The Hongkong & Shanghai Banking Corporation, Limited vs. National Steel Corporation and Citytrust Banking Corporation

An issuing bank of an irrevocable letter of credit is liable to pay the beneficiary upon due presentment of the required documents under UCP 400, which governs the transaction when expressly incorporated in the letter of credit, and the issuing bank cannot evade this obligation by invoking URC 322 collection rules. The independence principle dictates that the issuing bank's obligation to pay is separate from the underlying transaction, and the buyer's refusal to pay does not affect the issuing bank's liability.

The Hongkong & Shanghai Banking Corporation, Limited (HSBC) is an international bank that issued an irrevocable letter of credit in favor of National Steel Corporation (NSC) pursuant to an Export Sales Contract between NSC and Klockner East Asia Limited (Klockner). CityTrust Banking Corporation (CityTrust) served as the collecting bank through which NSC coursed its collection of payment, having earlier obtained a loan from CityTrust secured by the proceeds of the letter of credit. The letter of credit expressly stated that it is governed by the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits, Publication No. 400 (UCP 400). Letters of credit are recognized in Philippine jurisdiction and sanctioned under Articles 567 to 572 of the Code of Commerce, which must be read with Articles 2 and 50 of the same code.

National Steel Corporation (NSC) entered into an Export Sales Contract with Klockner East Asia Limited (Klockner) on October 12, 1993, for the sale of 1,200 metric tons of prime cold rolled coils under FOB ST Iligan terms. Pursuant to the Contract, Klockner applied for an irrevocable letter of credit with HSBC in favor of NSC in the amount of US$468,000. On October 22, 1993, HSBC issued an irrevocable and onsight letter of credit no. HKH 239409 (the Letter of Credit) in favor of NSC, which expressly stated that it is governed by UCP 400. The Letter of Credit required the following documents for payment: (1) one original commercial invoice; (2) one packing list; (3) one non-negotiable copy of clean on board ocean bill of lading made out to order, blank endorsed marked "freight collect and notify applicant"; (4) copy of Mill Test Certificate made out "to whom it may concern"; (5) copy of beneficiary's telex to applicant advising shipment details; and (6) beneficiary's certificate certifying that documents have been faxed and sent by air courier to the applicant.

The Letter of Credit was amended twice: on November 2, 1993, to change delivery terms from FOB ST Iligan to FOB ST Manila and increase the amount to US$488,400; and on November 18, 1993, to extend the expiry and shipment date to December 8, 1993. On November 21, 1993, NSC, through Emerald Forwarding Corporation, loaded and shipped the cargo on board MV Sea Dragon, which arrived in Hongkong on November 25, 1993.

NSC coursed collection of payment through CityTrust, from which it had obtained a loan secured by the proceeds of the Letter of Credit. On November 29, 1993, CityTrust sent a Collection Order to HSBC instructing: (1) deliver documents against payment; (2) cable advice of non-payment with reason; (3) cable advice payment; and (4) remit proceeds via TELEX. The Collection Order contained the statement "Subject to Uniform Rules for the Collection of Commercial Paper Publication No. 322" and stated that proceeds should be remitted to Standard Chartered Bank of Australia, Ltd., Offshore Branch Manila (SCB-M). On the same date, CityTrust presented to HSBC the Letter of Credit and all required documents, including the Bill of Lading, Commercial Invoice, Packing List, Mill Test Certificate, NSC's TELEX to Klockner, Beneficiary's Certificates, and DHL Receipt No. 669988911 and Certificate of Origin.

On December 2, 1993, HSBC acknowledged receipt of the Collection Order and stated that the documents will be presented to "the drawee against payment subject to UCP 322 as instructed." Neither CityTrust nor SCB-M objected to this statement. On December 7, 1993, HSBC repeated that the bill was being handled under URC 322 and informed SCB-M that it had referred the matter to Klockner for payment. The Letter of Credit expired on December 8, 1993. On December 10, 1993, HSBC advised SCB-M that Klockner had refused payment and that it intended to return the documents. CityTrust requested HSBC to inform it of Klockner's reason for refusing payment, and on December 17, 1993, insisted that demand for payment must be made from Klockner since the documents "were found in compliance with LC terms and conditions." HSBC replied that under URC 322, Klockner has no duty to provide a reason for refusal.

