Article

by Wang Xuehui (Ofei)

In Incoterms®2010, the FOB term is defined as follows: "Free on Board 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 [emphasis added]." It continues: "The seller is required either to deliver the goods on board the vessel or procure goods already so delivered for shipment. The reference to 'procure' here caters for multiple sales down a chain ('string sales'), particularly common in the commodity trades." Similarly, both CFR and CIF also reference string sales. From the wording it would seem that, with regard to these sales, FOB is equally as applicable as CIF or CFR.

This article will question whether this is, in fact, the case.

Definition of FOB

Unlike CIF contracts where definitions abound, there are no definitions concerning FOB contracts. It may be a reflection of the flexibility of the term that no satisfactory definition is possible. The flexibility is demonstrated by the three types of FOB contract in practice.

In the first type as well as the "classic FOB", the buyer's duty is to nominate the vessel, and the seller's is to place the goods on board the ship and procure bills of lading. In such a case, the seller may enter into a contract of carriage, but it acts only as an agent of the buyer.

The second type is also known as an "extended FOB", in which the seller is asked to make the necessary shipping arrangements (including entering into the contract of carriage). In this case, the seller makes the contract of carriage as a principal of the buyer, who is normally not a party to it. It is also the seller's obligation to nominate the vessel, and the extension of seller's duty may include an obligation to procure insurance.

The third type is called the "strict FOB", under which the buyer engages his own forwarding agent at the port of lading to book space and to procure the bills of lading. The seller has no obligation to contract for carriage, whether as agent for the buyer or as principal.

With regard to the obligation for both sellers and buyers listed in Incoterms®2010, FOB is defined as the third type, i.e., the "strict FOB", which is also considered to be the most typical type of FOB contract.

Characteristics of FOB

The characteristics of strict FOB can be found in Benjamin's Sale of Goods (8th edition, 2010): "It is the duty of an f.o.b. seller to put the goods on board a ship nominated or designated by the buyer. Under section 32(1) of the Sale of Goods Act 1979 the seller is, by performing this duty, prima facie deemed to have delivered the goods to the buyer, but it must be emphasized that a mere 'delivery of the goods to a carrier' within that subsection is not sufficient to discharge the seller's duty under an f.o.b. contract, since he must not merely deliver the goods to the carrier but actually put them on board the ship. The place at which the goods are thus delivered is considered to be the place of performance under an f.o.b. contract."

In brief, under a strict FOB contract, the buyer nominates the vessel and procures the shipping space. The seller is obliged to ship the goods on board the vessel at the port of shipment.

Characteristics of CIF/CFR

Unlike FOB, the core characteristic of CIF is that sales of documents has been accepted in many English cases. For example, in the case Arnold Karberg & Co v Blythe Green Jourdain & Co (1916), Judge Scrutton said: "... that CIF sale is not a sale of goods but a sale of documents relating to goods. It is not a contract that goods shall arrive, but a contract to ship goods complying with the contract of sale, to obtain, unless the contract otherwise provides, the ordinary contract of carriage to the place of destination, and the ordinary contract of insurance of the goods on that voyage, and to tender these documents against payment of the contract price." Though this explanation was disputed, it has been accepted in other cases. For example, in "Red Sea" (1999) 1 Lloyd's Rep 28, Judge Hobhouse stated: "This was a c.i.f. contract. It was therefore a contract for the sale of goods to be performed by the delivery of documents."

CFR is also deemed to involve sales of documents, though it is not as comprehensive as CIF. This is due to the lack of insurance by the seller under CFR. However, it has been also agreed that CFR, like CIF, is also applicable to sales of floating goods.

Differences between FOB and CIF/CFR

In the case Scottish & Newcastle International v Othon Ghalanos Ltd (2008), Lord Mance cited the differences between FOB and CFR. Though the comparison is between FOB and CFR, it is also applicable to FOB and CIF.

Lord Mance wrote:

"However, there are three general differences between FOB and C&F contracts:

(i) First, an FOB contract specifies a port or a range of ports for shipment of the goods. A C&F contract specifies a port or ports to which the goods are consigned.

(ii) Second, an FOB contract requires shipment (whether by or on behalf of the seller or the buyer) of the goods at the port (or a port within the range) so specified; i.e., the seller cannot buy afloat: see Benjamin para. 20- 009. In contrast, under a C&F contract responsibility for shipment rests on the seller, and this can be fulfilled by the seller either shipping goods or acquiring goods already afloat after shipment, and moreover shipment can be at any port (unless the contract otherwise provides).

(iii) Third, and as a result, a C&F contract involves (subject to any special terms) an all-in quote by the seller, who carries the risk of any increase (and has the benefit of any reduction) in the cost of carriage. In contrast, under an FOB contract, although the seller may contract for and pay the freight, the buyer carries the risk (and has the benefit) of any such fluctuation."

Clearly, Lord Mance considers CFR (also including CIF) to be applicable for floating goods, whereas an FOB contract is not. The FOB contract is considered to be a shipment sale instead of a documentary sale.

String sales

"String sales" usually involve floating cargo (oil, for example) during sea transportation. Under a chain sale, only the first transaction can be concluded using the FOB term, whereas the rest must be performed by CIF/CFR, which relates to sales of documents. This is because the goods might be resold many times, and their delivery will only be made by the last holder of a bill of lading until the goods arrive at the port of destination. Sellers and buyers in the middle chain never see or deal with the actual goods.

Resell transactions cannot be performed using FOB, since the goods have been shipped, and therefore there is no need for the buyer to nominate a vessel at the port of shipment. Consequently, floating cargo can be only traded using the CIF/CFR terms, under which the first seller only arranges for shipment and the rest of the sellers and buyers only deal with documents.

This has also been restated in the case Tradax v Andre (1976) 1 Lloyd's Rep 416, where Lord Denning said: "In an ordinary contract to sell goods of a particular description of CIF terms, the seller can perform his contract by shipping goods of that description himself, or by purchasing such goods afloat. "

Conclusion

Incoterms®2010 mentions FOB, CFR and CIF as all involving sales of documents. Consequently, it is not strange to see string sales to be cited in all the three terms. However, as explained above, FOB is not applicable for sales of floating goods. In my view, the reference to string sales under FOB is incorrect.

WANG Xuehui (Ofei) is a Lecturer in the School of Economics and Management at Anhui Agricultural University in Hefei, Anhui, China. She is also a contributing editor to Trade & Finance under The State Administration of Foreign Exchange, China. Her e-mail is ofeiliya@hotmail.com