous, this theory could lead to dangerous precedents. Since a bankdeals only with documents, it is not in a position to determine whether or not the documents required by the letter of creditare material or superfluous. The mere fact that the document was specified therein readily means that the document is ofvital importance to the buyer.

Moreover, the incorporation of the Uniform Customs and Practice for Documentary Credit (U.C.P. for short) in the letter ofcredit resulted in the applicability of the said rules in the governance of the relations between the parties.

And even if the U.C.P. was not incorporated in the letter of credit, we have already ruled in the affirmative as to theapplicability of the U.C.P. in cases before us.

In Bank of P.I.v. De Nery(35 SCRA 256 [1970]), we pronounced that the observance of the U.C.P. in this jurisdiction isjustified by Article 2 of the Code of Commerce. Article 2 of the Code of Commerce enunciates that in the absence of anyparticular provision in the Code of Commerce, commercial transactions shall be governed by the usages and customsgenerally observed.

There being no specific provision which governs the legal complexities arising from transactions involving letters of creditnot only between the banks themselves but also between banks and seller and/or buyer, the applicability of the U.C.P. isundeniable.

The pertinent provisions of the U.C.P. (1962 Revision) are:

Article 3.

An irrevocable credit is a definite undertaking on the part of the issuing bank and constitutes theengagement of that bank to the beneficiary and bona fide holders of drafts drawn and/or documentspresented thereunder, that the provisions for payment, acceptance or negotiation contained in the creditwill be duly fulfilled,provided that all the terms and conditions of the credit are complied with.

An irrevocable credit may be advised to a beneficiary through another bank (the advising bank) withoutengagement on the part of that bank, but when an issuing bank authorizes or requests another bank toconfirm its irrevocable credit and the latter does so, such confirmation constitutes a definite undertaking ofthe confirming bank. . . .


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Article 7.

Banks must examine all documents with reasonable care to ascertain that they appear on their face to bein accordance with the terms and conditions of the credit,"

Article 8.

Payment, acceptance or negotiation against documents which appear on their face to be in accordancewith the terms and conditions of a credit by a bank authorized to do so, binds the party giving the

authorization to take up documents and reimburse the bank which has effected the payment, acceptanceor negotiation. (Emphasis Supplied)

Under the foregoing provisions of the U.C.P., the bank may only negotiate, accept or pay, if the documents tendered to itare on their face in accordance with the terms and conditions of the documentary credit. And since a correspondent bank,like the petitioner, principally deals only with documents, the absence of any document required in the documentary creditjustifies the refusal by the correspondent bank to negotiate, accept or pay the beneficiary, as it is not its obligation to lookbeyond the documents. It merely has to rely on the completeness of the documents tendered by the beneficiary.

In regard to the ruling of the lower court and affirmed by the Court of Appeals that the petitioner is not a notifying bank buta confirming bank, we find the same erroneous.

The trial court wrongly mixed up the meaning of an irrevocable credit with that of a confirmed credit. In its decision, thetrial court ruled that the petitioner, in accepting the obligation to notify the respondent that the irrevocable credithas beentransmitted to the petitioner on behalf of the private respondent, has confirmed the letter.

The trial court appears to have overlooked the fact that an irrevocable credit is not synonymous with a confirmed credit.These types of letters have different meanings and the legal relations arising from there varies. A credit may bean irrevocablecreditand at the same time a confirmed credit or vice-versa.

An irrevocable credit refers to the duration of the letter of credit. What is simply means is that the issuing bank may notwithout the consent of the beneficiary (seller) and the applicant (buyer) revoke his undertaking under the letter. Theissuing bank does not reserve the right to revoke the credit. On the other hand, a confirmed letter of credit pertains to thekind of obligation assumed by the correspondent bank. In this case, the correspondent bank gives an absolute assuranceto the beneficiary that it will undertake the issuing bank's obligation as its own according to the terms and conditions of thecredit. (Agbayani, Commercial Laws of the Philippines, Vol. 1, pp. 81-83)

Hence, the mere fact that a letter of credit is irrevocable does not necessarily imply that the correspondent bank inaccepting the instructions of the issuing bank has also confirmed the letter of credit. Another error which the lower courtand the Court of Appeals made was to confuse the obligation assumed by the petitioner.

In commercial transactions involving letters of credit, the functions assumed by a correspondent bank are classifiedaccording to the obligations taken up by it. The correspondent bank may be called a notifying bank, a negotiating bank, ora confirming bank.

In case of a notifying bank, the correspondent bank assumes no liability except to notify and/or transmit to the beneficiarythe existence of the letter of credit. (Kronman and Co., Inc. v. Public National Bank of New York, 218 N.Y.S. 616 [1926];Shaterian, Export-Import Banking, p. 292, cited in Agbayani, Commercial Laws of the Philippines, Vol. 1, p. 76). A

negotiating bank, on the other hand, is a correspondent bank which buys or discounts a draft under the letter of credit. Itsliability is dependent upon the stage of the negotiation. If before negotiation, it has no liability with respect to the seller butafter negotiation, a contractual relationship will then prevail between the negotiating bank and the seller. (Scanlon v. FirstNational Bank of Mexico, 162 N.E. 567 [1928]; Shaterian, Export-Import Banking, p. 293, cited in Agbayani, CommercialLaws of the Philippines, Vol. 1, p. 76)

In the case of a confirming bank, the correspondent bank assumes a direct obligation to the seller and its liability is aprimary one as if the correspondent bank itself had issued the letter of credit. (Shaterian, Export-Import Banking, p. 294,cited in Agbayani Commercial Laws of the Philippines, Vol. 1, p. 77)

In this case, the letter merely provided that the petitioner "forward the enclosed original credit to the beneficiary."(Records, Vol. I, p. 11) Considering the aforesaid instruction to the petitioner by the issuing bank, the Security Pacific


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National Bank, it is indubitable that the petitioner is only a notifying bank and not a confirming bank as ruled by the courtsbelow.

