If you are importing or exporting goods, knowing your Incoterms is essential to understanding exactly who is responsible for what in the supply chain, and being able to arrange for things like loading, transportation and insurance cover, where applicable.
The following guide will help to simplify the freight shipping process. We explain what is meant by Incoterms and why these terms are so important, with definitions of the different types of terms used and how to choose the right one for your particular shipment.
What are Incoterms?
Short for ‘International Commercial Terms’, Incoterms are the standardised terms used in contracts for the sale and purchase of goods when shipping goods internationally. They are the world’s essential terms for those engaging in the import and export of global trade.
The International Chamber of Commerce (ICC) is responsible for publishing Incoterms, with Incoterms 2020 representing the most recent edition. It is open to the parties to a sales contract to use a different version, where the previous Incoterms 2010 version is still in effect. It is also possible to use variants of the previous or existing Incoterms rules, although the ICC recommends using the most recent rules in their original, unaltered format. This is because there are key changes within these rules to reflect the modern global business environment. Incoterms 2020 also features a more in-depth introduction and explanatory notes to help first-time users select the appropriate Incoterm for their transaction.
Other clauses for global trade exist around the world, including the Harmonised Tariff Schedule of the United States. However, Incoterms have very precise meanings for the sale of goods on a universal basis and do not include trade terms codified for national purposes.
Why are Incoterms important?
The ICC, set up to help facilitate international trade over a century ago, published the first ever Incoterms rules back in 1936. With different trade practices and legal interpretations between importers and exporters around the world, the standardisation of international commercial terms continues to be required to provide clarity and predictability for business-to-business transactions. Together with a common set of rules and guidelines, Incoterms are now regarded as a necessary part of the daily language within a global trade context, where they provide important and well-established guidance to traders, transporters and insurers alike.
Incoterms are essentially a set of internationally recognised rules which are used to define the responsibilities of the seller and buyer for the shipment of goods. The term selected for a particular shipment will then clearly set out how far along into the shipping process the seller will ensure that goods are moved, and at what point responsibility for the goods in question will transfer from the seller to the buyer, and the buyer takes over that process.
Each Incoterms rule will clarify the tasks, risks and costs to be borne by both the seller and buyer, clearly defining who is responsible for what at various points in the context of each step of the transaction, including: loading, delivery to port and export customs; unloading and loading at port of export; transit to destination; cargo insurance; unloading and re-loading at port of import; carriage to destination; as well as customs clearance and any import duties.
In broad terms, the Incoterms rules describe three key things:
- Obligations: who does what as between the parties, for example, who organises carriage or insurance of the goods, or who obtains the shipping documents and any licences
- Risk: where and when the seller is deemed to ‘deliver’ the goods, in this way identifying the point at which risk for the shipment transfers from the seller to the buyer, and
- Costs: who is responsible for which costs, such as transport and loading/unloading costs.
The Incoterms rules cover these three different areas in a set of ten articles, numbered A1/B1 etc, with ‘A’ representing the seller’s obligations and ‘B’ representing the buyer’s obligations.
What are the different types of Incoterms?
There are 11 Incoterms rules in total, grouped into two categories to reflect modes of transport. Once an Incoterm has been selected by the parties, this will be incorporated into the contract of sale, and clearly stated on relevant shipping documents.
Next to the selected three-letter trade term, the contractual and shipping documents should also include the name of a specific port, place or point, typically to indicate where the goods are ‘delivered’. This is the point at which the risk transfers from seller to buyer. The named place may also specify the point to which the seller must organise and pay for carriage.
Of the 11 Incoterms, there are seven for any mode or modes of transport, and four for sea and inland waterway transport. Below we set out each of these terms, grouped into their respective categories, together with a brief explanation of their meanings:
The terms applicable to any mode or modes of transport
EXW (Ex Works): this means the seller delivers when they place the goods at the buyer’s disposal at either the seller’s premises or another named place, for example, a factory or warehouse. The seller will not be required to load the goods onto any collecting vehicle, nor do they need to clear the goods for export, where applicable.
FCA (Free Carrier): this means the seller delivers the goods to the carrier at either the seller’s premises or another named place. The parties should clearly specify the point within the named place of delivery, as this is the point at which risk passes to the buyer.
CPT (Carriage Paid To): this means the seller delivers the goods to the carrier at an agreed place. The seller must arrange and pay for the costs of carriage to bring the goods to the named place of destination.
CIP (Carriage and Insurance Paid To): this means the seller delivers the goods to the carrier at an agreed place, and arranges and pays for the costs of carriage to bring the goods to the named place of destination. The seller must also arrange for insurance cover against the buyer’s risk of any loss or damage. However, the seller is only obligated to obtain insurance on minimum cover, where agreement must be reached for more insurance protection or the buyer must arrange their own extra insurance.
