Incoterms and their usage - Prof Archie D'Souza

INCOTERMS & their usage

Prof Archie D'Souza

Although Incoterms 2010 will be redundant by the end of the year. It is still current till Incoterms 2020 comes into force. Updates will be available one the same is published.

Introduction

One of the most common set of terms used in international trade is INCOTERMS; this is short for International Commercial Terms, published by the International Chamber of Commerce and it’s possibly its most read publication. It is also perhaps the best understood and most often represented.

The purpose of this session is to understand what INCOTERMS are and deal with some myths and misconceptions regarding the same. In this afternoon session we will get into INCOTERM straight and arrive at how to choose the right INCOTERM.

By the definition an INCOTERM or International Commercial Term is a formalized international term of trade, which specifies the responsibility of the exporter and importer in an international transaction.

Whenever an international sales transaction takes place i.e. when an exporter sells goods to a buyer in a foreign country, there is a host of steps involved in getting the goods to the location required by the buyer. This happens irrespective of whether the transaction has taken place directly or through an intermediary.

These steps include:

• Customs clearance of goods for export
• Organizing transport of the goods from the point of origin to the location it needs to be delivered
• Clearing customs in the importing country

Movement of goods involves a buyer, seller and transporter. An exporter and importer enter into an agreement under which the title of goods passes from one to another with risks also being transferred. INCOTERMS first coined in 1936 and last published before this in 2000, addresses some of the problems related to international movement of goods. It tries to bring clarity and reduces confusion about the duties and responsibilities of the seller and buyer.

Some of the questions they address are:

• At what point should the seller deliver the goods?
• At what point are the risks passed from the seller to the buyer?
• In case goods in transit are damaged, pilfered or lost, who takes the liability for the loss?

There are a total of eleven INCOTERMs divided into four groups, C, D, E and F; or rather E,F, C & D. Before we list them out and define each term let us look at some of the misconception about them, their scope, and areas covered and not covered by them.

We shall then look at transfer of property or title, their structure and the primary responsibilities of different parties under various terms.

In session II tomorrow, we shall delve into how to choose the right INCOTERM. Looked at in a proper perspective they can be a powerful tool in buyer/seller contracts, leading to a win-win situation.

INCOTERMs deal with the relationship between seller and buyer under a contract of sale. The distinct areas they deal with include:

1. Provision of goods in conformity with the contract and paying the price of the same.
2. Procuring licenses, authorization and formalities.
3. Entering into a contract of carriage and procuring insurance as may be necessary.
4. Point of delivery of goods, i.e. the transfer of ownership from seller to buyer.
5. Transfer of risks from seller to buyer.
6. Division of costs between the buyer and seller.
7. Notice to the buyer or seller.
8. Proof of delivery, transport documents either paper or electronic.
9. Checking the packing, marking etc.

The whole arrangement of INCOTERMs is based on the above heads. Each term defines the precise obligation of the seller and buyer. It helps give precise understanding of the objectives of the parties to the contract. Finally, it minimizes, if not totally eliminates the space for confusion or dispute.

In spite of their clarity, misconceptions do exist about their applicability. INCOTERMs apply to the contract of sale and not their carriage. They do not provide for all the duties and responsibilities which parties may wish to include in a contract of sale.

As indicated, INCOTERMS deal with the contract of sale, they do not cover carriage, insurance and finance. However, when parties agree on the use of a particular INCOTERM, there would be implication for other contracts. For example, a CIF or CFR contract cannot be performed without a contract of carriage. Under these terms, the seller must present to the buyer a bill of lading, air waybill, or any other transportation document, depending on the mode of transport used. This is also important from the point of view of documentary credit, something we shall be dealing with tomorrow in session II. Here, documents required would invariably depend upon the means of transport which may be used in a particular transaction.

