A practical guide to the Incoterms 2020 rules in international sales, explaining the eleven delivery terms, how costs and risk transfer at different points, what changed since 2010, the insurance obligation and how to choose the right term for a given shipment.
In the international sale of goods, the questions of by whom the costs arising in the process of the goods reaching the buyer from the seller will be borne, when and where the risk relating to damage to the goods will pass to the buyer, by whom the customs formalities will be carried out and on whose responsibility the carriage and insurance will lie, constitute the most critical elements of the contract. Since the detailed re-regulation of these matters in every contract would be both time-consuming and open to uncertainty, the world of international trade has developed a common language on this subject. The Incoterms rules published by the International Chamber of Commerce constitute this common language, determining clearly the rights and obligations of the parties through standard delivery terms consisting of three letters. The Incoterms 2020 rules currently in force have replaced the 2010 rules and have adapted to the changing needs of international trade. This article comprehensively examines the Incoterms 2020 rules, the eleven delivery terms, the distinction between the transfer of costs and of risk, the changes from the 2010 rules and the practical principles relating to the selection of the right rule.
1. The Nature and Function of the Incoterms Rules
Incoterms is a body of rules prepared by the International Chamber of Commerce and defining, in a standard manner, the delivery obligations of the parties in the international sale of goods. The basic function of these rules is to set out clearly and foreseeably, through three-letter abbreviations, how the costs, risks and obligations relating to the delivery of the goods will be shared between the seller and the buyer. An important point as regards the legal nature of the Incoterms rules is that they are not an international convention or a law, but rules of commercial usage incorporated into the contract by the will of the parties. That is, the Incoterms rules do not apply of themselves; the parties must expressly refer to a particular Incoterms rule in the sales contract. When the rules are incorporated into the contract, they constitute a binding framework determining the rights and obligations of the parties as regards that delivery term. The Incoterms rules do not regulate the transfer of ownership of the goods, the payment terms or the consequences of a breach of contract; they cover only matters connected with delivery, such as delivery, costs, risk and customs. Knowledge of this limit shows that the parties must separately regulate the contract as regards matters falling outside Incoterms.
2. Incoterms 2020 and the Classification of the Eleven Rules
The Incoterms 2020 rules, being the first update since the 2010 rules, consist of eleven delivery terms. These eleven rules are divided into two basic groups according to the mode of transport. The first group consists of seven rules applicable to any mode of transport; these are the EXW, FCA, CPT, CIP, DAP, DPU and DDP rules. These rules may be used in any type of road, air, rail, sea or multimodal transport. The second group consists of four rules applicable only to sea and inland waterway transport; these are the FAS, FOB, CFR and CIF rules. These rules are traditionally used in bulk cargo and sea transport. This classification of the rules is of critical importance as regards the selection of the right rule; because the use of a rule specific to sea transport in container transport may lead to serious problems in practice. The rules also lie on a spectrum extending from the EXW rule, where the seller's obligation is the least, to the DDP rule, where the seller's obligation is the greatest. This spectrum enables the parties to select the appropriate rule according to their commercial needs and bargaining power.
3. The Distinction between the Transfer of Costs and the Transfer of Risk
The most critical matter in understanding the Incoterms rules, and the one most often misunderstood in practice, is that the transfer of costs and the transfer of risk do not always occur at the same point. The transfer of costs determines up to which point the expenses such as the carriage, insurance and customs formalities of the goods will be borne by the seller and from which point by the buyer. The transfer of risk, on the other hand, shows at which moment and where the responsibility relating to the probability of the goods being damaged or lost passes from the seller to the buyer. In the D-group rules (DAP, DPU, DDP) the transfer of costs and of risk unite at the same point, that is, at the destination; the seller carries both the cost and the risk up to the destination. By contrast, in the C-group rules (CPT, CIP, CFR, CIF) these two points are separated from one another; the seller pays the freight up to the destination, but the risk passes to the buyer much earlier, at the point of departure where the goods are delivered to the carrier. This distinction often surprises the parties, particularly those exporting or importing for the first time. Where the goods are damaged in transit, the fact that the seller has paid the freight does not mean that the risk too lies with the seller. The correct understanding of this distinction is of vital importance as regards the correct determination of the insurance need and of responsibility.
