Transfield Philippines, Inc. vs. Luzon Hydro Corporation

The independence principle on letters of credit may be invoked not only by the issuing bank but also by the beneficiary, and a beneficiary may draw on a standby letter of credit upon presentation of the required documents without first awaiting resolution of disputes over the underlying contract, unless the fraud exception is properly pleaded and proven.

Transfield Philippines, Inc. (petitioner) and Luzon Hydro Corporation (LHC) were parties to a Turnkey Contract dated 26 March 1997 under which petitioner undertook to construct a 70-megawatt hydro-electric power station at the Bakun River in Benguet and Ilocos Sur. To secure performance of its obligations, petitioner opened two irrevocable standby letters of credit in favor of LHC, each in the amount of US$8,988,907.00, one with the Australia and New Zealand Banking Group Limited (ANZ Bank) and the other with Security Bank Corporation (SBC). The Turnkey Contract provided for liquidated damages of US$75,000.00 per day of delay and expressly authorized LHC to draw on the Securities for such damages. Disputes between the parties were to be resolved through arbitration under Clause 20.3 of the contract.

On 26 March 1997, Transfield Philippines, Inc. and Luzon Hydro Corporation (LHC) entered into a Turnkey Contract under which petitioner, as Turnkey Contractor, undertook to construct a 70-megawatt hydro-electric power station at the Bakun River in Benguet and Ilocos Sur. Petitioner was given sole responsibility for the design, construction, commissioning, testing, and completion of the project, with a target completion date of 1 June 2000. The contract entitled petitioner to claim extensions of time (EOT) for variations, force majeure, and delays caused by LHC itself, and required the parties to settle disputes through mediation, conciliation, and arbitration under Clause 20.3.

To secure performance of its obligations, petitioner opened two standby letters of credit in favor of LHC, both dated 20 March 2000, each in the amount of US$8,988,907.00 — Standby Letter of Credit No. E001126/8400 with ANZ Bank and Standby Letter of Credit No. IBDIDSB-00/4 with Security Bank Corporation (SBC). In the course of construction, petitioner sought various EOT allegedly due to typhoon Zeb, barricades, and demonstrations. LHC denied these requests, asserting that additional extensions were unwarranted and declaring petitioner in default. On 27 June 2000, LHC sent notice that petitioner had failed to comply with its obligation to complete the project, demanded payment of US$75,000.00 per day of delay beginning 28 June 2000 pursuant to Clause 8.7.1, and served notice that it would call on the Securities for liquidated damages.

Petitioner, anticipating LHC's call on the Securities, wrote to both banks on 10 August 2000, advising them of the pending arbitration proceedings before the CIAC and ICC and warning that any transfer, release, or disposition of the Securities would constrain it to hold the banks liable for liquidated damages. Both banks nonetheless informed petitioner that they would pay on the Securities if and when LHC called on them. Meanwhile, LHC had filed a Request for Arbitration before the CIAC on 1 June 1999, and petitioner had filed its own Request for Arbitration before the ICC on 3 November 2000, both raising the common issues of whether typhoon Zeb constituted force majeure justifying EOT and whether LHC had the right to terminate the contract.

On 5 November 2000, petitioner filed a Complaint for Injunction with prayer for a TRO and writ of preliminary injunction before the RTC of Makati, seeking to restrain LHC from calling on the Securities and the banks from transferring or paying on them. The RTC issued a 72-hour TRO on the same day, extended it for seventeen days on 9 November 2000, but denied the application for a writ of preliminary injunction on 24 November 2000, ruling that the independence principle applied and that LHC, as ultimate beneficiary, could draw on the Securities. Petitioner elevated the case to the Court of Appeals via a Petition for Certiorari under Rule 65. The appellate court issued a TRO on 28 November 2000 enjoining LHC from calling on the Securities, but failed to act on the preliminary injunction application before the TRO expired on 27 January 2001. Immediately thereafter, LHC representatives withdrew US$4,950,000.00 from ANZ Bank, reducing the balance to US$1,852,814.00. On 2 February 2001, the Court of Appeals dismissed the petition, holding that the credit was independent of the underlying transaction and that any error by the trial court was merely an error of judgment not correctible by certiorari. LHC later manifested that the subject letters of credit had been fully drawn. Petitioner subsequently alleged that the ICC had rendered its Third Partial Award on 18 February 2004 declaring that LHC wrongfully drew upon the Securities and that petitioner was entitled to return of the sums taken.

