Choosing Incoterms
Last update
Incoterms ("INternational COmmercial TERMS") are a set of codes developed by the International Chamber of Commerce (ICC) with the aim of standardising the commercial terms most frequently used in international trade.
Incoterms define the obligations of the buyer and the seller in a commercial transaction with regard to:
- the division of the costs of transporting goods (packaging, handling, carriage, customs duties, insurance, etc.);
- the point of transfer of risk, i.e. the point from which the buyer is responsible for the goods in the event of loss or damage;
- the documents and information which the seller must provide to the buyer.
By using one of the 11 existing Incoterms in their contracts, the buyer and seller can avoid misunderstandings related to different commercial practices in different countries. Incoterms, while optional, are standardised, internationally recognised clauses which allow to avoid disputes.
The 11 Incoterms are divided into 2 groups:
- terms which can be used regardless of the means of transport (multimodal);
- terms which can be used for transport by sea and inland waterways.
Who is concerned
Any companies which buy or sell goods internationally must agree on their respective obligations during the transaction with their business partners.
They can specify these obligations in the contract by using the appropriate Incoterm. The Incoterm defines the following, for each stage of the transaction:
- who bears the costs;
- who needs to take out insurance to cover the risks;
- and who needs to provide which document.
Incoterms are only valid if agreed by the parties to the contract (the buyer and seller), i.e. if they form an integral part of the contract or are the subject of a separate agreement. They apply exclusively to the relationship between the buyer and the seller and do not concern third parties involved in transportation such as forwarding agents, carriers or others.
How to proceed
Basic principles
Classification into groups
- Group E (EXW) – This group represents the minimum obligation for the seller who must simply make the packaged goods available to the buyer (at the factory of origin);
- Group F (FAS, FCA, FOB) – The seller transfers liability for the goods in terms of risks and costs at the point at which they are consigned to the carrier previously designated by the buyer. The seller does not therefore take responsibility for the main carriage method;
- Group C (CFR, CIF, CPT, CIP) – The seller arranges the main carriage method and bears the costs but not the risks, i.e. it bears the cost of the main carriage method and insurance, but the buyer is liable for the goods in the event of loss or damage;
- Group D (DAT, DAP, DDP) – The seller assumes maximum liability because it bears the risks and costs of transport through to delivery to the buyer at the appointed destination.
Difference between "transfer of risk" and "transfer of costs"
Transfer of risk
The term "transfer of risk" refers to the transfer of liability for the goods from the seller to the buyer. This transfer implies that the consequences of loss or damage to the goods will be borne by the buyer.
The transfer of risk may be carried out separately from the transfer of title, i.e. the buyer may bear the risks relating to transporting the goods prior to the physical delivery thereof.
It is therefore important to specify the point at which the transfer of risk takes effect in order to determine who will bear the financial consequences in the event of loss or damage.
Example: a contract between seller X and buyer Y stipulates that the transfer of risk takes place on unloading the goods from the ship. If, at the time of unloading, the goods fall into the water, the buyer will be liable.
Transfer of costs
The term "transfer of costs" refers to the point at which the buyer becomes liable for the financial costs of carriage and insurance, as well as customs import/export formalities (duties and taxes).
Each Incoterm determines the extent of each party's liability in terms of risks and costs which can be more or less advantageous for the buyer or the seller:
Difference between "sale on departure" and "sale on arrival"
Sale on departure
"Sale on departure" refers contractually to sales where the seller has completed its obligations when the goods leave its factory, or, at the latest, when the goods are handed over to the carrier. As a result, the seller does not assume any risks relating to carriage problems.
There are 8 Incoterms for "sale on departure".
For multimodal transportation:
- EXW;
- FCA;
- CPT;
- CIP.
For transportation by sea or inland waterways:
- FAS;
- FOB;
- CFR;
- CIF.
Incoterms relating to "sale on departure" are therefore more attractive for the seller, who will be highly interested in using them for the long-haul transport of goods involving greater risk of loss or damage.
Sale on arrival
"Sale on arrival" refers to sales where the seller undertakes to bear the costs and risks relating to international transport through to the agreed destination. This type of sale is advantageous for the buyer because it does not have to take responsibility for transport; in this way, it receives the goods as if it had purchased them locally.
The seller may also opt for "sale on arrival" for the purpose of controlling the distribution of its product.
There are 3 Incoterms which are multimodal and are for "sale on arrival":
- DAT;
- DAP;
- DDP.
Incoterms which can be used for all transportation methods (multimodal)
"Multimodal" Incoterms refer to deliveries which can be made by several different means of transport (road, rail or air).
EXW or "EX-works"
This Incoterm is the most attractive for the seller as it makes the packaged goods available on its premises (workshop, factory, warehouse, etc.) and the buyer is then responsible for loading, carriage and the resulting risks and costs.
