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What in the World are Incoterms?

By Megan Doyle

Ever wonder how international trade ever gets done, considering all the challenges that arise from very different people from very different cultures doing business together without so much as a common language to make sure they’re agreeing to the same things? What about the risks that emerge from the all-but-inevitable logistical problems of transporting goods vast distances, often across the borders of many different countries? Which party is responsible for what, when, and where throughout the trade journey? The solution – since 1936 – comes via Incoterms, or International Commerce Terms, as they are formally known.1

Risk, Risk, and More Risk?

 

As goods move from seller to buyer, the risk of lost, stolen, or damaged goods changes. Different parties take on different responsibilities at different times to ensure that if anything happens to the goods, both parties fully understand and acknowledge who is responsible for any mishaps. But without an internationally recognized set of standard trade terms, interpreting the transfer of risk can be risky in and of itself! This is because not all countries have the same shipping practices and import procedures.

 

In the 1920s, the International Chamber of Commerce (ICC) began to notice disparities in international trade procedures and how they could potentially introduce costly mishaps into the international trade landscape.2 To promote accurate interpretation of international trade stipulations regarding when risk is transferred between buyers and sellers, the ICC created Incoterms. Without standard responsibilities for importers and exporters, world trade could get messy. For example, if a business in Japan ships a container full of motorcycles to Canada, but the contents of the container are damaged at a U.S. port, who is responsible? In a case like this, Incoterms clarify who is considered in possession of the motorcycles at each point during transport and whether or not the goods are insured, mitigating potential disputes.

 

What are Incoterms?

 

Incoterms are internationally recognized and standardized trade terms that establish responsibilities for importers and exporters. They exist to clarify the costs, risks, and tasks involved in global trade, promoting ease and efficiency by ensuring all parties thoroughly understand their roles – and risks – in the trade journey.3 But what exactly are they, and how do they work?

 

To start, there are currently 11 Incoterms, including Ex Works (EXW), Carriage Paid To (CPT), Carriage and Insurance Paid To (CIP), and Delivered Duty Paid (DDP).4 Each Incoterm clarifies trade terms by answering common questions about international trade, such as where is the point of delivery? Who pays for cost of transport? Who pays for insurance, if at all? Who is required to manage customs clearance? And who pays for applicable duties and taxes?5 Each of the 11 Incoterms have different answers to the previous questions. Parties agree on which Incoterm best suits their needs.

 

For example, EXW stipulates that goods are considered “delivered” when they are placed at the buyer’s disposal at the seller’s premises or another named place, such as a warehouse. In other words, the seller is not required to load the goods on a carrier vehicle or clear the goods for export. As soon as the goods are placed at the disposal of the buyer, the buyer is responsible for freight, customs clearance, duties, or any desired insurance.6 The CIP Incoterm, on the other hand, requires the seller to obtain insurance to cover for the buyer’s goods, in addition to contracting for and paying the costs of carriage. However, the seller is only required to obtain minimum insurance protection – if the buyer wishes for greater protection, the parties must either mutually agree or the buyer must make its own additional insurance arrangements.7

 

It’s worth noting that some Incoterms can only be used for sea or inland waterway trades. These include Free Alongside Ship (FAS) and Free on Board (FOB).8 In addition, Incoterms do not cover all aspects of a shipping agreement. For example, the transfer of title or how goods are to be paid for are not included in Incoterms rules and must be established by other means.9

 

Navigating a Sea of Incoterms

 

Using Incoterms can be complicated. They’re made to simplify international import-export trade, but that doesn’t mean they are always used effectively. The ICC has updated the Incoterms six times since their introduction, with the intent of keeping them as clear and easy to understand as possible. But Incoterms can still “fail to achieve their intended purpose” and result in costly repercussions.10

 

Fortunately, this might be prevented by paying close attention when applying Incoterms.11 Wording can be tricky, with definitions changing for each Incoterm; words such as “delivery” have different meanings for different Incoterms. FAS, for example, considers goods delivered when they are placed alongside a shipping vessel, whereas FOB considers goods delivered when they are placed on board the vessel.12

 

Disputes between importers and exporters can arise if both parties do not fully understand the details of the Incoterm used. To combat disputes, some experts suggest it’s important to discuss the terms of sales and Incoterms not only at the start of the deal, but at “every stage of the contract-formulation process” to ensure all parties have full understanding of their contractual obligations.13 It may also be helpful to state which party’s legal system is to be used in case of a dispute.14

 

To further promote clarity, the most recent Incoterms 2010 stipulate that before signing a contract, the following information is required: place of departure port must be specified as precisely as possible; the chosen Incoterms must be applicable and be incorporated in the contract of sale or stipulated in a separate agreement; and any other contractual obligations (e.g., payment terms or breach of contract consequences) must be incorporated separately.15

 

The

Takeaway:

If the ICC found international trade to be complicated in the 1920s, one can only imagine how complex trade could be today without universal standards. Incoterms clarify a key aspect of trade: who is responsible for what at each point of the trade journey. Though sometimes difficult to navigate in their own right due to varying definitions and degrees of granularity, Incoterms are likely to prevent misunderstandings as long as international buyers and sellers pay close attention to the language.

Megan Doyle - The Author

The Author

Megan Doyle

Megan Doyle is a business technology writer and researcher based in Wantagh, NY, whose work focuses primarily on financial services technology.

Sources

1. “Incoterms rules history,” International Chamber of Commerce; https://iccwbo.org/resources-for-business/incoterms-rules/incoterms-rules-history/
2. Ibid.
3. “Incoterms Rules,” International Chamber of Commerce; https://iccwbo.org/resources-for-business/incoterms-rules/
4. “Incoterms rules 2010,” International Chamber of Commerce; https://iccwbo.org/resources-for-business/incoterms-rules/incoterms-rules-2010/
5. “What are Incoterms?,” NIBusinessInfo; https://www.nibusinessinfo.co.uk/content/what-are-incoterms
6. “Incoterms rules 2010,” International Chamber of Commerce; https://iccwbo.org/resources-for-business/incoterms-rules/incoterms-rules-2010/
7. Ibid.
8. Ibid.
9. “The Incoterms 2010 rules: Summary,” Incoterms Explained; https://www.incotermsexplained.com/the-incoterms-rules/
10. “All you need to know about INCO Terms,” Tradecloud; https://www.tradecloud1.com/blog/inco-terms-2010
11. Ibid.
12. “Incoterms rules 2010,” International Chamber of Commerce; https://iccwbo.org/resources-for-business/incoterms-rules/incoterms-rules-2010/
13. “All you need to know about INCO Terms,” Tradecloud; https://www.tradecloud1.com/blog/inco-terms-2010
14. “Incoterms and Contracts,” NIBusinessInfo; https://www.nibusinessinfo.co.uk/content/incoterms-and-contracts
15. “All you need to know about INCO Terms,” Tradecloud; https://www.tradecloud1.com/blog/inco-terms-2010

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