Have you ever come across abbreviations like ‘FOB’ or ‘CIF’ in a contract and wondered what they really mean? Or perhaps you’ve signed a contract and later realized you didn’t fully understand your obligations? Understanding Incoterms can help you avoid making costly mistakes in international sale contracts.
After reading this article you will have a clearer understanding of what Incoterms are, the various types, and how to incorporate them into your contracts with confidence.
1. What are Incoterms and how are they used?
Incoterms are standardised “international commercial terms” used in international sales contracts to define the responsibilities of sellers and buyers in export transactions. The terms clarify the tasks of both parties, as well as the costs and risks for both parties associated with the sale transaction.
Incoterms were developed by the International Chamber of Commerce (ICC) in 1936 and are internationally recognised. The latest version of Incoterms was released in 2020 and is the most current.
There are currently 11 distinct Incoterms.
2. Categories of Incoterms
Incoterms can be divided into two categories:
- Incoterms used for international sales contracts where goods are transported exclusively by water, and
- Incoterms used for international sales contracts where goods are transported using any mode of transportation.
3. Incoterms used when goods are transported exclusively by water
3.1. Free Alongside Ship (FAS)
When this Incoterm is used in a contract, the seller is considered to have delivered the goods once they are placed alongside the ship at the agreed-upon port of shipment. The buyer assumes responsibility for the transportation costs and the risk of loss or damage of the goods during transit from that moment onward. The buyer is responsible for loading the goods onto the outgoing ship. Both parties have the option to obtain transport insurance for the period during which they are responsible for transporting the goods.
3.2. Free on Board (FOB)
By including this Incoterm in a contract, the seller is responsible for both the risk of loss or damage to the goods and the costs of delivering the goods on board the ship selected by the buyer. Thereafter, the buyer becomes responsible for the transportation costs and risks associated with the goods. Both parties have the option to obtain transport insurance for the period during which they are responsible for transporting the goods.
3.3. Cost and Freight (CFR)
If this Incoterm is included in a contract, the seller agrees to bear the risk of loss or damage to the goods until they are delivered on board the (first) ship at the agreed-upon port of shipment. Thereafter, the risks related to the transportation of the goods pass to the buyer. Both parties have the option to obtain transport insurance for the period during which they are responsible for transporting the goods.
The seller is also responsible for the transportation costs up to the agreed-upon port of destination, including the unloading of the goods at the port. Thereafter, the buyer is responsible for the transportation costs to the final destination.
3.4. Cost Insurance and Freight (CIF)
This Incoterm is similar to CFR, but with the key difference that the seller is required to procure insurance for the transportation of the goods from the port of shipment to the port of destination. The risks and losses for both the seller and buyer remain the same as under CFR, as well as the costs borne by the seller.
4. Incoterms used when goods are transported by any means
4.1. Ex Works (EW)
Including this Incoterm in a contract greatly favours the seller. The seller’s only obligation is to ensure that the goods are available for pick-up at an agreed-upon location. From that point onward, the buyer is responsible for loading the goods, arranging transportation, and bearing all associated costs. The buyer also assumes the risk of loss or damage to the goods from that moment onward.
4.2. Free Carrier (FCA)
Under this Incoterm, the seller is responsible for delivering the goods to an agreed-upon external location. If the agreed location is at the seller’s premises, the seller must also load the goods onto the buyer’s carrier. However, if the location is external to the seller’s premises, the seller is not responsible or loading the goods. Once the goods have been delivered to the buyer’s carrier, the buyer assumes responsibility for the costs and risks of loss or damage to the goods. Both parties may choose to obtain transport insurance to cover the period during which they are responsible for transporting the goods.
4.3. Carriage Paid To (CPT)
When this Incoterm is used in a contract, the parties agree that the risk of loss or damage to goods passes from the seller to the buyer upon delivery of the goods to the buyer’s (first) carrier, irrespective of the location. The seller is responsible for the transportation costs until the agreed-upon destination. Both parties have the option to obtain transport insurance for the period during which they are responsible for transporting the goods.
4.4. Carriage and Insurance Paid To (CIP)
This Incoterm is similar to CPT, but with the key difference that the seller is required to procure insurance for the transportation of the goods from the destination where they are delivered to the buyer’s (first) carrier and loaded, up to the agreed place of destination. The risks and losses for both the seller and buyer remain the same as under CPT, as well as the costs borne by the seller.
4.5. Delivered At Place (DAP)
Under the DAP Incoterm, the seller is responsible for arranging and paying for the transportation of the goods to a destination agreed upon by both parties. The seller also bears the risk of loss or damage to the goods until the moment they are delivered to the agreed place of destination, before unloading takes place. After delivery, the buyer assumes responsibility for the unloading costs and bears the risk of loss or damage to the goods.
4.6. Delivered at Place Unloaded (DPU)
The DPU Incoterm is similar to DAP; but with one key difference: the seller bears the risk of loss or damage to the goods until they have been unloaded by the seller and handed over to the buyer. This differs from DAP, where the seller’s risk ends before the goods are unloaded. The costs incurred by the seller remain the same as under DAP.
4.7. Delivered Duty Paid (DDP)
Under the DDP Incoterm, the seller assumes the most obligations of any Incoterm. The seller is responsible for arranging and paying for the transportation of the goods to an agreed-upon destination, as well as handling the customs clearance and paying import duties in the destination country. Additionally, the seller bears the risk of loss or damage to the goods from the moment they are dispatched until the goods are handed over to the buyer at the agreed-upon place.
5. How to choose the right Incoterm for your contract
Choosing the correct Incoterm for your contract is crucial to clearly defining the responsibilities, risks, and costs for both parties. To ensure you choose the correct Incoterm, consider the following three questions:
- What type of transport will be used?
- How much responsibility are you willing to assume?
- Do you have the necessary knowledge and expertise to manage transportation of and customs clearance?
By answering these questions, you will be able to select the Incoterm that best aligns with your needs and business capabilities.
6. How to incorporate Incoterms in Contracts
Although Incoterms were primarily developed for use in international sale contracts, they can also be applied in national contracts by specifying the abbreviation and destination (e.g. DPU Germany). While it is generally recommended to use the latest version of Incoterms (Incoterms 2020), it is permissible to reference previous versions (e.g., 2010) in your contract. However, it is essential to clearly reference the applicable version of Incoterms by stating which edition is being used (e.g. Incoterms 2010 or Incoterms 2020).
If you are still unsure about how to use Incoterms in your contracts or need help choosing the right one, our experts are always here to assist. Contact our firm today for personalised advice and ensure that your contracts are crystal clear.
To stay up to date with the latest developments regarding Incoterms, as set by the International Chamber of Commerce, visit their official website.
