Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001

LETTERS OF CREDIT
What is a letter of credit?

A letter of credit is one issued by one merchant to another, or for the purpose of attending to a
commercial transaction. (Art. 567, Code of Commerce)

It is an engagement by a bank or other person made at the request of a customer that the issue will
honor drafts or other demands for payment upon compliance with the conditions specified in the credit.
(Prudential Bank v. IAC, 216 SCRA 257)

It is an instrument issued by a bank at the request of an importer, in which the bank promises to pay a
beneficiary upon presentation of documents specified therein.

What is the nature of a letter of credit and what role does it play in resolving the
basic import / export dilemma?

A letter of credit is a financial device developed by merchants as a convenient and relatively safe
mode of dealing with sales of goods to satisfy the seemingly irreconcilable interests of a seller, who
refuses to part with his goods before he is paid, and a buyer, who wants to have control of the goods
before paying. To break the impasse, the buyer may be required to contract a bank to issue a letter of
credit in favor of the seller so that, by virtue of the letter of credit, the issuing bank can authorize the
seller to draw drafts and engage to pay them upon their presentment simultaneously with the tender
of documents required by the letter of credit. The buyer and the seller agree on what documents are
to be presented for payment, but ordinarily they are documents of title evidencing or attesting to the
shipment of the goods to the buyer.
Once the credit is established, the seller ships the goods to the buyer and in the process
secures the required shipping documents or documents of title. To get paid, the seller executes a
draft and presents it together with the required documents to the issuing bank. The issuing bank
redeems the draft and pays cash to the seller if it finds that the documents submitted by the seller
conform with what the letter of credit requires. The bank then obtains possession of the documents
upon paying the seller. The transaction is completed when the buyer reimburses the issuing bank
and acquires the documents entitling him to the goods. (Bank of America NT & SA v. CA, 228
SCRA 357)

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001

Under this arrangement, the seller gets paid only if he delivers the documents of title over the goods,
while the buyer acquires the said documents and control over the goods only after reimbursing the
bank.

A letter of credit is one of the modes of payment set out in Section 8 of Central Bank Circular No.
1389 or the Consolidated Foreign Exchange Rules and Regulations, by which commercial banks sell
foreign exchange to service payments for, e.g., commodity exports. The primary purpose of a letter
of credit is to substitute for, and therefore support, the agreement of the buyer/importer to pay money
under a contract or other arrangement. It creates in the seller/exporter a secure expectation of
payment. (Reliance Commodities, Inc, v. Daewoo Industrial Co., Ltd.)

What are the essential conditions of letters of credit?

(1) They must be issued in favor of a definite person and not to order; and
(2) They must be limited to a fixed and specified amount, or to one or more undetermined

amounts, but within a maximum, the limits of which have to be stated exactly.
Code of Commerce)

(Art. 568,

NOTE: A letter of credit which does not have one of these conditions is considered
simply as a letter of recommendation.

Applicability of the Uniform Customs and Practice for Documentary Credits (UCP) in
transactions involving letters of credit

Being a product of international commerce, the impact of letters of credit transcends national
boundaries, and it is thus not uncommon to find a dearth of national law that can adequately
provide for the governance of letters of credit.

In the Philippine jurisdiction, the provisions of the Uniform Customs and Practice for Documentary
Credits have been applied in transactions involving letters of credit in the case of Feati Bank v.
Court of Appeals and BPI v. De Nery.

Application of the UCP is made possible by Article 2 of the Code of Commerce which expresses
that, in the absence of any particular provision in the Code of Commerce, commercial transactions
shall be governed by usages and customs generally observed.

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
Who are the basic parties to a letter of credit?
1)

the buyer, who procures the letter of credit and obliges himself to reimburse the issuing bank upon
receipt of the documents of title;

2)

the bank issuing the letter of credit, which undertakes to pay the seller upon receipt of the draft
and proper documents of titles and to surrender the documents to the buyer upon reimbursement;
and

3)

the seller, who in compliance with the contract of sale ships the goods to the buyer and delivers
the documents of title and draft to the issuing bank to recover payment. (Bank of America NT
& SA v. Court of Appeals, supra)

How are their respective relationships governed?

1)
2)
3)

Issuing bank and applicant / buyer / importer - Their relationship is governed by the terms of the
application and agreement for the issuance of the letter of credit by the bank.
Issuing bank and beneficiary / seller / exporter - Their relationship is governed by the terms of
the letter of credit issued by the bank.
Applicant and beneficiary - Their relationship is governed by the sales contract.

Procedure re. letter of credit

1)

The buyer and the seller agree on what documents are to be presented for payment, but ordinarily
they are documents of title evidencing or attesting to the shipment of the goods to the buyer.