If the petitioner was a confirming bank, then a categorical declaration should have been stated in the letter of credit thatthe petitioner is to honor all drafts drawn in conformity with the letter of credit. What was simply stated therein was theinstruction that the petitioner forward the original letter of credit to the beneficiary.

Since the petitioner was only a notifying bank, its responsibility was solely to notify and/or transmit the documentary ofcredit to the private respondent and its obligation ends there.

The notifying bank may suggest to the seller its willingness to negotiate, but this fact alone does not imply that thenotifying bank promises to accept the draft drawn under the documentary credit.

A notifying bank is not a privy to the contract of sale between the buyer and the seller, its relationship is only with that ofthe issuing bank and not with the beneficiary to whom he assumes no liability. It follows therefore that when the petitionerrefused to negotiate with the private respondent, the latter has no cause of action against the petitioner for theenforcement of his rights under the letter. (SeeKronman and Co., Inc. v. Public National Bank of New York, supra)

In order that the petitioner may be held liable under the letter, there should be proof that the petitioner confirmed the letterof credit.

The records are, however, bereft of any evidence which will disclose that the petitioner has confirmed the letter of credit.The only evidence in this case, and upon which the private respondent premised his argument, is the P75,000.00 loanextended by the petitioner to him.

The private respondent relies on this loan to advance his contention that the letter of credit was confirmed by thepetitioner. He claims that the loan was granted by the petitioner to him, "in anticipation of the presentment of the letter ofcredit."

The proposition advanced by the private respondent has no basis in fact or law. That the loan agreement between thembe construed as an act of confirmation is rather far-fetched, for it depends principally on speculative reasoning.

As earlier stated, there must have been an absolute assurance on the part of the petitioner that it will undertake theissuing bank's obligation as its own. Verily, the loan agreement it entered into cannot be categorized as an emphatic

assurance that it will carry out the issuing bank's obligation as its own.

The loan agreement is more reasonably classified as an isolated transaction independent of the documentary credit.

Of course, it may be presumed that the petitioner loaned the money to the private respondent in anticipation that it wouldlater be paid by the latter upon the receipt of the letter. Yet, we would have no basis to rule definitively that such "act"should be construed as an act of confirmation.

The private respondent no doubt was in need of money in loading the logs on the ship "Zenlin Glory" and the only way tosatisfy this need was to borrow money from the petitioner which the latter granted. From these circumstances, a logicalconclusion that can be gathered is that the letter of credit was merely to serve as a collateral.

At the most, when the petitioner extended the loan to the private respondent, it assumed the character of a negotiatingbank. Even then, the petitioner will still not be liable, for a negotiating bank before negotiation has no contractualrelationship with the seller.

The case of Scanlon v.First National Bank(supra) perspicuously explained the relationship between the seller and thenegotiating bank, viz:

It may buy or refuse to buy as it chooses. Equally, it must be true that it owes no contractual duty towardthe person for whose benefit the letter is written to discount or purchase any draft drawn against thecredit. No relationship of agent and principal, or of trustee and cestui, between the receiving bank and thebeneficiary of the letter is established. (P.568)


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Whether therefore the petitioner is a notifying bank or a negotiating bank, it cannot be held liable. Absent any definitiveproof that it has confirmed the letter of credit or has actually negotiated with the private respondent, the refusal by thepetitioner to accept the tender of the private respondent is justified.

In regard to the finding that the petitioner became a "trustee in relation to the plaintiff (private respondent) as thebeneficiary of the letter of credit," the same has no legal basis.

A trust has been defined as the "right, enforceable solely in equity, to the beneficial enjoyment of property the legal title towhich is vested to another." (89 C.J.S. 712)

The concept of a trust presupposes the existence of a specific property which has been conferred upon the person for thebenefit of another. In order therefore for the trust theory of the private respondent to be sustained, the petitioner shouldhave had in its possession a sum of money as specific fund advanced to it by the issuing bank and to be held in trust by itin favor of the private respondent. This does not obtain in this case.

The mere opening of a letter of credit, it is to be noted, does not involve a specific appropriation of a sum of money infavor of the beneficiary. It only signifies that the beneficiary may be able to draw funds upon the letter of credit up to thedesignated amount specified in the letter. It does not convey the notion that a particular sum of money has beenspecifically reserved or has been held in trust.

What actually transpires in an irrevocable credit is that the correspondent bank does not receive in advance the sum ofmoney from the buyer or the issuing bank. On the contrary, when the correspondent bank accepts the tender and pays

the amount stated in the letter, the money that it doles out comes not from any particular fund that has been advanced bythe issuing bank, rather it gets the money from its own funds and then later seeks reimbursement from the issuing bank.

Granting that a trust has been created, still, the petitioner may not be considered a trustee. As the petitioner is only anotifying bank, its acceptance of the instructions of the issuing bank will not create estoppel on its part resulting in theacceptance of the trust. Precisely, as a notifying bank, its only obligation is to notify the private respondent of theexistence of the letter of credit. How then can such create estoppel when that is its only duty under the law?

