Critical Evaluation of incoterms: Standardization of International Trade Terms and Risk Transition Between Parties
In this article Incoterms and its’ historical process will be mentioned. Incoterms are needed by buyers and sellers in sale contracts. It also agreed to be used by many different countries. This article will firstly evaluate the historical process and the development of it and brief information about the Incoterms will be given. Afterwards, it will be examined with a legal perspective of how to share the responsibility and risk transition between parties. The process in which the mutual actions in the stages arise from the sales contracts such as transportation, loading-unloading and insurance liability will be examined. Also when referring the sharing of the risk; electiveness and applicability of the terms will be analyzed.
Incoterms came into being for a need of standardized terms in international trade. This article will also examine how the process of standardization is formed and how risk sharing is associated with each term. The question of what Incoterms contributed to the commercial life, which comes up with the standardization of commercial terms and the question of how does the risk transition between parties take place with each Incoterms and in general will be answered with a legal framework.
II. Brief History and Developments of the Trade Terms
One of the most important things when talking about an international sales contract is the trade term. In such a contract, it is exceptional that it does not include a trade term. Each sale contract might have one of these terms to better understanding the extent of parties’ liability. It will be for their benefit in case there is a need for clarifying the responsibility of the parties because of the contradiction in the contract. Relations between the buyer and the seller have changed in many ways in the process. The biggest proofs of this are the legal systems,rights and obligations that changes from country to country. This instability and variability of the conditions in each contract; created the need for a standardized and generally accepted set of terms for merchants.
Incoterms is a program implemented by the International Chamber of Commerce (ICC) in order to provide a standard for the terms used in international trade. These terms regulate the liability and responsibility issues between the buyer and the seller in international trade. The purpose of this regulation is to make the process easier and more understandable for two parties by putting the tasks and responsibilities into a certain pattern.Incoterms, first published in 1936, was revised in 1963, 1967, 1976, 1980, 1990 and 2000 due to changes in international trade over time. The current version is INCOTERMS 2010, which was introduced on January 1, 2011.Incoterms 2010 consists of 11 terms under 4 main headings. In the 2010 version, the terms DAF, DES, DEQ, DDU have been removed and DAT (Delivered At Terminal) and DAP (Delivered At Place) are added. The ICC has also started writing new rules under the name of Incoterms 2020.
Incoterms should not be confused with a sales contract (including transfer of ownership, price, breach of contract, possible remedies, contractual obligations not related to delivery) or a contract of carriage (including packing and stacking) or a law governing these two contracts. The purpose of Incoterms is to define the responsibility arising from import and export, the obligations related to the regulation of crowning, the issues related to the insurance coverage during the transportation and the risk and transfer related to the delivery of the goods. In practice, Incoterms rules are usually supplemented by additional terms. Simultaneously, traders often choose the wrong terms in legal documents with other linked contracts.
III. Overview of the Incoterms
Incoterms rules are terms used by governments, legal authorities and practitioners worldwide. It is aimed to reduce or eliminate the proportion of uncertainties that occur during the interpretation of the rules in different countries. For this reason, it is possible to see it in worldwide sale contracts. In the Incoterm 2010 published by the ICC, Incoterms are divided into all forms of transport and rules only those suitable for marine and inland water transport. Thus, the ICC wants multimodal terms to be used rather than maintaining the habit of using maritime terms. Such practices are not restricted only to maritime trade because it tries to create the scope more extended. The Incoterms 2010 rules in the first chapter can be applied to any type of transportation and can be in any mode. EXW, FCA, CPT, CIP, DAT, DAP and DDP belong to this class. It can be used even if there is no sea transport. It should be remembered that these rules can also be used when a ship is used for transport. According to the rules of the second class of Incoterms 2010, it refers to sea and inland waterway because it refers to the delivery point and the ports where goods are transported to the buyer. FAS, FOB, CFR and CIF belong to this class. According to the latest rules, the ship’s rail is referred to as the delivery point when the ship is on board. This modern trade rule reflected a reality and avoided the confusion of an outdated concept in an uncertain oscillation.