• Independence Principle Inapplicable to Beneficiary: Petitioner contended that the independence principle on letters of credit could be invoked only by the issuing banks, not by the beneficiary LHC, and that any dispute must first be resolved through arbitration before LHC could call on the Securities.
• Fraud Exception Rule: Petitioner argued that LHC's call on the Securities was wrongful and fraudulent because LHC deliberately misrepresented the existence of delay despite knowing that the issue was still pending arbitration, bringing the case within the fraud exception to the independence principle.
• Unjust Enrichment: Petitioner asserted that LHC should be ordered to return the proceeds of the Securities pursuant to the principle against unjust enrichment, and that injunction was the appropriate remedy.
• Supplemental Allegations of Fraud: In supplemental pleadings, petitioner alleged that documentary and testimonial evidence from the ICC Arbitration demonstrated that LHC knowingly misrepresented that petitioner had incurred delays despite its own knowledge and admission that delays were excused under the Turnkey Contract.
• Irreparable Damage: Petitioner urged that it would suffer grave and irreparable damage if LHC were allowed to use the proceeds of the Securities and not ordered to return the amounts wrongfully drawn.

• Independence Principle (LHC): LHC argued that it was entitled to invoke the independence principle as beneficiary of the letters of credit, and that the Securities were independent of the main contract as shown on the face of the Standby Letters of Credit, which provided that the banks had no responsibility to investigate the authenticity or accuracy of the certificates.
• Contractual Right to Draw (LHC): LHC contended that the Turnkey Contract expressly conferred upon it the right to draw on the Securities for liquidated damages upon default, and that nothing in the contract required that disputes be resolved through arbitration before it could call on the Securities.
• Forum-Shopping (LHC): LHC charged petitioner with forum-shopping, alleging that petitioner maintained the present appeal while simultaneously pursuing Civil Case No. 04-332 before the RTC of Makati to enforce the ICC's partial award, and ICC Case No. 11264/TE/MW.
• Independence Principle (SBC): SBC argued that under the independence principle it was under no obligation to look into the validity or accuracy of the certification submitted by LHC, and that the act sought to be enjoined was already fait accompli.
• Independence Principle (ANZ Bank): ANZ Bank posited that its actions could not be regarded as unjustified under the independence principle, and that since its Standby Letter of Credit had been fully drawn, petitioner's prayer for preliminary injunction had been rendered moot.

• Applicability of Independence Principle: Whether the independence principle on letters of credit may be invoked by a beneficiary where the beneficiary's call thereon is wrongful or fraudulent.
• Right to Draw Before Arbitral Resolution: Whether LHC had the right to call and draw on the Securities before the resolution of the parties' disputes by the appropriate tribunal.
• Banks' Justification in Releasing Funds: Whether ANZ Bank and Security Bank were justified in releasing the amounts due under the Securities despite being notified that LHC's call thereon was wrongful.
• Entitlement to Injunctive Relief: Whether petitioner would suffer grave and irreparable damage warranting injunctive relief, and whether the petition had been rendered moot by the full drawdown of the Securities.

• Applicability of Independence Principle: Yes. The independence principle may be invoked by both the issuing bank and the beneficiary; limiting it to banks alone would render nugatory the purpose of letters of credit in commercial transactions.
• Right to Draw Before Arbitral Resolution: Yes. LHC had a contractual right to call on the Securities upon default under Clauses 4.2.5 and 8.7.2 of the Turnkey Contract, and nothing in the contract required prior arbitral resolution of disputes before drawing.
• Banks' Justification in Releasing Funds: Yes. Under the independence principle, the banks were under no obligation to determine the veracity of LHC's certification of default; their undertaking was simply to pay upon presentation of the required documents.
• Entitlement to Injunctive Relief: No. The petition was rendered moot by the full drawdown of the Securities, and petitioner failed to demonstrate a clear and unmistakable right to injunctive relief or to properly raise the fraud exception before the lower courts.

• Applicability of Independence Principle: The independence principle liberates the issuing bank from the duty of ascertaining compliance by the parties in the main contract; the obligation under the letter of credit is independent of the related and originating contract. Petitioner's argument that only issuing banks may invoke the principle was rejected because it would defeat the very purpose for which letters of credit are used. Letters of credit are employed mainly for the benefit of the parties to the original transaction — the applicant obtains security to convince the beneficiary to enter into the transaction, and the beneficiary is assured of the ability to call on the credit in case of nonperformance. The beneficiary is aptly named as such precisely because the credit exists for its benefit. Petitioner's position that disputes must first be resolved before the beneficiary may draw would convert the letter of credit into a mere guarantee, which is incompatible with its nature; the settlement of a dispute is not a prerequisite for the release of funds under a letter of credit, unlike a surety contract.