INCOTERM, therefore, identify the obligation that various parties to a transaction have; for example the seller’s obligation to place goods at the disposal of the buyer; or hand them over for carriage; or deliver them at the destination. Also provided for, is the transfer of money between the transacting parties. They further deal with the obligation to clear the goods for export/import, the packing, the obligation to take delivery and to provide proof of any complied with respective obligations. Thus, these terms deal with issues which are extremely important for the implementation of the contract of sale. Although INCOTERMs are primarily intended for use in international trade they are also widely used in domestic sales and purchasers.

It should be noted that INCOTERMs do not cover all possible legal or transport issues arising out of an international sale. What the terms do is specify the following:

• The portion of the transportation cost shared between buyer and seller.
• The point at which the risk of loss will be transferred from the buyer to seller.
• The party responsible for handling of customs formalities and dues payable at the origin and/ or destination.
• Seller’s responsibility for providing insurance cover in case stipulated by the buyer.

Areas not covered under INCOTERMs include:

• Transfer of ownership and property rights.
• Breach of contract and the consequences flowing from such breach
• Exemption of liability in certain situations.

These areas need to be taken care of by providing for specific stipulation in the contract of sale under the applicable law. It is therefore prudent to include in the sale contract precise details on the exact place and method of delivery, loading and unloading charges, extent of insurance and mode of transport.

Method of Entry into Foreign Markets

When an organization that has been focusing in the domestic market wishes to start exporting, it needs careful planning and thoughtful strategic thinking. In the unit on Customs Policy and Procedures we shall be looking at such topics as How to Obtain an IE Code Number, etc. We shall look here at the various marketing channels available for international trade.

An organization may go in for indirect exporting by using the services of an export trading company or an export management corporation. It may alternatively go in for active exporting by appointing an agent or distributor or even setting up its own representative office in a foreign location. Joint ventures and franchising are other methods available.

Before the organization does actively venture into exports, the following information should be sought:

• The size of the market
• The growth potential of the market
• The exporter's potential market share
• What type of after sales support the product requires and how they will adhere to it
• Whether a change in marketing strategy is required
• The levels of development of infrastructure in the said market
• The ability of potential buyers to handle imports

All these factors must be looked into before a company that was predominantly selling in the domestic market goes for exports. A core study in this area will give good insights into the potential hazards of getting into foreign markets.

Mr. Kumar and his wife were running a flower shop in a five star hotel in Bangalore. Besides procuring roses, greens, carnations and anthuriums from various parts of Karnataka and Kerela, they were also, through a third party, selling imported flowers like orchids and anthuriums. They were doing a roaring business.

The couple went on a holiday to the USA where they got to see the sophisticated flower markets in the East Coast State of Florida. They made contact with a flower shop in Miami and offered to supply Indian flowers and greens to them. The shop owner first asked them to ship a consignment of samples which, if approved a firm order would be placed.

After returning they very enthusiastically procured the best possible flowers and greens and booked them by air to Miami. The documents were scanned and flight details emailed to the potential buyer. The consignment reached Miami bang on schedule.

The buyer, who was procuring flowers through a wholesaler, had no clue on import formalities. He wasn't even aware that he could complete the formalities using the services of a customs broker. The Kumars on the other hand thought their task was over once goods were handed over to the carrier.

The end result was that by the time the Miami buyer was able to find out the formalities involved the flowers had perished and so had to be destroyed by the carrier. The cost of destruction and disposal had to be borne by the Kumars. Thus an otherwise successful businessman could not complete an international transaction due to lack of experience and knowledge of customs regulations.

Before entering into foreign markets an exporter should learn the rules and regulations and ensure that these are adhered to.

Role of International Chamber of Commerce

The ICC reviews INCOTERMS from time to time to ensure that they reflect and respond to current trade practices and trends. INCOTERMS 2020 will be the nineth revision of INCOTERMS since their inception in 1936.

International Agreements & Contracts – their role in trade & transportation

Transportation and trade involve agreements between two parties – trade, between buyer & seller and transportation between a shipper & a carrier. Being an agreement there have to be a minimum of two parties involved. An agreement enforceable by law is a contract.

