Trade between countries has increased manifold with the advent of globalization. This boost in global trade has also increased the complexity in dealing with international laws and customs. Harmonization of these vast arrays of legal terms and complexities led to the incorporation of “Incoterms” (International commercial terms) into modern contracts. Incoterms are trade terms used in a contract for sale. They specify in exact terms the cost and risk borne by the seller and the buyer, and more importantly draw the line where the risks and costs are passed in the transaction.
Once incoterms have been correctly incorporated into a sales contract, parties to that contract can clearly ascertain their respective obligations despite their different languages and professional backgrounds. Nevertheless, in the recent past, we have also seen that as a consequence of trying to standardize mercantile processes all over the world, the use of incoterms has been mainly as a tool for guidance, with parties incorporating their own variations to the terms.
There have also been legal issues concerning the incorrect usage of incoterms, sending a clear signal that knowledge and understanding of these important terms is not yet universal. With the latest revision (Incoterms 2010), there are now 11 terms namely EXW, FCA ,FAS, FOB, CIF, CFR, CIP, CPT, DAT, DAP and DDP, with EXW(ex-works) representing the minimum obligation of the seller to DDP(Delivery duty paid) representing the maximum obligation of the seller. 2. Uses and Benefits a. Contract of Sale.
Incoterms may be incorporated into a contract of sale, to clearly define the passing of risk and costs between the two parties. It’s important to understand that incoterms only cover the contract of sale between the seller and the buyer – setting out responsibilities and obligations of both parties over the delivery of the goods. Incoterms do not apply to the contract of carriage – a common assumption which can cause confusion. These terms also define the mode of transport to be used. For e. g. the FOB term is to be exclusively applied to ocean/sea transport. b. Reduce Costs.
Incoterms also help to reduce litigation and erroneous costs. In most cases while using the term EXW, the seller would assist the buyer in loading the goods onto the transport vehicle at the named place; however he is under no obligation to do so, and would not be held liable for any damages in loading the goods as the risk passes when he makes the goods ready at the named place. These terms also follow a general logic that in cross-border transactions, the seller would be better poised to deal with the exporting countries custom regulations and the same for the buyer.
Thus, with the exception of EXW and DDP, all incoterms require each party to deal with their own authorities. With regards to customs, the words “where applicable” are added to clauses A2, B2, A6 and B6 in order for these terms to be used without any ambiguity where customs procedures are not required in place such as the European Union or where cross-border customs are more relaxed(USA-Canada). (Jan Ramberg, 2000) c. Periodic updates The ICC is making an increasing effort to make sure these terms keep up with the pace of modern technology, by revising the terms and their scope every 10 years.
The current terms have been reduced from 13 to 11 removing redundant terms. Due to free trade areas and customs unions as well as increased acceptance of Incoterms in the USA, incoterms not only regulate international transport of goods but have also been expanded by guidelines to include “domestic transports”. The term “ship’s rail” as “place of delivery” was deleted and instead the goods are considered to be delivered, when they are loaded “on board the vessel”. This important change resolves long standing litigation regarding the passing of FOB risk between the seller and buyer.
In addition, parties can decide to incorporate a previous version of the incoterms by simply stating it in the contract e. g. FOB (Mauritius) INCOTERMS 2000. This gives them flexibility to use a set of terms they are more comfortable with. d. Indirect relation to other trade documents Incoterms affect the various documents used in the contract, if you decide to use FOB; you have to use ocean/sea transport, and with it documents such a bill of lading, which would in turn be required for a letter of credit.
If you decide to use CIF, the seller has to arrange for the insurance and in the case the buyer defaults, the bank needs to make sure this insurance is transferable in the advent of them having to sell the goods. This relationship with the other documents stresses the importance of choosing the right incoterms in the contract. 3. Limited scope of incoterms Despite the best efforts of the ICC, we find incoterms failing to provide guidance leading to incorrect usage and uncertainty in modifying the terms. a. Incorrect usage of incoterms.
This is most prevalent when the seller ships FOB for container trade. Take the example of a seller who contracts to sell FOB (Dublin), with payment by letter of credit. He requires the bill of lading to receive payment, but only receives a receipt of delivery from the carrier when he hands over custody of the container at the port. The two outcomes are that the seller cannot get paid because he does not have the necessary documents and there is a mismatch of risk, as the seller is liable till the goods are on board, but he has now lost control once the goods were unloaded from his truck.
The solution to this would be to use FCA, when the seller has to hand over goods to a carrier before they are loaded. b. Confusing incoterms with ownership rights Incoterms can provide a false sense of security that all the important issues in an international sale have been dealt with. In the case of “St. Paul Guardian Insurance Company. vs. Neurod Medical Systems”(2002), a US company bought medical equipment from a German manufacturer. The parties agreed on an ocean shipment, but the medical equipment was damaged during the ocean voyage.
The insurance company paid the US purchaser $285,000 because of the damages, and sued the German producer to recover that amount. The German company said it did not owe the money because this was a CIF shipment, which placed the risk of loss on the buyer. The insurance company argued, incorrectly, that the German supplier had to pay because the German company still owned the medical equipment when it was damaged. However, this was a case of confusing risk of loss with title. Incoterms only deal with risk of loss, not title.
