Common misunderstandings and mistakes when using Incoterms 2010
If News 9/2015 Marine. When doing trade it is in both parties interest to define rights, liabilities and obligations regarding transportation and delivery of the goods accurately. Who is to arrange transportation, who bears costs and which costs, who bears the risk of loss of or damage to the goods in transit and is there a requirement to insure the goods and what kind of insurance is expected.
Incoterms (International Commercial Terms) were created to simplify and clarify these issues in 1936 and the latest revision of the Incoterms® came into force on the 1st of January 2010. Despite the relative clarity of the rules we have faced and will face numerous misunderstandings and as a consequence awkward situations – unfortunately these cases pop up often in connection with a cargo claim.
Incoterms-clauses – basics
Prior to digging into the world of misunderstandings and mistakes let us get the basics right. Altogether there are thirteen different clauses, which can be split into two different categories: rules that can be used for any mode or modes of transports and on the other hand rules to be used only for sea and inland waterway transports.
Rules to be used for any mode or modes (in case of multimodal transportation) are: Ex Works (EXW), FCA (Free Carrier), CPT (Carriage Paid To), CIP (Carriage and Insurance Paid To), DAT (Delivered At Terminal), DAP (Delivered At Place) and DDP (Delivered Duty Paid). So these rules are usable even though there is no waterway transportation as part of the logistic chain. But having said that, these rules can be used if waterway transport is part of the logistic chain.
The following rules are to be used in connection with sea and waterway transports: FAS (Free Alongside Ship), FOB (Free On Board), CFR (Cost and Freight) and CIF (Cost Insurance and Freight). When using these rules both the place to which the goods are to be transported as well as the place of delivery are located in port.
And of these rules only CIF and CIP require the seller to insure the goods for the benefit of the buyer. Only minimum insurance coverage is expected (Institute Cargo Clauses C or similar), but naturally the parties are free to agree on additional insurance coverage.
Role of Incoterms
Incoterms rules form only part of the sales contract. These rules do not govern extensively different rights and duties of the parties. Incoterms instruct parties on what is expected from either party in respect of carriage of the goods from seller to buyer; export, import and security related clearance; and how division of risks as well as costs is being done.
The rules stay silent on transfer of property rights. This is something the parties have to state in the contract of sales. Same applies to the consequences of possible force majeure situations – is the party facing some kind of unexpected and unforeseeable event exempted from his/her duties and liabilities.
And also the possible numerous different situations of breach of contract are beyond the scope of Incoterms® – apart from the passing of the risk and costs when the buyer is in breach of his obligation to accept the goods or to appoint the carrier when F-term is being used. In this respect the most common misunderstandings are that Incoterms would say something on the transfer of property rights and also would rule the payment terms.
Referring to Incoterms
One should incorporate the chosen Incoterms into the sales contract as follows: chosen rule (three letter abbreviation), destination, Incoterms® 2010. So it’s as simple as that? Unfortunately, not quite. Often we see examples where the destination is stated far too vaguely. Luckily very seldom only the country of destination is mentioned, but it is common practice to state only the city/town and country.
In order to avoid unnecessary and time consuming quarrels one should state the named place as accurately as possible – even on the level of street address: DAP Niittyportti 4, Espoo Finland Incoterms® 2010. This level of address details should be found at least from the sales contract.
Why is this so important? On clauses EXW, FCA, DAT, DAP, DDP, FAS and FOB the place of delivery is the very place in which the delivery takes place and risk transfers from the seller to the buyer. With CPT, CIP, CFR and CIF the place of delivery is not the same as the final destination. On these four rules the destination is the place to which the seller pays the cost of carriage.
If for example using DAT one does not specify the terminal accurately the seller is entitled to choose any terminal in the region defined – DAT Helsinki, Finland Incoterms® 2010 would mean in practice any terminal in Helsinki area.
Costs, tax and other administrative hurdles
Every now and then we see situations in which DDP is being used before taking into account the question whether the seller can really take care of all the necessary formalities in the buyer’s country. These formalities could be for example GST (Goods and Services Tax) or VAT (Value Added Tax). If not properly planned beforehand, the duty to register oneself as importer and other responsibilities may result in additional risks, costs, delays and upset clients.
Similarly at first glance using EXW appears tempting to the seller and why not also to the buyer. If EXW is used for export cases the buyer (thus exporter) has to complete all possible export procedures and that may prove to be both costly and time consuming. Therefor one might be better of using EXW only on domestic sales or in situations that correspond to domestic sales.
Even then caution is advisable, because even though the loading of goods into the means of transportation is the buyer’s task quite often it is the seller who actually takes care of this. And if a loss occurs it is rather difficult for the buyer to explain that they have had nothing to do with the unfortunate occurrence.
Chosen Incoterms® rule and reality do not match
Let us presume that I sell goods and use CIF port, terminal Z, X-town, Y country Incoterms® 2010. Because I want to safeguard my relationship with my client I check the goods in the course of transport and should I notice any damage goods I replace them with new ones. And as my client does not even know that there was a cargo loss, I take care of the claims procedures with my cargo insurer. What are the consequences if any?
First of all, after the commencement of the transportation the seller is not entitled to “tamper” the goods in transit. The only party who is to check the condition of the goods is the buyer when the goods have reached their final destination. Buyer is also the only party who is entitled to make a claim for cargo loss – this is based on the insurance policy given to the buyer by the seller.
What are the consequences if the seller interferes the transport and replaces damaged goods with new ones? The insurance coverage ends at the time the transport is “stopped” and original goods are wholly or partially replaced with new ones – even if the goods are of the very same quality and nature this is the case. Otherwise the insurer in question might end up paying indemnity for the “same goods” twice or more, which of course is not the intention. And as said, buyer is the one who is to file a claim for a cargo loss.
Should the seller prefer handling the claims procedure he/she is required to present a letter of authority from the buyer. So if the seller prefers to serve its client as good as possible and deliver only unharmed goods in all situations I strongly recommend using D-terms for avoiding unnecessary hassle and unpleasant surprises of not having cargo insurance coverage.
Another slightly problematic – if not as bad – example is if the chosen Incoterms rule is in principle suitable for parties’ intention, but does not in the end quite match it. Let’s take DAT-delivery of containerized goods as an example. This is something we bumped into only a couple of days ago. First question: when does the delivery take place? Well, this is still relatively easy to answer: when the containers have been unloaded into the terminal.
But what if the containers continue their way a couple hundred kilometres and the buyer opens the containers at the final destination and finds the goods to be damaged? This can trigger messy discussions regarding the occurrence of the loss between the buyer and seller; did this happen during the transportation until the place of delivery as per DAT rule or only after. Simple solution for avoiding this would be agreeing the place of delivery to the final destination (hence up to the buyer’s location).
All the above is meant for general guidance only and do not by any means cover all possible Incoterms related situations, which cause us grey hair. I have had the pleasure of listening to Asko Räty (VTM) number of times and he always gives the following instructions for choosing the correct rule: 1) forget Incoterms; 2) ask yourself: how do we deliver and receive goods? (sourcing, sales, accounting and logistics); and 3) now take a look at the Incoterms and find the suitable rule.
And write all possible additional specifications to Incoterm –rules carefully: EXW loaded – seller is to take care of the loading onto the means of transportation. But at buyer’s or seller’s risk?
Kari Koljonen Head of Marine Underwriting Finland, LL.M.