4. EXW: Ex Works
EXW is the delivery term where the seller's obligation is the least. Under this rule the seller's only obligation is to make the goods available to the buyer at its own premises, packed and labelled. The seller is not obliged to load the goods onto the means of transport and is not obliged to carry out the export customs formalities. From the taking of the goods from the seller's premises, all costs and risks belong to the buyer. EXW is the rule where the buyer assumes the most responsibility; the buyer must organise and bear the whole of the loading, carriage, insurance, export and import customs formalities. This rule may be advantageous in situations where the buyer has a strong logistics network in the seller's country. However, in situations where the carrying out of the export customs formalities by the buyer may create difficulty in practice, the FCA rule may constitute a more suitable alternative. That the seller's obligation is at a minimum level under the EXW rule requires the buyer to have the capacity to plan and control the process from beginning to end.
5. The F-Group Rules: FCA, FAS, FOB
In the F-group rules the seller delivers the goods to the carrier determined by the buyer; however, the seller does not assume the cost of the main carriage. There are three rules in this group. Under the FCA (Free Carrier) rule the seller delivers the goods, having completed the export customs formalities, to the carrier determined by the buyer, at the agreed place. FCA may be applied to any mode of transport and is accepted as the most suitable rule in container transport; because the risk passes clearly when the goods are delivered to the carrier. Under the FAS (Free Alongside Ship) rule the seller is obliged to bring the goods alongside the ship at the port of loading, and from this point the risk passes to the buyer. Under the FOB (Free on Board) rule, on the other hand, the seller is obliged to load the goods onto the ship at the port of loading, and the risk passes to the buyer when the goods are loaded onto the ship. FAS and FOB apply only to sea and inland waterway transport. A frequent mistake in practice is the use of a rule specific to sea transport, such as FOB, for a container load that actually changes hands at an inland terminal; in this case, if the container is damaged on the road to the port, it becomes uncertain with whom the risk lies. In container transport FCA is almost always a more correct choice.
6. The C-Group Rules: CPT, CIP, CFR, CIF
In the C-group rules the seller pays the cost of the main carriage up to the destination; however, the risk passes to the buyer at the point of departure where the goods are delivered to the carrier. The most distinctive feature of this group is that the transfer of costs and of risk occurs at different points. Under the CPT (Carriage Paid To) rule the seller sends the goods paying the carriage cost to the destination, but has no insurance obligation. The CIP (Carriage and Insurance Paid To) rule is the same as CPT, but the seller is also obliged to take out transport insurance for the goods. The CFR (Cost and Freight) rule applies only to sea transport; the seller assumes the export customs and the main carriage cost, but has no insurance obligation. The CIF (Cost, Insurance and Freight) rule, on the other hand, is the same as CFR, but the seller must also take out transport insurance for the goods. In the C-group rules, knowledge that the seller's having paid the freight does not also place the risk on the seller is critical as regards the parties' protection of their interests.
7. The D-Group Rules: DAP, DPU, DDP
In the D-group rules the seller carries the goods up to the destination as regards both cost and risk; in this group the transfer of costs and of risk unite at the same point. Under the DAP (Delivered at Place) rule the seller places the goods at the buyer's disposal at the destination, ready for unloading; up to this point all costs and risk belong to the seller, while the buyer assumes the import customs formalities and the unloading. Under the DPU (Delivered at Place Unloaded) rule the seller delivers the goods by unloading them at the destination; the cost and risk pass to the buyer when the goods are unloaded from the seller's means of transport. DPU is the only rule under which the seller is obliged to unload the goods. Under the DDP (Delivered Duty Paid) rule, on the other hand, the seller delivers the goods at the destination assuming all costs and risks, including the import customs formalities and duties; this rule is the delivery term where the seller's obligation is the greatest. Under the DDP rule the seller must be in a position to fulfil the import obligations in the destination country legally and in fact; otherwise serious problems may arise.