• Right to Draw Before Arbitral Resolution: The Turnkey Contract itself conferred upon LHC the right to call on the Securities in the event of default. Clause 4.2.1 required petitioner to provide two irrevocable standby letters of credit to secure performance of its obligations. Clause 8.7.1 obligated petitioner to pay US$75,000.00 per day of delay as liquidated damages. Clause 8.7.2 expressly authorized LHC to deduct such damages from monies due or to become due to petitioner and/or by drawing on the Securities. Clause 4.2.5 required LHC to give seven days' notice of calling upon the Securities, except when calling for payment of Liquidated Damages for Delay, in which case no notice was required. Nothing in the contract indicated that the parties intended all disputes regarding delay to be settled through arbitration before LHC could call on the Securities. Under the principle of autonomy of contracts (Article 1306, Civil Code), petitioner could have incorporated such a proviso but did not. The pendency of arbitration proceedings did not per se make LHC's draws wrongful or fraudulent.

• Banks' Justification in Releasing Funds: Pursuant to the independence principle, the banks were under no obligation to determine the veracity of LHC's certification that default had occurred, nor were they bound by petitioner's declaration that the call was wrongful. The banks' undertaking was simply to pay once the required documents were presented by the beneficiary. Both banks submitted that it was "ministerial" for them to honor the call for payment. Should petitioner ultimately prove in the arbitration proceedings that LHC's draws were wrongful due to the non-existence of default, its right to seek indemnification would not be foreclosed under general principles of law.

• Entitlement to Injunctive Relief: Petitioner failed to show a clear and unmistakable right to restrain LHC's call on the Securities. By its own admission, LHC's right to call was contractually rooted. The fraud exception rule was not raised before the lower courts and could not be raised for the first time on appeal. Even assuming the fraud exception applied, petitioner failed to satisfy the three requisites for injunction based on fraud: (a) clear proof of fraud; (b) fraud constituting fraudulent abuse of the independent purpose of the letter of credit and not merely fraud under the main agreement; and (c) irreparable injury if injunction were not granted. The propriety of LHC's call was intertwined with the fact of default, which was still pending before the arbitral tribunals, and this Court was not called upon to rule on that issue. Moreover, LHC manifested that the letters of credit had been fully drawn, rendering the petition moot under the rule that injunction will not lie where the acts sought to be enjoined have become fait accompli.

• Independence Principle in Letters of Credit — The obligation under a letter of credit is independent of the related and originating contract. The issuing bank undertakes to pay the beneficiary once the draft and required documents are presented, regardless of problems arising in the underlying contract. The principle liberates the issuing bank from the duty of ascertaining compliance by the parties in the main contract and assures the beneficiary of prompt payment. The Court applied this principle to hold that both the issuing banks and the beneficiary may invoke the independence principle, and that the banks were obligated to honor the credit upon presentation of the required documents without investigating the truth of the beneficiary's certification of default.

• Fraud Exception to the Independence Principle — Fraud is recognized as an exception to the independence principle. The remedy for fraudulent abuse is an injunction, which should not be granted unless: (a) there is clear proof of fraud; (b) the fraud constitutes fraudulent abuse of the independent purpose of the letter of credit and not only fraud under the main agreement; and (c) irreparable injury might follow if injunction is not granted or the recovery of damages would be seriously damaged. The Court held the exception inapplicable because petitioner never raised it before the lower courts, the existence of fraud was fundamentally interwoven with the issue of default still pending before the arbitral tribunals, and petitioner failed to demonstrate a clear and unmistakable right to injunctive relief.

• Distinction Between Letters of Credit and Guarantees — A letter of credit is distinct from a surety contract or guarantee. In a surety contract, there is no duty to indemnify the beneficiary until the beneficiary establishes the fact of the obligor's default, which may require litigation. In a standby credit, the beneficiary receives cash promptly upon presentation of required documents, before any litigation over the nature of the applicant's performance. The Court applied this distinction to reject petitioner's argument that disputes must first be resolved before the beneficiary may draw on the credit.

• Mootness by Fait Accompli — Injunction will not lie where the acts sought to be enjoined have already become fait accompli or an accomplished and consummated act. The Court applied this doctrine to dismiss the petition, the letters of credit having been fully drawn by LHC.

• "To say that the independence principle may only be invoked by the issuing banks would render nugatory the purpose for which the letters of credit are used in commercial transactions. As it is, the independence doctrine works to the benefit of both the issuing bank and the beneficiary." — This passage articulates the Court's expansion of the independence principle to the beneficiary, a key holding that distinguishes this case from earlier jurisprudence focusing solely on the bank's perspective.

