21 August 2012

Using Incoterms 2010® in your contracts – choosing the right term

Incoterms 2010® were introduced by the International Chamber of Commerce (“ICC”) in September last year, reducing the number of terms from thirteen to eleven and updating Incoterms® 2000. The terms exist to clarify the obligations and risks of each party. Although Incoterms are an established internationally recognised standard set of terms, businesses still often confuse which term to use under which circumstances.

Using the terms correctly will assist with providing certainty into your sales contracts as each party should be aware of their obligations and where risk passes. The Incoterm chosen should ideally reflect how comfortable your business is with committing to the risks and obligations under the Incoterm, taking into account the level of service you wish to provide to the customer and where they are based. For example, would you commit to delivering goods 200 miles inland from Lagos, Nigeria? If not (and most businesses probably would not!), then why not end your risks and obligations at the port in Lagos by choosing a term which does not require you to deliver to the customer’s premises? Another aspect to consider when choosing a term is the effect on the documentary requirements of the transaction, especially where a letter of credit is used.

The standard position

Many standard terms of trading referring to delivery, state that any goods shall be delivered to the customer on an ex-works basis (“EXW”). EXW merely requires the seller to place the goods at the disposal of the buyer, the buyer is then required to arrange loading and onward delivery. However, we are aware that many businesses still continue to load goods onto the vehicle, provide onward delivery and in some circumstances, provide insurance for their customers, despite the contract of sale referring to goods being provided on an EXW basis. In addition, businesses selling goods to an overseas customer on an EXW basis have no proof of export, which is required for VAT purposes (as EXW requires the buyer to clear the goods for export).

So what other implications does using the wrong Incoterm have?

Complications when using the incorrect Incoterm

As stated, these terms exist to clarify the obligations and risks of each party. Although the terms are not a legal instrument, they are often scrutinised by judges in the event of a dispute between two parties. Problems can arise where a business has quoted an Incoterm and has not fully understood its obligations under it.

A common mistake made is using a term which applies to sea carriage only when delivering goods via air transport. Often, “FOB” (free on board) is quoted incorrectly. FOB requires the seller to deliver the goods on board the vessel nominated by the buyer at the named port of shipment. However, some businesses have used FOB to send goods via airfreight, which under the former Incoterms® 2000 caused problems with identifying the “ships rail” (i.e. the former point at which risk in the goods passed to the buyer).

Another common mistake made is the use of “CIF” (cost, insurance and freight). CIF is a sea freight term and should not be used when the seller has acquired a contract of carriage consisting of two methods of transport (e.g. if the seller is delivering to a carrier at a container base, before the goods are transferred to a ship). In these circumstances, “CIP” (carriage and insurance paid to) should be used as delivery takes place once the goods have been delivered to the named place (usually when they have been delivered to the first carrier).

The incorrect use of a term is likely to cause immense problems if using a letter of credit with your customer. An estimated 80% of letters of credit are rejected on the first presentation and over 50% on second presentation. The reasons for this vary, but a high proportion relate to use of the incorrect Incoterm. Such mistakes often increase the costs associated with the delivery of goods to the customer.

What Incoterms 2010® do not do

Incoterms do not require the ICC to impose sanctions against businesses who do not comply with their obligations. It is for the courts within the agreed jurisdiction to decide whether such obligations have not been complied with. Also, Incoterms do not provide for many other aspects of a contract of sale. For example, any provisions relating to inspection of goods, the point at which ownership passes to the buyer, payment terms, governing law, lien over goods/retention of title and many other aspects of the contract which do not directly relate to the delivery of the goods.

In addition, not all of the terms provide for insurance – only two terms, CIF and CIP, require the seller to arrange insurance. If these terms are not used, always remember to consider whether insurance is necessary. Organisations that use freight forwarders would be wise to check the forwarder’s terms and conditions in relation to the level of insurance cover in the event that goods are damaged. Carrier’s liability insurance is usually very low (approximately £7 per kilo) therefore ensure that goods which are high value (especially lightweight goods) are adequately insured.

Contracts referring to Incoterms® 2000

Any contracts of sale and purchase which include references to Incoterms® 2000 will still be valid, however, as many companies will now be introducing the revised rules, it is advisable to amend your standard documents and use the new rules when entering into new arrangements from this point forwards.

Checklist – using Incoterms® 2010

1. Incorporation – make sure you have expressly stated within your contract that Incoterms 2010 applies, e.g. “FCA Delivery Point A, XYZ Ltd Warehouse, Worcester, United Kingdom (the named place), Incoterms 2010”

2. Choose the right rule for the right customer – read through the description provided within the Incoterms® 2010 booklet. The booklet sets out the exact obligations of each party, where risk passes and clarifies when delivery is deemed to have taken place. A copy of Incoterms® 2010 can be purchased from your local Chamber of Commerce or online from the International Chamber of Commerce bookshop. This is definitely a worthwhile investment!

3. Check what the term does not cover – have you agreed payment terms, responsibility for arranging insurance cover, stating where ownership passes to the buyer in a contract of sale? Remember, Incoterms® 2010 do not cover these issues.

4. If unsure, always ask – never commit to risks and obligations which you cannot realistically comply with or do not fully understand. Always check with us, your bank or the Chamber of Commerce if uncertain about what agreeing to a particular term entails.

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About the Author
Robert Capper, Partner, Head of Commercial Team and Sectors
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