2)

Once the credit is established, the seller ships the goods to the buyer and in the process secures
the required shipping documents or documents of title. To get paid, the seller executes a draft and
presents it together with the required documents to the issuing bank.

3)

The issuing bank redeems the draft and pays cash to the seller if it finds that the documents
submitted by the seller conform with what the letter of credit requires. The bank then obtains
possession of the documents upon paying the seller.

4)

The transaction is completed when the buyer reimburses the issuing bank and acquires the
documents entitling him to the goods.

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
Other parties to a letter of credit
In commercial transactions involving letters of credit, correspondent banks are also parties to
such transactions. The functions assumed by a correspondent bank are classified according to
the obligations taken by it.
The correspondent bank may be called:
1)

a notifying bank, which conveys to the seller the existence of the credit. In this case,
the correspondent bank assumes no liability except to notify and/or transmit to the
beneficiary the existence of the letter of credit.

2)

a confirming bank, which will lend credence to the letter of credit issued by a lesser
known issuing bank. In this case, the correspondent bank assumes a direct obligation to
the seller and its liability is a primary one as if the correspondent bank itself had issued the
letter of credit (solidary liability with issuing bank).

3)

a paying bank, which undertakes to encash the drafts drawn by the exporter; or

4)

a negotiating bank, which buys or discounts a draft under the letter of credit.
Its liability is dependent upon the stage of the negotiation: if before negotiation,
it has
no liability with respect to the seller. However, after negotiation, a
contractual relationship
will then prevail between the negotiating bank and the
seller.

Requirements for opening a letter of credit

All letters of credit must be opened on or before the date of shipment with maximum validity of
one (1) year. Likewise, only one letter of credit should be opened for each import transaction. For
purposes of opening a letter of credit, importers shall submit to the commercial bank the following
documents:
a)

the duly accomplished letter of credit application;

b)

firm offer / pro forma invoice which shall contain information on the specific quantity of
the importation, unit cost and total cost, complete description/specification of the
commodity and the Philippine Standard Commodity Classification statistical code;

c)

permits/clearances from the appropriate government agencies, whenever applicable; and

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001

d)

duly accomplished Import Entry Declaration form which shall serve as basis for payment
of advance duties as required under PD 1853. (CB Circular No. 1389 or Consolidated
Foreign Exchange Rules and Regulations)

When does a letter of credit become void?

A letter of credit becomes void if the bearer does not make use of it within the period agreed upon with
the drawer. In default of a period fixed, 6 months, counted from its date, in any point in the Philippines
(domestic L/Cs), and within 12 months outside thereof (international L/Cs). (Art. 572)

What is the independence principle?

The independent principle provides that once a seller presents the draft and required documents to the
issuing bank, said bank must pay the seller. The issuing bank is precluded from determining whether the
main contract is actually accomplished or not. This arrangement assures the seller of prompt payment,
independent of any breach of the main sales contract. (See BPI v. De Reny Fabric Industries, Inc., 35
SCRA 256)

What is the rule of strict conformity?

The rule of strict conformity provides that in commercial transactions involving letters of credit, the
documents tendered must strictly conform to the terms of the L/C. The tender of documents by the
beneficiary (seller) must include all documents required by the L/C. A correspondent bank which departs
from what has been stipulated under the L/C (as when it accepts a faulty tender) acts on its own risks and
it may not thereafter be able to recover from the buyer or the issuing bank the money paid to the
beneficiary. (Feati Bank v. CA, 196 SCRA 576)
In other words, there is no such thing as substantial compliance as far as letters of credit are concerned!

Irrevocable credit v. confirmed credit

An irrevocable credit is not synonymous with a confirmed credit. These types of credit have
different meanings and the legal relations arising from there varies.

A credit may be an irrevocable credit and at the same time a confirmed credit or vice-versa.

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001

An irrevocable credit refers to the duration of the letter of credit. What it simply means is that the
issuing bank may not, without the consent of the beneficiary (seller) and the applicant (buyer),
revoke his undertaking under the letter.

A confirmed letter of credit pertains to the kind of obligation assumed by the correspondent bank.
In this case, the correspondent bank gives an absolute assurance to the beneficiary that it will
undertake the issuing banks obligation as its own according to the terms and conditions of the
credit.

Hence, the mere fact that a letter of credit is irrevocable does not necessarily imply that the
correspondent bank in accepting the instructions of the issuing bank has also confirmed the letter
of credit. (Feati Bank v. CA, 196 SCRA 576)

What is a sight draft?

Sight drafts are drafts which do not require presentment for acceptance. (Prudential Bank v. IAC, 216
SCRA 257)

What is a standby letter of credit and is it another type of letter of credit?

