International Commercial Terms – Incoterms
There are many standard terms of sale in everyday use and in order to ensure these terms are universally understood, the International Chamber of Commerce publish an agreed set of definitions called Incoterms. The current edition is Incoterms 2000.
The outline of the Incoterms, which are set out below, is only a guide to the buyers’ and sellers’ responsibilities under the individual contracts. Refer to the International Chamber of Commerce publication INCOTERMS 2000.
It is important to understand that if the parties to a contract intend to be bound by the definitions in Incoterms, they must state this explicitly. Unless they do, there is no certainty that the clarity of the definitions afforded by Incoterms will apply.
Incoterms are designed to cover a wide range of terms, from sales at the point of origin (for example the Seller’s factory) such as EXW through to delivered at the Buyer’s door (DDP).
These terms are not merely inventions of the International Chamber of Commerce, but reflect the terms on which international traders prefer to do business. As we will see, there are many reasons why the parties to the deal will decide on the most appropriate term to be used, including the type of goods, the forms of transport to be used, the method of payment and the state of the market at the time.
International trade is a dynamic business and its customs and practice change with the advent of new modes of transport, improved communications, changes in demand and supply, banking arrangements, national and international laws and hundreds of other factors.
As a result, the terms on which traders do business evolve to suit the changing times. To cope with this, the International Chamber of Commerce regularly review and revise Incoterms in accordance with the preferences of trade and changes in practice, after consultation with trade bodies and other organizations.
Many recent amendments, for example, have been to facilitate the increased use of electronic data interchange. Incoterms encompasses the following terms:
EXW Ex Works
FCA Free Carrier
FAS Free Alongside Ship*
FOB Free On Board*
CFR Cost and Freight*
CIF Cost, Insurance and Freight*
CPT Carriage Paid To
CIP Carriage and Insurance Paid To
DAF Delivered at Frontier
DES Delivered Ex Ship*
DEQ Delivered Ex Quay*
DDU Delivered Duty Unpaid
DDP Delivered Duty Paid
(*) Denotes Maritime Incoterms.
It will be seen that the terms fall neatly into groups. The “E” term (Ex Works) where the seller makes the goods available at his factory or premises, the “F” terms, where the Seller must deliver the goods to a carrier named by the buyer. These are followed by the “C” terms, in which the seller has to arrange the carriage, but without bearing the risk for loss or damage after shipment and despatch. Then finally the “D” terms whereby the Seller bears all the costs and risks needed to deliver the goods to the country of destination.
Under each of these terms, Incoterms define the duties of both the Buyer and the Seller in respect of every stage in the transport chain, establishes the division of costs and the stage at which payment must be made, property passes and risk is transferred from one to the other. It must be understood, however, that the risk may not pass at the same time, and we will examine this discrepancy under each of the most important terms.
Most Used Incoterms in Ship Chartering
Although there are 13 terms listed in the INCOTERMS there are three which we come across regularly in chartering as follows:
FOB (Free On Board) – one of the most commonly used terms, FOB means the shipper/seller will arrange and pay for the merchandise to be moved to the loading port and put on board the vessel and delivery is accomplished at this point.
CFR (Cost and Freight) – previously known as C&F, CFR defines the separate responsibilities – one dealing with the cost of the goods ‘C’ and the other, ‘F’, referring to the freight charges to an agreed discharge port; delivery is accomplished at the discharge port.
CIF (Cost, Insurance and Freight) – this is similar to CFR except that the shipper/seller will insure the goods for loss as damage and delivery is accomplished at the discharge port.
If we look at the extreme ends of the range of terms offered under Incoterms, it seems clear that to expect one party or the other to deal with all aspects of international transport must have its drawbacks.
If, for example, you are based in Canada and wish to purchase a consignment of washing machines from a manufacturer in Korea, your obligations under an EXW contract would be quite daunting. You would be responsible for arranging and paying for every stage of the transport chain, even the labour and equipment to load the goods at the manufacturer’s factory. All the risks involved would be your responsibility, and you would be expected to sort out customs formalities for both exporting and importing countries with a minimum of assistance from the seller.
Given this burden of cost, responsibility and risk, one might assume that all sellers would prefer to sell on EXW terms and that buyers would refuse to accept any terms other than DDP.
The reality is that most goods are sold on terms where both parties have some responsibility for their end of the transport. In the last example, it would almost certainly be easier and probably cheaper for the Korean manufacturer to arrange and pay for forklift trucks to load the washing machines on to vehicles and deliver them to the nearest port than for a non Korean-speaking buyer based in a distant continent and time zone to accomplish the same exercise.
At the other end of the journey, our Canadian buyer will be in a much better position to deal with import customs entry, duty payments and to co-ordinate delivery to his depots in Toronto and Vancouver than the seller.
In addition to purely practical considerations, there may well be advantages to one party or the other in controlling the sea transport leg, cargo handling and insurance.
An international seller of goods may well find that the buyers regard his arrangements for all aspects of shipment through to a port in their country to be a valuable service, leaving them only with local arrangements to be made.
On the other hand, he can often enhance his profit by his ability to earn additional profit, or at the very least a share of commission on the arrangement of insurance cover and on the sea-freight, especially, if he is used to making such arrangements and has his own shipping department.
