In international trade, precise agreements about the responsibilities of buyers and sellers are important. One crucial aspect of these agreements is the use of Incoterms, or International Commercial Terms. These 11 standardized terms, established by the International Chamber of Commerce (ICC), define the roles, risks and costs associated with the transportation and delivery of goods. If your company is involved in international trade, understanding Incoterms is essential for smooth and efficient transactions.
To put it simply, Incoterms specify who is responsible for paying for and managing the shipment, insurance, documentation, customs clearance and other logistical activities. These terms cover various aspects of the transaction, including the transfer of ownership, the point at which risk is transferred from the seller to the buyer and the allocation of transportation costs and responsibilities.
Background on Incoterms
Incoterms are decided upon by 13 ICC commissions made up of private-sector experts from across the world. Incoterms were first conceived by the ICC in 1921, and the first Incoterms rules were created and designated as Incoterms in 1936. Since their creation, Incoterms have evolved into a codified worldwide contractual standard. They are periodically updated when international trade events require attention. Amendments and updates have taken place in 1953, 1967, 1976, 1980, 2000, 2010 and, most recently, 2020.
There are currently 11 Incoterms, each denoting distinct obligations and conditions. These terms are divided into two main categories: seven rules applicable to any mode of transportation and four rules specifically designed for maritime transport.
The seven Incoterms suitable for any mode of transport include:
EXW (Ex Works): Under this term, the seller’s responsibility ends once the goods are made available at their location. The buyer bears all risks and costs from that point forward.
FCA (Free Carrier): Here, the seller delivers the goods, cleared for export, to the carrier appointed by the buyer at a specified location. The risk transfers to the buyer once the goods are loaded in the buyer’s transport.
CPT (Carriage Paid To): The seller delivers the goods to the carrier, but they are responsible for transportation costs to the agreed-upon destination. The risk transfers to the buyer upon delivery to the carrier.
CIP (Carriage and Insurance Paid To): Similar to CPT, but the seller is also responsible for insuring the goods during transportation. Risk transfers to the buyer upon delivery to the carrier.
The amount of insurance that the seller must purchase has increased under Incoterms 2020 rules for CIP. The seller must purchase a broader level of insurance coverage than under the old Incoterms 2010 CIP rule. It must be at least 110% of the value of the goods and transportation expenses as detailed in Clause A of the Institute Cargo Clauses.
DPU (Delivered at Place Unloaded): Previously named Delivered at Terminal (DAT), this Incoterm has been renamed Delivered at Place Unloaded (DPU) because the buyer and/or seller may want the delivery of goods to occur somewhere other than a terminal.Â
The seller must pay for unlading the goods. Like DAP, the seller clears the goods for export and bears all risks and costs associated with delivering the goods to the named place, which can be a port or other named location in the foreign destination. From this point going forward, the buyer is responsible for all costs and risks.
DAP (Delivered at Place): The seller is responsible for delivering the goods to a named place, ready for unloading. The risk transfers to the buyer upon arrival at the named place.
DDP (Delivered Duty Paid): Here, the seller bears all risks and costs associated with delivering the goods to the named destination, including duties and taxes. The goods are considered delivered once they are ready for unloading.
The four Incoterms specifically tailored for maritime transport include:
FAS (Free Alongside Ship): The seller delivers the goods, cleared for export, alongside the vessel at the named port. The buyer bears all risks and costs from that point forward.
FOB (Free on Board): The seller is responsible for delivering the goods, cleared for export, on board the vessel at the named port. The risk transfers to the buyer once the goods pass over the ship’s rail.
CFR (Cost and Freight): The seller delivers the goods on board the vessel at the named port of shipment. However, they are also responsible for the cost of freight to the destination port. Risk transfers to the buyer upon delivery on board.
CIF (Cost, Insurance, and Freight): Similar to CFR, but the seller bears the cost of freight and insurance for the goods during transportation. The risk transfers to the buyer upon delivery on board.
What Incoterms do not cover:
There are specific instances that Incoterms will not cover. Incoterms do not:
- Address all the conditions of a saleÂ
- Identify the goods being sold nor list the contract price
- Reference the method or timing of payment negotiated between the seller and buyer  Â
- Determine when the title, or ownership of the goods, passes from the seller to the buyer Â
- Specify which documents must be provided by the seller to the buyer to facilitate the customs clearance process in the buyer’s country Â
- Address liability for the failure to provide the goods in conformity with the contract of sale, delayed delivery, or dispute resolution mechanisms
The bottom line
Understanding and correctly implementing Incoterms is important for avoiding misunderstandings, disputes and unexpected costs. By clearly defining the responsibilities of both parties, these standardized terms facilitate smoother transactions and foster trust between international trade partners. If your company is buying or selling international goods, investing time and resources in understanding Incoterms is a critical aspect of ensuring a successful and profitable trade operation.
Please reach out to our team if you have any questions regarding Incoterms.