We also find erroneous the statement of the Court of Appeals that the petitioner "acted as a guarantor of the issuing bankand in effect also of the latter's principal or client, i.e., Hans Axel Christiansen."

It is a fundamental rule that an irrevocable credit is independent not only of the contract between the buyer and the sellerbut also of the credit agreement between the issuing bank and the buyer. ( SeeKingdom of Sweden v. New York TrustCo., 96 N.Y.S. 2d 779 [1949]). The relationship between the buyer (Christiansen) and the issuing bank (Security PacificNational Bank) is entirely independent from the letter of credit issued by the latter.

The contract between the two has no bearing as to the non-compliance by the buyer with the agreement between thelatter and the seller. Their contract is similar to that of a contract of services (to open the letter of credit) and not that ofagency as was intimated by the Court of Appeals. The unjustified refusal therefore by Christiansen to issue thecertification under the letter of credit should not likewise be charged to the issuing bank.

As a mere notifying bank, not only does the petitioner not have any contractual relationship with the buyer, it has alsonothing to do with the contract between the issuing bank and the buyer regarding the issuance of the letter of credit.

The theory of guarantee relied upon by the Court of Appeals has to necessarily fail. The concept of guarantee vis-a-

visthe concept of an irrevocable credit are inconsistent with each other.

In the first place, the guarantee theory destroys the independence of the bank's responsibility from the contract uponwhich it was opened. In the second place, the nature of both contracts is mutually in conflict with each other. In contractsof guarantee, the guarantor's obligation is merely collateral and it arises only upon the default of the person primarilyliable. On the other hand, in an irrevocable credit the bank undertakes a primary obligation. (SeeNational Bank of EaglePass, Tex v. American National Bank of San Francisco, 282 F. 73 [1922])

The relationship between the issuing bank and the notifying bank, on the contrary, is more similar to that of an agency andnot that of a guarantee. It may be observed that the notifying bank is merely to follow the instructions of the issuing bankwhich is to notify or to transmit the letter of credit to the beneficiary. (SeeKronman v. Public National Bank of NewYork, supra). Its commitment is only to notify the beneficiary. It does not undertake any assurance that the issuing bank


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will perform what has been mandated to or expected of it. As an agent of the issuing bank, it has only to follow theinstructions of the issuing bank and to it alone is it obligated and not to buyer with whom it has no contractual relationship.

In fact the notifying bank, even if the seller tenders all the documents required under the letter of credit, may refuse tonegotiate or accept the drafts drawn thereunder and it will still not be held liable for its only engagement is to notify and/ortransmit to the seller the letter of credit.

Finally, even if we assume that the petitioner is a confirming bank, the petitioner cannot be forced to pay the amountunder the letter. As we have previously explained, there was a failure on the part of the private respondent to comply with

the terms of the letter of credit.

The failure by him to submit the certification was fatal to his case. The U.C.P. which is incorporated in the letter of creditordains that the bank may only pay the amount specified under the letter if all the documents tendered are on their face incompliance with the credit. It is not tasked with the duty of ascertaining the reason or reasons why certain documentshave not been submitted, as it is only concerned with the documents. Thus, whether or not the buyer has performed hisresponsibility towards the seller is not the bank's problem.

We are aware of the injustice committed by Christiansen on the private respondent but we are deciding the controversyon the basis of what the law is, for the law is not meant to favor only those who have been oppressed, the law is to governfuture relations among people as well. Its commitment is to all and not to a single individual. The faith of the people in ourjustice system may be eroded if we are to decide not what the law states but what we believe it should declare. Dura lexsed lex.

Considering the foregoing, the materiality of ruling upon the validity of the certificate of approval required of the privaterespondent to submit under the letter of credit, has become insignificant.

In any event, we affirm the earlier ruling of the Court of Appeals dated April 9, 1987 in regard to the petition before itfor certiorariand prohibition with preliminary injunction, to wit:

There is no merit in the respondent's contention that the certification required in condition No. 4 of theletter of credit was "patently illegal." At the time the letter of credit was issued there was no Central Bankregulation prohibiting such a condition in the letter of credit. The letter of credit (Exh. C) was issued onJune 7, 1971, more than two months before the issuance of the Central Bank Memorandum on August16, 1971 disallowing such a condition in a letter of credit. In fact the letter of credit had already expired onJuly 30, 1971 when the Central Bank memorandum was issued. In any event, it is difficult to see how

such a condition could be categorized as illegal or unreasonable since all that plaintiff Villaluz, as seller ofthe logs, could and should have done was to refuse to load the logs on the vessel "Zenlin Glory", unlessChristiansen first issued the required certification that the logs had been approved by him to be inaccordance with the terms and conditions of his purchase order. Apparently, Villaluz was in too muchhaste to ship his logs without taking all due precautions to assure that all the terms and conditions of theletter of credit had been strictly complied with, so that there would be no hitch in its negotiation. (Rollo, p.8)

WHEREFORE, the COURT RESOLVED to GRANT the petition and hereby NULLIFIES and SETS ASIDE the decision ofthe Court of Appeals dated June 29, 1990. The amended complaint in Civil Case No. 15121 is DISMISSED.

SO ORDERED.


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G.R. No. L-24821 October 16, 1970

BANK OF THE PHILIPPINE ISLANDS, plaintiff-appellee,vs.DE RENY FABRIC INDUSTRIES, INC., AURORA T. TUYO and AURORA CARCERENY alias AURORA C.GONZALES, defendants-appellants.