On January 12, 1994, CityTrust sent a letter to NSC stating that it executed NSC's instructions "to send, ON COLLECTION BASIS, the export documents." NSC responded on January 18, 1994, disagreeing with CityTrust's contention, stating that it "negotiated with CityTrust the export documents pertaining to LC No. HKH 239409 of HSBC and it was CityTrust, which wrongfully treated the negotiation, as 'on collection basis.'" Klockner persisted in refusing payment, and on February 17, 1994, HSBC returned the documents to CityTrust, stating that it considered itself discharged of its duty. CityTrust responded on February 21, 1994, demanding payment and stating, for the first time, that "ICC Publication No. 322 is not applicable." HSBC insisted that CityTrust had instructed collection under URC 322 and considered the transaction closed.

On March 3, 1994, NSC sent its first demand letter to HSBC, followed by a final demand on March 11, 1994. Unable to collect from HSBC, NSC filed a complaint for collection of sum of money before the RTC Makati, alleging that HSBC unreasonably refused to pay its obligation of US$485,767.93 despite complete presentation of documents. HSBC filed its Answer denying liability, arguing that CityTrust modified the obligation when it stated in its Collection Order that the transaction is subject to URC 322. HSBC also filed a Third-Party Complaint against CityTrust, praying that CityTrust be subrogated in its place should the court find HSBC liable. The RTC Makati admitted the third-party complaint, and CityTrust denied that it modified the obligation, arguing that as a mere agent, it cannot modify the terms of the Letter of Credit without the consent of all parties.

• Applicability of URC 322: HSBC contended that CityTrust's order to collect under URC 322 did not modify nor contradict the Letter of Credit, and that it is customary practice in commercial transactions for entities to collect under URC 322 even if there is an underlying letter of credit.
• Agency and Authority: HSBC argued that CityTrust acted as an agent of NSC in collecting payment and, as such, had the authority to instruct HSBC to proceed under URC 322 and not under UCP 400.
• Estoppel: HSBC maintained that having clearly and expressly instructed HSBC to collect under URC 322, and having fully intended the transaction to proceed under such rule as shown by the series of correspondence, CityTrust is estopped from claiming that the collection was made under UCP 400.
• Failure to Prove Custom: HSBC claimed that the testimony of its witness Mr. Lincoln MacMahon sufficed to prove that URC 322 is an accepted custom in commerce and that beneficiaries commonly resort to collection under URC 322.

• Clear Obligation Under the Letter of Credit: NSC claimed that HSBC's obligation to pay is clear from the terms of the Letter of Credit and under UCP 400, and that HSBC has no basis to argue that CityTrust's presentment of the documents allowed HSBC to vary the terms of their agreement.
• Applicability of UCP 400: NSC asserted that the applicable rule is UCP 400, which was expressly incorporated in the Letter of Credit, and that HSBC cannot disregard its terms.

• Governing Rules: Whether UCP 400 or URC 322 governs the transaction between the parties.
• HSBC's Liability: Whether HSBC is liable to pay NSC the amount stated in the Letter of Credit despite Klockner's refusal to pay.
• Due Presentment: Whether CityTrust's presentment of the Letter of Credit and attached documents constituted due presentment under the terms of the Letter of Credit.
• Attorney's Fees: Whether the CA erred in awarding attorney's fees in favor of NSC.

• Governing Rules: UCP 400 governs the transaction. The Letter of Credit categorically stated that it is subject to UCP 400, and under Feati Bank & Trust Company vs. Court of Appeals, UCP 400 applies even without express stipulation in the letter of credit.
• HSBC's Liability: Yes. HSBC is liable to pay NSC the amount of US$485,767.93 under the Letter of Credit. HSBC failed to prove that URC 322 constitutes a recognized custom in commerce, and its argument that it could disregard the Letter of Credit undermines the value and reliability of letters of credit.
• Due Presentment: Yes. CityTrust's presentment of the Letter of Credit with the attached documents in behalf of NSC constitutes due presentment, triggering HSBC's obligation to pay under the independence principle.
• Attorney's Fees: No. The award of attorney's fees was deleted because none of the grounds stated in Article 2208 of the Civil Code are present in this case.

• Governing Rules: The Court held that letters of credit are governed primarily by their own provisions, by laws specifically applicable to them, and by usage and custom. Consistent with prior rulings, usage and custom refers to UCP 400. The Letter of Credit expressly stated that it is subject to UCP 400, and from the moment HSBC agreed to its terms, its actions became bound by UCP 400. Even assuming URC 322 is an international custom, this does not change the fact that HSBC, as issuing bank, undertook obligations dictated by the Letter of Credit and UCP 400. HSBC failed to present sufficient evidence to prove that URC 322 constitutes custom and usage recognized in commerce; its witness Mr. MacMahon was not presented as an expert witness capable of establishing existing banking and commercial practice.

