12 things you should know about Incoterms

international trade

By Cate Hull

The global marketplace, once envisioned as a futuristic dream, has now become reality.

Products manufactured on one continent are shipped across oceans and through the skies to customers on the other side of the globe in a hive-like fury of activity.

Which is why the visionaries at the International Chamber of Commerce (ICC) in 1936 developed the first set of International Commercial Terms or Incoterms, to promote a common understanding between parties of their respective operational obligations with a series of procurement rules to give clarity to respective risks and obligations in the procurement chain.

The original drafters of Incoterms envisioned these terms incorporated into supply contracts.

Over the years, the Incoterms have been updated, most recently at ten-year intervals. The 2020 version of Incoterms are currently under development.

With the updated version just around the corner, now would be a good time to review the 12 things you should know about Incoterms:

1. What are Incoterms?

Incoterms are a set of international rules established by the International Chamber of Commerce, which relate to the terms of international commercial supply contracts.

They are an essential consideration for importers and exporters as they determine who is responsible for:

● Covering the cost of each part of the international journey;
● The shipment at each part of the international journey;
● Arranging transportation;
● Ensuring the goods are insured;
● What documentation is required and responsible parties.

2. There are currently 11 different Incoterms

The Incoterms are divided into four groups, depending on the delivery location and the party responsible for covering each leg of the journey. Each category is then further broken down into different types of Incoterms to address different scenarios.

3. The first group, Group E, is the basic term

Incoterms Group E – The purchaser of the goods assumes full responsibility for collecting goods at seller’s warehouse and for all subsequent associated risks and costs.

4. The second group, Group F, addresses seller responsibilities

The seller is responsible for delivering goods to the buyer’s pre-agreed method of transportation. From this point onwards, the buyer is responsible for all costs and risks. Categories are FCA (Free Carrier, any means of transport); FAS (Free Alongside Ship, exclusive to shipping) and probably the best-known FOB (Free on Board, exclusive to shipping).

5. The third group, Group C, addresses responsibility to the destination port

The seller bears responsibility for all costs to the destination port (including international transport), however, when goods are loaded on the means of transport from that point on, risk transfers to the buyer.

Categories are CPT (Carriage Paid To, any means of transport); CIP (Carriage & Insurance Paid to, any means of transport); CFR (Cost & Freight, exclusive to shipping and also often called C&F and probably the most common), CIF (Cost, Insurance and Freight, exclusive to shipping).

6. The fourth group, Group D, addresses seller risks

The seller bears all risks and costs incurred to bring the goods to the destination country, to a point mutually agreed and indicated on the contract of sale (or invoice).
Categories are DAT Incoterm (Delivered At Terminal); DAP Incoterm (Delivered At Place); DDP Incoterm (Delivered Duty Paid).

7. Expected changes in the 2020 version

John Good Shipping believes the FAS and EXW terms will be retired in the 2020 version. The reasoning is that EXW tends to apply more to domestic trade, and could be considered to go against the EU’s new customs code. FAS is rarely used and no longer deemed a necessary option. This is by no means certain however, in many countries suppliers still insist on selling ex works and, with the growth of barge traffic as road haulage struggles to maintain its green credentials, FAS may well be back in fashion.

DDP is also being retired in its current form, for the same reasoning as EXW. However, drafters are considering splitting it into two different categories as follows:

● DTP – Delivered at Terminal Paid: The Seller is responsible for all transport-related costs, including customs duties, when goods are delivered to a terminal at the destination (e.g. to the port, airport or transport centre).
● DPP – Delivered at Place Paid: The Seller is responsible for all transport-related costs, including customs duties when goods are delivered to somewhere other than a transport terminal (e.g. to an address given by the buyer).

FCA Split – FCA is one of the most commonly used Incoterms and there is consideration is that it will be split into two different variations – one for land transportation and one for sea.

8. New Incoterms anticipated

Cost and Insurance (CNI): A brand new Incoterm that’s likely to come into play in 2020. CNI terms dictate that, from the departure port, the exporter has responsibility for cargo insurance, while the buyer is responsible for the risk of transportation. Some say this has potential problems as the insurer has no say in the quality and mode of carriage.

9. More clarity expected

Drafters indicate the 2020 Incoterms will be more straightforward and easier to understand, which should help to minimise the risk of misinterpretation. Australian Bob Ronai, a member of the Incoterms 2020 Drafting Group, is one of the proponents of more clear language.

“From a practical side of things, I kept hammering that we had to write the Incoterms rules in plain English – not legal English – with a sentence structure in such a way that somebody who is not a native English speaker could easily understand them,” he said.

10. How do Incoterms work with other forms of international law?

“The Incoterms rules have adapted to different needs and I think they are useful into unifying the terms in which the parties interact with each other and in the way that the contract in general or a specific kind of transaction will tend to have the same patterns and the same terms,” said Daniela Maria Rojas Garcia, a specialist in transport law who studied at Leiden University in the Netherlands. “It is very useful that all parties engaged in international trade law kind of speak the same language, even if it’s not completely unified or binding to apply specific terms, so that’s very useful for facilitating trade,” she added.

11. Are there any dangers or pitfalls to avoid with Incoterms?

“Whilst Incoterms have been widely adopted in many domestic and international supply arrangements around the world, including in Australia, they are often incorporated by reference into ‘off the shelf’ or ‘precedent’ supply contracts with insufficient thought and consideration given to the specific Incoterm selected and what aspects of their supply contracts need to change to properly incorporate the relevant Incoterm,” according to Geoffrey Wood with Baker McKenzie, a global law firm with a strong transportation practice. “This failure results in supply contracts that contain inherent inconsistencies with the Incoterms selected. These inconsistencies create uncertainty and may give rise to potential disputes,” he added.

12. What is the best way to incorporate Incoterms into a supply contract?

If incorporated correctly, Incoterms can play a very useful role in supply contracts by maximising efficiencies both in the drafting process and ‘on the ground’ since they are universally understood and eliminate the need for extensive obligations. Too regularly though, the procurement of critical equipment on projects is done ‘on the run’ using supply contracts that are not consistent with the Incoterms specified in them, according to Franco Aversa with Baker McKenzie.

“All of these issues can be dealt with in quite a straightforward manner if proper consideration is given ‘up front’ to the terms of a supply contract and its consistency with Incoterms,” he said.

Incoterms 2020 are expected to launch in September. Look for more information from the ICC.

Cate Hull is the CEO of FreightExchange, a freight and logistics company based in Sydney.