Article

Incoterms® 2010: Should banks change their L/C application forms?

by Roberto Bergami

Incoterms® 2010 provide a timely reminder about the use of delivery terms that may be less than appropriate for the maritime transport of goods. This article focuses on international transactions and not domestic sales, even though it is recognized that Incoterms® 2010 may apply to domestic contracts.

It is generally accepted that the majority of maritime consignments in international trade are transported inside shipping containers. The practices surrounding the movement of cargo in containers do not fit easily with the term FOB, and banking practices in letters of credit do not appear to have kept pace with modern transport practices and the correct use of Incoterms. It is hoped, however, that the introduction of Incoterms® 2010, with a revised layout, may be a catalyst for a change in future banking practices.

It is generally accepted that the majority of maritime consignments in international trade are transported inside shipping containers. The practices surrounding the movement of cargo in containers do not fit easily with the term FOB, and banking practices in letters of credit do not appear to have kept pace with modern transport practices and the correct use of Incoterms. It is hoped, however, that the introduction of Incoterms® 2010, with a revised layout, may be a catalyst for a change in future banking practices.

FOB

The term Free On Board (FOB) was coined at least two centuries before the first edition of Incoterms 1936. When containers were introduced for maritime trade, beginning in the 1960s, somehow FOB was subsumed into this new method of handling cargo, with little consideration given to the changed risk and cost profile of container consignments and FOB. The previous notion of the ship's rail as the imaginary demarcation line that transfers risk from seller to buyer did not sit easily with container traffic as, in reality, the seller lost physical control of the consignment prior to the goods crossing the ship's rail. This was recognized in Incoterms 1990, and again in Incoterms 2000. As clearly stated in the guidance notes to FOB, Incoterms® 2010 do not recommend the use of this term for container traffic.

The FOB Incoterms® 2010 also introduces a change in the risk transfer point. The notion of the ship's rail has been replaced by the requirement to have the goods loaded on board. If we consider the movement of goods from the seller's premises to the export wharf, it is not difficult to imagine that a number of parties may be handling the goods along this journey. Up to ten lift-on and lift-off movements could take place between the seller's premises and the loading of the goods on board the nominated vessel.

The goods may leave the exporter's premises destined for a container packing depot, and subsequently the container may be taken to the freight forwarder's premises. From there, the container may go to the export wharf, where it is lifted from the delivery vehicle and placed on a stack in the port marshalling area. From here, it may be transferred within the wharf to several different spots, for operational reasons (such as port congestion) before it is finally loaded on board the vessel. Under these conditions, the seller using the term FOB for container traffic has a higher risk exposure than necessary.

The term FCA in these circumstances would be a more appropriate term to use. Under FCA, the delivery and risk transfer points could then be structured to occur simultaneously, more accurately reflecting the point at which the seller loses physical control over the consignment.

It should be remembered that FOB does not place an obligation on the seller to enter into a contract of carriage, pursuant to Incoterms® 2010 Article A3(a), although it does require the goods to be placed on board. The Incoterms® 2010 state that the seller may, by choice, decide to enter into a contract of carriage on "usual terms at the buyer's risk and expense". This is an important consideration, because the party that contracts for carriage is issued with the transport document, a point that will be discussed later in the article.

An L/C is meant to be based on the underlying contract of sale, but is an independent instrument of trade finance to the contract of sale, pursuant to article 4 of UCP 600, that embodies the principle of independence, also known as the autonomy principle. Article 5 of UCP 600 states that "banks deal with documents and not with the goods, services or performance to which the documents relate". In issuing the L/C, the bank holds itself liable to settle the beneficiary's claim for payment, provided, of course, that a compliant presentation is made. A compliant presentation, in essence, is one in which all the documents and their data contentbmatch the demands of the L/C.

Questions

Two questions arise in the discussion in this article: 1) Why does a bank continue to condone the use of FOB (and by implication CFR and CIF) for maritime container traffic?; and 2) Why does a bank insist on the presentation of a transport document when clearly there is no obligation for the seller (beneficiary) to provide one?

In attempting to answer the first question, one proposition is that bankers have not kept up to date with the changes in transport practices and have thereby contributed to the continuing inappropriate use of terms such as FOB, CFR and CIF where clearly more appropriate terms should be used, that is, FCA, CPT and CIP. The evidence proferred for the claim that banks are not current with changing transport practices in their L/C clauses is from the L/C application forms currently in use. As an example, in Australia, at the time of writing this article, only one of the four major local banks had changed its L/C application form to incorporate the multimodal terms FCA, CPT and CIP. The other three are still showing FOB, CFR and CIF with an extra box titled "Other".