A standby letter of credit is a bank-issued option on a loan involving three (3) parties: the bank issuing the
credit, the party requesting for such issuance (otherwise known as the account party) and the beneficiary.
It is NOT another type of letter of credit.
Under the terms of a standby letter of credit (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 which case the
issuing bank disburses a specified sum to the beneficiary and books an equivalent loan to its customer. In
effect, the SLC operates as if another loan had been extended by the bank to the obligor. But instead of
the money going to the obligor, it goes to the beneficiary. This is to prevent interception by other
creditors.
SLCs may support non-financial obligations such as those of bidders, or financial obligations. 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 borrowers loan obligation is then passed on to the bank. (Prof. Catindig)

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
It must be noted that SLCs are in effect an absolute undertaking to pay the money advanced or the
amount for which credit is given on the faith of the instrument. They are primary obligations and not
accessory contracts. (IBAA v. IAC, 167 SCRA 450) Thus, in a case where a SLC is taken out to
secure a loan, partial payments made by the principal obligors on the loan do not reduce the liability of the
issuing bank under such SLC since the loan agreement and SLC are separate and independent
agreements. (IBAA v. IAC, supra)

CASES
FEATI BANK & TRUST CO. V. COURT OF APPEALS
196 SCRA 576
In this case, Bernardo Villaluz agreed to sell to Axel Christiansen 2,000 cubic meters of lauan logs
at $27.00 per cubic meter FOB. On the arrangements made and upon the instructions of consignee, Hanmi
Trade Development, Ltd., the Security Pacific National Bank of Los Angeles, California issued an
irrevocable letter of credit available 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. The letter of credit
also provided that the draft to be drawn is on Security Pacific National Bank and that it be accompanied
by certain documents.
The logs were thereafter loaded on a vessel but Christiansen refused to issue the certification
required in paragraph 4 of the letter of credit, despite repeated requests by the private respondent. The
logs however were still shipped and received by consignee, to whom Christiansen sold the logs.
Because of the absence of the certification by Christiansen, the Feati Bank and Trust company
refused to advance the payment on the letter of credit until such credit lapsed.
Since the demands by Villaluz for Christiansen to execute the certification proved futile, he filed
an action for mandamus and specific performance against Christiansen and Feati Bank and Trust
Company before the Court of First Instance of Rizal. Christiansen however left the Philippines and Villaluz
filed an amended complaint making Feati Bank and Trust Company solidarily liable with Christiansen.
Trial court held that Christiansen and Feati Bank were liable, the latter for refusing to negotiate
the letter of credit in the absence of Christiansens certification considering that the letter of credit is
irrevocable. Trial court said that Security Pacific National Bank, the issuing bank, undertook by the terms
Excellence. Not just a tradition.
Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
of the letter of credit that the same shall be honored upon presentment. On the other hand, the notifying
bank, Feati Bank, by accepting the instructions from the issuing bank, itself assumed the very same
undertaking as the issuing bank under the terms of the letter of credit.
The Court of Appeals affirmed the decision of the trial court thus this petition for review.
The principal issue in this case is whether or not a correspondent bank is to be held liable under
the letter of credit despite non-compliance by the beneficiary with the terms thereof.
The Supreme Court held that Feati Bank is not liable.
It is 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 required by the letter.
A correspondent bank which departs from what has been stipulated under the letter of credit, as
when it accepts a faulty tender, acts on its own risks and it may not thereafter be able to recover from the
buyer or the issuing bank, as the case may be, the money thus paid to the beneficiary. Thus the rule of
strict compliance.
We have heretofore held that these letters of credit are to be strictly complied with, which
documents and shipping documents must be followed as stated in the letter. There is no discretion in the
bank or trust company to waive any requirements. The terms of the letter constitutes an agreement
between the purchaser and the bank.
In the absence of any specific provision governing the legal complexities arising from transactions
involving letters of credit in the Philippines, the Supreme Court applied the Uniform Customs and Practice
for Documentary Credit (UCP) in lieu of Article 2 of the Code of Commerce 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.
Under the UCP, an irrevocable credit is a definite undertaking on the part of the issuing bank and
constitutes the engagement of that bank to the beneficiary and bona fide holders of drafts drawn and/or
documents presented thereunder, that the provisions for payment, acceptance or negotiation contained in
the credit will 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)
without engagement on the part of that bank, but when an issuing bank authorizes or requests another

