Choosing the wrong Incoterms® can mess up your contract – here’s how to get it right

What are Incoterms®?

The Incoterms® rules are an internationally recognized standard and are used worldwide in international and domestic contracts for the sale of goods.

Developed by the International Chamber of Commerce (ICC), Incoterms® help businesses operating internationally avoid costly misunderstandings by defining the costs, risk and obligations in each international trade transaction to importers, exporters, customs brokers, lawyers and students. Whether you are filing a purchase order, packaging and labelling a shipment for freight transport or preparing a certificate of origin at a port, the Incoterms® rules are there to guide you.

Incoterms are changing with the times

Which Incoterms® rule an organization chooses for a trade transaction will depend on a number of factors.

For example, if a buyer has facilities in the destination country and can arrange cost-effective transportation, then a good choice might be EXW or one of the F terms (in which the buyer takes responsibility for the goods after they are delivered to a carrier, alongside a ship or on board a ship).

If a seller is dealing with a buyer that is new to international trade and unsure about how to arrange transportation, then one of the C or D terms would be appropriate because the buyer would not be able to arrange efficient export clearance and transportation.

Negotiating Incoterms® rules

When negotiating contract terms, organizations should consider whether the buyer or the seller would be able to obtain a cost advantage for transportation and warehousing, e.g. because they ship large quantities annually.

Sellers may also add a surcharge to freight costs for the “value-added service”. When a buyer takes control of the supply chain, they are in control of carriers used and can access shipment details for tracking and tracing purposes without having to rely on a third party.

Sellers should consider the risk of goods sold for export remaining in the seller’s country. Under an EXW term, the buyer takes possession in the seller’s country and could actually resell the goods to the original seller’s clients. However, provisions in contracts could be included to avoid such cases.

It is important to note that with Incoterms® rules, there is an understanding that sellers and buyers will assist and exchange information for clearing export and/or import customs and for obtaining cargo insurance.

As well, sellers and buyers notify each other of delivery and collection arrival and departure times, in advance to ensure proper preparations can be made and to avoid issues and extra costs.

Selecting Incoterms® rules

Organizations must ensure their selection of an Incoterms® rule is appropriate for the type of goods, the means of transport, and that it is suitable for the intended payment transaction.

For example, FOB is appropriate to transport everyday items, but not to transport urgently required medical supplies.

Despite the long-standing use of Incoterms® rules, organizations still use them incorrectly.

It’s recommended that sellers and buyers consult with international trade experts and legal counsel for an explanation or a professional opinion on international sales contracts.

Using the wrong Incoterms® rule means that the contract between the buyer and seller might not be adhered to, which could result in delivery and payment problems, and unanticipated costs and disputes.

It might also mean that customs declarations are incorrect, which can have some serious legal ramifications. It is important to ensure that the Incoterms® rule selected will provide the documentation required to complete the transaction, for example, to claim the goods from the carrier, to take delivery or pick up goods, to obtain cargo insurance, and most importantly, to get paid.

Variations to any of the rules must be clearly stipulated in the contract of sale and must consider the effects, i.e. if there will also be a variation in the transfer of risk and assumption of costs.

This is very important for those terms where the buyer may wish to obtain additional insurance coverage (CIF and CIP) or where the carrier for the transfer of risk may not be the seller’s first carrier, or where the loading or unloading of the goods varies. If there are too many variations, sellers and buyers may need to select a different Incoterms® rule that better meets their needs.

Incorporating Incoterms® rules

When used properly, Incoterms® rules impose certainty on a sale contract. Incoterms® rules influence the documentary requirements for a shipment.

Using the correct Incoterms® rule is often essential for collecting payment, especially if documentary credit is the form of payment being used.

The ICC recommends that the Incoterms® 2020 rules be referred to specifically whenever the terms are used together with detail on location. For example, if the Incoterms® rule is Carriage Paid To (CPT), a reference to an exact airport or seaport should always accompany the destination; if a company had negotiated CPT to the Frankfurt Airport, the C term should state “CPT airport Frankfurt, Germany, Incoterms® 2020”.

It is important to further specify the actual point of delivery at the terminal, port or place of destination, to avoid doubt, confusion and extra costs (e.g. FCA Eckenheimer Landstr. 60b, 60318 Frankfurt, GERMANY).

Other sales terms

Incoterms® rules have traditionally been used in international sale contracts when goods pass across national borders. In various areas of the world, however, trade blocs like the European Union have made border formalities between different countries less significant.

Consequently, the subtitle of the Incoterms® 2020 rules formally recognizes they are available for application to both international and domestic sale contracts. As a result, the Incoterms® 2020 rules clearly state that the obligation to comply with export/import formalities exists only where applicable.

Two developments have persuaded the ICC that a movement in this direction is timely. First, traders commonly use Incoterms® rules for purely domestic contracts. The second reason is the greater willingness in the U.S. to use Incoterms® rules in domestic trade rather than the former Uniform Commercial Code (UCC) shipment and delivery terms. UCC terms should not be used for international sales. This can cause confusion, because the UCC terms are written the same way as Incoterms® rules, but do not have the same meaning.

It must be remembered that Incoterms® rules do not constitute a contract. They are a standardized means of setting out obligations with respect to carriage and insurance.

They do not contain provisions for delivery times and do not regulate the issue of title. Other terms of sales contracts must be negotiated and agreed upon. However, it is very important to include Incoterms® rules in contracts between sellers and buyers.

In the past, disputes surrounding these issues were dealt with by applying the sales law of the relevant country specified in the commercial contract. However, the UN Convention for the International Sale of Goods (CISG), which was ratified in 1980, has come to replace national sales laws in more and more countries.

Currently, when a sales contract does not make clear which national sales law applies, the CISG provides uniform, internationally applicable rules to govern legal questions surrounding transactions. From the perspective of the CISG, Incoterms® rules have to take the CISG into consideration because they supplement its provisions.

About the author

Author: Pamela Hyatt

I am the Content Marketing Specialist for the Forum for International Trade Training (FITT). You can find some of my work on TradeReady.ca. My background is in copywriting, journalism and social media. My passion lies in connecting people to the stories that are most important to them. View all posts by Pamela Hyatt