Incoterms_® and Commercial Contracts

2.1 Documents and sequence of events in an export transactions

International commercial transactions, like domestic transactions, are commonly based on an exchange of commercial forms between buyers. In international transactions, the sale contract requires the parties to enter into a number of subsidiary agreements with bankers, transport companies and insurers, also represented in standard documents.
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The documentary requirements in international transactions can be crucial, particularly in the case of the so-called “documentary sale”, the classic export transaction that requires the seller to submit shipping documents to a bank for payment under a documentary credit.
Let us review a possible sequence of events in an international trade transaction:

Commonly, the exporter markets goods at trade shows or through circulation of catalogues and or through a website. Thereafter, he receives an inquiry from an importer, requesting a price quote for a certain amount of goods of a specified quality.

1. REQUEST FOR QUOTE (RFQ)
   The importer’s inquiry typically arrives on a pre-printed form, which is referred to as an RFQ (Request for Quote) or RFP (Request for Proposal). SEE FIGURE 2.3

At this point, the exporter may wish to provide a full contractual offer along with the price quote.

1. PRO FORMA INVOICE
   A common technique is for the exporter to send a pro forma invoice, a document which specifies the basic terms of sale, including the price, delivery and payment terms. SEE FIGURE 2.6
2. ICC MODEL INTERNATIONAL CONTRACT OF SALE
   An alternative method for concluding an international sale or purchase contract is for either the exporter or importer to make an offer recorded on the Specific Conditions form of the ICC Model International Contract of Sale. SEE FIGURE 2.4
3. ICC MODEL GENERAL CONDITIONS OF SALE
   The ICC Model International Contract of Sale comes in two parts and, if the parties use the first part (a form called the Specific Conditions which is similar to a pro forma invoice or purchase order), it is assumed they wish to also use the General Conditions.
   SEE FIGURE 2.5

In law, a contract is formed when the seller’s offer receives the buyer’s unequivocal acceptance.

1. PURCHASE ORDER
   The acceptance is typically provided in the buyer’s purchase order, indicating assent to the prices and conditions contained in the pro forma invoice (or other sale offer). Note that in transactions involving a large commercial buyer, the purchase order is often the main contract form and constitutes the first legally binding offer. In such cases, the seller’s confirmation of the purchase order will constitute the acceptance. SEE FIGURE 2.7

When the exporter does not know the importer or is unable to obtain sufficient credit information about it, the exporter may wish to insist on payment by a confirmed, irrevocable documentary credit (commonly referred to as a “letter of credit”), a payment mode which offers certain security features for the exporter.

1. THE DOCUMENTARY CREDIT (LETTER OF CREDIT)
   When payment is to be by documentary credit, the buyer will be obliged to open or issue a documentary credit in advance of shipment. Ideally, the sale contract will give the buyer a deadline for opening the credit. Otherwise, a reasonable period will be presumed. The buyer opens the credit by filling out a documentary credit application form. SEE FIGURE 2.8

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In our case, the exporter quotes a CIF Incoterms® 2010 price, which means that the price includes freight to destination, plus insurance. Incoterms® 2010 are a set of 11 standard “trade terms” (such as FOB, CIF or EXW), developed by ICC. Incoterms define various cost and risk obligations of the parties and are dealt with in detail in Chapter 3. CIF stands for “cost, insurance and freight” and was developed in the context of the maritime shipment of general cargo. ICC has also developed a series of terms that are specifically suitable for other kinds of shipments, particularly those involving containerized cargo (see Chapter 13).

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2.2 Transport: the freight forwarder

The exporter commonly prepares his shipment with the assistance of a freight forwarder, who books space for the cargo and may, in addition, take care of customs formalities. The exporter must also be aware under CIF Incoterms® 2010 that he is responsible for export customs formalities, such as obtaining an export licence. Import formalities and duties, conversely, are for the importer’s account. An experienced export trader understands that there are often disputes about unloading or discharging costs under CIF, so he may choose to specify in the pro forma invoice or contract of sale that all unloading charges are for the importer, in which case this arrangement should also be made clear in the exporter’s instructions to his freight forwarder. When the goods are delivered to the carrier, the exporter, as shipper, receives from the carrier the bill of lading.

1. THE BILL OF LADING
   This central document acts as a receipt indicating that the goods were received in apparent good order and quantity, and also stipulates the contractual rights of the holder of the bill of lading against the carrier. In a CIF contract, the exporter must normally provide the importer with a negotiable bill of lading. A negotiable bill of lading allows the goods to be sold while in transit and is a key document in the documentary credit process. SEE FIGURE 2.9
2. THE INSURANCE CERTIFICATE
   Under CIF Incoterms® 2010, the exporter must respect an Incoterms requirement to obtain insurance coverage for 110% of the value of the goods (the extra 10% is meant to cover the minimum profit anticipated by the importer; it is possible to request greater coverage). SEE FIGURE 2.10

In our example, the contract specifies payment by letter of credit or documentary credit (they mean the same thing). In the bank’s terminology, the importer is referred to as the applicant or the account party. The exporter is referred to as the beneficiary of the documentary credit. The letter of credit contains the terms and conditions under which the bank will pay. Generally, this includes a listing of documents which the beneficiary (exporter) must furnish, such as the commercial invoice, insurance certificate, packing list, inspection certificate, bill of lading, etc.

