Ever since its introduction in 1936, Incoterms® has been a paradox to many buyers, sellers, traders, freight forwarders, shipping lines, and other stakeholders who use it in global trade..
The Incoterms® rules facilitate the conduct of global trade.. By referencing Incoterms® rules in a sales contract, the parties to the contract can clearly outline and define their respective obligations as far as transfer of risk, cost allocation, arrangement of transport, and customs clearance..
There are several consequences of using the incorrect Incoterms® and users need to fully comprehend what it means when they put a three-letter Incoterms® rule into their sales contract..
Emily O’Connor, Director of Trade and Investment for the International Chamber of Commerce (ICC), went as far as to say that “people will frequently choose the wrong Incoterms® rule for their transaction”..
Here are 6 tips to avoid the consequences of incorrect Incoterms®usage..
1) Use appropriate rules for the chosen mode of transport
FOB (Free On Board), one of the Incoterms® rules, was designed to be used only for sea or inland waterway transport wherein the seller delivers the goods on board the vessel nominated by the buyer at the named port of load..
The risk of loss or damage to the goods passes from the seller to the buyer when the goods are on board the vessel and thereon..
Although it is clear that FOB is suitable only for cargoes where the shipper delivers the goods such as Bulk or Break Bulk on board the ship, many customers still use FOB rules for containerized goods as well..
This is incorrect as containerized cargoes are delivered to a container terminal where it is received under the control of the carrier and not received on board the ship.. In this case, FCA would be the appropriate term to be used..
The incorrect usage of FOB in containerized cargoes has been and is quite prevalent across the world.. As a consequence of this incorrect usage, the seller is exposing themselves to unnecessary risks and costs..
2) Understand the allocation of costs and risks between the buyer and seller
Although the Incoterms® rules clearly outline the allocation of costs and risks between the buyer and seller, there are often several disputes around the costs and risks such as whether in FOB or FCA rules the bill of lading costs are for the seller or buyer..
Even certain statutory and seemingly straightforward charges such as THC (Terminal Handling Charges) have led to disputes as the quantum of THCs and its application varies from port to port.. In some ports, the carriers may offer a Free Out option while in some ports, it could be levied separately..
Another example is in CIF and CIP rules, both parties need to understand the extent of the cargo insurance coverage required..
Incoterms® 2020 rules require specified levels of cover like “limited insurance cover complying with Institute Cargo Clauses (C) or similar clause” under CIF and “extensive insurance cover complying with Institute Cargo Clauses (A) or similar clause” under CIP..
A lack of understanding of such requirements can lead to cost disputes and/or delays to the shipment itself which could impact the delivery time..
3) Reflect the version of Incoterms® rules agreed upon
While the latest Incoterms® 2020 is the version recommended by the ICC, parties can use a different version of the Incoterms® if they so choose..
However, they need to ensure that the year and version of the chosen Incoterms® rules is reflected clearly in their sales contract – for example – Incoterms® 2020..
Why, because different versions have different requirements.. For example, the below items have been changed in Incoterms® 2020 rules compared to the previous Incoterms® 2010 version..
- Bills of lading with an on-board notation and the FCA Incoterms® rule
- Costs, where they are listed
- Different levels of insurance cover in CIF and CIP
- Arranging for carriage with seller’s or buyer’s own means of transport in FCA, DAP, DPU, and DDP
- Change in the three-letter initials for DAT to DPU
- Inclusion of security-related requirements within carriage obligations and costs
If the year and version of the Incoterms® are left out, it could be open to interpretation and a judge, or an arbitrator will not be able to determine which version of the rules applies to the contract..
This will cause further costs and delays in the completion of the transaction..
4) Be geographically specific on origin and destination
It is very very important to be geographically specific when agreeing on the place of origin or destination..
For example, in a DAP transaction, if the delivery location is said to be DAP Mumbai, it leaves a lot for interpretation as Mumbai is a huge city..
The buyer based in Mumbai may be expecting the goods to be delivered to a place outside the central business district whereas the seller may have interpreted it differently and this could result in additional trucking costs and risks as it varies by areas..
In a FOB sale, not specifying the port or terminal of loading could leave it open to interpretation and if the cargo is already delivered to the wrong port/terminal it will result in massive cost implications and delays..
It is therefore best to be as geographically specific as possible in naming the port, place, or point, as the case may be, in the chosen Incoterms® rules..
5) Understand what Incoterms® rules DO and DOES NOT do
It is particularly important for the users to understand what the Incoterms® rules DO and DOES NOT do..
What the Incoterms® rules DO
Incoterms® rules describe:
- Obligations between seller and buyer such as who organises carriage or insurance of the goods or who obtains shipping documents and export or import licences;
- Where and when risk transfers from seller to buyer; and
- Which party is responsible for what costs between the buyer and seller such as carriage costs, packaging, loading/unloading or security and others.. In terms of costs, as per the Incoterms® rules, A articles represents the seller’s obligations and B articles represents the buyer’s obligations..
What the Incoterms® rules DO NOT do
It is important that the users understand that the Incoterms® rules
- Is NOT the Contract of Sale and does not apply to any specific cargoes or mode of transport.. It is included in the sales contract relating to the trade transaction irrespective of what the declared cargo is..
- Does not specify or deal with the time, place, method, or currency of payment relating to the sale price.. This forms part of the contract of sale..
- Does not deal with any legal, political, regulatory, sanctions, prohibitions, tariffs, or intellectual property matters..
- Does not dictate or deal with the transfer of ownership or title of the goods nor is it a remedy for any contract or performance breaches..
- Does not consider any aspect of force majeure, issues relating to delays, or other hardships
- Does not deal with any method, place, or laws for the resolution of any disputes that may arise
- Does not provide the applicable law, which might be covered by international agreements like the CISG, or domestic laws related to health, safety, or the environment
Users must be very clear on these aspects as incorrect assumptions or interpretations of the rules will result in additional costs and delays..
6) Choose the rules that suit the requirements of the business
The seller and buyer must understand the nature of the business in each other’s countries and agree on the rules and regulations prevailing in their respective countries and what can and cannot be done..
Choosing Incoterms® rules without understanding the rules and regulations in the origin and destination countries could result in unnecessary costs and delays..
For example, DDP rules place maximum responsibility on the seller.. Under these terms, the seller is responsible for paying import duty and all applicable taxes till delivery..
Therefore, the seller must be sure that they understand the requirements and be confident that they can undertake all these responsibilities..
Failure to do so could jeopardize the transaction adding to additional costs, risks, delays, and potential loss of future business..
On the other extreme, EXW places maximum responsibility on the buyer, and under these terms, the buyer is responsible from the time of loading of the goods at the seller’s premises including completing export clearance procedures which the buyer may not be au fait with..
Therefore, the buyer must be sure that they understand the requirements and are confident that they can undertake all these responsibilities..
Conclusion
Incoterms® rules were created to address the risk of misunderstanding and costly disputes in domestic and global trade where sale contracts may not have been adequately drafted..
As the volume and complexity of global trade increases, so does the possibility of incorrect usage of Incoterms® rules..
As per the International Chamber of Commerce, the latest version of the Incoterms®, which is the Incoterms® 2020 rules, seeks to “offer a simpler and clearer presentation of all the rules, featuring revised language, an expanded introduction, explanatory notes, and articles reordered to better reflect the logic of a sale transaction“..
I hope these tips will help avoid costly consequences due to the usage of incorrect Incoterms®..