DECIPHERING INCOTERMS

The economy and trade of the 21^st century truly consists of one global market. While Buyers and Sellers very often find themselves on different continents in different parts of the globe, they can rest assured that they have a uniform and standardized set of trading International Commercial Terms (“Incoterms”) to help them navigate through international transactions and also elucidate each Buyer and Seller’s role in the supply chain.

What are Incoterms?

In the early 1900’s, international traders located in different countries devised short abbreviations for certain commonly used trading terms. However, due to differences in culture, connotations, dictions, grammar, experience, translations and linguistics, these trading terms had different meanings for different global participants. Confusion and errors became a regular staple and a consistent risk of international trading. Therefore, in order to foster consistency and eliminate confusion, the International Chamber of Commerce in 1936 developed one standard and uniform set of Incoterms for global traders to adopt. Since then, these Incoterms have played a key role in global commerce. Specifically, Incoterms address certain key responsibilities and obligations and establish significant “markers” along the chain of the micrologistics components.

Incoterms are used to define the relationship between Buyer and Seller regarding:

The mode of delivery,
Who has to arrange for customs clearances and licenses,
Passage of title,
Transfer of risk and insurance responsibilities (i.e., who has to obtain insurance of the merchandise during transport),
What the delivery terms are,
How transport costs will be allocated between the parties and,
When is a delivery completed?

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Contract vs. Incoterms

To be clear, the Incoterms do not constitute a contract between two parties. Instead, you have two entities that very often have a separate contract for the purchase-sale transaction and part of the obligations and understandings of those parties based upon that separate contract are embodied in the Incoterms. In a situation where the two parties have no contractual agreement between them, they can still mutually agree on Incoterms, however, those Incoterms do not and will not constitute a legally binding contract. Additionally, specific use of Incoterms must be affirmatively included between the parties as they will not be implied in any transaction. In the event of a dispute between the parties, traditional courts would consider (and in order of precedence): 1) the Sales Contract if any, 2) Course of Performance, 3) Course of Dealing, and 4) Industry standards. Additional factors that would be considered are which entity has possession, whether payment has been made, and what the Incoterms are. As you can see, the Incoterms are not the contract and are not a legal definition and will not, on their own, adequately define the intent of the parties.

Incoterms will not:

Define contractual rights,

Define liabilities and/or obligations between the parties,

Specify transport details such as transfer and/or delivery of the merchandise,

Dictate how the title of the merchandise will pass (even though Incoterms can dictate WHEN they transfer),

Dictate obligations with regards to the merchandise prior to and after delivery,

Protect a party from his/her own risk of loss.

Understanding Incoterms

Rather than attempting to explain each individual Incoterm (which has already been done by the previous White Paper), the following will hopefully provide a broader understanding of how they are grouped, and what the essential characteristics are for each grouping so that the reader can develop more independent knowledge base.

Group 1: The “E” group is short for Ex-Works + (named location). The main characteristic of this group is that the Seller and/or Exporter represent to make the merchandise available at his/her own premises to the Buyer/Importer. Once the Buyer/Importer picks up the goods, then the Seller/Exporter’s duties and obligations are completed and fulfilled. Obviously, this is a situation where the Seller/Exporter has very few obligations, has an extremely low risk of loss and title is transferred almost immediately in the supply chain. Almost from the beginning, Buyer bears the risk of loss, title/possession has been transferred, and has to insure or bear the risks of transport.

Group 2: The “F” group includes terms such as FAS (Free Along Side), FOB (Free on Board) and FCA [(Free Carrier + named location)]. The essential characteristics of this group are that Buyer and Seller have agreed that the Seller/Exporter is responsible to deliver the merchandise to a carrier/location designated by the Buyer. Again, once Seller/Exporter has effectuated delivery to the specific carrier/location then Seller/Exporter’s obligations cease and the Buyer’s/Importer’s begins.

Group 3: The “C” group includes terms such as CIF (Cost, Insurance and Freight), CFR (Cost and Freight), CPT (Carriage Paid To…) and CIP (Carriage and Insurance Paid To…). The essential characteristics of this grouping are that the Seller/Exporter is obligated for contracting and paying for the transportation of goods but has no obligation to bear additional costs nor has to bear any risk of loss once the goods have been shipped. This grouping “evidences” shipment.

Group 4: The “D” group includes terms such as DAF (Delivered at Frontier + named location), DES (Delivered Ex Ship), DEQ (Delivered Ex Quay), DDU Delivered Duty Unpaid), DDP (Delivered Duty Paid). This grouping is the exact opposite of the “E” group. In other words, the Seller/Exporter has all the obligations of costs, risks (insurance) duties etc… and must make the merchandise available at the named place of destination (usually named by the Buyer and will also usually be the Buyer’s factory).

As you can see, the general theme in the groupings is that there exists a progression of obligations, risks, costs, liabilities and duties between Buyer and Seller. As the groupings progress, Buyer starts off with all risks costs and title while Seller has none. Towards the end of the groupings, the Seller has all risks and costs while Buyer has virtually none. Basically, the Incoterms designate and dictate which party has what obligations and when and where those obligations begin and cease.

Dangers of Improper Use of Incoterms

If used properly, Incoterms can be a vital resource and clearly define who has what risks, costs, burdens and obligations. This will enable each party to know exactly what prices to accurately quote and will avoid “hidden” and unexpected costs. As we all know, these hidden and unknown charges are often the heart of many disputes. Therefore, it is crucial that each party fully understand the implications of the Incoterms and what their respective roles and costs will be before agreeing to them. Improper use or lack of understanding of Incoterms can lead to ambiguity, disputes and significant financial losses due to the fact certain mis-uses of Incoterms may void certain insurance policies.

Continuation

Please consider this white paper as a continuum in this subject area, succeeding white papers will address common issues and address them with common solutions. We encourage our readers to direct any specific questions or comments to papers@transportgistics.com .

Disclaimer

The information presented above represents the opinion of the author and not necessarily the opinion of TransportGistics, Inc. nor is it presented as a legal position.

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