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
bank to confirm its irrevocable credit and the latter does so, such confirmation constitutes a definite
undertaking of the confirming bank.
Under the foregoing provisions, the bank may only negotiate, accept or pay, if the documents
tendered to it are on their face in accordance with the terms and conditions of the documentary credit.
And since a correspondent bank, like Feati Bank, principally deals only with documents, the absence of
any document required in the documentary credit justifies the refusal by the correspondent bank to
negotiate, accept or pay the beneficiary, as it is not its obligation to look beyond the documents. It merely
has to rely on the completeness of the documents tendered by the beneficiary.
SC also ruled out the contentions that Feati Bank is a trustee and guarantor.
BANK OF AMERICA , NT V. COURT OF APPEALS
228 SCRA 357
Bank of America received by registered mail an irrevocable letter of credit purportedly issued by
Bank of Ayudhya Samyek Branch, for the account of General Chemicals, Ltd., of Thailand in the amount
of $2,782,000.00 to cover the sale of plastic ropes and agricultural files, with Bank of America as the
advising bank and Inter-Resin Industrial Corporation as beneficiary.
Bank of America notified Inter-Resin of the letter of credit. Upon request by Inter-Resin for Bank
of America to confirm the letter of credit, latter refused although one of its employee explained to
Inter-Resin that there was no need for confirmation because the letter of credit is genuine.
Inter-Resin therefore twice sought availment under the letter of credit. Bank of America issued
P10,219,093 in the first availment upon being satisfied of the documents submitted by Inter-Resin.
However, Bank of America stopped the processing of the second availment upon being informed
by Bank of Ayudhya that the letter of credit was fraudulent. Further, upon conducting an examination of
the vans sent by Inter-Resin, it found out that they contain not ropes but plastic strips, wrappers, rags and
waste materials.
Bank of America sued Inter-Resin for recovery of the money it gave under the first availment,
considering the letter of credit has been disowned by Bank of Ayudhya. However, the trial court ruled in
favor of Inter-Resin which was affirmed by the Court of Appeals.
Supreme Court reversed the decision of the lower courts. It ruled that the crucial point of dispute
in this case is whether, under the letter of credit, Bank of America has incurred any liability to the
beneficiary thereof, an issue that largely is dependent on the banks participation in that transaction: as a
Excellence. Not just a tradition.
Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
mere advising or notifying bank, it would not be liable, but as a confirming bank, had this been the case, it
could be considered as having incurred that liability.
It cannot seriously be disputed, looking at this case, that Bank of America has, in fact, only been
an advising, not confirming, bank, and this much is clearly evident, among other things, by the provisions of
the letter of credit itself, the petitioner banks letter of advice, its request for payment of advising fee, and
the admission of Inter-Resin that it has paid the same. That Bank of America has asked Inter-Resin to
submit documents required by the letter of credit and eventually has paid the proceeds thereof, did not
obviously make it a confirming bank.
As an advising or notifying bank, Bank of America did not incur any obligation more than just
notifying Inter-Resin of the letter of credit issued in its favor, let alone to confirm the letter of credit.
Bringing the letter of credit to the attention of the seller is the primordial obligation of an advising
bank. The view that Bank of America should have first checked the authenticity of the letter of credit with
Bank of Ayudhya, by using advanced mode of business communications, before dispatching the same to
Inter-Resin finds no real support in the UCP.
As advising bank, Bank of America is bound only to check the apparent authenticity of the letter
of credit, which it did. Websters explains that the word apparent suggests appearance to unaided
senses that is not or may not be borne out by more rigorous examination or greater knowledge.
May Bank of America then recover what it has paid under the letter of credit when the
corresponding draft for partial availment thereunder and the required documents therefore were later
negotiated with it by Inter-Resin? The answer is yes.
This kind of transaction is what is commonly referred to as a discounting arrangement. This time,
Bank of America, has acted independently as a negotiating bank, thus saving Inter-Resin from the
hardship of presenting the documents directly to Bank of Ayudhya to recover payment. As a negotiating
bank, Bank of America has a right of recourse against the issuer bank and until reimbursement is obtained,
Inter-Resin, as the drawer of the draft, continues to assume a contingent liability thereon.
SC noted that the additional ground raised by Bank of America, i.e. that Inter-Resin sent waste
instead of its products, is really of no consequence. In the operation of a letter of credit, the involved banks
deal only with documents and not on goods described in those documents.
RELIANCE COMMODITIES , INC. V. DAEWOO INDUSTRIAL CO., LTD.
228 SCRA 545

