Companies engaged in the international purchase and sale of goods are likely accustomed to the use of “Incoterms” in their commercial agreements. Although widely incorporated in agreements for the purchase and sale of goods in international trade, Incoterms are often misused and misunderstood. The aim of this article is to explain the scope and proper use of Incoterms to newcomers to international trade, with some suggestions for experienced users as well.
Incoterms are standard three-letter trade definitions commonly used in international sales contracts. Incoterms were devised and first published by the International Chamber of Commerce (ICC) in 1936 and since that time have been updated six times. The current list of Incoterms was published in 1999.*
The Incoterms convention is used to allocate between buyer and seller the responsibility for risk in transit, payment of freight charges, engagement of freight carriers, customs clearing matters and costs of payment insurance. There are 13 Incoterms altogether, which are broken down into four categories, with each category allocating costs or risks differently. The four categories – E, F, C and D – are summarized as follows:
- The “E” term (EXW): The seller’s only obligation is to make the goods available to the buyer at the seller’s premises.
- The “F” terms (FCA, FAS and FOB): The seller is obligated to deliver the goods to a freight carrier appointed by the buyer.
- The “C” terms (CFR, CIF, CPT and CIP): The seller is obligated to contract with the freight carrier for transportation and to deliver the goods to that carrier at a named destination.
- The “D” terms (DAF, DES, DEQ, DDU and DDP): The seller is obligated for the costs and risks of bringing the goods to the destination designated by the buyer.
The Incoterm Official Rules provides detailed explanations of each of the 13 Incoterms and how each allocates costs and risks.
Incoterms do not have the legally binding effect of an international treaty or law; rather, they provide a written expression of custom and usage – or best practice – in the industry. However, Incoterms have been internationally recognized through their incorporation into the 1980 United Nations Convention on Contracts for the International Sale of Goods (CISG). Contracts governed by the CISG do not need to explicitly reference the Incoterm Official Rules to incorporate Incoterms. Contracts that are not governed by the CISG, however, generally must include both the three-letter Incoterm and the applicable version of Incoterms, e.g., “CIF (Incoterms 2000),” in order to bring the Incoterm within the agreement. Nevertheless, because of the pervasive use of these terms in international commercial agreements, even a contract containing merely a naked reference to an Incoterm is occasionally interpreted in accordance with that particular Incoterm.
There are several misconceptions about Incoterms, each involving their scope. Contrary to commonly held belief, Incoterms do not speak to the following issues: (1) transfer of title to goods; (2) delivery of nonconforming goods, product liability, or other breaches of contract and their consequences; (3) payment terms; or (4) relations with third parties, such as freight carriers, customs clearance clearing firms and insurance carriers. The latter matters should be covered by the party responsible in its contract with the third party. Other matters not covered by Incoterms should be expressly spelled out in the basic agreement between buyer and seller or in a collateral agreement.
Practical Pointers for Using Incoterms
• Documentation Consistency. Oftentimes buyer and seller will reference different Incoterms in their purchase order and sales documentation. In addition, in international transactions the parties often have third parties playing important roles, such as placing orders for buyers and processing or filling orders for sellers. These third parties must ensure that the Incoterm referenced in their documentation matches that of the party for which they are acting. Any discrepancies in the documentation should be discussed and resolved when the order is being processed to avoid disputes or shipping delays down the road.
• Appropriate Incoterms Referenced in Contract Documentation. As noted above, Incoterms are not implied terms and must be expressly referenced in contract documentation. For complete clarity, the documentation should include both the Incoterm and a reference to the applicable version, e.g., “FCA (Incoterms 2000).” Including the proper information will avoid ambiguity in contract documents, which defeats the purpose of standardized shortcuts.
• Maritime-Only Incoterms. According to the Incoterms Official Rules, only certain of the Incoterms should be used when the mode of transportation is maritime and inland waterways. These maritime-only Incoterms are FAS, FOB, CFR, CIF, DES and DEQ. All the other Incoterms can be used regardless of the mode of transport. Although this is a rule that is often violated (especially in the case of “FOB,” which is often used generically), inappropriate use of one of the maritime-only Incoterms could create ambiguity in the agreement and possibly be used by a party as an excuse to reopen negotiations on a wider range of issues or lead to disputes after performance.
• More Favorable Is Not Always Better. As with other terms of legal boilerplate, parties often include in their template contract documentation the most favorable version of a commercial term. In the case of Incoterms, sellers’ template contract documentation often includes “EXW” or one of the “F” Incoterms, which place a lesser burden on sellers. Buyers, on the other hand, will oftentimes designate one of the “D” Incoterms in their template contact documentation, which place a greater burden on sellers. Although this makes some intuitive sense, it might not always be the most realistic and practical approach to allocating shipment burdens and responsibilities between buyers and sellers. If, for example, the seller is a small and less sophisticated party, it might not be able to competently handle all the import and export regulatory matters allocated to it under the DDP Incoterm. And if it attempts to perform those duties, it may do so poorly or inefficiently. To the extent that the cost of performing those tasks may indirectly be absorbed into the price of goods, using “DDP” might not actually be in the best interest of buyer in that situation.
• Sometimes Incoterms Will Not Be Suitable. Although there are 13 possible Incoterms, there may be situations where none will apply. Although the parties can supplement a particular Incoterm with additional contract language to vary its meaning, there may be situations where it will be simpler and more straightforward to dispense with an Incoterm and draft a comprehensive provision.
Use of Incoterms in international commercial agreements has become common because they make the contracting process more expedient and efficient. However, like most documentation shortcuts, those objectives are met only if Incoterms are used skillfully and prudently. The author highly recommends using Incoterms 2000, ICC Official Rules for the Interpretation of Trade Terms (1999). It is in pamphlet form, written in a user-friendly format and contains valuable supplemental information for each of the Incoterms.