Incoterms_® and Commercial Contracts

1.1 Scope of book

This book provides a concise introduction to export and import practices, with a focus on the legal, payment and transport aspects of international trade in tangible goods. It also covers the basic forms of international distribution, including agency, distributorship and franchising (and other common international business contracts), as well as the international aspects of e-commerce and intellectual property.

1.2 Commercial sales and the law

“Commercial sales” refers to the sale of tangible goods between merchants, sometimes also referred to as “wholesale” or “B2B” transactions. Commercial sales are covered by special systems of law and legal codes in domestic transactions and by a specific treaty in the case of international transactions, the UN Convention on Contracts for the International Sale of Goods (CISG).

The definition of commercial sales excludes sales to consumers (who are not merchants) as well as sales of financial instruments, real estate or intellectual property. International commercial transactions are similar to domestic commercial transactions in that they make use of standard forms such as pro forma invoices and purchase orders, bills of lading, etc. Business people familiar with domestic commercial transactions should find it relatively easy to learn the basics of export-import. However, the additional distances, currencies and other variables involved in international trade compel us to use instruments (such as Incoterms and the letter of credit) that are not commonly used in domestic trade.

1.3 The risks of exporting and importing

While risk is a factor in all business transactions, international trade involves additional risks:

International transport involves greater distances, with cargo more often changing hands or undergoing prolonged storage, so that there is a greater risk of damage, loss or theft than in domestic trade. Consequently, exporters and importers must understand their legal rights vis-à-vis carriers. If the goods have been damaged through the carrier’s fault or negligence, the carrier’s liability may depend on the contractual provisions and shipping information
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contained in the bill of lading (a document which evidences the terms of the contract of carriage, examined at length in Chapter 13). Similarly, the importer needs to understand the extent of coverage provided by the insurance policy, because it may need to claim under its provisions if the goods are damaged during transport.

Since it can be difficult for exporters to verify the creditworthiness of foreign buyers there is an increased risk of non-payment, late payment or outright fraud. Consequently, wary exporters frequently insist on payment by irrevocable documentary credit (examined in detail in Chapter 9), or make use of other security devices (see Chapter 11).

Importers may find it difficult to physically check the quality of the goods before shipment, and it may happen that they do not receive goods of the quality they had expected. One way of avoiding this is for the importer to insist on provision of an inspection certificate. Pre-shipment inspection is very important in international trade and is frequently a documentary condition of letters of credit. Inspection certificates may be provided by highly specialized, independent inspection companies.

If a price has been set in a particular currency in an international contract, subsequent exchange rate fluctuations (between the contract currency and the accounting currencies of the parties) will inevitably benefit one party at the cost of the other. The easiest solution for a party wishing to avoid uncertainty is to denominate the contract price in one’s own currency. This is useful for small firms, because it standardizes the currency of payment, which can facilitate accounting and cash-flow projections. However, in many cases it is commercially necessary to make quotes in various foreign currencies. In such cases, exporters will seek to protect themselves from exchange rate fluctuations, such as by purchasing foreign exchange forward or option contracts, sometimes referred to as hedge contracts.

Sometimes an exporter or importer is compelled to agree to a contract that is made subject to the jurisdiction of foreign courts. In such cases, it can be virtually impossible - or at a minimum, quite expensive - to resolve disputes legally. This is why both exporters and importers would like to impose their own choice of law and choice of forum clauses, requiring disputes to be settled in their home courts. One way out of the resulting negotiating impasse is to contractually stipulate that dispute resolution will be by international commercial arbitration, such as that supervised by the ICC International Court of Arbitration (see Chapter 7).

A strike, natural disaster or war may render delivery impossible. Unexpected events may also dramatically alter the cost of transport by raising the price of shipping fuel or by closing off the most economical routes. Well-drafted contractual force majeure provisions can help protect the parties; these are dealt with further in Chapter 4.