Aviado and Aranda for plaintiff-appellee.

S. Emiliano Calma for defendants-appellants.

CASTRO, J .:.

This is an appeal from the decision of the Court of First Instance of Manila ordering the defendants-appellants to pay tothe Bank of the Philippine Islands (hereinafter referred to as the Bank), jointly and severally, the value of the credit itextended to them in several letters of credit which the Bank opened at the behest of the defendants appellants to financetheir importation of dyestuffs from the United States, which however turned out to be mere colored chalk upon arrival andinspection thereof at the port of Manila.

The record shows that on four (4) different occasions in 1961, the De Reny Fabric Industries, Inc., a Philippine corporationthrough its co-defendants-appellants, Aurora Carcereny aliasAurora C. Gonzales, and Aurora T. Tuyo, president andsecretary, respectively of the corporation, applied to the Bank for four (4) irrevocable commercial letters of credit to coverthe purchase by the corporation of goods described in the covering L/C applications as "dyestuffs of various colors" fromits American supplier, the J.B. Distributing Company. All the applications of the corporation were approved, and thecorresponding Commercial L/C Agreements were executed pursuant to banking procedures. Under these agreements,the aforementioned officers of the corporation bound themselves personally as joint and solidary debtors with thecorporation. Pursuant to banking regulations then in force, the corporation delivered to the Bank peso marginal depositsas each letter of credit was opened.

The dates and amounts of the L/Cs applied for and approved as well as the peso marginal deposits made were,respectively, as follows:.

Date Application Amount Marginal& L/C No. Deposit

Oct. 10, 1961 61/1413 $57,658.38 P43,407.33

Oct. 23, 1961 61/1483 $25,867.34 19,473.64

Oct. 30, 1961 61/1495 $19,408.39 14,610.88

Nov. 10, 1961 61/1564 $26,687.64 20,090.90

TOTAL .... $129,621.75 P97,582.75

By virtue of the foregoing transactions, the Bank issued irrevocable commercial letters of credit addressed to itscorrespondent banks in the United States, with uniform instructions for them to notify the beneficiary thereof, the J.B.Distributing Company, that they have been authorized to negotiate the latter's sight drafts up to the amounts mentionedthe respectively, if accompanied, upon presentation, by a full set of negotiable clean "on board" ocean bills of ladingcovering the merchandise appearing in the LCs that is, dyestuffs of various colors. Consequently, the J.B. DistributingCompany drew upon, presented to and negotiated with these banks, its sight drafts covering the amounts of themerchandise ostensibly being exported by it, together with clean bills of lading, and collected the full value of the drafts upto the amounts appearing in the L/Cs as above indicated. These correspondent banks then debited the account of theBank of the Philippine Islands with them up to the full value of the drafts presented by the J.B. Distributing Company, pluscommission thereon, and, thereafter, endorsed and forwarded all documents to the Bank of the Philippine Islands.


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In the meantime, as each shipment (covered by the above-mentioned letters of credit) arrived in the Philippines, the DeReny Fabric Industries, Inc. made partial payments to the Bank amounting, in the aggregate, to P90,000. Furtherpayments were, however, subsequently discontinued by the corporation when it became established, as a result of achemical test conducted by the National Science Development Board, that the goods that arrived in Manila were coloredchalks instead of dyestuffs.

The corporation also refused to take possession of these goods, and for this reason, the Bank caused them to bedeposited with a bonded warehouse paying therefor the amount of P12,609.64 up to the filing of its complaint with thecourt below on December 10, 1962.

On October 24, 1963 the lower court rendered its decision ordering the corporation and its co-defendants (the hereinappellants) to pay to the plaintiff-appellee the amount of P291,807.46, with interest thereon, as provided for in the L/CAgreements, at the rate of 7% per annum from October 31, 1962 until fully paid, plus costs.

It is the submission of the defendants-appellants that it was the duty of the foreign correspondent banks of the Bank of thePhilippine Islands to take the necessary precaution to insure that the goods shipped under the covering L/Cs conformedwith the item appearing therein, and, that the foregoing banks having failed to perform this duty, no claim for recoupmentagainst the defendants-appellants, arising from the losses incurred for the non-delivery or defective delivery of the articlesordered, could accrue.

We can appreciate the sweep of the appellants' argument, but we also find that it is nestled hopelessly inside a salientwhere the valid contract between the parties and the internationally accepted customs of the banking trade must prevail.1

Under the terms of their Commercial Letter of Credit Agreements with the Bank, the appellants agreed that the Bank shallnot be responsible for the "existence, character, quality, quantity, conditions, packing, value, or delivery of the propertypurporting to be represented by documents; for any difference in character, quality, quantity, condition, or value of theproperty from that expressed in documents," or for "partial or incomplete shipment, or failure or omission to ship any or allof the property referred to in the Credit," as well as "for any deviation from instructions, delay, default or fraud by theshipper or anyone else in connection with the property the shippers or vendors and ourselves [purchasers] or any of us."Having agreed to these terms, the appellants have, therefore, no recourse but to comply with their covenant.2

But even without the stipulation recited above, the appellants cannot shift the burden of loss to the Bank on account of theviolation by their vendor of its prestation.

It was uncontrovertibly proven by the Bank during the trial below that banks, in providing financing in international

business transactions such as those entered into by the appellants, do not deal with the property to be exported orshipped to the importer, but deal only with documents. The Bank introduced in evidence a provision contained in the"Uniform Customs and Practices for Commercial Documentary Credits Fixed for the Thirteenth Congress of InternationalChamber of Commerce," to which the Philippines is a signatory nation. Article 10 thereof provides: .