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
Reliance Commodities, Inc. and Daewoo entered into a contract of sale where latter undertook to
ship and deliver to former several tons of foundry pig iron.
First contract was consummated and completed but Daewoo fell short of 135.655 metric tons.
Second contract for 2,000 metric tons was also perfected.
However, Reliances application for a letter of credit was denied by the China Banking
Corporation, and it was shown later that the reason for this is that it has exceeded its foreign exchange
allocation.
Because of the failure of Reliance to comply with its undertaking under the contract, Daewoo was
forced to sell the foundry pig irons to another buyer at a lower price.
Reliance filed an action for damages against Daewoo for the recovery of P226,370.48
representing the value of the short delivery of 135.655 metric tons of foundry pig iron under the first
contract. Daewoo filed a counterclaim, contending that Reliance was guilty of breach of contract when it
failed to open a letter of credit as required in the second contract.
Trial court ruled that Reliance is entitled to short delivery price and ordered Daewoo to pay the
amount. However, it also held that Reliance is liable for breach of contract for its failure to open a letter of
credit. Thus, it also awarded damages to Daewoo.
Court of Appeals denied the appeal of Reliance. Supreme Court affirmed the decision.
SC agreed with the Court of Appeals that Reliance and Daewoo had a perfected contract. The
failure of Reliance to open the appropriate letter of credit did not prevent the birth of the contract, and
neither did such failure extinguish the contract. The opening of the letter of credit in favor of Daewoo was
an obligation of Reliance and the performance of that obligation by Reliance was a condition for
enforcement of the reciprocal obligation of Daewoo to ship the subject matter of the contract the
foundry pig iron to Reliance. But the contract itself between Reliance and Daewoo had already sprung
into legal existence and was enforceable.
The letter of credit provided for in that contract was the mode or mechanism by which payment
was to be effected by Reliance of the price of the pig iron.
We believe and so hold that failure of a buyer seasonably to furnish an agreed letter of credit is a
breach of the contract between buyer and seller. Where the buyer fails to open a letter of credit as
stipulated, the seller or exporter is entitled to claim damages for such breach. Damages for failure to open

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
a commercial credit may, in appropriate cases, include the loss of profit which the seller would seasonably
have made had the transaction been carried out.

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001

TRUST RECEIPTS LAW

Presidential Decree No. 115
Providing for the regulation of Trust Receipts Transactions
29 January 1973

What are the purposes of the law?

1.

to encourage and promote the use of trust receipts as an additional and convenient aid to
commerce and trade;

2.

to provide for the regulation of trust receipt transactions in order to assure protection of
the rights and the enforcement of obligations of the persons involved therein; and

3.

to declare the misuse and/or misappropriation of goods or proceeds realized from the sale
or goods, documents or instruments release under trust receipts as a criminal offense
punishable under Article 315 of the Revised Penal Code.

What is a trust receipt transaction, and who are the parties to such a transaction?
A trust receipt transaction is any transaction by and between the entruster (usually a bank;
hereinafter ER) and the entrustee (usually a buyer; hereinafter EE), whereby the ER, who owns or holds
absolute title or security interest over certain specified goods 1, documents2 or instruments3, releases the
same to the possession of the EE upon the latters execution and delivery to the ER of a signed document
called a trust receipt wherein the EE binds himself to hold the designated goods, documents or
instruments (GDI) in trust for the ER and to sell or otherwise dispose of the GDI with the obligation to turn
over to the ER the proceeds thereof to the extent of the amount owing to the ER or as appears in the trust
Goods shall include chattels and personal property other than money, things in action, or thins so affixed
to land as to become a part thereof.
1

Document means written or printed evidence of title to goods.

Instrument means any negotiable instrument, any certificate of stock, or bond or debenture for the
payment of money issued by a public or private corporation, or any certificate of deposit, participation
certificate or receipt, any credit or investment instrument of a sort marketed in the ordinary course of
business or finance, whereby the EE, after the issuance of the trust receipt, appears by virtue of
possession and the face of the instrument to be the owner.

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
receipt, or the goods, documents or instruments themselves if they are unsold or not otherwise disposed of,
in accordance with the terms and conditions specified in the trust receipt. (Sec. 4)
It must be noted that a trust receipt transaction is a tripartite transaction. It necessarily involves
three (3) parties, namely: the exporter / seller, the importer / buyer / EE, and the financer / bank / ER.

What is the nature of a trust receipt transaction?

A trust receipt is an accessory contract of the Letter of Credit. The set-up is like this: a bank
extends a loan covered by the Letter of Credit, with the trust receipt as a security for the loan.

A trust receipt is a security agreement, pursuant to which a bank acquires a security interest in the
goods.4 A trust receipt is considered as a security transaction intended to aid in financing importers
and retail dealers who do not have sufficient funds or resources to finance the importation or purchase
of merchandise, and who may not be able to acquire credit except through utilization, as collateral of
the merchandise imported or purchased. (Vintola v. IBAA, 150 SCRA 578) The purpose of the
Trust Receipts Law is to sell goods or procure their sale, because it is out of the sale of these goods
that the obligation will be paid. (Comment of Sir Catindig)