Never underestimate the power of market forces, however, under normal, stable market conditions trading partners may well be used to dealing on FOB or CIF terms as a matter of course. A sudden swing in the market for those good may however have a marked effect on the basis of sale.
In a sellers’ market, the producer is in a position to dictate the terms upon which he is prepared to sell his goods – which will probably be those which will involve the minimum of risk for him and ensure the best and fastest payment method.
In a buyers’ market, a seller will be forced to adapt his terms of sale to the buyer’s requirements if he is to stand any chance of doing business.
So at the end of the day, the terms on which goods are sold in international markets are a compromise, negotiated in the same way as all the other aspects of the business, between the parties who make the deal.
What are the differences between Incoterms 2000 and Incoterms 2010?
Incoterms 2000 contained 13 Rules, which have been reduced to 11 terms in Incoterms 2010. This has been achieved by introducing two new Rules to replace five current Rules. The two new Rules may be used irrespective of the mode of transport selected and under both new Rules, delivery takes place at a named destination. In essence, the “D” (Delivered) terms under the 2000 Rules have been consolidated to reduce the number of terms that were considered to have little real difference between them.
DAT (Delivered at Terminal) replaces DEQ (Delivered ex Quay). DAT may be used irrespective of the mode of transport selected and may also be used where more than one mode of transport is employed. “Delivered at Terminal” means that the seller delivers when the goods, having been unloaded from the arriving means of transport, are placed at the buyer’s disposal at a named terminal at the named port or place of destination. DAT requires the seller to clear the goods for export where applicable but the seller has no obligation to clear the goods for import, pay any import duty or carry out any import customs formalities. It was considered that DAT would prove more useful than DEQ in the case of containers that might be unloaded and then loaded into a container stack at the terminal, awaiting shipment. There was previously no term clearly dealing with containers that were not at the buyer’s premises.
DAP (Delivered at Place) replaces DAF, DES, DEQ and DDU. The arriving “vehicle” under DAP could be a ship and the named place of destination could be a port. Consequently, the ICC considered that DAP could safely be used instead of DES and that it would make the Rules more “user-friendly” if they abolished terms that were fundamentally the same. Again, a seller under DAP bears all the costs (other than any import clearance costs) and risks involved in bringing the goods to the named destination.
What are the differences between Incoterms 2010 and Incoterms 2020?
1. DAT Incoterm changed to DPU (Delivery at Place Unloaded)
Following on from several rounds of consultation, the drafting group made the choice of removing the word ’terminal’ as it often caused confusion. DAT required Delivery at Terminal (unloaded), however, after receiving feedback from practitioners, the drafting committee decided to change the term to DPU (Delivery at Place Unloaded), to broadly cover ‘any place, whether covered or not’.
2. Insurance cover differs between CIF and CIP
Under CIF and CIP, the seller buys insurance for the buyer. In Incoterms® 2010, insurance is required under clause C, but in Incoterms 2020, CIP requires insurance complying with Institute Cargo Clause (A) whereas CIF requires insurance under Clause C.
3. The listing of costs
All costs are now listed in the ‘Allocation of Costs’ sections for each rule, to avoid confusion. As the ordering of articles within the Incoterms 2020 rules has also changed, these now appear in the A9/B9 section of each rule. Costs were a big issue in the 2010 Incoterms. Carriers often changed their pricing structure to deal with add ons and sellers were often surprised by being back-charged terminal handling charges. The A9 sections in the Incoterms rules guide now collect together the costs, with the principle aim of clearly stating the costs to each party.
4. Security Requirements
Cargo security has been particularly important since the 11 September 2001 World Trade Centre attacks, and the 2020 rules now address many of the security-related requirements that became so prevalent in the early part of this century. From a carriage requirements perspective, security-related allocations have been added to A4 and A7 of each Incoterms rule and the necessary costs associated have been added to A9/B9
5. Own transport
Incoterms 2010 rules assumed that goods carried from the seller to the buyer were via a 3rd party. Incoterms 2020 allows for the buyer to use their own means of transport in the FCA rules and the seller to use their own means in the D rules.
6. FCA and Bills of Lading (BL)
According to FCA, part B4, ‘The buyer must contract or arrange at its own cost for the carriage of the goods’. There is a gap in delivery between FCA and FOB. If you’re selling FCA, your delivery point is different to FOB. The difference between FCA and FOB to the seller is a significant cost and risk. In the 2010 Incoterms rules, exporters of goods in containers were encouraged to use FCA, which seemed best for both parties. However, many people were using FOB when they should’ve really been using FCA. Even sophisticated sellers said they wanted to use FOB, because a standard letter of credit requires an onboard bill of lading to be presented. Therefore the sellers were often taking the risk and using FOB instead because they wanted to get paid under the LC. The Incoterms 2020 FCA extra provision now states that if the parties have so agreed, the buyer must instruct the carrier to issue to the seller, at the buyer’s cost and risk, a transport document stating that the goods have been loaded (such as a bill of lading with an on board notation).
7. Presentation and design
Incoterms 2020 rules have much more extensive explanatory notes, with better diagrams, a different structure for users and a reordering of rules to make delivery and risk more obvious. Maritime-related rules still haven’t changed and remain at the back of the rule book as they still might be used for bulk commodities.