Vital tips to avoid risk when using Incoterms® 2010 in commodity sales contracts

Incoterms® 2010 are a set of standardised rules for the interpretation of international and domestic trade terms. Frequently used in commodity sales contracts to regulate aspects of the relationship between buyers and sellers, Incoterms were first introduced in 1936 by the International Chamber of Commerce (ICC).  The terms were designed to reduce disputes by addressing a lack of clarity and understanding in the interpretation of trade terms amongst international trading partners. Over time the rules have evolved to adapt to the changing nature of international and domestic trade, including in relation to security, multi-modal transportation and electronic communications.

While Incoterms® 2010 have been enormously helpful and resulted in greater understanding and standardisation in domestic and international trade, there is a risk that users will develop a false sense of security. Care must be taken when selecting and using Incoterms® 2010 because they are not a substitute for giving proper consideration to the appropriate terms of a commodity sales contract.

Incoterms® 2010 overview

There are 11 trade terms specified in Incoterms® 2010, divided into two categories: rules for any mode of transport (including where there is no waterway transport at all) and rules for sea and inland waterway transport. The rules allocate certain costs and risks between the buyer and the seller and delineate responsibilities for practical matters such as customs formalities and duties, loading and unloading and insurance.

There are three commonly used Incoterms® 2010 in the sale and purchase of commodities.

Delivered at Place (DAP)

• The seller bears all risks involved in bringing the goods to the named place of destination.
• Delivery occurs when the seller places the goods at the disposal of the buyer on the arriving means of transport, ready for unloading at the destination.
• The seller must clear the goods for export, where applicable.

Free on Board (FOB)

• Delivery occurs when the seller places the goods on board the vessel nominated by the buyer at the named port of shipment or, procures the goods to be so delivered.
• The risk of loss or damage to the goods passes when the goods are on board the vessel, and the buyer bears all costs from that moment onwards.
• The seller clears the goods for export. However, the seller is not obliged to clear the goods for import.
• In Incoterms® 2010, the phrase ‘hip’s rail’is no longer used in FOB, CFR (Cost and Freight) or CIF as a reference point, at which cost and risk shifts from the seller to the buyer.

Cost, Insurance and Freight (CIF)

• Delivery occurs when the seller places the goods on board the vessel or procures the goods to be so delivered.
• The risk of loss or damage to the goods passes when the goods are on board the vessel. The seller must contract, and pay the costs necessary, to bring the goods to the named port of destination.
• The seller also contracts for freight and insurance.
• The seller clears the goods for export. However, the seller has no obligation to clear the goods for import.

How to reduce risk

No substitute for a sales contract

Although Incoterms® 2010 deal with a number of key matters relating to the sale and purchase of commodities, they are not a substitute for a sales contract because they do not provide a comprehensive set of sale and purchase terms.

Incoterms® 2010 do not deal with important matters including price, payment, specifications, force majeure, breach, termination, dispute resolution and governing law. Even where Incoterms® 2010 deal with a particular matter, the sales contract may need to expand on the relevant obligations to properly capture the parties’ intentions. For example, under CIF, the seller is required to obtain insurance only on minimum cover. If the buyer wants more comprehensive insurance, it must ensure that the seller is contractually obliged to do so.

Choose the right rules

When considering the use of Incoterms® 2010 in a commodity sales contract, it is important to carefully consider which rules are the most appropriate in terms of the cost and risk allocation agreed between the parties, the method of transport and the loading arrangements. For example, if a container of goods is dispatched from the seller’s warehouse under an FOB arrangement, even though the container is under the control of the carrier when it leaves the warehouse, the risk in the goods remains with the seller until the container is on board the nominated vessel.

If the seller intends for risk to pass when the container of goods leaves the warehouse under the control of the carrier, the most appropriate ‘F’ term to use is Free Carrier (FCA), as recommended by the ICC.

Be consistent with sales and carriage contracts

The use of Incoterms® 2010 in a commodity sales contract should be consistent, and interact properly, with the remainder of the sales contract with respect to cost and risk allocation, insurance obligations, liability for duties and loading and unloading arrangements. In addition, the choice of rules should be consistent with any relevant transportation or carriage contracts and harbour regulations.

Get the detail right

If the parties intend for a set of Incoterms® 2010 rules to apply to their commodity sales contract, the rules must be clearly specified in the sales contract by properly referencing the chosen rules, naming the relevant place or port and referring to ‘Incoterms® 2010’.

Incoterms® 2010 can only work if the parties name a place or port, and will work best when the place or port is described as precisely as possible. There is a heightened risk of a dispute when the seller or the buyer is located some distance from a port or has the choice of several possible ports with different handling and shipping charges. To help avoid risk, include a particular point in that place or port if possible.

This article first appeared in the December edition of National Resources Review magazine

Авторы: Jay Leary, Louise Bell