The normal commercial risks involved in marketing any product become magnified in the export context because of the additional investments required by an export programme. For example, a market which has been steadily growing for several years may suddenly decline (e.g., due to exchange rate instability) before an exporter can amortize investments in local distribution. Companies should begin by seriously considering whether or not to export at all. Some firms are not quite ready to export, and some may never be able to compete
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internationally and should concentrate on domestic niches. To launch a proper export effort requires the commitment of resources that can be irretrievably lost in the event of failure. Even leading companies have suffered financially after investing heavily and overoptimistically in export operations that subsequently foundered.

1.4 Standard documents and systems: understanding “documentary sales”

International trade professionals build a transaction from the foundation of a well-drafted contract, which is often found in the use of a pro forma invoice or purchase order accompanied by precise legal terms and conditions. The sale agreement between exporter and importer receives special attention as the “master” contract in the export-import transaction, as it may determine many of the other related obligations, such as provision of the correct transport document (e.g. bill of lading or waybill) and appropriate payment-related documents (e.g., documentary credit).

Export-import risk management is based on documentary systems and customs that translate the rights, costs and responsibilities of the export process into documentary equivalents.

The export process is actually twofold, involving:

1. the shipment of physical goods, and
2. the complementary documentary exchanges.

This documentary system developed centuries ago through transactions referred to as “documentary sales” under the classic “shipment” trade terms, FOB and CIF.

Documentary sales have been considered by courts of law to be transactions in documents to the same extent that they are transactions in goods. It is just as important for the exporter to provide the correct documents as it is for it to provide the correct goods.

The key documents in this scheme can be quickly enumerated:

1. the contract of sale,
2. bill of lading (or other transport document),
3. payment–related documents (particularly the documentary credit and bill of exchange or bank draft), and
4. insurance document (policy, certificate or note).

Inspection of the above documents must be as painstaking as that related to the goods.

While there are advantages to this documentary system, there are also inherent risks. Paper documents are susceptible to forgery, alteration or misrepresentation. In some cases, an importer may find that the documents presented are apparently conforming, but that the goods delivered contain defects. The unfortunate importer may be unable to stop or avoid payment despite the exporter’s breach of contract. Importers may protect themselves from these risks by requiring the exporter to provide a pre-inspection certificate.

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On the exporter’s side, the documentary system has a drawback in that the fulfilment of physical delivery does not excuse documentary failures. An exporter may substantially perform a contract and yet fail to receive prompt or complete payment as a result of the exporter’s failure to comply with a documentary formality. This is a problem particularly for small exporters that have requested payment by documentary credit, but then find that their own faulty record-keeping makes it impossible for them to present conforming documents in time. What was intended to be an irrevocable credit now becomes a credit conditional upon the importer’s willingness to waive objections to the documentary discrepancies. The all-too-common result is delayed payment or other payment difficulties.

The only solution, for exporters and importers alike, is to make sure before entering into an international contract of sale that they thoroughly understand the documentary obligations that will be required of them.

Documentary safeguards, such as those provided by the documentary credit or inspection certificate, can only do part of the overall job of countering international trade risk. Other important services - such as credit investigations, export credit insurance and factoring - can help complete the risk-reduction plan. Moreover, traders should in general adopt verification procedures for all proposed international transactions. International fraud is a reality, and all trade professionals should be aware of the need to verify credentials and deal only with established and well-known partners.

1.5 Cultural and language differences

Misunderstandings in international transactions can arise because the parties come from different cultures and express themselves with differing vocabularies.

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Not only do cultural and business practices differ across national borders, there are also differing tax systems, regulations, accounting methods, currency controls and customs systems. The same legal term, such as “agent”, may have different legal connotations in different jurisdictions. Technical and product standards may differ, as well as consumer tastes. Providing after-sales service to remote markets may be prohibitively expensive, with the result that foreign products can acquire a bad reputation. Also, translating marketing brochures and technical manuals into foreign languages can be unexpectedly time-consuming and costly, especially when the documents must be frequently revised or updated.