Incoterms, as mentioned before, should be divided into two main groups. Categories are grouped according to the delivery type: rules for any mode or modes of transport and rules for sea and inland waterway transport.
i)Any Mode or Modes of Transport
- EXW (Ex Works)
In accordance with the EXW requirement, the seller leaves the goods at the buyer’s disposal without the goods being loaded to the cargo and without clearing the goods (this may be the seller’s property or elsewhere). In such a specification, carriage of the goods can be difficult if buyer’s vehicle is expected to be delivered and the country that this transport process is happening is a member party to Convention on the Contract for the International Carriage of Goods by Road (CMR) The carrier will not be held liable for damaging the goods which made by the shipper or an agent who acts behalf of the shipper during the transportation process However, the buyer may experience a lack of insurance coverage within the time taken by the carrier. Despite this deficiency, this term usually gives minimum responsibility to seller. EXW is therefore usually a term proposed by sellers.
- FCA (Free Carrier)
In international trade, it means the delivery to the carrier by specifying the place of delivery in the seller’s country. In this type of trade, export formalities and domestic transportation to the designated location expenses belong to the seller. The buyer is responsible for the import formalities in the buyer country and also transports formalities after the designated location. This term is generally common in practice because sellers often apply the loading procedure.
- CPT (Carriage Paid To)
CPT means that the seller will deliver the goods to the specified location by paying the freight. After the seller has delivered the goods to his shipper in good condition, he / she has to carry out the customs clearance and is obliged to forward the loading information and documents to the buyer. The buyer must insure the goods against damage after receiving this information. That is because after the delivering of the goods to the carrier; all damages and additional costs belong to the buyer.
- CIP (Carriage And Insurance Paid To)
In this form of delivery, the seller pays for the transportation of the goods; in addition, the insurance costs of the goods belong to the seller. The seller is obliged to deliver the goods to the customs, pay the freight cost and deliver it in the place indicated in the form of delivery. Also, the seller is not obliged to pay for the insurance, but if it does not insured seller is responsible for all future damages and losses. At the same time, after arrival all the expenses from the goods (customs commission, successor, etc.) belong to the buyer. Buyers or sellers may be forced to insure their goods in their own country to reduce their spending in foreign currencies or to support the domestic insurance industries. In such cases the buyer may be obliged to import through the CPT or FOB terms. Whereas the seller is legally able to make sales according to the CIP requirement.
- DAT (Delivered At Terminal)
It means that the seller brings the goods and then unloads them and places the goods at the designated port, terminal or named destination at the buyer’s disposal. The terminal also includes closed or non-closed areas such as quay, warehouse, container area or road, rail or air cargo terminal. Seller is responsible for the risks that may arise in bringing and unloading goods to the specified port or destination.
- DAP (Delivered At Place)
According to the DAP term; seller’s responsibility ends when goods are delivered and unloaded. Seller is also responsible for export clearances.
- DDP (Delivered Duty Paid)
DDP exerts the maximum responsibility to the seller as opposed to EXW. It means that the seller has delivered the goods to the buyer without clearing it from the transport vehicle that arrives at the specified destination. In addition to the responsibilities in the DAP, it is also responsible for the fees (customs, clearances, authorization etc.) that are generated when the seller is importing. Implementation of DDP has many benefits in practice. One of them is the sale fee includes transport cost and custom clearance. Buyer is involved the process in the unloading of the goods to the designated place. This makes things easier for the buyer
ii) Rules for Sea and Inland Waterway Transport
- FAS (Free Alongside Ship)
In this term, the seller shall deliver the goods together with the ship and arrange export clearances. After this point, the risk is transferred to the buyer along with the transportation and insurance costs. In this type of trade, the export formalities and the shipping costs for the ship at the determined port by the buyer; belong to the seller.
- FOB (Free On Board)
It includes the responsibility of the supplier in the process of transporting the goods to the ship. The transportation costs from the factory, port customs and port fees belong to the supplier. After the good is moved to the ship’s deck, the responsibility belongs to the customer. It is a term used in maritime transport and it is the most commonly used term in conjunction with CIF. The use of FOB can have some difficulties in practice. Risk transfer is carried out at the loading point in the ship, but the seller actually loses control after unloading the goods. In addition, some authors and practitioners suggest the use of certain terms such as FAS, FOB, CFR, and CIF, since they do not comply with customs regulations and delivery options, especially when transporting maritime containers. Similarly, in another aspect, the confusion about the use of containers by FOB demonstrates that confusion over the use of containers can be avoided using terms such as FCA, CPT and CIP.
- CFR (Cost and Freight)
It is an international trade term which means cost and freight. All transportation costs up to the pre-determined port shall be fully covered by the exporter company. However, the increase in costs or damage during transportation is the responsibility of the other party (the buyer).