In attempting to answer the second question, the issue is rather more complex. The bank has an inherent requirement to protect its risk exposure. This claim would have little ground when the financial exposure of the bank is essentially zero, because the applicant (buyer) is required to provide 100% security against the L/C value, as is the case for importers in Australia. Consequently, the argument of financial risk exposure on issuing an L/C can only be accepted in cases where the applicant provides less than 100% security.

In these cases, the bank carries limited risk exposure, as represented by the shortfall between the amount of security provided by the applicant and the par value of the L/C. For example, if only 50% security was requested by the applicant, the issuing bank would have 50% exposure against the par value of the L/C, not the full value.

The banker would also claim that in demanding the presentation of a transport document, he is additionally protecting the risk exposure of the applicant (buyer). The bank would claim that the presentation of a transport document is clear evidence that the goods have been shipped. Leaving the issue of fraud aside for the purposes of this discussion, the provision of a transport document does not guarantee that the correct goods were shipped in any event, particularly, as is often the case, where the consignment is handed to the maritime carrier packed in a sealed container "ready for carriage".

Proof of dispatch

The legal strength of the transport document is another issue linked to the "proof of dispatch" argument. The classical bill of lading (B /L), issued in sets, consigned to order, requiring the presentation of one original to the carrier at destination to obtain the release of goods is being increasingly replaced by the non-negotiable sea waybill (NNSW) in its various forms. The attraction of the NNSW is that it can be easily produced in electronic format and, as there is no negotiability attached to it, an original document is not required to obtain the goods at destination.

Additionally, the traditional role of the B/L is changing. Recent clauses on this document indicate that, unless required by local laws, the carrier reserves the right to discharge the consignment at destination without the surrender of an original bill. The banker is not in a position to examine terms and conditions of carriage on transport documents according to UCP sub-article 20 (a )(v), in line with ICC Opinion TA.675 (rev), and it is questionable whether statements on the B/L about how goods are released render documents discrepant.

Conclusion

In conclusion, there is no reason for bankers to continue the use of FOB terms in an L/C where it is known that the cargo will be transported by maritime trade in containers. Instead, the term FCA should prevail, as discussed earlier. The provision of a transport document, when dealing with FCA contracts, is questionable, as Incoterms® 2010 do not place any obligation on the seller to enter into a contract of carriage. It is argued here that "forcing" a beneficiary to provide a transport document under either FCA or FOB may blur the risk transfer point and the cost structure of the transaction. The seller may incur unexpected costs that he may need to attempt to recover later. This may strain cash flows, making it more expensive to service the contract because carriers demand immediate payment, and that may not be recoverable until sometime later.

The "evidence of dispatch" requirement could be obtained through the provision of the FIATA Forwarders Certificate of Receipt (FCR), or similar document. The FCR is not a transport document, but it does evidence that the freight forwarder has received the consignment in order to arrange for its carriage. Given that the freight forwarder is nominated by the buyer in FCA Incoterms® 2010 contracts, the banker should not be concerned about its risk exposure or that of the applicant.

Some thought should be given by banks to change their L/C application forms to reflect the more appropriate Incoterms® 2010 multimodal terms. The ICC Banking Commission should consider issuing a position paper on the issues raised in this article, to bridge the gap between the correct usage of Incoterms and banking practices relating to L/C transport clauses.

Roberto Bergami is Senior Lecturer, Practice of International Trade in the School of International Business at Victoria University in Melbourne, Australia. His e-mail is Roberto.Bergami@vu.edu.au

Incoterms® 2010 and documentary credits

by Pavel Andrle

The new revision, Incoterms® 2010, is of the utmost importance to sellers and buyers who use them in their contracts of sale, but also for other parties whose services are used by the contract parties to fulfil their respective contract of sale obligations.

One of the crucial obligations of the seller is the delivery obligation. Incoterms clearly state where the delivery takes place. The parties are well advised to specify the exact point of delivery as clearly as possible, taking into account the specific features of their goods and the respective transport used.

Incoterms also specify other obligations of the seller, for example contracting for carriage, insurance, export and import clearance and providing assistance and information to the buyer, if applicable. Fulfilling some of these obligations can require documents evidencing that the seller has fulfilled his contract obligations.

