Incoterms® and Commercial Contracts

Why should importers and exporters use and understand the Incoterms® rules in detail?

In order to understand the value of the Incoterms® rules, we might ask ourselves: what would happen if a trader forgot to use the Incoterms® rules, or failed to understand the allocation of risks/obligations thereunder?

Let us consider the example of a transaction where the sale contract (or at least the pro forma invoice, if there is no sale contract) mentions 'FCA' but does not specifically mention 'Incoterms® 2010' or even 'Incoterms® rules'. In such a case, if a dispute or uncertainty should arise, the traders would first have to ask themselves the preliminary question – where will we look for a definitive interpretation of FCA? Who decides what FCA means? The courts? ICC? In the absence of a specific reference to the Incoterms® rules in the contract of sale, it is possible that the only way to arrive at a definitive interpretation is to look to the national law. Unfortunately, this is a potentially complicated undertaking, as it requires one to ascertain which national law is applicable to the contract, which in turn requires an analysis of the conflict of laws rules of any national law that might be applied to the contract. Such a procedure sounds complicated, and it is. If there is litigation over the dispute, lawyers' time may have to be spent studying all pertinent jurisprudence on trade terms, and this analysis can be very expensive. All of this is unnecessary if the parties simply remember to take the precaution of specifically incorporating the Incoterms® rules into the contract of sale.

Many international traders, unfortunately, have only a general idea of the differences between such Incoterms® rules as EXW, FCA, FOB, CIF or DDP. As a result, they are unprepared for certain common contingencies with respect to transfer of risk, loading/ unloading, customs clearance and insurance. Thus, for example one of the most common questions asked the ICC about the Incoterms® rules is: Who is responsible for loading (or unloading) the goods? As a matter of fact, the rule on loading varies from one Incoterms® rule to another, and this is an important area in which international trade professionals should develop their understanding.

In light of the above, traders clearly need to understand the nature, extent and limitations of the Incoterms® rules' coverage. The Incoterms® rules do not cover all possible legal or practical issues arising out of an international sale. The Incoterms® rules are merely a sort of contractual shorthand that allows the parties to easily specify their understanding as to: 1) the transport costs that the seller will cover; 2) the point at which risk of loss will be transferred from seller to buyer; 3) who must handle customs formalities and pay duties; and, 4) in the case of CIF and CIP, what are the responsibilities of the seller to provide insurance cover. All other important details should be dealt with specifically in the contract of sale.

For example, there is nothing in the Incoterms® rules on how the seller should transport the goods to the named delivery point. Thus, if a sale is 'FCA Terminal 4, Buenos Aires Airport, Incoterms® 2010' the buyer has no control – under the Incoterms® rules – over how the seller gets the goods to Buenos Aires; that is up to the seller, and is considered outside the remit of the FCA rule. However, in some cases it may be very important to the buyer that the goods be transported in a certain way, for example, in refrigerated containers. If this is the case, the buyer must specify in the contract how the goods should be transported up to the delivery point.

The Incoterms® rules cannot be expected to make up for a contract that is not sufficiently precise. In many cases it is advisable to include in the sales contract precise details on exact place and method of delivery, allocation of loading and/or unloading charges, extent of insurance, and mode of transport.

The Incoterms® rules cover only those cases where one party has an obligation to the other party to do something. The Incoterms® rules do not indicate when a trader should do something because it is prudent or advisable. This is frequently misunderstood. Thus, traders will ask why the seller is not obliged to insure the merchandise under a DDP sale, since it would seem obvious that the seller has to be responsible for the goods all the way to destination. Yet this approach confuses a business need with a legal obligation – the Incoterms® rules refer only to the legal obligations, and are silent on matters of common business needs and usages.

Thus, similarly, a buyer of merchandise in an FCA contract has no obligation to take out insurance, and the Incoterms® rule FCA is silent on this matter. But since the risk of loss is on the buyer once the goods have been loaded, the buyer would be very foolish not to take out insurance.

The Incoterms® rules and transfer of title: what relation?

One of the key areas not governed by the Incoterms® rules is that of the transfer of property or title to goods. In fact, there is no international legal harmonization as regards the transfer or title or property in international transactions. Thus, the matter is not resolved by the 1980 Vienna Convention on the International Sale of Goods (CISG).

Since the law on transfer of property rights differs from country to country, the parties to a contract of sale may wish to specifically provide for this matter in the contract, but only after determining what is permissible under the applicable law. Under many jurisdictions it is possible for the seller to retain title and ownership of the property until the purchase price is paid in full, even if this takes years. This 'retention of title' by the seller is usually set out in a clause in the contract of sale (see discussion above in the section on Contract of Sale). Thus, one typical question raised by newcomers to the Incoterms® rules is: Where are the provisions on transfer of property in the Incoterms® rules? Such a question may arise, for example, because the goods have been damaged or lost during transit, and the seller may be eager to find out if the damage occurred when the goods were still his or her property, or if the damage took place only after the goods had become the property of the buyer; this question is primarily of interest for insurance purposes.

However, these questions remain largely governed by national law alone. It is possible for the parties to add to their contracts, in addition to the Incoterms® rule, a clause that clearly establishes the place and manner of transfer of ownership/title in the goods. Drafting such clauses requires knowledge of the transfer of property laws of both countries involved, as well as their respective conflict of law rules with regard to such property laws. Seeking specialist advice is advisable.