• HSBC's Liability: The Court emphasized that an irrevocable letter of credit cannot, during its lifetime, be cancelled or modified without the express permission of the beneficiary. CityTrust's subsequent correspondences could not affect or amend the letter of credit, as it was not a party thereto. HSBC's obligation arose from two sources: (1) its contractual duty to Klockner to pay NSC upon due presentment, and (2) its obligation to NSC to honor the Letter of Credit. Under the independence principle, the issuing bank's obligation to pay is separate from the underlying transaction, and Klockner's refusal to pay carries no effect on HSBC's obligation. To allow HSBC to refuse to honor the Letter of Credit simply because it could not collect first from Klockner would countenance a breach of the independence principle.

• Due Presentment: The Court ruled that CityTrust's presentment of the Letter of Credit with the attached documents constituted due presentment. Under UCP 400, an irrevocable credit payable on sight constitutes a definite undertaking of the issuing bank to pay, provided the stipulated documents are presented and the terms and conditions of the credit are complied with. The issuing bank has the obligation to examine the documents with reasonable care. HSBC failed to observe the highest degree of diligence required of banks when it failed to notice the discrepancy between CityTrust's request for collection under URC 322 and the terms of the Letter of Credit. A bank exercising appropriate diligence would have inquired if NSC was seeking payment under the Letter of Credit or merely seeking collection under URC 322.

• Attorney's Fees: The Court found no basis for the CA's grant of attorney's fees. Article 2208 of the Civil Code enumerates the grounds for the award of attorney's fees, and the award is an exception rather than the rule. None of the grounds stated in Article 2208 are present, and NSC did not cite any specific ground nor present any particular fact to warrant the award.

• Independence Principle in Letters of Credit — The issuing bank's obligation to pay under a letter of credit is separate and independent from the underlying contract of sale between the buyer and seller. Under Article 17 of UCP 400, the issuing bank assumes no liability for the form, sufficiency, accuracy, genuineness, falsification or legal effect of any documents. As long as the proper documents are presented, the issuing bank has an obligation to pay even if the buyer should later refuse payment. The Court applied this principle to hold that Klockner's refusal to pay had no effect on HSBC's obligation to pay NSC.

• Strict Compliance Doctrine in Letters of Credit — The issuing bank's obligation to pay arises only upon strict compliance with the terms and conditions of the letter of credit, including the presentation of all required documents. The Court applied this doctrine in determining that CityTrust's presentment of the Letter of Credit and all attached documents constituted due presentment, triggering HSBC's obligation to pay.

• Standard of Care for Banks — Banks engaged in business imbued with public interest have the duty to act with the highest degree of diligence in dealing with clients. The Court applied this standard to find that HSBC fell below the required standard when it failed to notice the discrepancy between CityTrust's request for collection under URC 322 and the terms of the Letter of Credit, and failed to make a separate determination of the significance of the presentment.

• Custom and Usage in Commercial Transactions — Under Article 2 of the Code of Commerce, commercial transactions are governed by the Code's provisions, by commercial usages generally observed in each place, and in the absence of both, by civil law. The Court applied this doctrine to hold that HSBC failed to prove that URC 322 constitutes a recognized custom in commerce, and that UCP 400, as the recognized international custom governing letters of credit, applies.

• "The entire system of letters of credit rely on the assurance that upon presentment of the proper documents, the beneficiary has an enforceable right and the issuing bank a demandable obligation, to pay the amount agreed upon. Were a party to the transaction allowed to simply set this aside by the mere invocation of another set of norms related to commerce - one that is not established as a custom that is entitled to recognition by this Court - the sanctity of letters of credit will be jeopardized." — This passage articulates the core rationale for upholding the enforceability of letters of credit and rejecting HSBC's attempt to evade its obligation by invoking URC 322.

• "To allow HSBC to refuse to honor the Letter of Credit simply because it could not collect first from Klockner is to countenance a breach of the Independence Principle." — This statement defines the application of the independence principle, holding that the issuing bank's obligation is not conditioned on the buyer's payment.

• "Notwithstanding any statements by CityTrust in the Collection Order as to the applicable rules, HSBC had the independent duty of ascertaining whether the presentment of the Letter of Credit and the attached documents gave rise to an obligation which it had to Klockner (its client) and NSC (the beneficiary)." — This passage establishes the issuing bank's independent duty to examine documents and determine its obligation, regardless of instructions from the collecting bank.

• Bank of America, NT & SA vs. Court of Appeals, G.R. No. 105395, December 10, 1993, 228 SCRA 357 — Cited for the definition of a letter of credit as "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."