In documentary credit operations, all parties concerned deal in documents and not in goods . Payment,negotiation or acceptance against documents in accordance with the terms and conditions of a credit by aBank authorized to do so binds the party giving the authorization to take up the documents and reimbursethe Bank making the payment, negotiation or acceptance.

The existence of a custom in international banking and financing circles negating any duty on the part of a bank to verifywhether what has been described in letters of credits or drafts or shipping documents actually tallies with what was loadedaboard ship, having been positively proven as a fact, the appellants are bound by this established usage. They were, afterall, the ones who tapped the facilities afforded by the Bank in order to engage in international business.

ACCORDINGLY, the judgment a quo is affirmed, at defendants-appellants' cost. This is without prejudice to the Bank, inproper proceedings in the court below in this same case proving and being reimbursed additional expenses, if any, it hasincurred by virtue of the continued storage of the goods in question up to the time this decision becomes final andexecutory.


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G.R. No. 146717 November 22, 2004

TRANSFIELD PHILIPPINES, INC.,petitioner,vs.LUZON HYDRO CORPORATION, AUSTRALIA and NEW ZEALAND BANKING GROUP LIMITED and SECURITYBANK CORPORATION,respondents.

D E C I S I O N

TINGA, J.:

Subject of this case is the letter of credit which has evolved as the ubiquitous and most important device in internationaltrade. A creation of commerce and businessmen, the letter of credit is also unique in the number of parties involved andits supranational character.

Petitioner has appealed from the Decision1

of the Court of Appeals in CA-G.R. SP No. 61901 entitled "TransfieldPhilippines, Inc. v. Hon. Oscar Pimentel, et al.," promulgated on 31 January 2001.2

On 26 March 1997, petitioner and respondent Luzon Hydro Corporation (hereinafter, LHC) entered into a TurnkeyContract3whereby petitioner, as Turnkey Contractor, undertook to construct, on a turnkey basis, a seventy (70)-Megawatthydro-electric power station at the Bakun River in the provinces of Benguet and Ilocos Sur (hereinafter, the Project).Petitioner was given the sole responsibility for the design, construction, commissioning, testing and completion of theProject.4

The Turnkey Contract provides that: (1) the target completion date of the Project shall be on 1 June 2000, or such laterdate as may be agreed upon between petitioner and respondent LHC or otherwise determined in accordance with theTurnkey Contract; and (2) petitioner is entitled to claim extensions of time (EOT) for reasons enumerated in the TurnkeyContract, among which are variations, force majeure, and delays caused by LHC itself.5Further, in case of dispute, the

parties are bound to settle their differences through mediation, conciliation and such other means enumerated underClause 20.3 of the Turnkey Contract.6

To secure performance of petitioner's obligation on or before the target completion date, or such time for completion asmay be determined by the parties' agreement, petitioner opened in favor of LHC two (2) standby letters of credit bothdated 20 March 2000 (hereinafter referred to as "the Securities"), to wit: Standby Letter of Credit No. E001126/8400 withthe local branch of respondent Australia and New Zealand Banking Group Limited (ANZ Bank )7and Standby Letter ofCredit No. IBDIDSB-00/4 with respondent Security Bank Corporation (SBC)8each in the amount of US$8,988,907.00.9

In the course of the construction of the project, petitioner sought various EOT to complete the Project. The extensionswere requested allegedly due to several factors which prevented the completion of the Project on target date, such asforce majeure occasioned by typhoon Zeb, barricades and demonstrations. LHC denied the requests, however. This gaverise to a series of legal actions between the parties which culminated in the instant petition.

The first of the actions was a Request for Arbitration which LHC filed before the Construction Industry ArbitrationCommission (CIAC) on 1 June 1999.10This was followed by another Request for Arbitration, this time filed by petitionerbefore the International Chamber of Commerce (ICC)11on 3 November 2000. In both arbitration proceedings, the commonissues presented were: [1) whether typhoon Zeb and any of its associated events constituted force majeure to justify theextension of time sought by petitioner; and [2) whether LHC had the right to terminate the Turnkey Contract for failure ofpetitioner to complete the Project on target date.

Meanwhile, foreseeing that LHC would call on the Securities pursuant to the pertinent provisions of the TurnkeyContract,12petitionerin two separate letters13both dated 10 August 2000advised respondent banks of the arbitrationproceedings already pending before the CIAC and ICC in connection with its alleged default in the performance of itsobligations. Asserting that LHC had no right to call on the Securities until the resolution of disputes before the arbitral
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tribunals, petitioner warned respondent banks that any transfer, release, or disposition of the Securities in favor of LHC orany person claiming under LHC would constrain it to hold respondent banks liable for liquidated damages.

As petitioner had anticipated, on 27 June 2000, LHC sent notice to petitioner that pursuant to Clause 8.214of the TurnkeyContract, it failed to comply with its obligation to complete the Project. Despite the letters of petitioner, however, bothbanks informed petitioner that they would pay on the Securities if and when LHC calls on them.15

LHC asserted that additional extension of time would not be warranted; accordingly it declared petitioner in default/delayin the performance of its obligations under the Turnkey Contract and demanded from petitioner the payment of

US$75,000.00 for each day of delay beginning 28 June 2000 until actual completion of the Project pursuant to Clause8.7.1 of the Turnkey Contract. At the same time, LHC served notice that it would call on the securities for the payment ofliquidated damages for the delay.16

On 5 November 2000, petitioner as plaintiff filed a Complaint for Injunction, with prayer for temporary restraining order andwrit of preliminary injunction, against herein respondents as defendants before the Regional Trial Court (RTC) ofMakati.17Petitioner sought to restrain respondent LHC from calling on the Securities and respondent banks fromtransferring, paying on, or in any manner disposing of the Securities or any renewals or substitutes thereof. The RTCissued a seventy-two (72)-hour temporary restraining order on the same day. The case was docketed as Civil Case No.00-1312 and raffled to Branch 148 of the RTC of Makati.