1.6 Solutions: examples of risk management for export-import

Well-established professional practices enable traders to manage the above–described risks:

• The risk of misunderstanding, e.g., risk of disagreements over payment terms or quality conditions; risk of having to undertake a legal action in a foreign, biased forum

• substantial credit checking of counterparties; demanding references
• negotiating firmly for minimum legal protection, or refusing the deal
• use of well–drafted contracts and general terms and conditions, including provisions for choice of law/forum, arbitration
• specifying Incoterms® 2010
• well-researched and well-prepared contract negotiations

• The exporter’s risk of non–payment

• use of suitable payment securities, such as documentary credits under UCP 600
• alternative: using open account terms backed by a standby credit or demand guarantee

• The importer’s risk that goods of inadequate quality will be shipped

• requirement of inspection certificates made out by recognized authorities

• The risk that the other party will not go ahead with performance as promised

• partial advance payment, e.g., bank guarantees, standby credits; also, use of performance bonds

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• The risk that the goods will be damaged in transit or lost, or that part of the shipment will be stolen.

• sufficient insurance coverage against all likely contingencies and attention to stipulations in the bill of lading
• proper review of conditions in the contract of carriage
• proper packaging and shipment instructions

• The exporter’s risk that an apparently good customer will manage to receive the goods and then seek to avoid paying; the importer’s risk of outright fraud

• thorough credit investigations of prospective partners
• membership in and/or utilization of ICC Commercial Crime Services.

1.7 International organizations and chambers of commerce

1.7.1 Chambers of commerce

Local, regional and national chambers of commerce often contain international departments for assisting importers and exporters. Many chambers organize seminars and provide information on trade and trade-related procedures. Commonly, large or well-funded chambers will also organize trade missions, primarily oriented to assist new exporters find agents and distributors in foreign markets. The first “chambre de commerce” was established in 1599 in Marseille. The concept caught on and expanded in the 18th and 19th centuries, with chambers opening in New York (1768), Calcutta (1834) and Paris (1873). Today, virtually every major city in the world has an active chamber of commerce.

1.7.2 ICC, supplier of global standards for international trade

The International Chamber of Commerce (ICC), the world business organization based in Paris, is of fundamental importance in international trade. Although ICC’s activities are diverse, of primary interest to the exporter and importer is ICC’s role as a developer of international commercial, legal and banking standards. Thus, ICC developed the rules that govern global documentary credit (letter of credit) practice - the UCP. On the legal side, ICC’s International Court of Arbitration is probably the world’s foremost private commercial dispute-resolution forum. ICC Incoterms, standard trade terms such as FOB and CIF, define the legal content of price quotes in international transactions.

Objectives – ICC serves world business by promoting trade and investment and open markets for goods and services, as well as the free flow of capital. It defends the private enterprise system and encourages self-regulation by business. Founded in 1919, ICC is a non-governmental organization whose membership is composed of thousands of companies and business associations in more than 143 countries and across all economic sectors. Approximately 90 ICC national committees throughout the world present ICC views to their governments and alert Paris international headquarters to national business concerns.

Membership and revenues – ICC is financed partially through revenues received from dues paid by its member companies and business associations to ICC national committees. A further important share of ICC’s revenues is derived from the administrative fees earned by the ICC Court of International Arbitration. Additional income is generated by the marketing of ICC rules and codes, as well as other books (ICC Publications) and seminars.

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Consultative status - ICC has had general consultative status with the United Nations (U.N.) since 1946, where it puts forward the consensus views of business worldwide, including industrialized and developing countries. It also maintains close working relations with the World Trade Organization (WTO), the Organisation for Economic Co-operation and Development (OECD), the European Commission and other intergovernmental and nongovernmental bodies. ICC’s permanent representative at the U.N. in New York monitors developments affecting business within the U.N. and its specialized agencies. ICC ensures that business concerns are brought to the attention of intergovernmental organizations, through policy statements issued from its international headquarters in Paris and via the representations of ICC national committees to their national governments throughout the world.