FCA or "Free Carrier"
The seller takes responsibility for loading (the truck, wagon or ship), i.e. puts the packaged goods on board the means of carriage chosen by the buyer after having cleared the goods for export. The buyer then arranges carriage of the goods at its cost and risk.
CPT or "Carriage Paid To"
The seller takes responsibility for loading and initial carriage of the goods to the first carrier (or main carrier) after having cleared the goods for export. The risks are transferred to the buyer when the goods are handed over to the carrier at the agreed point.
CIP or "Carriage and Insurance Paid to"
The seller has the same obligations as in the case of CPT but must also provide insurance against the risk of loss or damage being incurred during transport.
DAT or "Delivered at Terminal"
The seller takes responsibility for the main carriage of the goods and has fulfilled its obligations when the goods are unloaded and delivered to the buyer at the "appointed terminal", i.e. the port, air, road or rail terminal agreed with the buyer. It therefore bears the risks relating to carriage and unloading the goods at their destination.
DAP or "Delivered at Place"
The seller takes responsibility for the main carriage of the goods and has fulfilled its obligations when the goods are made available to the buyer, ready for unloading at the agreed place, on the date and within the deadline stipulated in the contract. The seller bears the risks relating to transporting the goods to the final destination without however taking responsibility for clearing the goods for import.
DDP or "Delivered Duty Paid"
This term is the opposite of EXW (ex-works), and places the maximum obligations on the seller. The seller takes responsibility for the transport in its entirety, including clearing the goods for import and paying any taxes and duties due. The transfer of costs and risks takes place on delivery to the buyer. The buyer's sole obligation is to unload the goods.
Incoterms used for transportation by sea and inland waterways
FAS or "Free Alongside Ship"
The seller has fulfilled its obligation to deliver once the goods are placed alongside the buyer's vessel at the named port of shipment and the goods have been cleared for export. The buyer must then bear all the costs, damages and risks of loss which may be incurred from that moment.
FOB or "Free on Board"
The seller has fulfilled its obligations to deliver once the goods are placed on board the vessel at the named port of shipment and have been cleared for export. The transfer of risk takes place once the goods are on board the vessel (port transit). The buyer then bears all the risks and costs of marine freight transportation.
CFR or "Cost and Freight"
The seller must choose the vessel, clear the goods for export and pay the fees and freight charges needed to ship the goods to the named port of destination. The transfer of risk takes place at the point when the goods are on board the vessel (Incoterm equivalent of the CPT Incoterm for multimodal transportation).
CIF or "Cost, Insurance and Freight"
The seller has the same obligations as for CFR but must also provide maritime insurance against the risk of loss or damage to the goods during shipment. Clearing the goods for export is the seller's responsibility and the transfer of risk takes place at the point when the goods are placed on board the vessel (Incoterm equivalent of the CIP Incoterm for multimodal transportation).
Drafting the contract
Basic rules for international contracts
When drafting international contracts, certain clauses must be observed:
- the contract must be drafted in a language understood by each of the parties. English is still the main business language and its use is advisable;
- whenever a Luxembourg company draws up a contract with a foreign company, the law of only one country may apply in the event of dispute. The choice of applicable law is at the discretion of the parties.
In certain cases, the parties can decide to apply different legislation for different parts of the contract;
- if the applicable law is not mentioned in the contract, the judge will rely on international agreements to determine the applicable law;
- the seller is expressly responsible for packing the goods concerned in the contract of sale. The transfer of responsibility for this obligation to the buyer must be clearly mentioned without ambiguity.
The standards with which the packaging and packing must comply correspond to the usual packaging practices for goods of the same type. In the absence of such practices, the ICC shall refer to common practice in international trade or, failing this, to those of the place in which the seller is based. If there are no common practices, packaging must ensure that the goods are preserved and protected until they are delivered to the buyer;
- the contract must include the means of payment (cheque, bank transfer, postal order, bill of exchange or promissory note), and the payment deadline.
Example: 60 days from date of invoice.
Standards applicable to Incoterms
In order to use an Incoterm in a contract, the parties to the contract must observe certain typographical rules:
- to avoid ambiguity, only Incoterms recognised by the ICC may be used and, preferably, the most recent version of the Incoterms (Incoterms 2010).
Previous versions remain valid but the reference year must be stipulated (Incoterms 2000 or 2010); - the word "Incoterms" must not be written in capital letters or italics; only the first letter is capitalised;
- the Incoterm must always be followed by precise details of the place of delivery.
Examples: CPT New York (Incoterms 2010 ICC), FOB port of Amsterdam (Incoterms 2010 ICC), etc.;
- other additional details or any restrictions may be added, e.g. the exact point of transfer of costs and/or risks from the seller to the buyer or the precise address of the warehouse/port/airport;
Example: CPT Paris – Charles de Gaulle airport, 95700 Roissy-en-France, France – excluding taxes and duties (Incoterms 2010 ICC).
Only these rules have the force of law with the ICC in the event of dispute.
Summary table
