In a letter of credit transaction, the issuing bank must honor its commitment to pay the beneficiary upon presentation of the required documents, regardless of issues in the underlying sales contract. This case affirms that the Uniform Customs and Practice for Documentary Credits (UCP 400) governs letters of credit, obligating banks to pay against conforming documents. The Supreme Court held that The Hongkong & Shanghai Banking Corporation, Limited (HSBC) was liable to National Steel Corporation (NSC) for failing to honor its obligations under an irrevocable letter of credit, highlighting the importance of the independence principle in letter of credit transactions and the banks’ duty of diligence.

When Worlds Collide: UCP 400 vs. URC 322 in Letter of Credit Disputes

This case arose from a dispute between The Hongkong & Shanghai Banking Corporation, Limited (HSBC) and National Steel Corporation (NSC) regarding an irrevocable letter of credit. NSC had entered into a sales contract with Klockner East Asia Limited, and HSBC issued a letter of credit to ensure payment. When NSC presented the required documents through City Trust Banking Corporation, HSBC refused to pay, arguing that the collection was subject to the Uniform Rules for Collection (URC 322), not the Uniform Customs and Practice for Documentary Credits (UCP 400). The central legal question was whether HSBC could avoid its obligation under the letter of credit by claiming that URC 322 applied instead of UCP 400, which typically governs letter of credit transactions.

The Supreme Court emphasized the nature of a letter of credit as a financial device ensuring payment to a seller, providing assurance through a third party, usually a bank. The Court outlined three key transactions involved in a letter of credit: the sales contract between buyer and seller, the issuance of the letter of credit between the buyer and the issuing bank, and the transaction between the seller and the issuing bank. The last one gives the seller the right to demand payment under the letter of credit. In this framework, correspondent banks like notifying, negotiating, or confirming banks may also facilitate these transactions. The standard of care imposed on banks engaged in letter of credit transactions is high, reflecting their role in public interest.

The value of letters of credit in commerce relies on the assurance of payment to the seller-beneficiary, regardless of the underlying transaction’s status. To ensure consistent practices, letters of credit are governed by the Code of Commerce, usages, customs, and the UCP. The International Chamber of Commerce (ICC) developed the UCP, which has become the worldwide standard for letter of credit transactions. The Court recognized the binding nature of UCP 400, the prevailing version during the period relevant to this case, highlighting that its application is justified by Article 2 of the Code of Commerce, which acknowledges usages and customs in commercial transactions.

The Supreme Court firmly established that HSBC was indeed liable under the provisions of the Letter of Credit, aligning with both usage and custom as embodied in UCP 400, and also adhering to the principles of general civil law. The Letter of Credit explicitly stated its subjection to UCP 400, establishing a clear framework for the transaction. This explicit reference to UCP 400 automatically bound HSBC’s actions, irrespective of whether URC 322 was a recognized custom in commerce. The Court highlighted its previous stance in Feati Bank & Trust Company v. Court of Appeals, where UCP 400 was applied even without an express stipulation in the letter of credit, emphasizing the Court’s legal duty to enforce UCP 400.

According to UCP 400, an irrevocable credit payable on sight, like the Letter of Credit in this case, mandates the issuing bank to pay, given the stipulated documents are presented, and the credit’s terms are met. Additionally, UCP 400 places an obligation on the issuing bank to examine the documents with reasonable care. Upon City Trust’s submission of the Letter of Credit with the necessary documents, HSBC had a responsibility to determine if its obligation to pay had been triggered through a thorough examination of the documents. Thus, HSBC’s claim that URC 322, a set of norms compiled by the ICC prescribing collection procedures for banks, should govern the transaction was deemed unmeritorious. HSBC failed to provide sufficient evidence that URC 322 constitutes a custom recognized in commerce.

The Court noted that HSBC did not present an expert witness to validate URC 322 as an existing banking and commercial practice related to letters of credit. Without such evidence, the Court could not establish that URC 322 or its invocation by beneficiaries of letters of credit are customs warranting application in this case. Accepting HSBC’s position that URC 322 applies, allowing the issuing bank to disregard the Letter of Credit, was deemed unacceptable. The Court reiterated that the reliability of letters of credit depends on the assurance that the beneficiary has an enforceable right, and the issuing bank a demandable obligation, to pay the amount agreed upon.