It is not possible nor even advisable to incorporate evidence in a documentary credit that the seller has fulfilled all of his obligations; however, L/Cs commonly require documentary evidence that a seller has met his key obligations - such as delivery of the goods, contracting for the carriage to the place of destination and payment of the freight, if applicable, as well as contracting for the cargo insurance, if applicable (CIF and CIP), etc. Therefore, one should be as precise as possible in choosing the documents for the L/C that match the seller's obligations stemming from the agreed delivery term and that are specified in the contract of sale.

In many circumstances, the seller needs the buyer to provide him with assistance and/or relevant information or even to have taken some action in order that the seller can fulfil his obligation(s) and viceversa. If the buyer does not provide this, it might impede or even prevent the seller from obtaining the necessary documentary evidence that he has fulfilled his obligation. The seller might not be then able to present the required document(s) under the L/C.

It should be noted that Incoterms® 2010 only provide default rules, and they are particularly concise when it comes to documentation. They provide guidance, but it is up to the contract parties to choose and specify the requested documents. Following are some hints.

Delivery documentary evidence:1
E-term (EXW)

Under EXW, what document should be requested in the L/C to evidence that the seller has fulfilled his delivery obligation, i.e., placed the goods at the disposal of the buyer?

The most favourable option from the seller's perspective:

- Document issued by the seller stating the goods are placed at the disposal of the buyer.

Comment: The seller is fully in control of the issuance of this document. Here the buyer has to fully trust the seller that the goods are actually placed there. This option is not seen in practice.

The most favourable option from the buyer's perspective:

- Taking/handing over protocol countersigned by the buyer;2 or

- Transport document showing receipt of the goods by the carrier at the seller's premises.

Comment: This is clear evidence that the goods were taken over by or received on behalf of the buyer. However, the seller might not wish to bear the risk that the buyer has not taken delivery of the goods nor signed the handing over protocol nor arranged for the carriage. What if the carrier does not turn up and/or does not take the goods and/or does not arrange that a clean transport document be given to the seller?

The balanced choice:

- The balanced choice is an inspection certificate issued by a third party confirming that the goods were placed at the disposal of the buyer at the agreed place and within the agreed time.

Comment: A document issued by a third party evidences that the goods were placed at the agreed place within the agreed time at the disposal of the buyer.

F-terms

The seller delivers the goods to the carrier or another person nominated by the buyer at the agreed place. The chosen document depends on whether the goods are to be delivered to a carrier or another person (most likely a freight forwarder).

The most favourable option from the seller's perspective:

-Preferable for the seller would be a freight forwarder's document, transport document, a cargo receipt, a dock receipt3 or similar confirming the receipt of the cargo from the seller. As a second option, in the event this document cannot be obtained (due to the failure of the buyer to nominate a carrier, a vessel or to notify the seller), a document issued by the seller himself or a third party (an inspection company) declaring that the goods were ready for shipment and could not be delivered due to the failure of the buyer.

Comment: The seller has the obvious risk that the buyer will not fulfil his obligation (to nominate the vessel, the carrier and to contract for carriage, if not agreed otherwise4). In this case, the seller will not be able to obtain the transport or another document required by the L/C. The second option above under the L/C would remain.

The most favourable option from the buyer's perspective:

- Transport document showing receipt of the goods by the carrier or the freight forwarder's certificate of receipt (as agreed in the contract of sale).

Comment: This is clear evidence that the goods were received by the carrier or the freight forwarder nominated by the buyer.

Balanced choice:

- Transport or freight forwarder's (or another - see above) document as agreed; or

- As a second option an inspection certificate issued by a third party (an inspection company) confirming the goods were ready for shipment within the agreed time and could not be delivered to the carrier (or another person, as agreed in the contract of sale) due to the failure by the buyer to nominate him.

Comment: The seller wants to be sure that he can present required documents under the L/C even if the buyer does not nominate the carrier or another person or does not fulfil his notification obligation, etc. Therefore, the option in such an eventuality is to present an inspection certificate, which also gives protection to the buyer.

C-terms

The C-terms are the most L/C -friendly delivery terms. The seller's delivery obligation is complete when he delivers the goods to the carrier at the agreed place and within the agreed time. The seller must also contract for the carriage and pay the freight to the destination. The document which evidences that the seller performed these tasks would be the relevant transport document. The seller is fully in control and does not depend on the buyer to fulfil his delivery obligation.

The balanced and traditional choice:5

- Transport document for the respective mode(s) of transport showing freight prepaid.

Comment: The transport document is requested under the documentary credit. This conforms to the Incoterms® 2010 requirement as defined in Incoterms article A8. The parties are advised to indicate any specifications, such as those concerning carriers, types of transport documents, the manner in which these are issued, etc.

