Consequences of using incorrect Incoterms

Ever since its introduction in 1936, Incoterms® has been a paradox to many buyers, sellers, traders, freight forwarders, shipping lines and other service providers involved in the business of global trade..

In a recent interview, Emily O’Connor, Director of Trade and Investment for the International Chamber of Commerce (ICC), goes as far as to say that “people will frequently choose the wrong Incoterms® rule for their transaction”..

O’Connor emphasises the importance for anyone who uses the Incoterms® rules to learn or re-learn them – even if you consider yourself an expert – in order to avoid costly mistakes in the process of shipping their goods..

The usage of incorrect Incoterms® rules happens most commonly due to

1. Inappropriate rules being used for the chosen mode of transport;
2. Lack of understanding of the allocation of costs and risks between the buyer and seller;
3. The usage of incorrect version of the Incoterms® rules;
4. The rules not being geographically specific;
5. Not understanding what the Incoterms® rules does and does not do;
6. Choosing rules that do not suit the requirement of the business;

There are several consequences of using the incorrect Incoterms® and users need to fully comprehend what it means when they put a three letter Incoterms® rule into their sales contract..

Apart from reflecting business-to-business practice in contracts for the sale and purchase of goods, the Incoterms® rules describe the obligations of the seller and buyer in terms of carriage, documentation, clarifies where the risk transfers from seller to buyer, allocates responsibility for costs between seller and buyer..

1) Inappropriate rules being used for the chosen mode of transport

FOB (Free On Board) as one of the Incoterms® rules, was designed to be used only for sea or inland waterway transport and under this rule, the seller delivers the goods on board the vessel nominated by the buyer at the named port of load or procures the goods already so delivered..

The risk of loss or damage to the goods passes when the goods are on board the vessel, and the buyer bears all costs from thereon..

Under the above definition, FOB is suitable only for cargoes where the shipper is responsible for delivering/loading the goods on board the ship such as with Bulk/Break Bulk cargoes on FIO basis..

FOB is not suitable for use in containerised cargoes which are usually delivered to a container terminal where it is received under the control of the carrier and not on board the ship..

In FOB, seller is responsible till the container is loaded on board the ship whereas the seller does not have any control of the container as it has already been handed over to the carrier.. In this case, FCA would be the appropriate term to be used..

The incorrect usage of FOB in containerised cargoes has been and is quite prevalent around the world.. As a consequence of this incorrect usage, the seller is exposing themselves to unnecessary risks and costs..

2) Lack of understanding of the allocation of costs and risks between the buyer and seller

Although the Incoterms® rules clearly outlines the allocation of costs and risks between the buyer and seller, there are several discussions and disputes surrounding the costs and risks..

There have been several discussions on the allocation of bill of lading costs on FOB or FCA rules.. Whether this cost belongs to the seller or buyer etc..

Even certain statutory and seemingly straight forward charges such as THC (Terminal Handling Charges) could lead to disputes as the quantum of THCs and the application of the same can vary from port to port.. In some ports the carriers may be offering a Free Out option and in some port it could be levied separately..

Under CIF and CIP for example, both parties need to understand the extent of the coverage required for the cargo insurance as these Incoterms® rules require a specified level of cover like “limited insurance cover complying with Institute Cargo Clauses (C) or similar clause” under CIF and “extensive insurance cover complying with Institute Cargo Clauses (A) or similar clause” under CIP..

Lack of understanding of these type of requirements can lead to cost disputes and/or delays to the shipment itself which could impact on the delivery time..

3) The usage of incorrect version of the Incoterms® rules

If the seller and buyer want the appropriate rules to apply to their sales contract, the best way is to ensure that the year and version of the Incoterms® rules is made clear in the sales contract..

For example the rules should be written as CIF Hong Kong, Incoterms® 2020, or DAP 123, Trade Road, Shanghai.. If the year and version of the Incoterms® is left out, it could be open to interpretation and a judge or an arbitrator will not be able to determine which version of the rules applies to the contract..

This will cause further costs and delays in the completion of the transaction..

4) The rules not being geographically specific

It is very important to be geographically precise when agreeing on the place of delivery or destination..

For example in a DAP transaction if the location is said to be DAP Mumbai, it leaves a lot for interpretation as Mumbai is a huge city..

The buyer based in Mumbai may be expecting the goods to be delivered to a place outside the central business district whereas the seller may have interpreted it differently..

Additional trucking costs and risks may be involved in moving the goods to the buyer’s nominated place..

For example in an FOB sale, not specifying the port or terminal of loading could leave it open to interpretation and if the cargo is already delivered to the wrong port/terminal it will result in massive cost implications and delays..

It is therefore best to be as geographically specific as possible in naming the port, place or point, as the case may be, in the chosen Incoterms® rule..

5) Not understanding what the Incoterms® rules does and does not do

The biggest consequence here is the clear lack of understanding on what the Incoterms® rules does and does not do..

It is most important to understand that Incoterms® rules is NOT a Contract of Sale itself and neither does it apply only to select cargoes.. It is included in the sale contract relating to the trade transaction irrespective of what the declared cargo is..

Incoterms® rules also does not specify or deal with the time, place, method or currency of payment of the sale price.. This should form part of the contract of sale..

Incoterms® also does not deal with any legal, political, regulatory or intellectual property matters and most importantly, Incoterms® rules DOES NOT dictate or deal with the transfer of ownership or title of the goods..

Users must be very clear on these aspects as incorrect assumptions or interpretation of the rules will result in additional costs and delays..

6) Choosing rules that do not suit the requirement of the business

The seller and buyer must understand the nature of the business in each other’s countries and come to an agreement on the rules and regulations prevailing in their respective countries and what can and cannot be done..

For example, DDP terms places maximum responsibility on the seller.. Under these terms, the seller is responsible for the payment of import duty and all applicable taxes till delivery..

Therefore the seller must be sure that they understand the requirements and confident that they can undertake all these responsibilities..

Failure to do so could jeopardise the transaction adding to additional costs, risks, delays and potential loss of future business..

On the other extreme, EXW places maximum responsibility on the buyer and under these terms, the buyer is responsible from the time of loading of the goods at the seller’s premises including completing export clearance procedures which the buyer may not be au fait with..

Therefore the buyer must be sure that they understand the requirements and confident that they can undertake all these responsibilities..

Conclusion

Incoterms® rules were created to address the risk of misunderstanding and costly disputes in domestic and global trade where sale contracts may not have been adequately drafted..

As the volume and complexity of global trade increases so does the possibility of incorrect usage of Incoterms® rules..

As per the International Chamber of Commerce, the recently released Incoterms® 2020 rules seeks to “offer a simpler and clearer presentation of all the rules, featuring revised language, an expanded introduction, explanatory notes, and articles reordered to better reflect the logic of a sale transaction“..

But if you are struggling to learn and understand the rules and how to apply them, don’t worry, help is at hand..

ICC Academy, the educational arm of the ICC has created a new online training course – the Incoterms® 2020 Certificate which is designed to help users both experienced and inexperienced, a comprehensive and up-to-date understanding of the rules, avoid mistakes and save costs..

This course is the world’s only ICC-endorsed online training on the Incoterms® 2020 rules..

No other online training on the new rules can offer the same level of expertise and this course can be purchased online here..

So do yourself a favour and take this highly recommended course which will greatly enhance your knowledge on this crucial trade related subject..