After appropriate proceedings, the trial court issued an Order on 9 November 2000, extending the temporary restrainingorder for a period of seventeen (17) days or until 26 November 2000 .18

The RTC, in its Order19dated 24 November 2000, denied petitioner's application for a writ of preliminary injunction. It ruledthat petitioner had no legal right and suffered no irreparable injury to justify the issuance of the writ. Employing theprinciple of "independent contract" in letters of credit, the trial court ruled that LHC should be allowed to draw on theSecurities for liquidated damages. It debunked petitioner's contention that the principle of "independent contract" could beinvoked only by respondent banks since according to it respondent LHC is the ultimate beneficiary of the Securities. Thetrial court further ruled that the banks were mere custodians of the funds and as such they were obligated to transfer thesame to the beneficiary for as long as the latter could submit the required certification of its claims.

Dissatisfied with the trial court's denial of its application for a writ of preliminary injunction, petitioner elevated the case tothe Court of Appeals via a Petition for Certiorari under Rule 65, with prayer for the issuance of a temporary restrainingorder and writ of preliminary injunction.20Petitioner submitted to the appellate court that LHC's call on the Securities waspremature considering that the issue of its default had not yet been resolved with finality by the CIAC and/or the ICC. It

asserted that until the fact of delay could be established, LHC had no right to draw on the Securities for liquidateddamages.

Refuting petitioner's contentions, LHC claimed that petitioner had no right to restrain its call on and use of the Securitiesas payment for liquidated damages. It averred that the Securities are independent of the main contract between them asshown on the face of the two Standby Letters of Credit which both provide that the banks have no responsibility toinvestigate the authenticity or accuracy of the certificates or the declarant's capacity or entitlement to so certify.

In its Resolution dated 28 November 2000, the Court of Appeals issued a temporary restraining order, enjoining LHC fromcalling on the Securities or any renewals or substitutes thereof and ordering respondent banks to cease and desist fromtransferring, paying or in any manner disposing of the Securities.

However, the appellate court failed to act on the application for preliminary injunction until the temporary restraining orderexpired on 27 January 2001. Immediately thereafter, representatives of LHC trooped to ANZ Bank and withdrew the totalamount of US$4,950,000.00, thereby reducing the balance in ANZ Bank to US$1,852,814.00.

On 2 February 2001, the appellate court dismissed the petition for certiorari. The appellate court expressed conformitywith the trial court's decision that LHC could call on the Securities pursuant to the first principle in credit law that the credititself is independent of the underlying transaction and that as long as the beneficiary complied with the credit, it was of nomoment that he had not complied with the underlying contract. Further, the appellate court held that even assuming thatthe trial court's denial of petitioner's application for a writ of preliminary injunction was erroneous, it constituted only anerror of judgment which is not correctible by certiorari, unlike error of jurisdiction.

Undaunted, petitioner filed the instant Petition for Review raising the following issues for resolution:
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WHETHER THE "INDEPENDENCE PRINCIPLE" ON LETTERS OF CREDIT MAY BE INVOKED BY ABENEFICIARY THEREOF WHERE THE BENEFICIARY'S CALL THEREON IS WRONGFUL OR FRAUDULENT.

WHETHER LHC HAS THE RIGHT TO CALL AND DRAW ON THE SECURITIES BEFORE THE RESOLUTIONOF PETITIONER'S AND LHC'S DISPUTES BY THE APPROPRIATE TRIBUNAL.

WHETHER ANZ BANK AND SECURITY BANK ARE JUSTIFIED IN RELEASING THE AMOUNTS DUE UNDERTHE SECURITIES DESPITE BEING NOTIFIED THAT LHC'S CALL THEREON IS WRONGFUL.

WHETHER OR NOT PETITIONER WILL SUFFER GRAVE AND IRREPARABLE DAMAGE IN THE EVENTTHAT:

A. LHC IS ALLOWED TO CALL AND DRAW ON, AND ANZ BANK AND SECURITY BANK AREALLOWED TO RELEASE, THE REMAINING BALANCE OF THE SECURITIES PRIOR TO THERESOLUTION OF THE DISPUTES BETWEEN PETITIONER AND LHC.

B. LHC DOES NOT RETURN THE AMOUNTS IT HAD WRONGFULLY DRAWN FROM THESECURITIES.21

Petitioner contends that the courts below improperly relied on the "independence principle" on letters of credit when thiscase falls squarely within the "fraud exception rule." Respondent LHC deliberately misrepresented the supposedexistence of delay despite its knowledge that the issue was still pending arbitration, petitioner continues.

Petitioner asserts that LHC should be ordered to return the proceeds of the Securities pursuant to the principle againstunjust enrichment and that, under the premises, injunction was the appropriate remedy obtainable from the competentlocal courts.