The trust receipt arrangement does not convert the ER (bank) into an investor; neither does it make
the ER into the real owner of the goods. The ER (bank)remains a lender and creditor. The bank
has previously extended a loan for which the L/C represents to the importer (EE), and by that loan, the
importer should be the real owner of the goods. If under the trust receipt, the bank is made to appear
as the owner, it is but an artificial expedient, more of a legal fiction than fact, for if it were so, it could
dispose of the goods in any manner it wants, which it cannot do, just to give consistency with the
purpose of the trust receipt of giving a stronger security for the loan obtained by the importer. To
consider the bank as the true owner from the inception of the transaction would be to disregard the
loan feature thereof. (Sia v. People, 121 SCRA 655 as cited in Vintola v. IBAA, 150 SCRA 582)

Security interest means a property interest in goods, documents or instruments to secure performance of
some obligations of the EE or of some third persons to the ER and includes title, whether or not expressed
to be absolute, whenever such titles is in substance taken or retained for security only. (Sec. 3)

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001

Distinguish a trust receipt transaction from pledge, conditional sale, chattel

mortgage, and consignment.
Trust receipt v. pledge
In a pledge, the person doing the financing (the pledgee) has possession of the property. However, in a
trust receipt transaction, the property is in the possession of the person financed.
Trust receipt v. conditional sale
A conditional sale necessarily involves a sale by the financer to the person being financed. On the other
hand, in a trust receipt transaction, the EE acquires the goods through advances made by the ER, not
through a sale.
Trust receipt v. chattel mortgage
A chattel mortgage involves the passing of a defeasible title to, or a lien upon, the property from the
mortgagor directly to the mortgagee. In a trust receipt transaction, the entruster takes the full title to the
goods at the very beginning of the transaction, and continues to hold that title as his indispensable security
until the vendee (EE) is called upon to pay for them. No lien is created.
Trust receipt v. consignment
In consignment, the title of the bailor / consignor is not retained to secure the indebtedness due from the
bailee or consignee. In a trust receipt transaction, the ER retains the full title to the goods as his
indispensable security until the vendee (EE) is called upon to pay for them.

What is a trust receipt?

Trust receipt shall refer to the written or printed document signed by the EE in favor of the ER containing
terms and conditions substantially complying with the provisions of this Decree. No further formality of
execution or authentication shall be necessary for the validity of a trust receipt. (Sec. 5)

Form of trust receipts

A trust receipt need not be in any particular form, but every such receipt must substantially
contain:
1.

a description of the goods, documents, or instruments subject of the trust receipt;

2.

the total invoice value of the goods and the amount of the draft to be paid by the EE;

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001

3.

an undertaking of a commitment of the EE:

a.

to hold in trust for the ER the goods, documents or instruments therein described;

b.

to dispose of them in the manner provided for in the trust receipt; and

c.

to turn over the proceeds of the sale of the goods, documents or instruments to
the ER to the extent of the amount owing to the ER or as appears in the trust
receipt or to return the goods, documents or instruments in the event of their
non-sale within the specified period. (Sec. 5)

Can a trust receipt be denominated in foreign currency? (Sec. 6)

YES, for as long as such currency is acceptable and eligible as part of the Philippines international
reserves.
If the trust receipt is denominated in foreign currency, payment shall be made in equivalent Philippine
currency computed on prevailing exchange rate on the date the proceeds of the sale are turned over to the
ER, or on such other date as may be stipulated in the trust receipt or other agreements executed between
the ER and the EE.

What are the rights of the entruster? (Sec. 7)

The ER is entitled to the proceeds from the sale of the goods / documents / instruments (GDI).

In case of non-sale, he is entitled to the return of the GDI.

Upon default or failure of the EE to comply with any other agreement between them, the ER may
cancel the trust and take possession of the GDI or the proceeds at any time. The GDI may then
be sold at either a public or a private sale (after proper notice to the EE, and not less than 5 days
after serving or sending notice), with the proceeds to be applied to payment of expenses for
retaking, keeping, storing, and the satisfaction of the EEs indebtedness. 5
It must be noted that the ER is not limited to such course of action. As held in the case of
Prudential Bank v. NLRC (251 SCRA 421), the ER has the discretion to avail of the right to
cancel the trust, or to seek any alternative action such as a third-party claim or a separate civil

Note that the EE shall receive any surplus from the sale, but shall not be liable to the ER for any
deficiency. (Sec. 7)
Excellence. Not just a tradition.
Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
action which it deems best to protect its right at any time upon default or failure of the EE to
comply with any of the terms and conditions of the trust agreement.

The ER holding a security interest shall not, merely by virtue of such interest or having given the
EE the liberty of sale or other disposition of the goods, documents or instruments under the terms
of the trust receipt transaction, be responsible as principal or as vendor under any sale or contract
to sell made by the EE. (Sec. 8) Thus, in a case where Mr. X suffers food poisoning from
seafood sold by Mr. Y covered under a trust receipt with ABC Bank, Mr. X cannot sue ABC
Bank. He can only go after the EE Mr. Y.

