Why Incoterms are so important.
Client Executive, AIB
The Incoterms rules or International Commercial Terms are a series of pre-defined commercial terms published by the International Chamber of Commerce (ICC).They are widely used in International commercial transactions.
The rationale for using Incoterms is to alleviate or reduce confusion over interpretation of shipping terms, by outlining exactly who is obligated to take control of and/or insure goods at a particular point in the shipping process. Further, the terms will outline the obligations for the clearance of the goods for export or import, and requirements on the packing of items.
The Incoterms rules are intended primarily to clearly communicate the tasks, costs, and risks associated with the transportation and delivery of goods. These rules are accepted by governments, regulatory authorities, and practitioners worldwide. As such, they are regularly incorporated into sales contracts worldwide, and a specific version of the Incoterms should be referenced in the text of every contract.
The most common Incoterms are: F.O.B. (Free onboard), C.I.F (Cost, Insurance and Freight), DDP (Delivered Duty Paid) and FCA (Free Carrier).
Each Incoterm is an acronym of the condition it indicates. For example, if your agreement with a buyer calls for the release of goods by the seller to occur at the seller's location, the Ex Works (EXW) Incoterm would be used. This term states, among other things, that the buyer is to take over carriage and insurance responsibilities at the seller’s dock. Alternatively, if the seller were to deliver goods to the buyers dock, including all carriage and insurance, the term DDP would be appropriate. DDP stands for Delivered Duty Paid and includes in its definition that the seller will deliver goods to the buyers dock with all carriage, insurance, and duties paid. DDP represents the most obligations for the seller, whereas EXW represents the least.
Here is a good example, a series of explosions occurred at a container storage yard at the Port of Tianjin in China on August 12, 2015. A client, who had a container at the port, advised his broker that his cargo underwriters could end up having to pay a total loss of goods in the container valued at around $150,000. When asked under which Incoterm the goods were purchased, the assured confirmed that the goods were purchased according to F.O.B. terms. Since the explosions occurred before the container was loaded on the ship, it was the client’s supplier (the seller) that was liable for this loss, not the client.
Caution must be exercised when using Incoterms because the Incoterms relate to particular modes of transportation. For example, some of the Incoterms deal solely with transport by sea. Terms such as FOB and CIF can be used only for ocean bound freight. FOB, meaning Free on Board, translates to the shipper (seller) having upheld his/her part of the agreement when the goods are loaded on the ship.
Transportation by rail, aircraft or other mode cannot use the term FOB. For a shipment scheduled for delivery by air, rail, or some other form of transport with the same agreement as for FOB, one would need to use the Incoterm FCA, or Free Carrier. Whereas transfer under FOB takes place when the cargo is loaded on the ship, transfer with FCA occurs when delivery of goods has been made at a destination previously outlined by the buying party.
For a company in the import/export business, or retail or that transits shipments internationally, it is important to understand Incoterms thoroughly and their specific implications. Furthermore, your broker can help you decide what terms would work best for you when taking the insurance component into account.