International trade is both important and problematic.
Important, because we live in a globally interconnected economy where we depend on one another for commercial activity. At times this dependence is dangerous, as the problems created in one country may affect others.
Problematic, because international trade is not easy. As one of my former staff members used to say when trying to explain the complexity of export transactions to others in the organisation: when you export, you just don't whistle for a taxi. How true this is.
The purpose of this article is not to explore the various challenges and benefits of international trade transactions, as this would probably fill up a series of volumes. Rather, this article revisits the continuing problem of one aspect of international trade transactions that continues to create potential problems; that is, the incorrect application of Incoterms 2010 rules, based on the mode of transport and commercial practices.
Exporter Usage of Incoterms
Recent research in Australia has shown the following distribution of Incoterms international trade terms usage among exporters of manufactured goods to the Association of Southeast Asian Nations (ASEAN), as shown in Figure 1. It should be noted that this research was conducted just prior to the introduction of the Incoterms 2010, and the terms have been adjusted accordingly to reflect current usage.
Figure 1: Incoterms® 2010 Rules Usage by Exporters to ASEAN
There are some interesting data patterns that can be observed from Figure 1. The term Ex Works (EXW), that is transport neutral as far as the seller is concerned, is used in 18% of occasions. On further enquiry, it was discovered that the term is not actually being used as intended, and that indeed there are considerable variations.
Let me provide an example. A seller in Australia has contracted with a buyer in Japan for the supply of certain goods on an EXW basis. This means the seller is neither responsible for carriage nor border clearance.
The buyer in Japan has contracted a freight forwarder to pick up the goods at the seller's warehouse. The forwarder has advised the seller that they will need forwarding instructions from them and that they (the seller) will be shown as the shipper on the transport document. Furthermore, the seller discovers that the freight forwarder has been clearing the consignments for export, declaring the seller as the exporter.
"So what?" some may well ask. So what is that these practices are not correct. The seller has become alarmed about this, worrying about their risk exposure and asks what they can do. The simple answer to this is to revisit the Incoterms 2010 and apply them correctly, and that is what we are going to do now. (See the article, Incoterms Lesson: The Danger of Using Ex Works for Your Exports.)
Using an Appropriate Incoterms 2010 Trade Term
Imagine the conversation between the seller and their adviser on this issue. It may go something like this:
Adviser: Why did you provide the forwarding instructions to the freight forwarder?
Seller: Because they asked for them.
Adviser: Are you responsible for the contract of carriage?
Seller: No, the buyer is.
Adviser: Did you appoint the freight forwarder?
Seller: No, the buyer did.
Adviser: So, if you did not engage the freight forwarder and you are not a party to the contract of carriage, why would you complete the forwarding instructions that usually state that you are authorising the forwarder to do things on your behalf?
Seller: I am not sure. They asked us to do it, and they were quite emphatic that it was our responsibility.
Adviser: Well, the short answer to this problem is that you have no obligation to contract for carriage or make any arrangements for carriage and, in fact, you are not the exporter.
Seller: But the forwarder has told us that we need to be shown as the shipper on the transport document.
Adviser: The forwarder has not been engaged by you, and therefore, there is no contractual link between you and them. They ask what they like, but that does not mean they are going to get it. Who is paying them to perform the arrangement for clearance and carriage?
Seller: The buyer.
Adviser: And, therefore, you are not responsible for these charges, correct?
Seller: No, we have nothing to do with these.
Adviser: And you should have nothing to do with these processes. By the way, do you get a copy of the export declaration made to customs?
Seller: No. Why does it matter?
Adviser: Well, I would be concerned. You have no idea what the freight forwarder is declaring to customs, yet they are using your organisation's name in doing so. This is risky; far too risky for me. I would not be happy about it. If I am not exporting, my organisation should not be named anywhere.
Seller: So, what should I do?
Adviser: Here is a suggestion. Do not complete forwarding instructions. Do not have yourself shown as the shipper. Instead let the freight forwarder be shown as the shipper, as after all they are acting on behalf of the buyer under instructions. And one more thing, as you are selling EXW, at least under Australian legislation, you are not the exporter. Certainly that is how the taxation department looks at it, so do not have the freight forwarder list you as the seller on the customs export declaration. Again, they can list themselves as being the agent of the buyer.