DAP (Delivered at Place): this means the seller delivers when the goods are placed at the buyer’s disposal on the arriving means of transport at the named place of destination. The seller will bear all risks of bringing the goods to that place.
DPU (Delivered at Place Unloaded): this means the seller delivers once the goods, having been unloaded from the arriving means of transport, are placed at the buyer’s disposal at the named place of destination. The seller will bear all risks associated with bringing the goods to, and unloading them, at the named place.
DDP (Delivered Duty Paid): this means the seller delivers the goods when the goods are placed at the buyer’s disposal and are cleared for import on the arriving means of transport ready for unloading at the named place of destination. The seller will bear all the costs and risks involved in bringing the goods to the named place. They will also be required to clear the goods, pay any duty owed and complete all customs formalities.
The terms for sea & inland waterway transport
FAS (Free Alongside Ship): this means the seller delivers when the goods are placed alongside the vessel, for example, on a quay or barge, as nominated by the buyer at the named port of shipment. The risk of any loss or damage to the goods passes when the goods are alongside the ship, where the buyer will bear all costs from that point on.
FOB (Free On Board): this means the seller delivers the goods on board the vessel, as nominated by the buyer at the named port of shipment, or they procure the goods already delivered. The risk of any loss or damage to the goods will pass when the goods are on board the vessel, where the buyer will bears all costs from that point onwards.
CFR (Cost and Freight): this means that the seller delivers the goods on board the vessel or they procure the goods already so delivered. The risk of any loss or damage to the goods will pass when the goods are on board the vessel. The seller must arrange and pay for the costs and freight to bring the goods to the named port of destination.
CIF (Cost Insurance and Freight): this means the seller delivers the goods on board the vessel or they procure the goods already delivered to it. The risk of any loss or damage to the goods will pass when the goods are on board the vessel. The seller must arrange and pay for the costs and freight to bring the goods to the named port of destination. The seller must also arrange for minimum insurance cover against the buyer’s risk of any loss or damage, where agreement for additional insurance protection must be reached between the parties or the buyer must arrange their own extra insurance.
Under the Incoterms 2010 version, DPU was previously DAT (Delivered at Terminal), which appeared before DAP (Delivered at Place). DAT has simply been renamed and moved to more accurately reflect the content of the rule. The revised rule is designed to emphasise that the place of destination can be any place and not just a ‘terminal’, and to underscore the sole difference between Delivered at Place (DAP) and Delivered at Place Unloaded (DPU). Under DAP the seller does not unload the goods, and under DPU the seller does, and since delivery under DAP happens before unloading, the newly named DPU is now presented after DAP.
Which Incoterms should be used?
When it comes to which Incoterm to use, choosing the one that is right for your particular shipment will depend on a number of different factors, including what type of goods you are shipping, your previous experience as a shipper, your relationship with your supplier and your budget for freight costs. Much will also turn on the mode or modes of transport used, whether by road, rail, air and/or sea. Most Incoterms are applicable for any mode of transport, although the exceptions are FAS, FOB, CFR and CIF, where these are used for sea freight only.
In some cases, most of the costs and risks will be the responsibility of the buyer while, in others, the seller will be responsible for all the costs and risks until arrival of the goods at their final destination. For example, when using EXW (Ex Works), the buyer will assume responsibility at the seller’s warehouse and take charge of everything, from transportation to insurance, while DDP (Delivered Duty Paid) places these obligations on the seller. They will burden all the costs and risks of transport, insurance and even customs clearance.
Importers and exporters should always consider which Incoterm is best for them before any contract of sale is negotiated, as this can help to prevent unexpected costs and unnecessary complications later on. Equally, when importing or exporting goods, costs can quickly escalate and the risks can be significant, so it is vital that the contract of sale, and the Incoterm incorporated into this, accurately reflects your intentions. Importantly, Incoterms are not, in themselves, a contract of sale, and are no substitute for one. This means that clear contractual provision must be made for the transfer of ownership of the goods sold, among other things.
If you would like the Incoterms 2020 rules to apply to your transaction, this must be made clear in the contract, through words such as: “[the chosen Incoterms rule] [the named port, place or point] Incoterms 2020”. It is imperative that if you choose any previous version of the Incoterms rules, that the edition year is stated in the contract, where absent any year, the Incoterms 2020 rules will usually apply by default. For the substantive terms of the contract, such as transfer of title, price and payment, expert legal advice should always be sought.
Author
Gill Laing is a qualified Legal Researcher & Analyst with niche specialisms in Law, Tax, Human Resources, Immigration & Employment Law.
Gill is a Multiple Business Owner and the Managing Director of Prof Services - a Marketing & Content Agency for the Professional Services Sector.