In other words, a contract is an agreement in which a party undertakes to do or not do a particular thing. It describes a transaction in which each party comes under an obligation to the others, and each reciprocally acquires a right to whatever is promised by the other.

A person purchasing a transportation service must know what constitutes a contract. Also, s/he must know what should be included in or excluded from a contract

Air/sea waybills, bills of lading and other transport documents contain the conditions of contract of carriage. We’ll speak a little more about these documents later.

A contract must certain elements to be considered one. These elements are:

• An offer and acceptance
• Consideration
• Competent parties, and
• Legal purpose, i.e. it must be enforceable by law.

Agreements need not be in writing. However, in case of disputes, it is for the aggrieved party to find a way to prove his/her point. In case of a transportation agreement, it is therefore prudent for the freight forwarder to get a shipper’s letter of instructions duly signed by the shipper prior to executing the transportation document.

Consideration is one of the tools that make a contract enforceable. A shipper tenders goods to a transporter to move them from one location to another for a price. This price is the consideration in their contract of carriage.

When one or both the parties to a contract is a minor or lacks the capacity to perform the conditions laid down in an agreement, the same is not enforceable by law and therefore void. Similarly, an agreement to perform an illegal or criminal act is not enforceable by law and therefore not a contract.

Failure to discharge a contract is called a breach. A purchaser of transportation services must have some knowledge of what remedies are available in case of a breach of contract.

International Contracts

An organisation involving itself in international business enters into a number of contracts with other organisations, possibly located in different countries. These contracts may be written or implied. We list out some examples of what such contracts would be:

• The contract of sale between the buyer (importer) and seller (exporter)
• An insurance contract, here an insurance company would be involved
• A contract of carriage with a carrier, i.e. an airline, shipping line, an MTO, etc.
• A documentary letter of credit with a bank
• An agreement with an agent or distributor

The possibilities are endless.

INCOTERMS – definition & usage

As stated earlier, the ICC reviews INCOTERMS from time to time to ensure that they reflect and respond to current trade practices and trends. INCOTERMS 2010 is the eighth revision of INCOTERMS since their inception in 1936. By definition, INCOTERMS are a series of internationally recognised standardised trade terms published by the International Chamber of Commerce (ICC) and widely used in international sales.

Let us look at what they cover. In simple layman’s terms they cover the following:

• Who does what
• Who pays for what
• When do risks pass from seller to buyer
• When delivery occurs

In addition to the above INCOTERMS also cover such issues as insurance, export & import clearance and the division of other costs pertaining to the delivery of goods.

Let us now look at what they don’t cover. There is nothing on ownership/title to the goods, nothing in detail on payment obligations, viz. when, how, what security, against what documents or for that matter nothing on detailed vessel requirements, force majeure, termination, insolvency, etc. In short, INCOTERMS do not constitute a complete contract of sale. However, they provide convenient internationally recognised rules for the sale of goods.

Now we shall look at how they are used. INCOTERMS are incorporated into many contracts by express reference. E.g. DAP one safe berth Rotterdam, INCOTERMS 2010. They may be referred to in standard for, contracts. They may also provide some guidance as to the generally accepted meaning of trade terms such as CIF/FOB/DES. However, it is important that one expressly refers to them if one wants them to apply.

Now, let us look at the reason they changed in 2010. It was to take account of the spread of customs-free-zones, the increasing use of electronic communications, concerns about security following the 9/11 tragedy and the latest developments in trade since the 2000 version was published.

INCOTERMS 2010 was published on SEP 27, 2010 and came into effect from JAN 1, 2011. For any contract entered into from JAN 1, 2011 onwards it will be assumed that any reference to INCOTERMS, unless stated otherwise, will mean the 2010 version.