The ERs security interest in the GDI shall be valid as against all creditors of the EE for the
duration of the trust receipt agreement. (Sec. 12)
Exception: When the properties are in the hands of an innocent purchaser for value and in good
faith. (Prudential Bank v. NLRC, 251 SCRA 421)

What are the obligations of the entrustee? (Sec. 9)

(1) The ER must hold the GDI in trust for the ER and dispose of them strictly in accordance
with the terms and conditions of the trust receipt.
(2) The EE must receipt the proceeds in trust for the ER and turn over the same to the ER to the
extent of the amount owing to the ER or as appears in the trust receipt.
(3) The EE must insure the goods for their total value against loss from fire, theft, pilferage or other
casualties.
(4) The EE must keep said goods and proceeds thereof (whether in money or whatever form)
separate and capable of identification as property of the ER.
(5) The EE must return the GDI in the event of non-sale or upon demand of the ER.
(6) The EE must observe all other terms and conditions of the trust receipt not contrary to the
provisions of the Trust Receipts Law.

Liability of EE for loss (Sec. 10)

The risk of loss shall be borne by the EE.

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001

Loss of goods, documents or instruments which are the subject of a trust receipt pending their
disposition shall not extinguish the EEs obligation to the ER for the value thereof. This is
irrespective of whether or not such loss was due to the fault or negligence of the EE (Sec. 10).
Thus, in a case where ABC Bank releases to Mr. X 500 crates of grapes under a trust receipt,
and the grapes are stolen while they are in a warehouse, Mr. X is still obliged to pay his obligation
to ABC Bank notwithstanding the loss of the grapes.

What are the rights of a purchaser for value and in good faith?

Any purchaser of goods from an EE with right to sell, or of documents or instruments through
their customary form of transfer, who buys the goods, documents, or instruments for value and in
good faith from the EE, acquires said goods, documents or instruments free from the ERs
security interest. (Sec. 11)

Liability for estafa (Sec. 13)

The failure of an EE to turn over the proceeds of the sale of the goods, documents or instruments
covered by a trust receipt to the extent of the amount owing to the ER or as appears in the trust
receipt or to return said goods, documents or instruments if they were not sold or disposed of in
accordance with the terms of the trust receipt shall constitute the crime of estafa punishable under
Article 315 of the Revised Penal Code.

If the violation or offense is committed by a corporation, partnership or association, or other

juridical entities, the penalty provided for shall be imposed upon the directors, officers, employees
or other officials or persons therein responsible for the offense, without prejudice to the civil
liabilities arising from the criminal offense.

CASES
I. VIOLATION OF TRUST RECEIPTS LAW IS AN OFFENSE AGAINST PUBLIC ORDER .
PEOPLE V. NITAFAN
207 SCRA 726
Petitioner Allied Banking Corporation filed an information for estafa against Betty Sia Ang. It was
alleged that the accused, proprietess of Eckart Enterprises, received from the bank Goardon plastics,
plastic sheeting and Hook Chromed, amounting to P398,000 specified in a trust receipt and covered by a
Domestic Letter of Credit. She had the obligation to sell the goods and to account for the proceeds, if sold,
Excellence. Not just a tradition.
Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
or to return the goods, if not sold, on or before 16 October 1980, or upon demand. Despite repeated
demands, Ang paid only P283,115. It was alleged that she misappropriated, misapplied and converted the
balance to her own personal use and benefit. The accused filed a motion to quash the information, alleging
that violation of the trust receipt constitutes only a civil liability. The respondent judge granted the motion.
The Supreme Court held that acts involving the violation of a trust receipt agreement after 29
January 1973 (the date of enactment of PD 115) would make the accused criminally liable for estafa
under Article 315(b) of the Revised Penal Code.
Section 13 of PD 115 provides that failure of the EE to turn over the proceeds of the sale of the
goods, documents or instruments covered by a trust receipt or to return said goods, documents or
instruments if they are not sold or disposed of constitute the crime of estafa, punishable under Article 315
paragraph 1(b) of the Revised Penal Code.
Section 1(b) of Article 315 states that one of the means by which to commit estafa is by
misappropriating or converting, to the prejudice of another, money, goods received by the offender in
trust or under any other obligation involving the duty to make delivery of or to return the same
It is the failure of Ang to account for the balance that makes her liable for estafa.
NOTE:
The courts in the cases of People v. Cuevo and Sia v. CA, which were relied upon by the
respondent judge and the accused in the case above, adopted the view that a violation of obligations under
a trust receipt gave rise only to a civil liability because the two cases occurred before the effectivity of PD
115.
Trust receipt arrangements do not involve a simple loan transaction. Apart from a loan feature, the
trust receipt arrangement has a security feature covered by the trust receipt itself. The second feature
provides needed financial assistance to traders in the importation or purchase of goods through the use of
the goods as collateral for the advancements made by the bank. The title of the bank to the security is the
one sought to be protected and not the loan which is a separate and distinct agreement.
The Trust Receipts Law punishes the dishonesty and abuse of confidence in the handling of
money or goods to the prejudice of another, regardless of whether or not the latter is the owner. The law
does not seek to enforce payment of the loan. There is thus no violation of the Constitutional right
imprisonment for non-payment of debts.

