Mercantile Law

RELIANCE COMMODITIES, INC. v. DAEWOO INDUSTRIAL CO., LTD. Letter of Credit as a Mode of Payment

FACTS:

On 9 January 1980, petitioner Reliance, as buyer, and respondent Daewoo, as seller, entered into a contract of sale of 2,000 metric tons of foundry pig iron.

Upon arrival in Manila, the subject cargo was found to be short of 135.655 metric tons. Only 1,864.345 metric tons were discharged and delivered to Reliance.

On 2 May 1980, another contract was entered into between the same parties for the purchase of another 2,000 metric tons of foundry pig iron. Daewoo acknowledged the short shipment of 135.655 metric tons under the earlier contract and, to compensate Reliance therefor, bound itself to reduce the price by US$1 to US$2 per metric ton of pig iron for succeeding orders. However, that contract was not consummated and was later superseded by still another contract dated 31 July 1980.

On August 1, 1980, Reliance filed with the China Banking Corp., an application for a Letter of Credit (L/C) in favor of Daewoo.

The application was denied. 

When was asked to submit purchase orders for 2,000 metric tons to support its application for L/C. Reliance was able to present purchase orders for 900 metric tons only. 

Daewoo rejected the proposed L/C for being short of the contracted tonnage. Thus, Reliance withdrew the application for the L/C.

Because of the failure of Reliance to to open the L/C as stipulated in the contract, Daewoo was compelled to sell the 2,000 metric tons to another buyer at a lower price.

When Daewoo failed to pay the amount of P226,370.48, representing the value of the short delivery of 135.655 metric tons of foundry pig iron under the first contract, Reliance filed an action for damages against Daewoo with the trial court. 

Daewoo responded, inter alia, with a counterclaim for damages, contending that Reliance was guilty of breach of contract when it failed to open an L/C as required in the 31 July 1980 contract.

The trial court ruled that:

(1) the 31 July 1980 contract did not extinguish Daewoo’s obligation for short delivery pursuant to the 9 January 1980 contract and must therefore pay Reliance P226,370.48 representing the value of the short delivered goods plus interest and attorney’s fees; and

(2) Reliance is in turn liable for breach of contract for its failure to open a letter of credit in favor of Daewoo pursuant to the 31 July 1980 contract and must therefore pay the latter P331,920.97 as actual damages with legal interest plus attorney’s fees.

Reliance appealed the judgment against it. 

The CA found no merit in the appeal and affirmed the decision of the trial court.

In the present Petition for Review, Reliance assails the award of damages in favor of Daewoo.

ISSUE:

Whether or not the failure of an importer (Reliance) to open a letter of credit on the date agreed upon makes him liable to the exporter (Daewoo) for damages.

RULING:

A letter of credit is one of the modes of payment, set out in Sec. 8, Central Bank Circular No. 1389, “Consolidated Foreign Exchange Rules and Regulations,” by which commercial banks sell foreign exchange to service payments for, e.g., commodity imports. 

The primary purpose of the letter of credit is to substitute for and therefore support, the agreement of the buyer/importer to pay money under a contract or other arrangement. It creates in the seller/exporter a secure expectation of payment.

A letter of credit transaction may thus be seen to be a composite of at least three (3) distinct but intertwined relationships being concretized in a contract:

(a) One contract relationship links the party applying for the L/C (the account party or buyer or importer) and the party for whose benefit the L/C is issued (the beneficiary or seller or exporter). In this contract, the account party, here Reliance, agrees, among other things and subject to the terms and conditions of the contract, to pay money to the beneficiary, here Daewoo.

(b) A second contract relationship is between the account party and the issuing bank. Under this contract, (sometimes called the “Application and Agreement” or the “Reimbursement Agreement”), the account party among other things, applies to the issuing bank for a specified L/C and agrees to reimburse the bank for amounts paid by that bank pursuant to the L/C.

(c) The third contract relationship is established between the issuing bank and the beneficiary, in order to support the contract, under (a) above, of the account party and the beneficiary to, inter alia, pay certain monies to the latter.

Certain other parties may be added to the foregoing, but the above three are the indispensable ones.

The Court considers that under 31 July 1980 contract, the opening of an L/C upon application of Reliance was not a condition precedent for the birth of the obligation of Reliance to purchase foundry pig iron from Daewoo. 

We agree with the CA that Reliance and Daewoo, having reached “a meeting of minds” in respect of the subject matter of the contract, the price thereof, and other principal provisions, “they had a perfected contract.”  

The failure of Reliance to open, the appropriate L/C did not prevent the birth of that contract, and neither did such failure extinguish that contract. The opening of the L/C in favor of Daewoo was an obligation of Reliance and the performance of that obligation by Reliance was a condition of enforcement of the reciprocal obligation of Daewoo to ship the subject matter of the contract — the foundry pig iron — to Reliance. But the contract itself between Reliance and Daewoo had already sprung into legal existence and was enforceable.

The L/C provided for in that contract was the mode or mechanism by which payment was to be effected by Reliance of the price of the pig iron. In undertaking to accept or pay the drafts presented to it by the beneficiary according to the tenor of an L/C, and only later on being reimbursed by the account party, the issuing bank in effect extends a loan to the account party. This loan feature, combined with the bank’s undertaking to accept the beneficiary’s drafts drawn on the bank, constitutes the L/C as a mode of payment. 10 Logically, before the issuing bank open an L/C, it will take steps to ensure that it would indeed be reimbursed when the time comes. Before an L/C can be opened, specific legal requirements must be complied with.

This Court finds that the CA committed no reversible error when it ruled that the damages incurred by Daewoo were sufficiently proved with various evidence showing the loss suffered by the defendant when it was compelled to sell the subject goods at a lower price.

The Petition for Review is hereby DENIED for lack of merit.

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