8. The Transition from DAT to DPU
One of the most notable differences of the Incoterms 2020 rules from the 2010 rules is the change of the name of the DAT rule to DPU. The DAT (Delivered at Terminal) rule contained in the 2010 rules provided for the delivery of the goods by unloading them at a particular terminal. However, in practice the need arose that the place of delivery need not be limited only to a terminal, and that the goods could be delivered by being unloaded at any agreed place. In line with this need, the DAT rule was renamed DPU (Delivered at Place Unloaded). This change is not merely a change of name; by broadening the scope of the rule, it has enabled the place of delivery to cease being limited to a terminal and to be any agreed place. DPU retains its feature of being the only Incoterms rule under which the seller bears the obligation to unload the goods. This change is an important step as regards the adaptation of the rules to commercial reality and enables the parties to determine the place of delivery more flexibly.
9. The Insurance Difference between CIF and CIP
One of the most important innovations brought by the Incoterms 2020 rules is the difference in the level of insurance between the CIF and CIP rules. In the 2010 rules both the CIF and the CIP rules required the seller to take out insurance only at the minimum level, within the scope of Institute Cargo Clause C. In the Incoterms 2020 rules, on the other hand, different levels of insurance are provided for as regards these two rules. The CIF rule, being traditionally used in bulk cargo and commodity trade, maintains the lower Clause C coverage. By contrast, the CIP rule, being used more in manufactured goods, has been raised to the more comprehensive Institute Cargo Clause A, that is, the level of coverage covering all risks. This change carries the aim of ensuring insurance coverage suited to the nature of the goods. In both rules the parties have the possibility of freely agreeing on a different level of insurance. This regulation requires the parties to determine their insurance needs according to the type of goods and the conditions of carriage. The correct determination of the level of insurance is of great importance as regards the protection of the parties in the event of the goods being damaged during carriage.
10. The Use of One's Own Means of Transport and the Bill of Lading under FCA
The Incoterms 2020 rules have brought two further important innovations adapting to the changing realities of international trade. The first of these is the regulation relating to the parties' ability to use their own means of transport. The 2010 rules based all transport obligations on the making of a contract with a carrier. The Incoterms 2020 rules, on the other hand, have for the first time expressly accepted that the buyer or the seller may use its own means of transport instead of a third-party carrier. This regulation applies to the FCA, DAP, DPU and DDP rules and reflects the commercial reality that large logistics operations use their own fleets. The second important innovation relates to the issue of a bill of lading under the FCA rule. Where the goods are sold under the FCA rule for carriage by sea, the parties or their banks often require a bill of lading showing that the goods have been loaded onto the ship. Incoterms 2020, in order to meet this need, has introduced the possibility of an on-board bill of lading being issued to the seller after the loading of the goods. This regulation facilitates the use of the FCA rule particularly in situations requiring the presentation of a bill of lading in payments by letter of credit.
11. Security Obligations and the Allocation of Costs
The Incoterms 2020 rules have regulated the security obligations relating to carriage and the allocation of costs more clearly than the 2010 rules. Security requirements in international trade have gained increasing importance in recent years, and various security controls and documentation obligations have arisen in the process of carriage of the goods. The Incoterms 2020 rules have determined more clearly, as regards each rule, by which party the security requirements relating to carriage will be met. This regulation ensures that the security obligations in the import and export process are clearly allocated between the seller and the buyer. Moreover, the rules set out in more detail which cost will be borne by which party as regards each delivery term. The clear determination of this allocation of costs is important as regards the prevention of disputes relating to costs between the parties. In practice a significant part of cost disputes arises from the failure to determine clearly in the contract which cost will be borne by which party. The clarity of the Incoterms 2020 rules on this subject enables the parties to foresee their cost obligations from the outset.
12. The Selection of the Right Rule
The correct selection of the Incoterms rules constitutes the basis of the sound operation of the international sales contract. The most common mistake made in practice is the selection of the rule out of habit rather than according to the concrete conditions of carriage. The correct selection of the rule must be made according to the type of goods, the mode of transport, the logistics capacity of the parties and their commercial bargaining power. In container transport, instead of FOB or CIF, which are specific to sea transport, the FCA or CIP rule, applicable to any mode, is often more suitable; because the risk passes clearly when the container is delivered to the carrier. In situations where the buyer wants maximum control over the freight and the main carriage, FCA may be the most practical choice. In situations where the seller is willing to organise the carriage but does not want to assume the import customs formalities in the destination country, the CPT, CIP, DAP or DPU rules may be more suitable for the transaction. In situations where the buyer wants the seller to handle almost everything, DDP may be attractive; however, it is essential that the seller be in a position to fulfil the import obligations in the destination country. The selection of the rule in a manner suited to the concrete transaction prevents a significant part of the disputes that may arise in the future from the outset.
