In the case of Metropolitan Waterworks and Sewerage System vs. Hon. Reynaldo B. Daway and Maynilad Water Services, Inc., the Supreme Court ruled that a Standby Letter of Credit is an independent and primary obligation of the issuing bank. Because of this independence, the letter of credit is not subject to the stay order issued in corporate rehabilitation proceedings of the party who procured the letter of credit. This means creditors can still claim against these letters of credit even if the debtor is undergoing rehabilitation.

Navigating Rehabilitation: Can a Letter of Credit Shield a Failing Company?

The central question in this case revolves around whether a rehabilitation court has the authority to prevent a creditor from seeking payment from banks that issued an Irrevocable Standby Letter of Credit on behalf of a company undergoing rehabilitation. The Metropolitan Waterworks and Sewerage System (MWSS) sought to draw on a letter of credit issued by banks to guarantee the obligations of Maynilad Water Services, Inc. under a Concession Agreement. When Maynilad filed for rehabilitation, the lower court issued a stay order, effectively preventing MWSS from accessing the funds under the letter of credit. This ruling prompted MWSS to question the lower court’s jurisdiction over the letter of credit, arguing that it was separate and distinct from Maynilad’s assets undergoing rehabilitation.

The legal framework rests on the Interim Rules of Procedure on Corporate Rehabilitation, specifically Section 6 (b), Rule 4, which addresses the stay of claims against a debtor undergoing rehabilitation, its guarantors, and sureties. Maynilad argued that MWSS’s attempt to draw on the Standby Letter of Credit was a prohibited enforcement of a claim. MWSS, on the other hand, contended that the letter of credit represented a solidary obligation of the issuing banks, independent of Maynilad’s rehabilitation proceedings.

The Supreme Court held that the rehabilitation court acted in excess of its jurisdiction. The Court emphasized that the Irrevocable Standby Letter of Credit was not part of Maynilad’s assets subject to rehabilitation. Instead, it represents a direct and primary obligation of the issuing banks to MWSS. Building on this principle, the Court cited previous jurisprudence, specifically Feati Bank & Trust Company v. Court of Appeals, clarifying that letters of credit are distinct from guarantees.

In contracts of guarantee, the guarantor’s obligation is merely collateral and it arises only upon the default of the person primarily liable. On the other hand, in an irrevocable letter of credit, the bank undertakes a primary obligation.

The obligation of the issuing banks is solidary with Maynilad because it constitutes a direct, primary, definite, and absolute undertaking to pay MWSS upon presentation of the required documents, irrespective of Maynilad’s financial status. The obligations of the banks are not contingent on the prior exhaustion of Maynilad’s assets. Solidary obligations allow creditors to pursue claims against any of the solidary debtors, and in this case, the issuing banks, without waiting for the resolution of the debtor’s rehabilitation proceedings.

The Court also addressed the argument that the call on the Standby Letter of Credit violated the stay order. It stated that the stay order could not extend to assets or entities outside the rehabilitation court’s jurisdiction. Therefore, the attempt to draw on the letter of credit was not a violation. The court referenced the Uniform Customs and Practice for Documentary Credits (U.C.P), which governs letters of credit and supports the principle of the issuing bank’s independent obligation. The Court noted that international commercial practices, as embodied in the U.C.P, are applicable in the Philippines under Article 2 of the Code of Commerce.

MWSS sought to draw on the letter of credit per their agreement to cover unpaid concession fees. The Court stated that barring MWSS from doing so would undermine the very purpose of the letter of credit. Letters of credit ensure that the beneficiary, in this case MWSS, receives payment regardless of the financial condition of the party requesting its issuance. Letters of credit protect against exactly this situation which makes them so valuable in these types of agreements.

In summary, the Supreme Court underscored the independence and solidary nature of obligations under a letter of credit. This ruling has significant implications for creditors dealing with companies undergoing rehabilitation because creditors are permitted to seek fulfillment of obligations from sureties, like banks in the case of a letter of credit, without having to wait on the rehabilitation court’s proceedings.

FAQs

What was the key issue in this case?	The main issue was whether a rehabilitation court could prevent a creditor from claiming against an Irrevocable Standby Letter of Credit issued on behalf of a company undergoing rehabilitation.
What is a Standby Letter of Credit?	A Standby Letter of Credit is a guarantee issued by a bank on behalf of a client, assuring payment to a beneficiary if the client fails to fulfill a contractual obligation. It is an independent obligation of the issuing bank.
What is the significance of the obligation being “solidary”?	A solidary obligation means that each debtor is independently liable for the entire debt. The creditor can pursue any of the debtors for full payment.
Why was the rehabilitation court’s order deemed to be in excess of its jurisdiction?	The court exceeded its jurisdiction because the letter of credit and the issuing banks’ obligations were not part of the debtor’s assets subject to rehabilitation. It was an independent agreement between the bank and the creditor.
How did the court distinguish a letter of credit from a guarantee?	The court explained that a letter of credit creates a primary obligation for the bank, whereas a guarantee is only a collateral obligation that arises upon the debtor’s default.
What are the practical implications of this ruling for creditors?	Creditors can still claim against Standby Letters of Credit even if the debtor is undergoing rehabilitation. This can give creditors assurance that they can receive the financial obligations that they are contractually entitled to.
What is the Uniform Customs and Practice for Documentary Credits (U.C.P.)?	The U.C.P. is a set of rules developed by the International Chamber of Commerce that standardizes the use of letters of credit in international transactions.
Did Maynilad’s rehabilitation filing affect MWSS’s claim?	No, the Supreme Court ruled that the filing for rehabilitation by Maynilad did not prevent MWSS from pursuing its claim under the Standby Letter of Credit.

The Supreme Court’s decision reinforces the principle of the independence of letters of credit from underlying contracts and rehabilitation proceedings. This ruling is very crucial for upholding the reliability of letters of credit in commercial transactions and ensuring the protection of creditors’ rights, even in the face of a debtor’s financial distress.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: MWSS vs. Daway, G.R. No. 160732, June 21, 2004