Business

The ins and outs of Incoterms®

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Incoterms® are an integral part of 90 percent of international sales contracts. They regulate transport costs and clarify the assumption of risk to which goods are exposed. A new version of the Incoterms® has been in force since 2020. Read here which Incoterms® are valid in 2021 and how to avoid the pitfalls.

What are Incoterms®?

Incoterms®, or International Commercial Terms, are published by the International Chamber of Commerce (ICC). They define international commercial standards, including the cross-border delivery of goods from seller to buyer. In practice, they take the form of standardized terms and conditions included in sales contracts. Their use is recommended by the ICC. The current Incoterms® version dates from 2020. Each Incoterm® regulates the obligations of the seller (A1-A10) and buyer (B1-B10).

  • A2/B2 Delivery/acceptance
  • A3/B3 Transfer of risk
  • A4/B4 Transport
  • A5/B5 Insurance
  • A6/B6 Delivery/transport document
  • A7/B7 Export/import clearance
  • A8/B8 Testing/Packaging/Marking
  • A9/B9 Allocation of costs
  • A10/B10 Notifications

Incoterms Trainer Wilfried MüllerEvery term has its pros and cons. It often depends on whether you are looking at them as a seller or a buyer.

Wilfried Müller, ICC-certified trainer for Incoterms® 2010 and 2020, Managing Director of LOCON Consult GmbH & Co. KG
(Image: LOCON-Consult GmbH & Co. KG)

What don’t Incoterms® cover?

Incoterms® only constitute a small part of a sales contract and are no substitute for one. They do not cover contractual aspects such as transfer of ownership, transport or insurance. Here is a list of the contractual elements not covered by Incoterms®:

  • Transfer of ownership or retention of title
  • Breaches of contract
  • Dates
  • Time, place and method of payment
  • Regulations in case of force majeure
  • Warranty
  • Responsibilities for insurance of the transported goods, unless the clauses CIP or CIF are agreed upon

Why are Incoterms® important?

Incoterms® establish a standard set of rules governing the relationship between the seller and the buyer on specific points. That is why they are important. Incoterms® regulate transport costs and the risk to goods during domestic and cross-border shipment. Since these rules benefit both contractual parties, Incoterms® form an integral part of 90 percent of all international sales contracts.

Do Incoterms® have to be included in a sales contract?

Incoterms® do not constitute a legal requirement, rather they represent agreements made in accordance with private contract law. For this reason, including recommended terms in sales contracts is not mandatory. “Many sellers and buyers do not understand the implications of waiving Incoterms®,” says Wilfried Müller, an ICC-certified trainer for Incoterms® 2010 and 2020 and managing director of the consulting firm LOCON Consult GmbH & Co. KG. But Incoterms® do not regulate every last detail. “Each clause has its pros and cons,” Müller explains. “ That’s why know-how and experience are required when incorporating them into contracts.”

Where Incoterms® are waived, statutory regulations apply 

Where Incoterms® do not form part of a contract, statutory regulations apply:

  • Where shipments within Germany are concerned, the German Civil Code (BGB) and the German Commercial Code (HGB) apply.
  • Where international shipments are concerned, EU law or the United Nations Convention on Contracts for the International Sale of Goods (CISG) may apply.

Not everyone is aware of German and international law as far as transport costs and risk to goods are concerned. Citing transfer of risk as an example, Incoterm’s specialist Wilfried Müller says, according to the CISG, the risk passes to the buyer as soon as the goods are collected by the carrier. “But few buyers will find that acceptable,” he says.

The eleven rules

The eleven Incoterms® rules specify different contractual conditions but are often similar in structure. Among other things, they define rules for the transfer of costs and risks from the seller to the buyer and the place of delivery.

EXW

Ex Works – seller has to make the goods available at a specified place, usually the seller’s factory or depot.

FCA

Free Carrier – the seller delivers the goods at the agreed place to the carrier nominated by the buyer.

FAS

Free Alongside Ship – the seller delivers the goods, alongside the vessel at the port of shipment.

FOB

Free On Board – the seller delivers the goods on board the ship at the port of shipment.