On 25 August 2003, petitioner filed a Supplement to the Petition22and Supplemental Memorandum,23alleging that in thecourse of the proceedings in the ICC Arbitration, a number of documentary and testimonial evidence came out throughthe use of different modes of discovery available in the ICC Arbitration. It contends that after the filing of the petition factsand admissions were discovered which demonstrate that LHC knowingly misrepresented that petitioner had incurreddelaysnotwithstanding its knowledge and admission that delays were excused under the Turnkey Contract to be ableto draw against the Securities. Reiterating that fraud constitutes an exception to the independence principle, petitionerurges that this warrants a ruling from this Court that the call on the Securities was wrongful, as well as contrary to law andbasic principles of equity. It avers that it would suffer grave irreparable damage if LHC would be allowed to use theproceeds of the Securities and not ordered to return the amounts it had wrongfully drawn thereon.

In its Manifestation dated 8 September 2003,24LHC contends that the supplemental pleadings filed by petitioner presenterroneous and misleading information which would change petitioner's theory on appeal.

In yet another Manifestation dated 12 April 2004,25petitioner alleges that on 18 February 2004, the ICC handed down itsThird Partial Award, declaring that LHC wrongfully drew upon the Securities and that petitioner was entitled to the returnof the sums wrongfully taken by LHC for liquidated damages.

LHC filed a Counter-Manifestation dated 29 June 2004,26stating that petitioner's Manifestation dated 12 April 2004enlarges the scope of its Petition for Review of the 31 January 2001 Decision of the Court of Appeals. LHC notes that thePetition for Review essentially dealt only with the issue of whether injunction could issue to restrain the beneficiary of an

irrevocable letter of credit from drawing thereon. It adds that petitioner has filed two other proceedings, to wit: (1) ICCCase No. 11264/TE/MW, entitled "Transfield Philippines Inc. v. Luzon Hydro Corporation," in which the parties madeclaims and counterclaims arising from petitioner's performance/misperformance of its obligations as contractor for LHC;and (2) Civil Case No. 04-332, entitled "Transfield Philippines, Inc. v. Luzon Hydro Corporation" before Branch 56 of theRTC of Makati, which is an action to enforce and obtain execution of the ICC's partial award mentioned in petitioner'sManifestation of 12 April 2004.

In its Comment to petitioner's Motion for Leave to File Addendum to Petitioner's Memorandum, LHC stresses that thequestion of whether the funds it drew on the subject letters of credit should be returned is outside the issue in this appeal.At any rate, LHC adds that the action to enforce the ICC's partial award is now fully within the Makati RTC's jurisdiction inCivil Case No. 04-332. LHC asserts that petitioner is engaged in forum-shopping by keeping this appeal and at the sametime seeking the suit for enforcement of the arbitral award before the Makati court.
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Respondent SBC in its Memorandum, dated 10 March 200327contends that the Court of Appeals correctly dismissed thepetition for certiorari. Invoking the independence principle, SBC argues that it was under no obligation to look into thevalidity or accuracy of the certification submitted by respondent LHC or into the latter's capacity or entitlement to so certifyIt adds that the act sought to be enjoined by petitioner was already fait accompli and the present petition would no longerserve any remedial purpose.

In a similar fashion, respondent ANZ Bank in its Memorandum dated 13 March 2003 28posits that its actions could not beregarded as unjustified in view of the prevailing independence principle under which it had no obligation to ascertain thetruth of LHC's allegations that petitioner defaulted in its obligations. Moreover, it points out that since the Standby Letter of

Credit No. E001126/8400 had been fully drawn, petitioner's prayer for preliminary injunction had been rendered moot andacademic.

At the core of the present controversy is the applicability of the "independence principle" and "fraud exception rule" inletters of credit. Thus, a discussion of the nature and use of letters of credit, also referred to simply as "credits," wouldprovide a better perspective of the case.

The letter of credit evolved as a mercantile specialty, and the only way to understand all its facets is to recognize that it isan 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 ofproblems subsequently arising in the underlying contract. Since the bank's customer cannot draw on the letter, it does notfunction 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 oftennegotiable.29

In commercial transactions, a letter of credit is a financial device developed by merchants as a convenient and relativelysafe mode of dealing with sales of goods to satisfy the seemingly irreconcilable interests of a seller, who refuses to partwith his goods before he is paid, and a buyer, who wants to have control of the goods before paying .30The use of creditsin commercial transactions serves to reduce the risk of nonpayment of the purchase price under the contract for the saleof goods. However, credits are also used in non-sale settings where they serve to reduce the risk of nonperformance.Generally, credits in the non-sale settings have come to be known as standby credits .31

There are three significant differences between commercial and standby credits. First, commercial credits involve thepayment of money under a contract of sale. Such credits become payable upon the presentation by the seller-beneficiary

of documents that show he has taken affirmative steps to comply with the sales agreement. In the standby type, the creditis payable upon certification of a party's nonperformance of the agreement. The documents that accompany thebeneficiary's draft tend to show that the applicant has not performed. The beneficiary of a commercial credit mustdemonstrate by documents that he has performed his contract. The beneficiary of the standby credit must certify that hisobligor has not performed the contract.32

By definition, a letter of credit is a written instrument whereby the writer requests or authorizes the addressee to paymoney or deliver goods to a third person and assumes responsibility for payment of debt therefor to the addressee .33Aletter of credit, however, changes its nature as different transactions occur and if carried through to completion ends up asa binding contract between the issuing and honoring banks without any regard or relation to the underlying contract ordisputes between the parties thereto.34

