International trade transactions involve considerable negotiation between sellers and buyers to determine which party will pay for transportation, cargo insurance and other costs associated with shipping goods, as well as who is responsible for the goods at any given time during shipping. Given differences in culture, language and government regulations, negotiations have the potential for confusion and misunderstandings, which could result in irresolvable disputes.
In 1936, as part of their work towards rules-based trade, the International Chamber of Commerce (ICC) created a system of standardized international trade terms, known as the Incoterms® system, that represents different methods of transportation and assumption of risk and cost between sellers and buyers.
The use of the Incoterms® system is for domestic and international trade and refers to the parties as gender-neutral buyers and sellers.
New Incoterms® 2020 rules come into effect soon
Since their inception, Incoterms® rules have undergone seven revisions in order to reflect the development of international trade. At the time of this publication, Incoterms® rules 2010 are in use, but new Incoterms® 2020 rules have been introduced and will come into effect on January 1, 2020.
Contracts made under Incoterms® 2010 rules remain valid even after 2019. It is recommended that you use Incoterms® 2020 rules after 2019, however, parties to a contract for the sale of goods can agree to choose any version of the Incoterms® rules. It is important however, to clearly specify the chosen version of Incoterms® rules, either 2020 or 2010. If using Incoterms® 2010 in the contract of sale, be sure to understand what the older terms mean.
What are Incoterms® rules?
Incoterms® rules are used in negotiations to resolve specific terms and conditions of sales contracts by addressing the following:
- Costs: Who is responsible for the expenses associated with a shipment at a specific point in the shipment’s journey, such as export packing costs, the main transport costs and custom duties?
- Risks: Who bears the risk of loss or damage to the shipment, i.e. who is responsible for the goods during transit?
Incoterms® 2020 rules clearly define the obligations and responsibilities related to the transport of goods for both the seller and buyer. Incoterms® 2020 rules should not be considered a contract of sales. They do not:
- Provide specific details of transfer points, transport, and delivery (must be defined in sales contract)
- Determine ownership or title transfer of the goods
- Determine payment terms
- Apply to intangible services
- Define contract rights or dispute processes
- Relate to goods before or after delivery
- Specify the types of document to be issued or what their content should be
- Provide default Incoterms® rule
It is worth noting that Incoterms® rules include the use of electronic data information systems for customs purposes and other documentation and information exchange. The terms also include customs requirements for security for specific types of goods including chain of custody documentation.
Although many reference tables suggest that buyers must buy cargo insurance, the Incoterms® rules do not specify insurance as a requirement, except for two Incoterms® rules: CIF and CIP require the seller to purchase cargo insurance for the benefit of the buyer, i.e. the buyer can make a claim for loss or damage directly to the insurance company. The rest of the terms do not require the seller to obtain cargo insurance, nor do the terms require the buyer to obtain insurance.
The decision to purchase cargo insurance is the responsibility of buyers. However, given the cost of replacement and the loss of profit should cargo be lost or damaged, it is generally in buyers’ interest to obtain cargo insurance. Organizations should consider the cost of insurance in a per-transaction basis versus the utilization of an umbrella insurance that can cover all of their shipments.
Each of the Incoterms® rules represents a different situation involving the domestic or international movement of goods. Incoterms® rules also deal with the documentation that is required for international trade because they specify which parties are responsible for producing each document. Because documentary requirements vary so much between countries, this specification is very helpful in facilitating trade transactions.
What are the different categories of Incoterms® rules?
There are two categories of Incoterms® rules:
- Rules for any mode or modes of transportation
- Rules for sea and inland waterway transportation
Each Incoterms® rule is referred to by three letter abbreviations, and are usually listed by category of transport. It is important to note that there are several charts with images for Incoterms® rules online, and they tend to have significant differences. The key to learning Incoterms® rules is not to memorize, but to interpret each of the rules. Depending on the shipment’s point of departure and point of arrival, and the modes of transportations used, rules might or might not apply.
The first letter of the abbreviation provides information on the focus of that group of terms:
- Terms beginning with the letter E indicate that the seller’s responsibilities are fulfilled when the goods are made available for shipping by the buyer’s chosen carrier. There is only one rule under the E term: EXW.
- Terms beginning with the letter F refer to shipments where the primary cost of shipping, or main carriage, is not paid for by the seller.
- Terms beginning with the letter C refer to shipments where the seller pays for a portion of the shipping, usually the pre-carriage and main carriage, but the seller’s responsibility ends when the goods are delivered to the carrier somewhere on the seller’s side.
- Terms beginning with the letter D are destination contract terms because the seller delivers somewhere on the buyer’s side. The shipper or seller’s responsibility ends when the goods arrive at a predefined point. Delivery on the buyer’s side means that recognition of payment is deferred. With these terms, the seller pays the pre-carriage, main carriage and onward carriage.