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
Like BP 22, PD 115 punishes the act as an offense against public order, not against property. The
offense is punished as a mala prohibitum regardless of the existence of intent or malice. A mere failure
to deliver the proceeds of the sale or the goods constitute a criminal offense that causes prejudice to
another and, more importantly, to the public interest.

II. THE TRUST RECEIPTS LAW IS DEEMED TO COVER GOODS NOT INTENDED FOR SALE.
ALLIED BANKING CORPORATION V. O RDOEZ
192 SCRA 246 (1990)
Philippine Blooming Mills (PBM), a steel manufacturer, through its duly authorized officer, private
respondent Alfredo Ching, applied for the issuance of commercial letters of credit with petitioner bank to
finance the purchase of 500 M/t Magtar Branch Dolomites and one Lot High Fired Refractory Sliding
Noozle Bricks. Petitioner bank issued an irrevocable letter of credit in favor of Nikko Industry Co. Ltd.
(Nikko) by virtue of which the latter drew four drafts which were accepted by PBM and duly honored and
paid by the petitioner bank.
To secure payment of the amount covered by the Drafts, and in consideration of the transfer of
the goods to PBM, the latter as EE, through private respondent, executed four Trust Receipt Agreements
acknowledging petitioners ownership of the goods and its obligation to turn over the proceeds of the sale
of the goods, if sold, or to return the same, if unsold, within the stated period.
Out of the said obligation resulted an overdue amount of P1,475,274. Despite repeated demands,
PBM failed and refused to either turn over the proceeds of the sale of the goods or to return the same.
Allied Bank filed a criminal complaint against private respondent for violation of PD 115.
PBM contents that PD 115 does not cover the transaction he entered into because the said law
only refers to goods which are ultimately intended for sale. In this case, the dolomites and nuzzle bricks
are not part of the steel products that they make. Rather, they are used in the operation of PBMs
equipment. Furthermore, they are not engaged in the sale of dolomites and nozzle bricks.
The issue here is whether the penal provision of PD 115 apply or not when the goods covered by
a Trust Receipt do not form part of the finished products which are ultimately sold but are, instead, utilized
or used up in the operation of the equipment and machineries of the EE /manufacturer.

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops

Primer on Letters of Credit and Trust Receipts

UP Bar Ops 2001
SC held that PD 115 applies. The penal provision of PD 115 encompasses any act violative of an
obligation covered by the trust receipt; it is not limited to transactions in goods which are to be sold,
reshipped, stored or processed as a component of a product ultimately sold.
In an attempt to escape criminal liability, PBM claims PD 115 covers goods which are ultimately
destined for sale and not goods for use in manufacture. But the wording of Section 13 of PD 115 covers
failure to turn over the proceeds of the sale of entrusted goods, or to return said goods if unsold or
disposed of in accordance with the terms of the trust receipts.
And even assuming the absence of a clear provision in the trust receipt agreement, Lee v. Rodil
and Sia v. CA have held: Acts involving the violation of trust receipt agreements occurring after 29
January 1973 (when PD 115 was enacted) would render the accused criminal liable for estafa under par.
1(b), Article 315 of the Revised Penal Code, pursuant to the explicit provision in Section 13 of PD 115.
The act punishable is malum prohibitum.
NOTE:
Prof. Follosco and Prof. Catindig do not agree with the decision which did not actually address the
issue raised by PBM: how could PBM return goods which were used up in its operations and which are
not integrated in the processed and finished product of the company?
According to Prof. Catindig, the Trust Receipts Law is not contemplated to cover capital goods.
Even a cursory reading of sec. 4 will show that the intent of the law is to cover goods that are meant to be
sold. (The provisions speak of ultimate sale.)

ACKNOWLEDGMENTS:
This primer is based on Prof. Tristan Catindigs
syllabus, outline of bar review lecture, and
class lectures. Many thanks, Sir, for your
generosity with your time, your resources, and
your insights!
Our thanks, too, to Prof.
Rachel Follosco whose comments and insights
likewise found their way into this primer via
her lectures in Banking and Finance.
Thank you to Dan Calica and Tanya Lat who
collaborated on this primer.

Excellence. Not just a tradition.

Its a commitment.
- UP LSG Bar Ops