(U.S. exporters should read the article, What the Heck Is a Routed Export Transaction?)
Seller: But will this not make it more complicated or messy?
Adviser: No, not really, but it may create problems for the buyer from a tax perspective. But I am not a tax expert, so you would need further advice.
Using Free Carrier (FCA) as Your Incoterm
Adviser: There is another option to overcome the issue of export clearance and potential buyer taxation liability at the local level. Sell Free Carrier (FCA), and make the delivery point your nominated works.
Seller: But this means that I have to do the export clearance and provide a transport document to the buyer.
Adviser: No, it does not mean all of that. Yes, you do have to provide export cleared goods to the buyer's agent (the freight forwarder). It means that the risk in transit will transfer from you to the buyer at the nominated premises. It does not mean that you have to provide a transport document, unless you agree to do so. If you do not want to enter into a contract of carriage, then you do not have to.
Does this make sense to you now? Do you understand where you stand on an EXW transaction and that you can use FCA instead to overcome some of the difficulties that EXW may present?
Seller: Yes, I get it now. Thanks a lot. This was helpful, but I have one more question. May I ask?
Adviser: Sure, go ahead.
Avoiding the FOB Incoterm for Container Shipments
Seller: We are sending goods in containers by sea, as you know, so why not use FOB? A lot of buyers seem to want to buy on this term, and the fact that the goods are shipped in containers does not seem to bother them at all. So what is the problem?
Adviser: The problem is not one, but many. First, we need to understand that the term FOB had been around for a long time before maritime container transport was invented. The term FOB has been questionable for nearly the past 50 years. The main issue has been the risk transfer point between the seller and the buyer in the FOB contract. In fact, in a rather famous court case of 1954, the judge expressed his concerns about the means by which risk would be transferred with the following words:
Only the most enthusiastic lawyer could watch with satisfaction the spectacle of liabilities shifting uneasily as the cargo sways at the end of the derrick across a notional perpendicular projecting from the ship's rail (Devlin J in Pyrene Co Ltd v. Scindia Navigation Co Ltd  2QB402 at 419).
The Incoterms themselves appear to have been somewhat unclear over the years. The Incoterms 1990 stated:
It should be noted that FOB, CFR and CIF all retain the traditional practice to deliver the goods on board the vessel. While, traditionally, the point of delivery of the goods according to the contract of sale coincided with the point for handing over the goods for carriage, contemporary transportation techniques create a considerable problem of 'synchronisation' between the contract of carriage and the contract of sale. Nowadays goods are usually delivered by the seller to the carrier before the goods are taken on board or sometimes even before the ship has arrived in the seaport. In such cases, merchants are advised to use such 'F-' or 'C-' terms that do not attach the handing over of the goods for carriage to shipment on board, namely FCA, CPT or CIP instead of FOB, CFR and CIF.
The Incoterms 2000 stated in part:
The buyer must bear all risks of loss of or damage to the goods from the time they have passed the ship's rail at the named port of shipment.
The Incoterms 2000 also stated:
This term can be used only for sea or inland waterways transport. If the parties do not intend to deliver the goods across the ship's rail [such as is the case for containerised traffic] the FCA term should be used.
The introduction to the Incoterms 2000 highlights the uneasy fit with containerisation:
The delivery point under FOB, which is the same under CFR and CIF, has been left unchanged in Incoterms 2000 in spite of a considerable debate. Although the notion under FOB to deliver the goods 'across the ship's rail' nowadays may seem inappropriate in many cases, it is nevertheless understood by merchants and applied in a manner which takes account the goods and the available loading facilities [emphasis added]. It was felt that a change of the FOB-point would create unnecessary confusion, particularly with respect to sale of commodities carried by sea typically under charter parties.
With all due respect to that statement, it is exactly why this is not well understood that problems arise. The Incoterms 2010 international trade terms make it quite clear that the term FOB is not the preferred choice for container traffic because, in practice, the container is invariably part of a multimodal movement.