The Court ruled that when a party knowingly and freely agrees to perform an act, a legal obligation is created, requiring fulfillment of the obligation. HSBC had a contractual duty to Klockner, committing to pay NSC upon due presentation of the Letter of Credit and attached documents. HSBC also had an obligation to NSC to honor the Letter of Credit. To meet these obligations, HSBC was required to perform all necessary acts, including carefully examining the presented documents. Additionally, as a bank, HSBC had a duty to observe the highest degree of diligence.

The Court emphasized that a bank exercising the appropriate degree of diligence would have, at the very least, inquired if NSC was seeking payment under the Letter of Credit or merely seeking collection under URC 322. By failing to do so, HSBC did not meet the required standard of care. Furthermore, the Court found that NSC’s presentation of the Letter of Credit with the attached documents through City Trust constituted due presentment. Given that HSBC undertook to pay US$485,767.93 upon presentment of the Letter of Credit and required documents, its refusal to comply constituted a breach of its obligations.

The Court emphasized the Independence Principle, stating that the issuer must pay upon due presentment, regardless of any defect or breach in the underlying transaction. Allowing HSBC to refuse payment simply because it could not first collect from Klockner was deemed a violation of this principle. HSBC’s refusal to comply with its obligation constituted a delay under Article 1169 of the Civil Code, making it liable for damages under Article 1170. As a result, the Court awarded NSC damages of US$485,767.93, along with interest from the date of NSC’s extrajudicial demand. However, the Court found no basis for the CA’s grant of attorney’s fees, noting that none of the grounds stated in Article 2208 of the Civil Code were present.

Regarding CityTrust’s liability, the Court found that when NSC engaged CityTrust to collect under the Letter of Credit, it established CityTrust as its agent. As such, CityTrust was obligated to carry out the agency according to the instructions of NSC. By communicating with HSBC and consistently proceeding with collection under URC 322, CityTrust failed to act according to NSC’s instructions. However, because NSC did not raise any claims against CityTrust, the Court made no finding of liability against CityTrust in favor of NSC.

FAQs

What was the key issue in this case?	The key issue was whether HSBC could avoid its obligation under a letter of credit by claiming the transaction was governed by URC 322 instead of UCP 400.
What is a letter of credit?	A letter of credit is a financial instrument guaranteeing payment to a seller, provided they meet specific requirements outlined in the credit. It assures sellers they will be paid, even if the buyer defaults.
What is UCP 400?	UCP 400 is the Uniform Customs and Practice for Documentary Credits, a set of rules established by the International Chamber of Commerce that govern letter of credit transactions. These rules are widely adopted and provide a standard framework for banks and beneficiaries.
What is URC 322?	URC 322 is the Uniform Rules for Collections, another set of rules by the ICC that governs collection procedures for banks. It prescribes collection procedures, technology, and standards for handling collection transactions for banks
What is the Independence Principle?	The Independence Principle states that the issuing bank’s obligation to pay under a letter of credit is separate from the underlying contract between the buyer and seller. As long as the required documents are presented, the bank must pay, regardless of any disputes in the sales contract.
What documents did NSC present to HSBC?	NSC presented the Letter of Credit, Bill of Lading, Commercial Invoice, Packing List, Mill Test Certificate, and proof of communication with Klockner, among other documents. These documents were necessary to comply with the terms of the letter of credit.
Why was HSBC found liable?	HSBC was found liable because it failed to honor its obligation under the letter of credit by refusing to pay upon due presentment of the required documents. The court emphasized HSBC’s duty of diligence and failure to adhere to UCP 400.
What was CityTrust’s role in the transaction?	CityTrust acted as NSC’s agent in collecting payment under the letter of credit. While it may have deviated from NSC’s instructions, this did not absolve HSBC of its obligations.
What damages was HSBC ordered to pay?	HSBC was ordered to pay NSC US$485,767.93, the amount stated in the Letter of Credit, with legal interest from the time of extrajudicial demand until full payment. Attorney’s fees were not awarded in this case.

This case reinforces the importance of adhering to international standards in commercial transactions, particularly those involving letters of credit. It underscores the responsibilities of issuing banks and provides clarity on the application of UCP 400. The ruling serves as a reminder that banks must exercise a high degree of diligence and honor their obligations to ensure the reliability of letters of credit in trade and commerce.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: The Hongkong & Shanghai Banking Corporation, Limited vs. National Steel Corporation and Citytrust Banking Corporation (now Bank of the Philippine Islands), G.R. No. 183486, February 24, 2016