The (un)Exciting World of Letters of Credit

Letters of Credit (LC) is a topic included in the Supreme Court Bar Exam Syllabus. Unfortunately, very few would find this topic interesting. Unknown to many though, LC plays a very important role in the economy. Thus, it is not farfetched that we will encounter LC beyond the classroom.

Understanding LC is not that tough if we know the context why this instrument was developed in the first place. By definition, an LC is a financial device to serve as a safe way of dealing with sales of goods to satisfy the seemingly irreconcilable interest of the seller, who want to be paid first before he/she delivers the goods, and the buyer, who wants to be assured of the delivery before paying.

The LC is a remedy to this situation. The Buyer may contract a Bank (called Issuing Bank) to issue an LC in favor of the Seller.

Upon such issuance, the Seller ships the goods to the Buyer. To get paid, the Seller executes a draft and present it to the bank together with the required documents. The Issuing Bank redeems the draft and pays the Seller if it is satisfied with the documents presented.

This, I think, is the gist of the LC. As the Supreme Court said, "in the operation of a letter of credit, the involved banks deal only with documents and not on the goods described in those documents." (Bank of America, NT & SA vs. Court of Appeals, 228 SCRA 357 [1993])

The transaction is completed when the Buyer reimburses the Issuing Bank and acquires the documents that will in turn entitle him to the title over the goods.