Since letters of credit have gained general acceptability in international trade transactions, the ICC has published from

time to time updates on the Uniform Customs and Practice (UCP) for Documentary Credits to standardize practices in theletter of credit area. The vast majority of letters of credit incorporate the UCP.35First published in 1933, the UCP forDocumentary Credits has undergone several revisions, the latest of which was in 1993 .36

In Bank of the Philippine Islands v. De Reny Fabric Industries, Inc. ,37this Court ruled that the observance of the UCP isjustified by Article 2 of the Code of Commerce which provides that in the absence of any particular provision in the Codeof Commerce, commercial transactions shall be governed by usages and customs generally observed. More recently, inBank of America, NT & SA v. Court of Appeals,38this Court ruled that there being no specific provisions which govern thelegal complexities arising from transactions involving letters of credit, not only between or among banks themselves butalso between banks and the seller or the buyer, as the case may be, the applicability of the UCP is undeniable.
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Article 3 of the UCP provides that credits, by their nature, are separate transactions from the sales or other contract(s) onwhich they may be based and banks are in no way concerned with or bound by such contract(s), even if any referencewhatsoever to such contract(s) is included in the credit. Consequently, the undertaking of a bank to pay, accept and paydraft(s) or negotiate and/or fulfill any other obligation under the credit is not subject to claims or defenses by the applicantresulting from his relationships with the issuing bank or the beneficiary. A beneficiary can in no case avail himself of thecontractual relationships existing between the banks or between the applicant and the issuing bank.

Thus, the engagement of the issuing bank is to pay the seller or beneficiary of the credit once the draft and the requireddocuments are presented to it. The so-called "independence principle" assures the seller or the beneficiary of prompt

payment independent of any breach of the main contract and precludes the issuing bank from determining whether themain contract is actually accomplished or not. Under this principle, banks assume no liability or responsibility for the form,sufficiency, accuracy, genuineness, falsification or legal effect of any documents, or for the general and/or particularconditions stipulated in the documents or superimposed thereon, nor do they assume any liability or responsibility for thedescription, quantity, weight, quality, condition, packing, delivery, value or existence of the goods represented by anydocuments, or for the good faith or acts and/or omissions, solvency, performance or standing of the consignor, thecarriers, or the insurers of the goods, or any other person whomsoever.39

The independent nature of the letter of credit may be: (a) independence in toto where the credit is independent from thejustification aspect and is a separate obligation from the underlying agreement l ike for instance a typical standby; or (b)independence may be only as to the justification aspect like in a commercial letter of credit or repayment standby, which isidentical with the same obligations under the underlying agreement. In both cases the payment may be enjoined if in thelight of the purpose of the credit the payment of the credit would constitute fraudulent abuse of the credit.40

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 defenseavailable only to respondent banks. LHC, on the other hand, contends that it would be contrary to common sense to denythe benefit of an independent contract to the very party for whom the benefit is intended. As beneficiary of the letter ofcredit, 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 arepresented and the conditions of the credit are complied with.41Precisely, the independence principle liberates the issuingbank from the duty of ascertaining compliance by the parties in the main contract. As the principle's nomenclature clearlysuggests, 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 argumentthat it is only the issuing bank that may invoke theindependence principle on letters of creditdoes not impress this Court. To say that the independence principle may onlybe invoked by the issuing banks would render nugatory the purpose for which the letters of credit are used in commercialtransactions. 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 theissuing bank but mainly for the benefit of the parties to the original transactions. With the letter of credit from the issuingbank, the party who applied for and obtained it may confidently present the letter of credit to the beneficiary as a securityto convince the beneficiary to enter into the business transaction. On the other hand, the other party to the businesstransaction, i.e., the beneficiary of the letter of credit, can be rest assured of being empowered to call on the letter of creditas 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 mereguarantee. Jurisprudence has laid down a clear distinction between a letter of credit and a guarantee in that thesettlement of a dispute between the parties is not a pre-requisite for the release of funds under a letter of credit. In otherwords, the argument is incompatible with the very nature of the letter of credit. If a letter of credit is drawable only aftersettlement of the dispute on the contract entered into by the applicant and the beneficiary, there would be no practical andbeneficial 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:
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The standby credit is an attractive commercial device for many of the same reasons that commercial credits areattractive. Essentially, these credits are inexpensive and efficient. Often they replace surety contracts, which tendto generate higher costs than credits do and are usually triggered by a factual determination rather than by theexamination of documents.

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

Traditionally, upon the obligor's default, the surety undertakes to complete the obligor's performance, usually byhiring someone to complete that performance. Surety contracts, then, often involve costs of determining whetherthe obligor defaulted (a matter over which the surety and the beneficiary often litigate) plus the cost ofperformance. The benefit of the surety contract to the beneficiary is obvious. He knows that the surety, often aninsurance company, is a strong financial institution that will perform if the obligor does not. The beneficiary alsoshould understand that such performance must await the sometimes lengthy and costly determination that theobligor 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 ofnonperformance, 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 oppositeeffect 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 factof the obligor's performance. The beneficiary may have to establish that fact in litigation. During the litigation, thesurety 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 promptlyupon presentation of the required documents. It may be that the applicant has, in fact, performed and that thebeneficiary's presentation of those documents is not rightful. In that case, the applicant may sue the beneficiary intort, in contract, or in breach of warranty; but, during the litigation to determine whether the applicant has in factbreached the obligation to perform, the beneficiary, not the applicant, holds the money. Parties that use a standbycredit and courts construing such a credit should understand this allocation of burdens. There is a tendency insome quarters to over

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