You can own a shipment and, depending on the incoterms you choose, the risk of loss could be on the other party, as was the case here. The court concluded that the insurance company did not have a case and dismissed the lawsuit. Variance in the terms It is common to see minor changes to the incoterms such as FOBS (stowed) or EXW loaded, where an additional responsibility is added to the contract of sale. The ambiguity in this case is that the ICC provides no guidance regarding these variances and leaves it up to the parties involved to decide. This can be seen in the following cases. . Minex Shipping v International Trading Company of Virginia and SS Eirini In the American case, Minex Shipping v International Trading Company of Virginia and SS Eirini the sales contract provided that bags of cement would be shipped “FOB stowed Polish port”. The cement became contaminated during the voyage as a result of soy beans falling on the cement bags. While the buyer maintained that the contract term required the seller to sweep, clean and dry the holds of the vessel, the court held that the “stowed” term did not impose these duties upon the seller.
The seller was merely obligated to place the cement in the holds “in an orderly, compact manner” and “in such a manner as to protect the goods from friction, bruising, or damage from leakage”. The court held that when the goods were so placed, the title passed to the buyer with the resulting risks of ownership, and once the cargo was properly stowed, the risk of damage passed to the buyer. This case points out the ambiguity in changing the FOB term and also marks the change in risk from just loading to loading and stowing the goods. . Jasminal A Chinese seller and a Californian buyer contracted for the sale of 10,000 kg of jasmine aldehyde (jasminal), CIF New York. The seller was warned of the sensitivity of the cargo to high temperatures and had been asked to make sure that it would be stored in a cool place and on a direct line. The seller confirmed that the temperature at the port was suitable, but when the cargo reached New York, after passing by the port of Hong Kong, a large part of it had melted and leaked because of excessive heat during the voyage.
The cargo was shipped to the final user, who rejected it. The seller was obliged to pay US $ 60,000 as damages but refused to pay the cash. The buyer claimed payment of US $60,000 plus interest and damages, upon an Arbitration Commission. The Arbitrators decided that the seller was responsible for the damage according to article 66 CISG. Even though, according to the CIF clause, the risk passes when the goods pass the ship’s rail, in the present case there had been a separate special contractual agreement regarding the temperature during transport.
The seller had not complied with his obligations under the special contractual agreement, since he had not given sufficient and correct directions to the carrier and instead of arranging for a direct route, he had, on the contrary, sent the cargo via Hong Kong, which resulted in its deterioration. Therefore, as provided in article 66 CISG, the damage was caused by “an act or omission of the seller” and as a result the risk had not passed to the buyer. The effect of these variants creates confusion such as the case FOB with an ‘I’ for insurance added.
This would denote that the seller must arrange for insurance. But what constitutes insurance, do the same rules as CIF apply in this case? These terms must be clearly spelt out by the parties involved before the transaction commences. To summarize the issues related to incoterms, the ICC provides for freedom of contract and changes to the incoterms for global acceptance and usage, but however, does not provide guidelines for standardization of common variants. 4. Recommendations While there are obvious benefits to using incoterms, we have seen the potential drawbacks as well.
Their existence in the current economic scenario is vital to provide parties with a clear understanding of the costs and risks associated in the transaction. However, there are avenues to improve and the recommendations for the use of incoterms would include not using the terms incorrectly as demonstrated in the cases before and to also discuss the role of the ICC in resolving the ambiguity regarding variable terms and the difference between the actual commercial practices compared to the incoterm.
Should incoterms be modified for common variants? Some analysts argue that in the case of “CIF landed”, the word “landed” usually refers to the costs of discharge, and “CIF Outturn weights merely signifies that the buyer should pay according to the weight ascertained after discharge so that condensation of the goods during their transport should be taken into regard when fixing the price. However, this does not mean that the seller bears the risk of loss of or damage to the goods during the carriage.
The very opposite of this was seen in the case of Minex Shipping v International Trading Company of Virginia and SS Eirini. Thus there is no universal understanding on whether variations intend to extend the seller’s obligations merely with respect to the financial costs such as the costs of stowing and trimming, or whether they also include the risk of loss or damage to the goods in the process of having the goods stowed and trimmed. Although there is a need for standardized variants, the ICC might not include them in the incoterms until it becomes a universally constant practice.
Dealing with obligations rather than practical commercial practice Incoterms only decide the obligation with respect to the other party, and don’t comment on commercial practice. An example could be when the buyer contracts to FOB terms, he has no obligation to arrange for insurance. However, he will still go ahead and take out insurance to protect himself against any damage to the goods. These changes could be incorporated into the incoterms as guidance to the parties, and could work towards creating guiding principles for trade in general as the terms incorporation increases.
Despite the drawbacks, incoterms ambitiously strive to offer a set of international rules for the understanding of the most important terms used in international trade. Although they only deal with certain aspects of the contractual relationship, they regulate them in a clear and certain manner in accordance with global trends. With their periodic updates and effort to stay relevant, I believe incoterms form an integral part of global trade and will continue to be of increasing importance in the future.
