Fraud Exception Principle

AT A GLANCE

A letter of credit is a commercial instrument developed to address the unique needs of certain commercial transactions. (The Hongkong & Shanghai Banking Corp., Limited v. National Steel Corp., G.R. No. 183486, February 24, 2016)

In the realm of commercial transactions, a letter of credit stands as one of the most reliable financial instruments used to facilitate trade. It provides security to sellers while assuring buyers that payment will only be made upon compliance with agreed conditions.

The nature and function of a letter of credit have been explained by the Supreme Court in the case of The Hongkong & Shanghai Banking Corp., Limited v. National Steel Corp., G.R. No. 183486, February 24, 2016. 

Letter of Credit, defined

A letter of credit is a commercial instrument developed to address the unique needs of certain commercial transactions. (The Hongkong & Shanghai Banking Corp., Limited v. National Steel Corp., G.R. No. 183486, February 24, 2016)

Nature of a Letter of Credit

A letter of credit generally arises out of a separate contract requiring the assurance of payment of a third party. In a transaction involving a letter of credit, there are usually three transactions and three parties.   

As explained in The Hongkong & Shanghai Banking Corp., Limited v. National Steel Corp., the process generally unfolds as follows:

Once the seller ships the goods, he or she obtains the documents required under the letter of credit. He or she shall then present these documents to the issuing bank which must then pay the amount identified under the letter of credit after it ascertains that the documents are complete. 

The issuing bank then holds on to these documents which the buyer needs in order to claim the goods shipped. The buyer reimburses the issuing bank for its payment at which point the issuing bank releases the documents to the buyer.

The buyer is then able to present these documents in order to claim the goods. At this point, all the transactions are completed. The seller received payment for his or her performance of his obligation to deliver the goods. The issuing bank is reimbursed for the payment it made to the seller. The buyer received the goods purchased. 

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