D-terms

The seller is to deliver goods on the arriving means of transport at the named place of destination ready for unloading (DAP and DDP)6 or placing the goods unloaded at the disposal of the buyer at the named terminal (DAT).

Generally speaking, the D-terms are not very compatible with the documentary credit. In practice, most L/Cs require a transport document that does not reflect delivery to the destination, but does indicate the receipt of the goods and possibly shipment from the place of receipt. Therefore, the transport document 7 does not prove that the seller has fulfilled his D-term delivery obligation. This constitutes a significant risk from the buyer's perspective.

The situation might be different under the new DAT term. Under DAT, the seller must unload the goods from the arriving means of transport8 and then deliver them by placing them at the disposal of the buyer at the named terminal.9 The document to evidence delivery under DAT might be a dock receipt, cargo receipt, delivery note, warehouse warrant or similar. The parties are advised to learn about practices in the respective terminal at place of destination and to clearly specify the document in the contract of sale and the L/C.

The most favourable option from the seller's perspective:

-Transport document showing shipment to the place of destination and freight paid.

Comment: The seller is fully in the control of the issuance of this document. On the other hand, the document does not evidence that the goods were actually delivered to the destination (which is the seller's obligation) but rather that they were "only" shipped from the place of receipt.

The most favourable option from the buyer's perspective:

- Taking/handing over protocol countersigned by the buyer; or

-Transport document showing receipt of the goods by the consignee - the buyer (countersigned by the buyer).10

Comment: If the seller accepts such a condition he bears the risk that the buyer will not take delivery of the goods nor sign the handing over protocol or the receipt for the goods on the transport document, even if the goods were delivered in time and fully in compliance with the contract of sale.

On the other hand, the buyer would like to have the right to object if the goods delivered were not the ones he ordered or if they were damaged or only partially delivered (because of pilferage, etc.). In these circumstances, the seller would not have fulfilled his delivery obligation.

The balanced choice:

- Taking/handing over protocol countersigned by the buyer; or

- Transport document (possibly also showing receipt of the goods by the buyer at the buyer's

- As a second option an inspection certificate issued by an inspection company confirming the goods were delivered; or

-Warehouse receipt (the goods would be delivered to a warehouse if the delivery was not taken by the buyer).

- The best option seems to be DAT and a request for the respective delivery note, warehouse receipt or similar, a document issued by a third party (operator of the terminal, warehouse). This document would ideally reflect that the seller has fulfilled his DAT Incoterms® 2010 delivery obligation.11

Comment: Both the risk of the seller that the buyer does not take delivery of the goods (and confirms it by his signature) and the risk of the buyer that the goods were not delivered are mitigated.

Conclusion

As noted, Incoterms® 2010 are only default rules providing guidance. When using them, the parties are advised to choose the delivery term to suit their purposes. They should also think seriously about the documents to be presented by the seller, especially when a documentary credit is utilized. By choosing and specifying the content of the document(s), they can make a significant impact on risks and costs.

Pavel Andrle is Secretary of the ICC Czech Republic Banking Commission and an international trade finance trainer and consultant. His e-mail is pa@cmail.cz

1
This paper focuses only on the delivery aspect of Incoterms® 2010 and not, for instance, on fulfilment of other sellers‘ obligations such as quality of goods, etc.

2
Credits should not call for documents signed by applicants, except in rare situations where such documents are unavoidable.

3
The type of document and its issuer depend on the delivery term chosen, contract specifications, if any, and the custom of the place of delivery.

4
It can be agreed in the contract of sale that the seller contracts or might contract for carriage. This would obviously give him more control.
5
In this general context this choice is the only proper choice, as it reflects the Incoterms® 2010 requirement.

6
For practical reasons there is no document which would evidence that goods were delivered to the place of destination ready for unloading. Article A8 for DA P, DDP and DAT says that the seller must provide the buyer with a document enabling the buyer to take delivery of the goods.

7
Unless it also shows the receipt of the cargo in the place of destination by the consignee (which is very rare) - see further in the text.

8
DAT can be used with any mode of transport.

9
"Terminal" in the context of DAT includes any place, whether covered or not, such as a quay, warehouse, container yard or road, rail or air cargo terminal.

10
The place of destination would most likely be the buyer's premises.

11
The possible drawback of this option would be the timing issues. Can the document showing the delivery to the terminal at place of destination be obtained by the seller quickly enough and then presented under the documentary credit so the buyer would not face additional cost such as demurrage or even detention?