Let us assume in this example that the beneficiary has stipulated that the credit be confirmed.
By this, the exporter requires the importer to obtain from another bank (usually one located in the exporter’s country) a confirmation of the credit, which means that the confirming bank adds its own irrevocable undertaking to pay under the terms and conditions of the credit. This may be considered advantageous by the exporter who prefers to work with a relatively close and reliable paymaster, such as his own bank. Let us assume that the confirming bank agrees to confirm the credit. NOTE: not all credits are confirmed; confirmation is an additional bank service performed for a fee, and therefore makes sense whenever the exporter does not wish to take the risk that the issuing bank may become unable to pay under the credit. Of course, the exporter may simply be more comfortable dealing with a known bank, and that is also a sufficient reason for requesting a confirmed credit.

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1. ADVICE OF CONFIRMED DOCUMENTARY CREDIT
   The confirming bank will notify the exporter that a confirmed credit is available through its services. This notice will specify the amount of the credit and the precise documents required for payment. The exporter should carefully review this notice upon receipt to ensure that it will be feasible to comply with the documentary conditions, and also to verify that the credit conforms to any conditions spelled out in the sale contract. SEE FIGURE 2.11

The exporter prepares the shipment and instructs the freight forwarder to obtain the necessary transport document. After shipment of the goods, the exporter goes to the confirming bank and presents the various documents required under the credit. In addition to the bill of lading, the exporter will likely be required to present the following documents under the conditions of the documentary credit (note that the number and type of documents should be agreed to by both parties in the contract of sale):

1. COMMERCIAL INVOICE
   The commercial invoice is the bill of sale from exporter to importer. Although it is prepared by the exporter itself, it is of vital importance that accuracy be perfect when the commercial invoice is one of the documents presented under a documentary credit. Even small errors in a commercial invoice will generally be counted as discrepancies. SEE FIGURE 2.12
2. CERTIFICATE OF ORIGIN
   The certificate of origin certifies the country in which the goods originated or in which the preponderance of manufacturing or value was added. Not all countries require a certificate of origin. In many cases, the exporter’s own certification on company letterhead will suffice. SEE FIGURE 2.13
3. CERTIFICATE OF INSPECTION
   Certificates of pre-shipment inspection are not mandatory in international trade, but they are quite common in large-value shipments, especially between unfamiliar parties. Inspection certificates are commonly required under a documentary credit and are a powerful security and anti-fraud device for buyers. SEE FIGURE 2.14
4. CONSULAR INVOICE
   Consular invoices contain detailed descriptions of the goods shipped as certified by a consul of the receiving country. SEE FIGURE 2.15
5. PACKING LIST
   An export packing list itemizes the material in each individual package and indicates the type of shipping package, such a box, crate, drum or carton. Commercial and legal stationers and freight forwarders often carry packing list forms. SEE FIGURE 2.16

2.3 Examination of the documents by the bank: the problem of discrepancies

The confirming bank takes up the documents, examines them and, if it finds them conforming to the conditions of the credit, gives or promises to give value to the exporter under the credit. There are different ways the exporter can get paid, depending on the type of credit. It can be paid immediately (“sight” credit), or at a later time (“deferred payment” credit) or a draft payable in the future can be discounted for a partial, immediate payment (“acceptance” or “negotiation” credit). Documentary credits are explored in detail in Chapter 9.

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The confirming bank will transmit the documents to the issuing bank which, if it finds they are conforming, will in due time reimburse the confirming bank for the funds it has paid out under the credit, and will then turn the documents over to the importer and debit its account for the amount of the credit. The importer will use the transport documents to obtain delivery of the goods from the carrier. This is assuming that everything works out as planned. However, it should be kept in mind that shipping documents frequently contain errors when they are first presented to the bank for payment, and correction and/or waiver of these discrepancies may take time and, in some cases, even delay or impede payment.

2.4 Liability of carriers and coverage of insurance

If the goods are damaged or short-delivered, the ability of the importer to recover from the insurance company will depend on whether or not the damage arises from a cause or circumstance excluded from coverage under the insurance policy. If the damage or loss is a result of the carrier’s acts, the importer or its insurer may be able to recover damages from the carrier, but this will depend on the exclusions and limitations on liability contained in the carrier’s bill of lading, as well as on the law applicable to the bill.

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