Transfield Phils. (TPI) and Luzon Hydro (LHC) entered into a Turnkey Contract* where TPI undertook to construct a hydro electric power station. The contract provided completion date and for extensions of time (EOT) in cases such as force majeure.
To secure the performance of TPI, TPI opened in favor of LHC two standby letters of credit (securities) with two banks.
In the course of the project, TPI sought for EOTs due to several factors such as typhoon Zeb, barricades, and demonstrations but LHC denied the requests. This gave rise to a series of legal actions between TPI and LHC. The issues raised whether the arrival of typhoon justified the extension sought by TPI and whether LHC had the right to terminate the Turnkey Contract due to failure of completion within the target date.
TPI (which opened the securities) foresaw that LHC would call on the securities. TPI advised the banks ANZ and Security Bank that arbitration proceedings are already pending, and LHC defaulted in its performance. TPI warned the banks not to transfer any amount of money to LHC. Otherwise, TPI will hold the banks liable. LHC sent notice the banks as anticipated. LHC asserts that TPI is in delay because it failed to complete within the agreed date. The banks informed TPI that they would pay the Securities when LHC calls on them. LHC supported this call.
Issues and Ruling
Issue #1: Whether or not the “independence principle” is applicable to letters of credit here. Yes.
Yes. Under Uniform Customs and Practice (UCP) Article 3, LCs are SEPARTE transactions from sales or other contracts on which they may be based. The banks are in NO WAY CONCERNED by such contracts, even if they are included. The ONLY UNDERTAKING of the issuing bank is to pay the seller or beneficiary the credit once the draft and the required documents are presented. – Transfield Philippines vs. Luzon Hyrdro
“No way concerned of underlying contracts” – Banks assume no liability or responsibility for the form, sufficiency, accuracy, genuineness, falsification, or legal effect of any document, or the general and/or particular conditions stipulated in the documents or superimposed thereon, nor do they assume any liability or responsibility for the description, quantity, weight, quality, condition, packing, delivery, value or existence of the goods represented by any documents, or for the good faith or acts and/or omissions, solvency, performance or standing of the consignor, the carriers, or the insurers of the goods, or any other person whomsoever.
Class question: Is this only limited to the bank? My answer: No, because this may also cover non-bank entities such as private creditors whom the applicant-buyer dealt with.
Issue #1b: Should only the bank invoke the independence principle? No, Transfield’s argument fails to impress the court.
The purpose of letters of credit is for the convenience of the parties to the original transactions. The applicant may confidently present it to the beneficiary as security to convince the beneficiary to enter into the business transaction. Hence, the beneficiary can invoke the independence principle.
Issue #2: Whether the “fraud exception rule” is applicable here. No because of lack of factual determination.
Fraud is the exception to the independence principle, and is a clear abuse of the independent purpose of the letter of credit. It is when the beneficiary, for the purpose of drawing credit, presents to the confirming bank documents that contain material representation. But before the court can declare the existence of fraud, there must be clear proof of the fact of such and must be resolved by the court with competent jurisdiction. But unfortunately for Transfield, this is yet to be resolved/
Issue #3: Should the dispute be resolved first before the credit be drawn by the beneficiary? No.
Transfield argues that the dispute must be resolved first. The Court disagrees because this is not a contract of guaranty. The main difference between a letter of credit and a contract of guaranty is that the settlement of dispute is not required in the former but required in the latter. Also, as the entitled to cash, letters of credit only requires non-performance of obligations or requirements; while contract of guarantee requires default or insolvency of the debtor. The former is an attractive commercial device, while the latter takes costs and time.
In the event of nonperformance, the beneficiary shall hold the cash immediately, even when the litigation is being done. It may be that the beneficiary’s documents are not rightful, in that case, the applicant may sue the beneficiary in tort, in contract, or in breach of warranty; but, during the litigation to determine whether the applicant has in fact breached the obligation to perform, the beneficiary, not the applicant, holds the money. The beneficiary has the right to ask the bank to honor the credit.