- CIF (Cost, Insurance and Freight)
The word equivalents are the cost of goods, insurance and freight. In this type of trade, the seller undertakes the same obligations as in CFR, but in addition he is obliged to provide marine insurance against the risk of loss and damage of goods during transportation. It is here that the insurance contract is concluded and the insurance premium is paid to the seller. The buyer has to take into account that the CIF term requires only a minimum level of insurance coverage from the seller. The term CIF also requires that the goods are exported by the seller. This term may only be used in sea or river transport.
IV. Sharing the Risk by Parties While Selecting and Applying the Terms
The selection of the appropriate term may be difficult. When choosing the term, it is generally recommended for the parties to consider the following: who is responsible for the transport, who is responsible for the packaging of goods for export, the main transport costs and insurance coverage, who is responsible for the export clearance, and other related documents Depending on the terms of the sales contract, the parties decide which term to use. The choice can vary depending on the individual capacities of the parties. For example, if the seller is an expert in the transport business, this may be a promising factor in choosing which term it should be. (Preferably one of the terms in which the transportation is the seller’s responsibility). If, on the other hand, seller does not have sufficient experience in the transport business, then a term in which the responsibility of transportation is under the liability of the buyer must be selected. In practice, shared responsibility is positive for both parties because both parties mostly do not know the functioning of each other’s internal law hence buyer and seller are reluctant to deal with the legislation in each other’s countries.
V. Passage of the Risk
i) Overview of the Risk Transition
In case of sales involving the transport of goods from one point to another, there is always a risk factor in unexpected events that may cause loss or damage of goods. In most cases, although these goods are insured, the allocation of risk is still significant. There are financial implications for each transaction, so it is important that there are prescribed rules governing the passage of risk. In the first instance, where no provision is found for the insurance, the risk rule determines who will be responsible for the damage or the loss, or whether the buyer should be able to take the goods that have never been taken or damaged. However, the risk rule does not only determine who is responsible for the catastrophic events, but also indirectly determines the obligations of the parties regarding the insurance or depending on which side can deal well with the insurer. The loss or damage of the goods usually occurs after the receipt of the goods, so the buyer is in a better position than the seller to initiate a claim to the insurance company. This applies to cases where the containerized goods have been damaged but the container has not been damaged and it cannot be understood when the damage occurred. For example, while there is no damage to the container itself, damage to the goods can occur due to disturbance during transport or due to deterioration of organic goods inside the container as a result of failure to maintain adequate conditions. It is important that, in practice, the seller or the buyer or none of them takes responsibility for the goods. The passage of risk has existed since the old Roman law period and is equally important today.
All accidents related to the loss or damage of the goods cannot be regulated by rules related to risk transition. These rules can be vary depending on the definition of risk. Legally, risk refers to events that have caused physical damage and deterioration of goods. Therefore, the damage must not be attributed to one of the parties’ actions related to the contract. At the same time risk also includes; theft, exposure to sea water, exposure to overheating, mixing of goods (especially liquids with other goods), deterioration, shrinkage and evaporation. When goods are transported over a long period of time, such risks may affect the seller’s performance. The problem of risk distribution determines whether the parties have a legal responsibility for the contract with the actual events. Whether the risk passes to the buyer will depend on the time of loss. If the loss or damage occurred after the transfer of the risk to the buyer, then the buyer will be responsible for the payment of the purchase price. Otherwise, the damage remains with the seller. If the goods are no longer available, contractual liability is ended and there is nothing left to sell. But at the time of sale, when performance of the act has become impossible to do and when the risk has passed from the seller to the buyer; the buyer still will be responsible for the loss. Even if the seller has been relieved from the obligation to perform the performance; the buyer is still liable for the purchase price due to the transfer of the risk. The seller must cover the damage even if the seller still owns the goods when the risk has passed.
