Correspondent Banks' Right to Reimbursement in Dishonored Letters of Credit

In Marphil Export Corporation v. Allied Banking Corporation (G.R. No. 187922, September 21, 2016), the Supreme Court clarified the rights and obligations of correspondent banks when a letter of credit is dishonored by the issuing bank. The ruling is significant for exporters, banks, and sureties because it confirms that a correspondent bank that is not a confirming bank may still recover amounts it credited to an exporter's account, provided there is a separate reimbursement agreement.

The Facts of the Case

Marphil Export Corporation, a Philippine exporter of agricultural products, obtained loans from Allied Banking Corporation to finance its export business. These loans were secured by continuing guaranty agreements executed by Ireneo Lim and others, and by irrevocable letters of credit issued by foreign banks.

For one transaction, Nanyang Commercial Bank, a bank in China, issued Letter of Credit No. 21970 in favor of Marphil, with Allied Bank as correspondent bank. After Marphil presented the export documents and drafts, Allied Bank credited Marphil's account with P1,913,763.45, the peso equivalent of the letter of credit's face value.

When Nanyang Bank dishonored the letter of credit due to discrepancies in the shipping documents, Allied Bank reversed the credit entry and debited Marphil's account. Marphil sued Allied Bank for declaratory relief, while Allied Bank filed a collection case against Lim as surety. The trial court and the Court of Appeals ruled in favor of Allied Bank, and Marphil appealed to the Supreme Court.

The Role of a Correspondent Bank

The Supreme Court affirmed that Allied Bank was not a confirming bank under L/C No. 21970. A confirming bank assumes a direct obligation to the seller as if it had issued the letter of credit itself. For a correspondent bank to be considered a confirming bank, the letter of credit must contain a categorical declaration that the correspondent bank will honor all drafts drawn in conformity with the letter of credit.

In this case, the instructions from Nanyang Bank to Allied Bank did not contain such a declaration. The Court found that Allied Bank acted at most as a negotiating or discounting bank, which buys or discounts drafts under a letter of credit. As a negotiating bank, it has a right of recourse against the issuing bank, and until reimbursement is obtained, the drawer of the draft continues to assume a contingent liability on the draft.

The Right to Reimbursement Under a Letter Agreement

Even though Allied Bank was not a confirming bank, the Court held that it had a separate and independent right to reimbursement under the Letter Agreement executed by Marphil. In that agreement, Marphil expressly bound itself to refund the amount paid by Allied Bank in purchasing the export bill or draft in case of dishonor by the drawee bank.

The Court cited Velasquez v. Solidbank Corporation, which ruled that an obligation under a letter of undertaking, where the drawer undertakes to pay the full amount of the draft in case of dishonor, is independent from the liability under the sight draft. This obligation is direct and primary, without need to establish collateral facts such as a violation of the letter of credit.

Legal Compensation and the Right to Debit

The Court also upheld Allied Bank's right to unilaterally debit Marphil's account through legal compensation. Under Article 1279 of the Civil Code, legal compensation may take place when two parties are principal creditors and debtors of each other, and both debts consist of money, are due, and are liquidated and demandable.

When Allied Bank credited the amount to Marphil's account, it became Marphil's debtor. But when Nanyang Bank dishonored the letter of credit, Marphil became Allied Bank's debtor for the same amount under the Letter Agreement. Since both debts were due, liquidated, and demandable, legal compensation was proper.

The Court emphasized that banks must exercise the highest degree of care when exercising their right to set off. In this case, Allied Bank properly exercised its right because it informed Marphil twice of Nanyang Bank's refusal to honor the documents before debiting the account, and the debiting was not the proximate cause of Marphil's losses.

No Forum Shopping in Suing the Surety Separately

The Court also ruled that Allied Bank did not commit forum shopping when it filed a collection case against Lim as surety while its counterclaim against Marphil was pending in the declaratory relief case. Citing Gilat Satellite Networks, Ltd. v. United Coconut Planters Bank General Insurance Co., Inc., the Court explained that a surety's liability is direct, primary, and absolute. A surety may be sued separately or together with the principal debtor, and the creditor may proceed against the surety alone without prior demand on the principal.

Dissolution of the Writ of Preliminary Attachment

The Court partially granted the petition by ordering the dissolution of the writ of preliminary attachment issued against Lim's properties. Under Section 1(d) of Rule 57 of the Rules of Court, a writ may issue against a party guilty of fraud in contracting the obligation sued upon. However, the applicant must show specific facts constituting the fraud, and the fraud must have been committed upon contracting the obligation.

The Court found that Allied Bank's application for the writ contained only general averments of fraud and did not allege specific acts showing that Lim had a preconceived plan not to pay. Since fraud is never presumed, the general allegations were insufficient to support the writ's issuance.

Practical Takeaways

• Correspondent banks that are not confirming banks do not assume the issuing bank's obligation, but they may still recover amounts credited to an exporter's account if there is a separate reimbursement agreement.

• A letter agreement or letter of undertaking creates an independent obligation to reimburse the bank in case of dishonor, separate from the obligations under the draft and the letter of credit.

• Banks may use legal compensation to debit an account when a letter of credit is dishonored, provided the requirements of Article 1279 of the Civil Code are met and the bank exercises the highest degree of care.

• Sureties may be sued separately from the principal debtor, and such separate suits do not constitute forum shopping because the parties and causes of action are different.

• A writ of preliminary attachment based on fraud requires specific factual allegations; general averments of fraud are insufficient to support its issuance.

This article is general information and not legal advice. For your specific situation, consult a lawyer or ask ASG Legal AI.