13. The Relationship between Incoterms and the Letter of Credit
The Incoterms rules are closely connected with the methods of payment in international trade, particularly with the letter of credit. In payment by letter of credit, for the bank to be able to make payment, the seller must present certain documents; among these documents the transport document, the insurance document and the commercial invoice hold an important place. The Incoterms rule selected directly affects which documents will be procured by whom. For example, under the CIF or CIP rule, since the seller is obliged to take out insurance, it is expected to present an insurance document within the scope of the letter of credit. Under the FOB rule, on the other hand, since the insurance obligation does not lie with the seller, this document is not requested from the seller. Moreover, the on-board bill of lading possibility introduced by Incoterms 2020 under the FCA rule provides great convenience in situations requiring the presentation of a bill of lading in transactions by letter of credit. The determination of the Incoterms rule and the terms of the letter of credit in a manner compatible with one another is of critical importance as regards the smooth operation of the payment process. The incompatibility of these two elements may lead to problems in the presentation of documents within the scope of the letter of credit and to the delay of payment. For this reason, when the sales contract is being prepared, the Incoterms rule and the payment terms must be assessed together.
14. Matters Falling Outside the Scope of Incoterms
The correct use of the Incoterms rules requires knowledge of what these rules do not regulate as much as of what they regulate. The Incoterms rules regulate only matters connected with delivery, that is, the obligations of cost, risk, carriage, insurance and customs. By contrast, when and how the ownership of the goods will pass falls outside the scope of the Incoterms rules; the transfer of ownership is determined according to the law applicable to the contract. Likewise, the payment terms and the time and method of payment are not regulated by the Incoterms rules; these must be separately agreed in the contract. The sanctions to be applied in the event of a breach of contract, and consequences such as compensation and rescission of the contract, also fall outside the Incoterms rules and are subject to the applicable law. The competent court or arbitration to which recourse is to be had in the event of a dispute is also not within the scope of Incoterms. For this reason, when an international sales contract is being prepared, while the Incoterms rule is used to determine the delivery term, matters such as the transfer of ownership, payment, the law applicable to the contract, dispute resolution and the consequences of breach must be separately regulated in the contract. The provision of this integrity ensures that the contract is complete and foreseeable.
15. Conclusion and Practical Recommendations
The Incoterms 2020 rules are a basic tool determining the delivery terms in the international sale of goods in a standard manner and rendering foreseeable the sharing of costs, risks and obligations between the parties. The prominent practical considerations in this field are as follows. First, the Incoterms rule to be used in the sales contract must be selected not out of habit, but according to the concrete conditions of carriage, the type of goods and the logistics capacity of the parties. In container transport, the FCA and CIP rules should be preferred instead of FOB and CIF, which are specific to sea transport. It must not be forgotten that the transfer of costs and the transfer of risk do not always occur at the same point, and that particularly in the C-group rules the risk passes at departure. Having regard to the difference in the level of insurance between the CIF and CIP rules, insurance coverage suited to the nature of the goods must be ensured. When the Incoterms rule is being selected, the version to which the rule to be used belongs, for example Incoterms 2020, must be expressly stated in the contract. Finally, it must be known that the Incoterms rules do not regulate matters such as the transfer of ownership, payment and dispute resolution, and these must be separately agreed in the contract. The correct selection of the rule and the integrated preparation of the contract prevent a significant part of the disputes in international sales from the outset.
The Incoterms rules are closely connected with the other layers of international trade and the sale of goods. Our article on letters of credit and the UCP 600 rules, which addresses payment security, our analysis of choice of law and jurisdiction agreements in international commercial contracts, which explains the contractual regime forming the basis of the international sale of goods, and our article on the CMR Convention in international carriage of goods by road address the matters connected with delivery terms.
For advisory services on the preparation of international sales contracts, the correct selection of Incoterms rules, the structuring of payment by letter of credit and the resolution of international trade disputes, you may contact us at info@guzeloglu.legal.