ii)Price Risk and the Risk of Non-Performance
If the goods are lost or damaged under the seller’s risk, the buyer is not responsible for the price; at the same time, the seller may be responsible for the damage caused by the non-delivery. If the risk is also passed to the buyer, the seller may indemnify the damage caused by the non-acceptance of the goods (such as storage fee). However, seller may also request payment of the price. At this stage, it is important to make a distinction regarding the risk transition and the financial liabilities that applied to the person responsible for the risk. Schmittoff says that the legal definition of the risk will be incomplete only when it is considered as price risk. This concept is a limited explanation when only mentioned by saying price risk. In theory, it is possible to divide the risk concept into two as price risk and non-performance risk. Price risk means that the purchase price is still paid despite the fact that the performance cannot be performed. Non-performance risk means that, despite the impossibility of performing the performance, it is still responsible for the fulfillment of this act or for the damage that occurs.However, when physical integrity is affected by risk before it passes to the buyer and performance becomes objectively impossible; contractual responsibilities of both parties are over. Risk theory for these reasons; not to be confused with the impossibility of performance, frustration and force majeure. It should be clearly differentiated from legal doctrines with the same conditions in relation to the risk. These doctrines sometimes represent the exceptions and exemption forms that can terminate the responsibility of the parties, both internally and sometimes unilaterally.
iii) The Concept of Risk Transition under English Law
In English law, the risk usually passes after the ownership has been transferred. The property rule is not fully complementary. Because in many cases it is difficult to determine the moment of transition of property. The English risk rule depends on the parties’ intentions and the circumstances of the situation. Once the property is transferred to the buyer, the buyer must pay the purchase price even if the seller is not responsible for damaging the goods. This still applies even if the buyer is not the owner of the goods or does not qualify for it. In addition, English risk rule is not consistent with the implementation of a property rule criterion for the passage of risk. Since the goods are delivered to the carrier prior to the right of disposal, it is considered to be unconditionally appropriate to the contract, so the property and the risk is transferred to the carrier with this transportation. In English law, the relationship between risk transition and frustration doctrines is more complex. It is particularly difficult to distinguish between certain and uncertain goods. The Sale of Goods Act 1979 shows various ways of distinction between unascertained goods and generic goods could not be made entirely. According to English law, discussions on trade terms show that the commercial practice distinguishes the transfer of property and risk transfer from each other. This means that the commercial application does not need such a connection. The use of trade terms indicates the inadequacy of the default rule. An effective and efficient default rule must be able to provide legal certainty and reduce tolls, which the English rule cannot achieve.
Due to the highly competitive nature of the international trade; it is an economic endeavor that aims to maximize profit as quickly as possible and tries to reduce the level in disputes. That is why international trade is aimed at correct and precise conclusions when dealing with business and trade. This certainty brought the standardization, and internationally accepted trade terms took place. The popularity and use of terms can also be seen in international and local trade. When the parties choose the Incoterms, even though there are 11 terms; each term is shaped according to the specific needs of traders, for example the type of goods sold, the type of transport used, and the ability of the parties to manage specific risks and costs associated with the sale contract and the transportation contract. Traders often do not adequately analyze the possible side-effects or benefits when choosing a commercial term. On the contrary, they continue to sell as they did before and like the previous ones. Nonetheless, traders should consider which Incoterm to choose, in terms of costs, risks, responsibilities and other formalities.
The risk transition between the parties is different from country to country. The concept of the passage of the risk that has survived to the present day since the beginning of the trade has also varied in theory and practice. Therefore, the distinction of responsibility began to be important for the traders. This concept is important for merchants in determining the responsibilities and criteria that may arise from the transporting, loading, unloading, damage of goods or other procedures. Risk transition, which will be one of the sine qua non concept of trade in the future; will continue to exist with the Incoterms concepts, which are tried to standardize what extent the responsibility is imposed on the parties while trading.
Av. Eren GUNDAY, LL.M.
i) Books & Journals
- Bergami, Incoterms 2010: What You Need to Know for Smooth Trading, (MHD Supply Chain Sollutions, 2011)
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- Docherty, An Overview of Incoterms 2010, (Special Report, IIFA, 2010)
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- ISM, Incoterms 2010 – What do the Changes Mean?, (Special Report, Institute for Supply Management, 2010)
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- P.M. Roth, The Passing of Risk, (American Journal of Comparative Law (27), 1979)
- Posner, Economic Analysis of law, (Iowa Law Review Vol.93No:2)
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- Valioti, Passing of Risk in international sale contracts: A comparative examination of the rules on risk under the United Nations Convention for the International Sale of Goods (Vienna, 1980)
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iii) Case Law
- Howell v Coupland  1 QBD 258
- Sale of Goods Act 1979
- Incoterms 2010 by ICC p.2 <https://iccwbo.org/resources-for-business/incoterms-rules/incoterms-rules-2010/> accessed at 04.05.2019