Business self–regulation – ICC also draws up voluntary codes for business which set ethical standards. Its Business Charter for Sustainable Development contains 16 principles governing every aspect of a company’s activities in relation to the environment from product design to customer advice. ICC’s Marketing and Advertising Codes cover ethical conduct as regards direct marketing, advertising, sales promotion, marketing research, environmental advertising and sponsorship. In 1977, ICC first issued rules against corruption, bribery and unethical business practices in international trade, which were revised in 1999 and 2005.

ICC commissions and task forces – forums for international business policy - Specialist ICC commissions meet regularly to review issues affecting world business. They cover a wide range of sectors, among them banking, competition, the environment and energy, financial services and insurance, intellectual property, marketing, transportation, taxation and trade and investment policy. These policy commissions are, in effect, international committees of senior business experts, including traders, lawyers, carriers, bankers and other professionals. When a particular commission decides to undertake a project, it creates a sub-committee, known as a task force, to accomplish the given task.

Most of ICC’s key instruments are products of these commissions and task forces. For example, the revision of Incoterms or UCP is initially entrusted to a smaller task force operating as a drafting group. Revised drafts are then circulated broadly to experts from various relevant commissions and internationally through ICC national committees, with the resulting comments channelled back to the task force. Final drafts, once approved by the task force and commission, are submitted for adoption by the ICC Executive Board. Although the broad international consultation entailed by this procedure is time-consuming, it ensures that official ICC products carry great authority as representing the consensus viewpoint of the world business community.

ICC Commercial Crime Services – This is the umbrella organization of three ICC units dealing with different aspects of crime affecting business. They are the:

• International Maritime Bureau, which deals with all types of maritime crime, including fraud, cargo theft and piracy;
• Financial Investigation Bureau, which provides commercial banks the financial services sector and investors with a range of services to combat financial fraud and money laundering; and
• Counterfeiting Intelligence Bureau, which helps companies to prevent the faking of their products.

The World Chambers Federation (WCF) is ICC’s platform for serving the global chamber of commerce community. Over 12,000 local, regional, national, transnational and bilateral
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chambers from all over the world work with WCF on a variety of projects and activities. WCF’s World Chambers Congress is the only international forum where chamber leaders and executives worldwide meet to share best practice experience, develop networks and learn about new areas of innovation from other chambers as they face the challenge of remaining relevant to companies in their region. The Congress is held every two years in different regions of the world. A key feature of the Congress is the World Chambers Competition, rewarding chamber best practice. WCF also manages the ATA Carnet System and its guarantee chain for temporary duty-free imports. Approximately 71 countries use the ATA Carnet for the temporary admission of commercial samples, professional equipment and goods destined for international trade fairs and similar events. WCF is also actively supporting chambers in their issuance of certificates of origin, by establishing international guidelines as well as working with agencies such as the WCO and regional trade bodies to reinforce the important role chambers play in supporting international trade. WCF runs the World Chambers Network (WCN) - a global Internet platform fostering a comprehensive exchange of business information between chambers and their member companies throughout the world.

ICC Services Publications Department offers international business people more than 80 practical reference works. New guides, sets of rules, model contracts and handbooks are added to the list every year. ICC publications may be ordered directly from ICC Publications in Paris, from ICC national committees or from the bookstore’s website www.iccbooks.com.

1.7.3 International organizations involved in international trade

There are a variety of other international organizations involved in the field of international trade. International organizations are commonly divided into two categories: intergovernmental organizations (IGOs), which are the creation of nation states and are staffed with international civil servants, and non-governmental organizations (NGOs), which may be associations or federations representing business, sectoral, professional, consumer or other interests. Several of the key international organizations are listed below.

See the end of this book for addresses and contact information.

The United Nations Commission on International Trade Law (UNCITRAL) (Vienna) - The United Nations’ international private law body is UNCITRAL. UNCITRAL works primarily on instruments intended to become a part of international or national law, such as treaties, conventions and model and uniform laws. Among other instruments, UNCITRAL has approved an international convention for independent bank guarantees and a model law for electronic data interchange. Perhaps UNCITRAL’s key contribution to international trade has been the Vienna Convention on the International Sale of Goods, the drafting of which was concluded in 1980 and which entered into force in 1988. UNCITRAL Rules for international commercial arbitration provide an alternative to other arbitral and litigation systems.