CFR

Cost and Freight – the seller assumes transport costs (freight) to the port of destination, although the risk of loss or damage to the goods is transferred from seller to buyer once the goods have been placed on board the ship at the port of shipment.

CIF

Cost Insurance Freight – commits the seller to the same obligations as the CFR Incoterm®. The seller also has to procure transport insurance, although only minimum cover is required.

CPT

Carriage Paid To – the seller commissions and pays for transportation to the place of delivery in the buyer's country.

CIP

Carriage Insurance Paid – this Incoterm® places the same obligations on the seller as the CPT Incoterm®. Also, the seller has to procure transport insurance, although only minimum cover is required.

DAP

Delivered At Place – the seller delivers the goods ready for unloading in the country of destination, at a place other than a terminal or transport infrastructure point (port, airport, etc.).

DPU

Delivered At Place Unloaded – the seller delivers the goods unloaded in the country of destination at a terminal or transport infrastructure point (port, airport, etc.).

DDP

Delivered Duty Paid – the seller delivers the goods ready for unloading at the destination country, usually at the buyer´s premises (factory or warehouse).  

Case study 1: Ex Works at a glance

Ex Works is a very common term in road transport and relates to the collection of goods. This rule places minimum responsibility on the seller, who simply makes the goods available for collection at a predefined location. The seller is freed of any liabilities pertaining to the delivery of the goods and, consequently, has nothing to do with the loading and shipping to the buyer. The consequences for the buyer are as follows:

  • The seller shall inform the buyer about the time, place, and quantity of collection.
  • The goods are provided to the buyer at the place of collection. The buyer is solely responsible for loading the goods, as well as the cost involved, the labor, and the means of transport. In accordance with Incoterms®, the buyer must also prepare the export paperwork.
  • Until they are handed over at the place of collection, the goods are the sole responsibility of the seller. From the moment the goods are handed over, transport risk (damage, loss, theft) is transferred to the buyer. Securing the cargo is regulated by law and cannot be overridden by Incoterms®. Thus, the seller is also liable.
  • But, says Wilfried Müller, the Ex Works term is customer-friendlier in practice. For example, in the case of shipments to a non-EU country, export documentation must also be prepared for Ex Works, as with any other Incoterm®. According to Incoterms®, the seller shall help to obtain export documentation, but does not have to provide the documentation. Although, typically, a seller will still manage the documentation. “But this also means that Ex Works is no longer Ex Works, but FCA,” says Wilfried Müller.

Tip: Use the FCA term instead of ex works for loading and export documentation! With FCA, loading and export documentation are the responsibility of the seller.

Who is responsible for cross-border export documentation? The Incoterms® provide several options.
Who is responsible for cross-border export documentation? The Incoterms® provide several options.

Case study 2: the DDP term

For the buyer, the benefit of Delivered Duty Paid is that the seller bears all the shipping costs and risks to the buyer. Unloading the goods from the means of transport, provides the only exception to this rule. However, caution is advised. Regulatory requirements in some countries may counteract or override this Incoterm®. Duties in some countries, for example, must be paid directly by the importer. “It can be expensive and lead to some unpleasant customs and tax-related consequences if specific contractual agreements cannot be legally fulfilled, even if they are prescribed by Incoterms®,” notes Müller.

Tip: DAP is a good solution for sellers when it comes to duties and taxes etc., since under this term they are not responsible for them. Or there is CPT, whereby the seller pays the freight to the destination, but the risk is passed to the buyer at the time of loading. Whether this term is appropriate, however, can depend on the seller’s outlook and the countries in which the buyer and seller are based.

Case study 3: insurance

Most customers, says Mueller, assume that shipments are insured. “But an insurance requirement only exists if the terms CIP or, in the case of marine transport, CIF are included in the contract.” The Incoterms® specialist, therefore, strongly recommends talking openly with the customer. If not insured, damage caused in transit can become a business risk.