• Bank of the Philippine Islands vs. De Reny Fabric Industries, Inc., G.R. No. L-24821, October 16, 1970, 35 SCRA 256 — Cited to justify the application of international custom (UCP) in Philippine jurisdiction under Article 2 of the Code of Commerce.

• Feati Bank & Trust Company vs. Court of Appeals, G.R. No. 94209, April 30, 1991, 196 SCRA 576 — Cited as controlling precedent for the rule that the UCP should be applied in cases where the letter of credit expressly states that it is the governing rule, and that the UCP applies even if it is not incorporated into the letter of credit.

• Metropolitan Waterworks and Sewerage System vs. Daway, G.R. No. 160732, June 21, 2004, 432 SCRA 559 — Cited to affirm that "[l]etters of credit have long been and are still governed by the provisions of the Uniform Customs and Practice for Documentary Credit[s] of the International Chamber of Commerce."

• Transfield Philippines, Inc. vs. Luzon Hydro Corporation, G.R. No. 146717, November 22, 2004, 443 SCRA 307 — Cited for the nature of the relationship between the seller-beneficiary and the issuing bank, which is not strictly contractual and does not constitute a stipulation pour autrui.

• Far East Bank and Trust Company vs. Tentmakers Group, Inc., G.R. No. 171050, July 4, 2012, 675 SCRA 546 — Cited for the standard of care imposed on banks engaged in business imbued with public interest, requiring the highest degree of diligence in dealing with clients.

• Nacar vs. Gallery Frames, G.R. No. 189871, August 13, 2013, 703 SCRA 439 — Cited for the award of legal interest at six percent (6%) per annum.

• Republic vs. Lorenzo Shipping Corporation, G.R. No. 153563, February 7, 2005, 450 SCRA 550 — Cited for the rule that the award of attorney's fees is an exception rather than the rule, and that grounds for its award must approximate as closely as possible the enumeration in Article 2208 of the Civil Code.

• Article 567, Code of Commerce — Defines letters of credit as those issued by one merchant to another, or for the purpose of attending to a commercial transaction. Applied to establish the legal basis for letters of credit in Philippine jurisdiction.

• Article 2, Code of Commerce — Provides that commercial transactions are governed by the Code's provisions, by commercial usages generally observed in each place, and in the absence of both, by civil law. Applied to justify the application of UCP 400 as the recognized international custom governing letters of credit.

• Article 50, Code of Commerce — Provides that commercial contracts are governed by the Code of Commerce and special laws, and in their absence, by general civil law. Applied to find that the Civil Code provisions on obligations apply suppletorily to letters of credit.

• Article 1169, Civil Code — Provides that a party to an obligation incurs in delay from the time the other party makes a judicial or extrajudicial demand for fulfillment. Applied to hold that HSBC incurred in delay when it failed to fulfill its obligation despite due presentment, which is tantamount to a demand.

• Article 1170, Civil Code — Provides that those who in the performance of their obligations are guilty of fraud, negligence, or delay are liable for damages. Applied to hold HSBC liable for damages for its delay in fulfilling its obligation under the Letter of Credit.

• Article 1868, Civil Code — Defines a contract of agency. Applied to determine that CityTrust acted as NSC's agent in collecting under the Letter of Credit.

• Article 1887, Civil Code — Provides that an agent is obliged to carry out the agency in accordance with the instructions of the principal. Applied to find that CityTrust breached its obligation to NSC by treating the negotiation as "on collection basis" contrary to NSC's instructions.

• Article 2208, Civil Code — Enumerates the grounds for the award of attorney's fees. Applied to delete the CA's award of attorney's fees, as none of the enumerated grounds were present.

• UCP 400, Article 10(a) — Provides that an irrevocable credit constitutes a definite undertaking of the issuing bank to pay, provided that the stipulated documents are presented and that the terms and conditions of the credit are complied with. Applied to establish HSBC's obligation to pay NSC upon due presentment.

• UCP 400, Article 15 — Provides that banks must examine all documents with reasonable care to ascertain that they appear on their face to be in accordance with the terms and conditions of the credit. Applied to determine HSBC's duty to examine the documents presented.

• UCP 400, Article 17 — Provides that an issuing bank assumes no liability for the form, sufficiency, accuracy, genuineness, falsification or legal effect of any documents. Applied to explain the independence principle.

Presbitero J. Velasco, Jr. (Chairperson), Diosdado M. Peralta, Jose Portugal Perez, and Bienvenido L. Reyes concurred in the decision.