Standby Letters of Credit Stand Outside Corporate Rehabilitation Stay Orders

The Supreme Court's 2004 decision in Metropolitan Waterworks and Sewerage System v. Hon. Reynaldo B. Daway and Maynilad Water Services, Inc. (G.R. No. 160732) clarifies a critical point in Philippine corporate rehabilitation law: a rehabilitation court's stay order does not prevent a creditor from drawing on a standby letter of credit issued for the debtor's account. The ruling protects the independence of letters of credit and confirms that issuing banks' obligations are solidary with the debtor, placing them beyond the rehabilitation court's reach.

Background of the Case

MWSS granted Maynilad a 20-year concession to operate water services in the West Zone Service Area. To secure Maynilad's performance, the Concession Agreement required it to put up a bond or bank guarantee acceptable to MWSS. Maynilad arranged for a US$120 million irrevocable standby letter of credit from a group of foreign banks led by Citicorp International Limited, in favor of MWSS.

Disputes arose over concession fees, leading Maynilad to file a petition for corporate rehabilitation on November 13, 2003. The trial court issued a Stay Order on November 17, 2003, which prohibited Maynilad from paying its outstanding liabilities and stayed enforcement of claims against the company, its guarantors, and sureties not solidarily liable with it.

On November 24, 2003, MWSS made a written demand on the standby letter of credit for US$98,923,640.15, citing Maynilad's failure to pay concession fees. The rehabilitation court then issued a clarificatory order declaring MWSS's draw on the letter of credit a violation of the Stay Order and voiding any payment by the banks. MWSS challenged this order before the Supreme Court.

The Issue

The central question was whether the rehabilitation court acted without or in excess of its jurisdiction when it enjoined MWSS from drawing on the standby letter of credit. This required the Court to determine whether the letter of credit and the issuing banks fell within the rehabilitation court's jurisdiction over the debtor's estate.

The Ruling

The Supreme Court granted MWSS's petition and set aside the rehabilitation court's order. The Court held that the rehabilitation court exceeded its jurisdiction in enjoining MWSS from claiming from an asset that did not belong to the debtor.

The Court reasoned that the rehabilitation court's jurisdiction extends to assets of the debtor that should be reflected in its audited financial statements. The standby letter of credit was not part of Maynilad's assets or liabilities, as its own financial statements confirmed. The banks did not hold any assets belonging to Maynilad that would be material to the rehabilitation proceedings.

Letters of Credit Are Primary Obligations

The Court distinguished letters of credit from contracts of guarantee. Citing Feati Bank & Trust Company v. Court of Appeals, the Court explained that in a contract of guarantee, the guarantor's obligation is collateral and arises only upon default of the person primarily liable. In contrast, an irrevocable letter of credit involves a primary, direct, and definite undertaking by the bank to pay upon presentation of the stipulated documents.

The Court applied the Uniform Customs and Practice for Documentary Credits of the International Chamber of Commerce, which defines the issuing bank's liability on an irrevocable letter of credit as a "definite undertaking" to pay at sight if the stipulated documents are presented and the terms and conditions are complied with.

Solidary Obligation of Issuing Banks

The Court held that, unless a letter of credit specifically stipulates otherwise, the obligation of issuing banks is solidary with that of the person requesting its issuance. The banks' obligation under the standby letter of credit was primary, direct, definite, and absolute—characteristics of a surety or solidary obligor—and was not conditioned on the prior exhaustion of the debtor's assets.

Because the obligation was solidary, claims against the banks could be pursued separately and independently of the rehabilitation case. Citing Traders Royal Bank v. Court of Appeals and Philippine Blooming Mills, Inc. v. Court of Appeals, the Court noted that property of a surety cannot be taken into custody by the rehabilitation receiver, and the surety can be sued separately to enforce liability.

Practical Takeaways

• Standby letters of credit are independent of rehabilitation proceedings. A rehabilitation court's stay order does not bar a beneficiary from drawing on a letter of credit issued for the debtor's account.
• Issuing banks are solidary obligors. Unless the letter of credit states otherwise, the issuing bank's obligation is primary and direct, not merely collateral like a guarantor's.
• Rehabilitation courts have limited jurisdiction. Their authority extends to the debtor's assets and persons holding those assets, not to third parties with independent obligations to creditors.
• Creditors may act promptly. A creditor with a clear right under a letter of credit need not wait for the rehabilitation case to conclude before enforcing that right.
• Immediately executory orders may still be challenged. A party aggrieved by a rehabilitation court's order exceeding its jurisdiction may seek certiorari despite the order's immediate executory nature.

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