In fact, a recent study on container movements conducted by the Port of Melbourne, Australia, reveals that 54% of export containers are staged. This means that these containers are not delivered directly from the exporter's premises to the wharf; rather, they go through third parties such as container packing warehouses, freight forwarders, containers parks, etc.
Prudent risk-management practices would have the risk transfer when the journey commences or when the seller loses control of the goods by handing them over to a third party. Indeed this is the case in FCA, CPT and CIP that are the multimodal answer to FOB, CFR and CIF.
But let's stick to FOB, particularly as there has been a change in the risk transfer point. Under Incoterms 2010, the risk transfer point under FOB is once the goods have been placed on the vessel. In the absence of a court case, at the time of writing, this is understood to mean that the whole consignment has to be loaded on board, but this does not mean stowed and lashed.
Seller: Look, that is very nice, but my buyer is comfortable with FOB, after all they have been doing this for years.
Adviser: If I had $5 for every time I heard, "We have been doing this for years," I would have retired a rich man long before I sat down to this conversation with you. Some say history is everything—yes it is, but to learn from, otherwise there is no progress. There is also another counterargument to the, "I have been doing for years" claim. That is, "If you stand in one place long enough, eventually a bus will come along and run you over."
Times change, processes change, and we need to respond to those. The buyer wants to minimise their risk and so does the seller. It is a matter of negotiation. I am going to put it to you that the seller is best placed to transfer the risk to the buyer when they (the seller) lose physical control of the goods. This is because they cannot control the risk without possession of the goods. Under these circumstances someone else has the goods, and that someone else should carry the risk.
In FOB transactions, the seller would be responsible for 10 or more uploads and offloads from the time the goods leave the export premises until they are loaded on to the vessel, as shown in Table 1. Do you really want to be responsible for this?
|Movement||# of Uploads/Offloads||Description|
|Export Warehouse to Container Packing Station (CPS)||2||On/Off|
|CPS to Forwarder||2||On/Off|
|Forwarder to Container Park||2||On/Off|
|Container Park to Wharf||2||On/Off|
|Wharf to Ship||2||On/Off|
|Total number of cargo movements for which the seller retains risk under the FOB Incoterm.||10 (or more depending on how many times the container is moved at the wharf, post acceptance).|
Table 1: 10+ product movements prior to loading;
how will the seller mitigate risks?
Seller: Well, when you put it like that, I don’t really want to retain all these risks, but the buyer wants me to deliver on board.
Adviser: I am going to suggest to you that you can negotiate with the buyer to take the goods to the wharf, but not load them on the vessel. You can do this by using FCA, XXX Port, Incoterms 2010 Rules. If you do this, you retain the risks until the cargo terminal operator has the goods made available to them, but terminal movements and loading on the vessel are at the risk and cost of the buyer. You need to explain to them that times have changed and so should contract delivery clauses. By the way, you still have no obligation to contract for carriage under these circumstances.
Seller: OK, I get it now. I guess that I can try to change what I have done in the past and convince the buyer to do the same.
Adviser: Yes, that's the spirit.
Incoterms 2010 CFR, CIF, CPT and CIP
Seller: ou said something about other terms before: CFR, CIF, CPT and CIP and risk transfer. I am not sure that you explained that completely though. Which is more appropriate?
Adviser: The CFR and CIF terms are an extension of FOB. CFR (Cost and Freight) requires the seller to enter into a contract of carriage and prepay the freight costs, and CIF (Cost, Insurance and Freight) requires the additional provision of insurance from the seller to the buyer. However, the important issue to remember is that the risk transfer under FOB, CFR and CIF are the same once the goods have been placed on board, regardless of who pays for the freight and the procurement of insurance.
As FOB is not suitable for container traffic, CFR and CIF are also not suitable for container traffic. In container traffic, the Incoterms 2010 Rules recommend the usage of FCA (Free Carrier), which I mentioned earlier, in place of FOB; CPT (Carriage Paid To) in place of CFR; and CIP (Carriage and Insurance Paid to) in place of CIF. It is important to note that the risk transfer point in FCA, CPT and CIP is the same, and this is essentially when the goods are handed over to a third party.
Seller: So exactly where does the risk transfer take place for CPT and CIP in container traffic?