The following are the changes in INCOTERMS 2010 that every transport user must be aware of:

1. Removal of four terms, viz. DAF, DES, DEQ and DDU and introduction of two terms, viz. DAP – Delivered at Place & DAT – Delivered at Terminal
2. Creation of two classes of INCOTERMS as against four for INCOTERMS 2000. These two classes are:
   1. Rules for any mode or modes of transport, and
   2. Rules for sea and inland waterways.
3. Rules which are able to serve both international and domestic trade
4. Express reference to the use of the term equivalent electronics records if the parties agree or it is customary
5. Amended insurance cover to reflect the alterations made to the Institute Cargo Clauses
6. Allocation of parties’ respective obligations to obtain or provide information in order to obtain security-related clearances
7. Responsibility for Terminal Handling Charges expressly allocated
8. Including an obligation to procure goods to reflect current practices in string sales

Let us now look at these aspects a little in detail.

1. Removal of four terms from INCOTERMS 2000: We have seen over the decades the steady growth of container traffic all over the World. In fact, more than ever, today commodities are being traded and moved in containers. This onward march and the increased usage of point-to-point services have led the ICC to introduce two new Delivered terms. Delivered at Place (DAP) should be used in place of DAF, DES & DDU. Additionally Delivered at Terminal (DAT) replaces DEQ. These new terms may be used irrespective of the agreed mode of transport. The main reason for fewer terms/simplifications was that traders often chose a term incorrectly or muddles terms leading to contradictory or unclear terms.
2. Creation of two rather than four categories of terms: The 11 INCOTERMS, as against 13 in the 2000 version, have been categorized under two categories:
   1. Deliveries by any mode of transport: EXW, FCA, CPT, CIP, DAP & DDP may all be used where there is no maritime transport at all; and
   2. Deliveries by sea/inland waterway: FAS, FOB, CFR & CIF

These changes have been made to make the new INCOTERMS easier to use

3. Adapted Rules: The new INCOTERMS are expressly stated to be for both domestic and international trade. This is achieved by statements within the rules that the obligation to comply with export/import formalities exists only where applicable. For trade blocs like the EU & NAFTA, where border formalities have largely disappeared and in the US where there has been an increasing willingness to use INCOTERMS rather than the former Uniform Commercial Code shipment and delivery, the new terms are now easier to apply.
4. Electronic Records: The buyer’s and seller’s obligations to provide contractual documentation may now be by electronic record if agreed between the parties or customary reflecting the recognition by the ICC of the increasing importance and contractual certainty, owing to speed of transfer, provided by electronic communication. This will also future proof INCOTERMS 2010 as electronic procedure/communications develop over time
5. Institute Cargo Clauses: WHERE an INCOTERM requires that one party obtains insurance, the insurance requirements have been amended to reflect the changes to the Institute Cargo Clauses. The parties’ obligations regarding insurance have also been clarified.
6. Security: The issue of security of goods/vessels, etc. is now at the front of most people’s minds when considering international trade. Given that many countries now require heightened security checks, the rules now require that both parties are obliged to provide all necessary information, e.g. the chain of custody information, in order to obtain import/export clearance. The 2000 version did not require this degree of cooperation.
7. Terminal Handling Charges: Where the seller is required to arrange and pay for carriage of goods to an agreed destination under CIP, CPT, CFR, CIF, DAT & CCP terms, it may be the case that terminal handling charges are passed on to the buyer as part of the contractual price of goods. However, historically, in some cases, the buyer also had to pay the terminal for this service amounting to a double charge.
8. String Sales: In contracts for the sale of commodities as opposed to manufactured goods, it is often the case that a cargo is sold in high-seas a number of times when it’s on board a vessel, a term called string sales. In such situations, sellers in the middle of the string do not ship the goods, as the goods are in high seas, being shipped by the seller at the top of the string. As such, the obligation on sellers in the middle of the string is to procure the goods that have been shipped. The new INCOTERMS clarify this by including an obligation to procure goods shipped as an alternative to the obligation to ship goods.

Considering the improvements and simplifications, the ICC expects INCOTERMS 2010 to be well received by most, if not all, sections of the trade. However, as with any change, work is required within trading companies and service to make sure that they are ready for this change. This is where the need for a programme like this one comes in. They will have to make the necessary amendments to their standard contracts for future sales & purchases. If the companies do not incorporate these changes, it could be a potential recipe for disputes.