Institute for the Unification of Private Trade Law (Unidroit) (Rome) - This international organization was set up under the League of Nations and continued an independent existence after the founding of the United Nations. In recent years, Unidroit has been active in studying the international private law relating to leasing, agency, franchising and inspection contracts, with a view to proposing international legal conventions where necessary.

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World Customs Organization (WCO) (Brussels) - Formerly known as the Customs Cooperation Council, the WCO is the competent global inter-governmental organization on customs matters. Its membership is composed of national customs administrations, which work together to advance the efficiency of the customs process.

The International Trade Centre (ITC) UNCTAD/WTO (Geneva) is the central agency of the United Nations’ system for export assistance for developing nations. ITC conducts a wide range of training programmes for exporters and importers, as well as local chamber of commerce trainers. The ITC also publishes a full range of export guides focusing on specific areas of trade, such as packaging, marketing or promotion.

International Air Transport Association (IATA) (Montreal and Geneva) - The trade organization for the world’s airlines, IATA has had an important role in simplifying and standardizing air transport documents, such as air waybills.

International Federation of Freight Forwarder’s Associations (FIATA) (Zurich) - A world organization which promotes standards and quality in international freight forwarding. Certain FIATA standard documents, such as the FIATA Bill of Lading, have become important references in international trade. FIATA’s customs clearance manual is an important professional reference tool in transport circles.

International Maritime Committee (CMI – for Comité Maritime International) (Brussels) - An organization founded in 1897 to promote the unification of maritime and commercial law, maritime customs, usages and practices. Between 1910 and 1971, the CMI’s work gave birth to 18 “Brussels” conventions and protocols on maritime law, including those key pieces of international regulation of bills of lading generally referred to as the Hague and Hague–Visby Rules.

International Road Transport Union (IRU) (Geneva) - An international federation representing commercial operators of road vehicles, the IRU notably administers the TIR customs system, which allows lorries or trucks sealed by customs officials to cross intervening national borders without having to undergo full customs formalities.

1.8 The multilateral framework for world trade: the World Trade Organization (WTO)

After World War II, there was a strong international consensus in favour of creating an international trade organization to oversee the progressive liberalization of international markets. From 1947 until 1995, the supposedly “interim” GATT functioned very effectively as the co-ordinator of the multilateral trade system. As a result of the GATT, tariffs, which had averaged 40% in the industrialized countries in the late 1940s, dropped to about 5% by the early 1990s. World exports grew from USD 61 billion in 1950 to USD 4090 billion in 1994. At the conclusion of the Uruguay Round in 1994, the WTO was established as the successor to the GATT. The Uruguay Round, which lasted from 1986 through 1993, was the most ambitious and comprehensive trade liberalization round ever negotiated.

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WTO replaced the GATT and has quite a different character. While the GATT was primarily a set of rules administered by an interim body, the WTO is a permanent institution with its own secretariat. Although the GATT’s scope of application was limited to trade in goods, the WTO also covers trade in services and trade-related aspects of intellectual property. Of great practical significance is the fact that settlement of disputes under the WTO mechanism is much faster and more automatic than under the GATT system, so that trade blockages can be more rapidly and efficiently overcome.

The long-standing principles enshrined in the original GATT have not disappeared under the WTO - rather, they have simply been subsumed under the new structure. Thus, the original GATT (from 1947) lives on as the so-called “GATT 1994”, an amended and updated version of GATT 1947, which forms an integral part of the WTO agreement. In November 2001, in the Qatari capital of Doha, the WTO launched the “Doha Development Agenda”, the ninth round of multilateral trade negotiations held under GATT/WTO auspices, with a view to further liberalizing world trade and better integrating developing countries into the world trading system. The WTO’s website is www.wto.org.

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