Adviser: Under CPT and CIP, the risk transfers from seller to buyer when the goods are placedat the disposal of the buyer or their agent. What this usually means in practice is when the freight forwarder engaged by the buyer takes possession of the goods. The place where this takes place may vary from transaction to transaction and will depend on whether the forwarder is collecting the goods from you or you are delivering to them. And if there is no forwarder involved and you are delivering the container directly to the wharf, it will be at the cargo terminal at the wharf.
Seller: Ok, what about insurance then?
Adviser: The seller has to provide evidence of insurance to the buyer, most commonly by the provision of an insurance certificate, under CIF and CIP. A few words of warning about insurance. As the risk transfers at the beginning of the journey in the export country, the buyer carries the bulk of the transport risk. It therefore makes sense that the buyer should be particularly concerned about the insurance clauses to ensure they are adequate to their perceived risk needs.
We do have standard insurance clauses, commonly referred to as the Institute Cargo Clauses. These clauses have three levels of insurance for maritime traffic, and we need to specify which of these clauses forms part of the contract. Clauses A offer the highest form of insurance (these are called "All Risk" insurance, but they are not really all risk; rather the greatest risk coverage). Clauses B offer intermediate cover and Clauses C the minimum cover. Be careful because Clauses C do not cover vessel loading and unloading risks.
Seller: Sorry, but again, why have CPT or CIP instead of CFR and CIF? It seems the seller carries less risk under CPT and CIP.
Adviser: You may look at it that way, but let's imagine that you have delivered the goods at the cargo terminal at the wharf. This is a customs controlled area, and we can look at this as limbo land. The goods have not yet left the country physically, but in reality, their international journey has started as these are now destined to be loaded onto the vessel for export. So, the risk should transfer at that point because the cargo terminal operator acts as the agent of the shipping line. I hope this clarifies it.
Educating Exporters about the Correct Use of Incoterms
Seller: Okay, thanks, but what about Figure 1; at the start of our conversation you said that there were surprising patterns.
Adviser: Figure 1, (located near the top of this article) which shows the distribution of Incoterms usage among exporters of manufactured goods to the Association of Southeast Asian Nations (ASEAN), indicates a mismatch between the mode of transport and the choice of Incoterms. This is based on the commonly accepted fact that maritime trade accounts for more than 80% of all trade and the majority of goods are sent containerised around the world.
In Figure 1, I pointed out that these were usage rates for Australian manufactured goods to ASEAN (Burma, Brunei, Cambodia, Indonesia, Laos, Philippines, Malaysia, Singapore, Thailand and Vietnam). There is no evidence to suggest that world container usage rates are different to those found in the Australian research. If we look at the usage rates of FOB (15%), CFR (14%), and CIF (28%), these total to 57% of transactions. These terms are not recommended for use in container traffic movements, yet these continue to be used. There is a problem.
Seller: What can be done to remedy the incorrect choice of Incoterms?
Adviser: The answer to this question has to be education. Rules change, processes change, practices change, and people also need to change the way they do things in response to the changed environment in which they work. It will not be easy to do.
Some of the barriers will be historical—the "We have always done it this way" approach. Others will be cultural: "I cannot challenge my manager as they are more important than me in the hierarchy of the organisation." Yet changes need to be made, otherwise there will continue to be a higher risk element than need be.
Seller: Thanks for this. It seems to make sense, but as you say, not easy to do. One final question: if traders wanted to develop their own terms, could they do so?
Utilizing Non-Incoterm Trade Terms
Adviser: Yes, but it is a bit like re-inventing the wheel. The 11 Incoterms 2010 Rules pretty much cover every major shipment configuration. If you did want to develop your own terms you would need to make sure you comprehensively cover the issues identified in the Incoterms 2010. There may be a disadvantage in doing so, though, as the Incoterms have a long history and enjoy the benefit of court cases and precedent, something your own rules are unlikely to have.
I hope these conversations have provided some practical examples. In as much as the information given here is believed to be correct at the time of publishing, before taking any course of action, readers are advised to seek appropriate specialist advice on their particular circumstances.
This article was first published in three parts in November and December 2011 and January 2012. They have been combined into a single article, which has also been updated to include current information, links and formatting.