• "If a letter of credit is drawable only after settlement of the dispute on the contract entered into by the applicant and the beneficiary, there would be no practical and beneficial use for letters of credit in commercial transactions." — This passage defines the functional distinction between letters of credit and guarantees, explaining why requiring prior dispute resolution would defeat the commercial utility of the instrument.

• "The remedy for fraudulent abuse is an injunction. However, injunction should not be granted unless: (a) there is clear proof of fraud; (b) the fraud constitutes fraudulent abuse of the independent purpose of the letter of credit and not only fraud under the main agreement; and (c) irreparable injury might follow if injunction is not granted or the recovery of damages would be seriously damaged." — This passage sets out the three-part test for invoking the fraud exception, a formulation frequently cited in subsequent Philippine jurisprudence on letters of credit.

• "Settled is the rule that injunction would not lie where the acts sought to be enjoined have already become fait accompli or an accomplished or consummated act." — This passage states the controlling procedural ground for dismissal, the full drawdown of the letters of credit having rendered the petition moot.

• Bank of the Philippine Islands vs. De Reny Fabric Industries, Inc., 146 Phil. 269 (1970) — Followed. The Court cited this case for the proposition that observance of the Uniform Customs and Practice (UCP) for Documentary Credits is justified by Article 2 of the Code of Commerce, which provides that commercial transactions shall be governed by usages and customs generally observed in the absence of specific provisions.

• Bank of America, NT & SA vs. Court of Appeals, G.R. No. 105395, 10 December 1993, 228 SCRA 357 — Followed. The Court relied on this case to establish that the UCP applies to transactions involving letters of credit, there being no specific statutory provisions governing the legal complexities of such transactions.

• Ticzon vs. Video Post Manila, Inc., 389 Phil. 20 (2000) — Applied. The Court used this case to support the rule that where the period or purpose of a preliminary injunction has expired or been accomplished, any declaration on the propriety of the writ would be entirely useless, there being no actual case or controversy.

• Article 3, Uniform Customs and Practice (UCP) for Documentary Credits — Provides that credits are separate transactions from the sales or other contracts on which they may be based, and that banks are in no way concerned with or bound by such contracts. The Court applied this provision to establish the independence of the letters of credit from the Turnkey Contract.

• Article 15, UCP — Provides that banks assume no liability or responsibility for the form, sufficiency, accuracy, genuineness, falsification, or legal effect of any documents, or for the good faith or acts of any person whomsoever. The Court applied this provision to hold that the banks were under no obligation to determine the veracity of LHC's certification of default.

• Article 10, UCP — Provides that where a credit is stipulated as irrevocable, there is a definite undertaking by the issuing bank to pay the beneficiary provided the stipulated documents are presented and the conditions of the credit are complied with. The Court applied this provision to confirm the banks' obligation to honor the credit.

• Article 1159, Civil Code — Provides that obligations arising from contracts have the force of law between the contracting parties and should be complied with in good faith. The Court applied this provision to hold that LHC was merely enforcing its contractual rights under the Turnkey Contract.

• Article 1306, Civil Code — Embodies the principle of autonomy of contracts, allowing parties to establish such stipulations as they deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy. The Court applied this provision to note that petitioner could have, but did not, incorporate a proviso requiring final arbitral determination of default before enforcement of the Securities.

• Article 1315, Civil Code — Provides that a contract once perfected binds the parties to the fulfillment of what has been expressly stipulated and to all consequences which according to their nature may be in keeping with good faith, usage, and law. The Court applied this provision to enforce the Turnkey Contract's stipulations regarding the Securities.

• Clauses 4.2.1, 4.2.5, 8.7.1, 8.7.2, and 20.3, Turnkey Contract — Clause 4.2.1 required petitioner to provide two irrevocable standby letters of credit to secure performance. Clause 4.2.5 governed LHC's notice requirements for calling on the Securities, dispensing with notice for liquidated damages for delay. Clause 8.7.1 imposed liquidated damages of US$75,000.00 per day of delay. Clause 8.7.2 authorized LHC to deduct damages or draw on the Securities. Clause 20.3 mandated dispute resolution through mediation, conciliation, and arbitration. The Court applied these provisions to hold that LHC's right to draw on the Securities was contractually rooted and did not require prior arbitral resolution.

Puno (Chairman), Austria-Martinez, Callejo, Sr., and Chico-Nazario, JJ., concurred.