Using Incoterms® 2010 in commodity sales contracts

Incoterms® 2010 are a set of standardised rules for the interpretation of international and domestic trade terms.  Incoterms 2010 are commonly used in commodity sales contracts to regulate aspects of the relationship between the buyer and the seller.  

In brief

Incoterms® 2010 are a set of standardised rules for the interpretation of international and domestic trade terms.  Incoterms® 2010 are commonly used in commodity sales contracts to regulate aspects of the relationship between the buyer and the seller.  Incoterms, which were first introduced by the International Chamber of Commerce (ICC) in 1936, were developed to address problems arising out of the inconsistent interpretation of trade terms amongst international trading partners and thereby reduce the number of disputes.  These rules have evolved over time to adapt to the changing nature of international and domestic trade including in relation to security, multi-modal transportation and electronic communications. 

Overview of Incoterms® 2010

There are 11 trade terms specified in Incoterms® 2010 which are divided into two categories – rules for any mode of transport¹ (including where there is no waterway transport at all) and rules for sea and inland waterway transport.²  These rules allocate certain costs and risks between the buyer and seller, and delineate responsibilities for practical matters such as customs formalities and duties, loading and unloading, and insurance. 

The most commonly used Incoterms® 2010 in the sale and purchase of resources commodities include Delivered at Place (DAP), Free on Board (FOB) and Cost, Insurance and Freight (CIF), each of which are described in further detail below. 

DAP means that the seller delivers when the goods are placed at the disposal of the buyer on the arriving means of transport ready for unloading at the named place of destination, not cleared for import.  The seller bears all risks involved in bringing the goods to the named place.  However, the seller has no obligation no clear the goods for import, pay any import duty or carry out any import customs formalities.  The seller must clear the goods for export, where applicable.  A requirement to clear goods for export would not apply, for example, in a domestic commodity sales contract.

FOB means that the seller delivers the goods on board the vessel nominated by the buyer at the named port of shipment or procures the goods already so delivered.  The risk of loss of, or damage to, the goods passes when the goods are on board the vessel, and the buyer bears all costs from that moment onwards.  The seller clears the goods for export, however the seller is not obliged to clear the goods for import, pay any import duty or carry out any import customs formalities.  In Incoterms® 2010, the phrase ‘ship’s rail’ is no longer used in FOB, CFR or CIF as a reference point at which cost and risk shifts from the seller to the buyer. 

CIF means that the seller delivers the goods on board the vessel or procures the goods already so delivered. The risk of loss of, or damage to, the goods passes when the goods are on board the vessel.  However, the seller must also contract, and pay the costs and freight necessary, to bring the goods to the named port of destination.  The seller also contracts for insurance cover against the buyer’s risk of loss of or damage to the goods during the carriage.  The seller clears the goods for export, however the seller has no obligation to clear the goods for import. 

Recommendations for using Incoterms® 2010 

No substitute for a sales contract: Although Incoterms® 2010 deal with a number of important matters relating to the sale and purchase of commodities, they are by no means a substitute for a sale of goods contract as they do not provide a comprehensive set of sale and purchase terms.  Incoterms® 2010 do not deal with matters such as price, payment mechanisms, specifications, force majeure, breach and termination, dispute resolution or governing law.  Even where the Incoterms® 2010 deal with a particular matter, the sale of goods contract may need to expand on the relevant obligations.  For example, under CIF the seller is required to obtain insurance only on minimum cover.  If the buyer requires the seller to effect more comprehensive insurance, then it must ensure that the seller is contractually obliged to do so. 

Choosing the right rule: When considering the use of Incoterms® 2010 in a commodity sales contract, it is important to carefully consider which rule is most appropriate in terms of the cost and risk allocation agreed between the parties, the method of transport and loading arrangements.  By way of example, if a container of goods is dispatched from a seller’s premises under an FOB arrangement then, even though the container is under the control of the carrier when it leaves the warehouse, the risk in the goods remains with the seller until the container is on board the nominated vessel.  If the seller intends for risk to pass when the container of goods leaves the warehouse under the control of the carrier then, as recommended by the ICC, FCA is the most appropriate ‘F term’.  Similarly, the ICC recommends the use of CIP, rather than CIF, for containerised goods which are typically handed over to a carrier before they are on board the vessel. 

Consistency with sales contracts and carriage contracts: The use of any Incoterms® 2010 in a sales contract must be consistent with the remainder of the sales contract in terms of cost and risk allocation, insurance obligations, liability for duties and loading or unloading arrangements, and should also be consistent with any harbour regulations.  The choice of rule should also be consistent with transportation or carriage contracts.  For example, under DAP and CIF the buyer is responsible for unloading at the port of destination.  However, if the seller’s contract of carriage includes unloading services at the port of destination, then the seller will not be able to recover its costs for unloading under its contract of carriage unless it is expressly agreed between the buyer and seller. 

Proper referencing: If the parties intend for an Incoterms® 2010 rule to apply to their contract, the rule must be clearly specified in the contract by properly referencing the chosen rule, naming the relevant place or port and referring to ‘Incoterms® 2010’.  Incoterms® 2010 can only work if the parties name a place or port, and will work best when the place or port is chosen as precisely as possible including a particular point in that place or port.  When using rules such as CIF, the parties may wish to specify both of the port of shipment and the port of destination.  There is a heightened risk of a dispute where the seller or the buyer (as applicable) is located some distance from a port or has the choice of several possible ports with different handling and shipping charges. 

In summary, it is important that care is taken when selecting and using Incoterms® 2010 to ensure that problems of interpretation and the risk of disputes are minimised. 

The article was written by Jay Leary, Partner and Louise Bell, Senior Associate, Brisbane.

Endnotes

1. Ex Works (EXW), Free Carrier (FCA), Carriage Paid To (CPT), Cost and Insurance Paid To (CIP), Delivered at Terminal (DAT), Delivered at Place (DAP) and Delivered Duty Paid (DDP). 
2. Free Alongside Ship (FAS), Free On Board (FOB), Cost and Freight (CFR) and Cost, Insurance and Freight (CIF).