Make sure international agreements are well put together

Which Incoterms® are the right ones for your business and your contract? To incorporate Incoterms® into contracts, the ICC and ICC-certified specialists offer training. Here are some helpful ICC tips for contracts:

  • Name the contractual parties and the object of the contract (services and payment). Formulate all the constituent parts of a contract in such a way that third parties can also understand them. Put in writing what has been agreed orally.
  • Are the seller and buyer from member states of the Vienna Convention? If so, the UN Convention on Contracts for the International Sale of Goods (CISG) applies. Unless you have agreed otherwise.
  • Use globally recognized specimen contracts. Specimen contracts can be downloaded from the ICC. Get legal advice is you choose to adapt a contract.
  • Use the globally recognized Incoterms®.
  • Insure yourself against unforeseeable events. These include force majeure or a pandemic.
  • Make sure the money side of things is secure. The globally recognized ICC banking rules are a good place to start.
  • Check the creditworthiness of companies or unknown business partners. This will help you avoid becoming a victim of fraud.

Remain clear and negotiate where there is a dispute

Not all business deals run smoothly. So, what do you do if a dispute arises? Ulrich Helm, a partner in the Frankfurt office of the law firm Mayer Brown, offers the following tips for reaching an agreement:

  • Think about your walk-away point carefully: Walk-aways are the extreme positions of both parties, so the solution may lie somewhere in the middle. Do not state your own demand too hastily since this will allow the other party to determine your midway position.
  • Think ahead about your goal. You need to identify the cornerstones of a settlement internally. This will help you determine when to break off negotiations.
  • Assess opportunities and risks properly, including cost estimates.
  • Select expert lawyers. If the dispute is about plant engineering, for example, get a lawyer who understands engineering jargon.
  • Prepare your negotiating tactics. This includes naming team members and messages.
  • Create clarity and structure. Do not present the dispute chronologically since this encourages a counter-narrative. It is better to structure the dispute around the contract.
  • Pressure creates resistance and threats usually undermine objective negotiations.
Incoterms® prevent disputes in international business transactions. If the buyer and seller still disagree think carefully about your walk-away point!
Incoterms® prevent disputes in international business transactions. If the buyer and seller still disagree think carefully about your walk-away point!

Resolve disputes through arbitration

Many buyers and sellers stipulate ICC arbitration in the contract should a dispute arise. For this purpose, the ICC offers a clause that can be adapted to the specific contractual situation. The ICC lists the following benefits of arbitration:

  • In the event of a dispute, no one must submit to the judicial system of another country whose language they do not speak and whose rules they do not understand.
  • The parties to the dispute can select arbitrators based on their expertise.
  • Arbitral awards can be enforced in accordance with the UN Convention. This applies to judgments made by state courts to a limited extent only.
  • The ICC's International Court of Arbitration has a worldwide reach and assistance is provided in the company’s preferred language.
  • On average, ICC arbitration proceedings take approximately two years.

Currently, some $130 million is in dispute. The costs of proceedings depend on the amount being disputed and the number of arbitrators involved. The ICC's cost calculator provides and overview of the procedural costs. However, additional costs are incurred by lawyers, among other things. The ICC Court of Arbitration offers a less expensive procedure called the “accelerated arbitration procedure” for amounts up to $3 million.

The origins of Incoterms®
Entrepreneurs, merchants and financiers founded the International Chamber of Commerce (ICC) in 1919, a year after the end of the First World War. The founding idea of the “merchants of peace,” as they called themselves, was economic growth and prosperity. It was believed that nations that traded more with each other would engage in fewer wars. The ICC’s goals were the liberalization of international trade and the establishment of uniform legal and technical standards. The German National Committee of the ICC was founded in 1925. Since 1923, studies have compared standard terms in different countries. The first version of the Incoterms® rules was published in 1936.

How often are Incoterms® updated?

Incoterms® are issued by the International Chamber of Commerce (ICC). There are no fixed intervals for updating. However, since 1980 they have been updated every ten years.

  • Incoterms® 2020 take into account changes in trade practices, innovations in financing and insurance coverage, and increased safety requirements.
  • An editorial team comprising lawyers, entrepreneurs, and company representatives from around the world worked on the current version for approximately two years.  
  • According to the ICC, 90 percent of all international sales contracts contain Incoterms® clauses. A total of 120 countries uses them.

Incoterms® and post-Brexit

Trade with the UK: Customs and Incoterms® expertise is in high demand

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