Incoterms® 2020 rules, what to expect and what not to

Incoterms® have been developed and published periodically by the ICC to facilitate international trade. Like we've seen, they've been designed to aid parties that trade in goods internationally to interpret the terms of trade that two parties to a contract of sale and purchase agree to apply. As we've seen, they were first introduced in 1936 and periodically revised in 1957, 67, 76, 80, 90, 2000, and 2010. these revisions were made to accommodate changes as global trade developed and evolved. The current version of Incoterms rules is the 8^th so published. Today, they are used worldwide, not just for international sales and purchases but for domestic trade as well. They are an internationally recognized and accepted set of standards. So universal is their acceptance, that they have become an essential part of day-to-day international and domestic trade.

We will, at a later stage, be taking a detailed look at the history of the Incoterms. It is essential to look at it because, besides being interesting, it highlights their importance. For over eight decades now, they have been the cornerstone of international trade is goods. They have created the basis for robust trade negotiations. We have seen earlier how various service providers take part in the international movement of goods and the steps involved to pick goods up from the seller's premises and deliver them at the buyer's. Some of these steps may not apply to domestic movements and transactions. Some of the service-prociders include carriers – viz. shipping lines, airlines, truckers, MTOs, etc. – forwarders, customs, port & airport authorities, banks and several more. These reules have been designed by expert practitioners acting on behalf of the ICC.

Incoterms 2010 was published in September 2010 and came into effect from January 1, the following year. Incoterms 2020 will replace Incoterms 2010 from january 1, 2021.

is it possible for scrupulous elements to take advantage of the situation, using devious methods? As with any legitimate business organisation or transaction, it is possible. Let us see how.

To begin with, the ICC has announced that it is coming up, some time in 2019, with a new edition of which will be christened Incoterms 2020. Several scrupulous fly-by-night operators, claiming to be educational and training institutions, have already started offering sessions on Incoterms 2020. May be they have access to information that even senior ICC officials don't.

Many, in fact I'd say most, service-providers and users are not aware of the latest rules. It isn't uncommon to receive a request with terms mentioned as FOB, with an airport being mentioned. FOB is a term to be used only for non-containerized water transport. The same applies for FAS, CIF and CFR. FCA, CPT and CIP are the terms to be used for other modes of transportation. Similarly, DAP and DAT are terms introduced in 2010, with certain terms being rendered redundant. To assist users and service-providers, the ICC has innued a notification entitled 3 ways to spot fake Incoterms® rules. Every service-provider and user should note the following:

1. The Drafting Group for Incoterms 2020 was formed and convened by the ICC in 2016. It combines the collective knowledge and expertise of eight recognized specialists from across the world. Its mandate is to finalise the latest update to the Incoterms rules. Since its been convened, it has met several time. The members of the group propose, discuss and analyse more than 3000 substantial suggestions and comments made by ICC national committees.

So, how does one spot a misleading website or organisation? To begin with, the fact that they're offering a training programme on Incoterms 2020 before it is published is one sure sign. One should remember that Incoterms is an official trademark of the ICC and it should be acknowledged as such.

2. The second thing one should note is the language that these operators use. While suggestions are fine, predictions aren't. Of course these suggestions should be made to the ICC. Users and service-providers should be careful about such fly-by-night operators and so-called experts, whose sole purpose is to make money and not impart knowledge. Following their lead could be detrimental to business. Please wait for the release of the next edition before one attends such training sessions.
3. The release of the next edition of Incoterms is months away. While, it is still okay to conduct sessions on the general principles of Incoterms, doing the same on Incoterms 2020 is not. The current edition in use is Incoterms 2010 and, before that, it was Incoterms 2000. Anyone offering sessions suffixing it with any other year, e.g. 2015, 2017, etc. is fraudulent. Till Incoterms 2020 comes into force Incoterms 2010 will continue to be the one applicable.

Having said this, several textbooks, even those published as late as this year, still use older versions. This too needs to be corrected. Students and professionals must keep themselves updated with the latest.