Understanding Incoterms - What you should watch for when buying equipment
by James Waite and Don Galvez
Question: I’m buying some equipment, and the shipping terms in the purchase agreement refer to “EXW Incoterms 2020.” I’m generally familiar with “Incoterms,” but I don’t really have a lot of time to study what each one means. Can you give me a summary of what I’m dealing with when a contract I sign references “Incoterms” and what I should be looking out for?
Answer: Referencing Incoterms in a contract that requires shipping generally is a good idea, whether the shipment is coming from overseas or from within the United States. That said, you’re in the majority; most people, including lawyers, don’t have time to study them every time they ship a piece of equipment or a container of parts.
Generally, Incoterms — short for “International Commercial Terms” — consist of 11 “shorthand” descriptions provided by the International Chamber of Commerce of the shipping terms that can be applied to a given contract. Using Incoterms effectively eliminates the need to go into minute detail regarding every element of the shipping process every time a contract for the purchase, sale, lease, transportation, etc. of goods is entered into. For example:
- Where delivery takes place.
- Which party shoulders the risks of loss and damage, and when.
- Who is responsible for clearance by customs.
- Which party is liable for payment of duties and taxes.
- Which party is responsible for insurance.
- When acceptance by the buyer occurs.
- When the seller is permitted to recognize sales revenue.
- Who is responsible for loading and/or unloading of the goods.
- When the purchaser’s lender(s) can safely provide funding for purchases.
First published in 1936 and having since been translated into 29 languages, Incoterms have garnered general acceptance throughout the shipping industry worldwide, providing a crucial means of expediting the shipping process while enabling parties on both sides to avoid misunderstandings. Note that some countries still publish their own independent shipping terms — even in the U.S., UCC Sections 2-319 through 2-324 still apply — but none have gained acceptance like the way that Incoterms have.
So what are Incoterms? Most people in the equipment industry are familiar with at least two Incoterms, free on board (FOB) and ex works (EXW). In fact, 11 exist, breaking down the shipping process into its critical elements and allowing the parties to shift costs and risks as appropriate among them. The chart on this page sets forth the basic terms and how they can be divided between buyers and sellers who elect to use them.
- EXW: The seller is deemed to have completed delivery when the seller places the goods at the disposal of the buyer at the seller’s premises or at another named place. The seller is not required to load the goods on any vehicle or vessel, nor is the seller required to clear the goods for export where applicable.
- Free carriers (FCA): The seller delivers the goods to the carrier or to another party named by the buyer at the seller’s premises or at another agreed upon delivery point. The parties should specify as clearly as possible the actual delivery point within the named delivery destination, as the risk passes to the buyer at that point.
- Carriage paid to (CPT): The seller delivers the goods to the carrier or another party named by the seller at an agreed place, if any such place is agreed between parties. The seller must contract for and pay the cost of carriage necessary to bring the goods to the named place of destination.
- Carriage and insurance paid to (CIP): The seller delivers the goods to the carrier or another person named by the seller at an agreed place, if any such place is agreed between parties, and the seller must contract for and pay the costs of carriage necessary to bring the goods to the agreed upon destination. The seller also contracts for insurance to cover against risk of loss of or damage to the goods during transportation. The buyer should note that, under CIP, the seller is required to obtain only the minimum prescribed levels and types of insurance. If the buyer seeks greater or broader protection(s), the buyer will need either to expressly agree on that with the seller or arrange for its own additional insurance.
- Delivered at place (DAP): The seller is deemed to have completed delivery when the goods are placed at the disposal of the buyer on the arriving means of transport ready for unloading at the agreed upon destination. The seller bears all risks involved in transporting the goods to the delivery destination.
- Delivered at place unloaded (DPU): The seller is deemed to have completed delivery when the goods, once unloaded, are placed at the disposal of the buyer at the agreed destination. The seller bears all risks associated with transportation as well as unloading of the goods at the destination.
- Delivered duty paid (DDP): The seller is deemed to have completed delivery when the goods are placed at the disposal of the buyer, cleared for import, and ready for unloading at the agreed destination. The seller bears all costs and risk of loss involved in transporting the goods to the destination and must also clear the goods for export from the export country, clear the goods for import at the destination, pay all export/import duties and satisfy all customs formalities.
- Free alongside ship (FAS): The seller is deemed to have completed delivery when the goods are placed alongside the vessel named by the buyer at the named port of shipment. The risk of loss of or damage to the goods passes from the seller to the buyer when the goods are alongside the ship; thereafter, the buyer bears all costs and risks.
- Free on board (FOB): The seller is deemed to have completed delivery when the goods are loaded on board the vessel named by the buyer at the named port of shipment. The risk of loss of or damage to the goods passes from the seller to the buyer when the goods are on board the vessel, and the buyer bears all costs and risks from that point forward.
- Cost and freight (CFR): The seller is deemed to have completed delivery when the goods have been loaded on board the agreed upon vessel. The risk of loss and damage to passes from the seller to the buyer when the goods are on board the vessel, but the seller must still contract for and pay the cost of the transportation necessary to deliver the goods to the agreed destination.
- Cost, insurance and freight (CIF): The seller is deemed to have completed delivery when the goods have been loaded on board the vessel. The risk of loss of or damage to the goods passes when the goods are on board the vessel, but the seller must still contract for and pay the costs of the transportation necessary to deliver the goods to the agreed destination as well as the associated insurance.
Negotiating Incoterms. Whether and how vigorously a buyer or seller should negotiate shipping and delivery terms depends largely on how the equipment will be shipped and which party customarily shoulders the associated risks. EXW places virtually all of the risk on the buyer, which is more than a little unusual within the context of an equipment sale, particularly if the equipment is coming from overseas. So, negotiating more favorable terms is probably not only possible but necessary. Fortunately, by utilizing Incoterms, you can make this as simple as changing EXW to DDP [name your delivery point] destination.
Domestic and international use. As originally conceived, Incoterms were intended to apply internationally, but they are commonly used for stateside transportation of goods because, as discussed above, they are so well understood in the transportation industry. As valuable as they are domestically, however, they can be crucial with respect to a wide array of issues internationally. Without attempting to cover all of them, consider what in our view, constitute the three most common, and often most important, issues:
- Import and export duties and taxes. Depending on the countries of origin and destination, and whether those countries might be parties to a trade agreement, part of an international trade association or at odds — think of punitive import and anti-dumping duties — if your contract makes you responsible for duties and taxes, you could be taking on far more financial responsibility than you had planned.
- Customs compliance. The party responsible for serving as the exporter and/or importer of record, might also bear on whether, for example, certain export, import and/or internal taxes might be recovered through refunds. Canada, with which the U.S. shares the world’s largest international trading partnership, for example, allows for refunds of GST, HST and QST, but only in certain situations, and only pursuant to carefully, and scrupulously, administered rules. This can amount to hundreds of millions of dollars in taxes every year for large manufacturers and dealers.
- Delivery timing. More recently, think about delivery timing. As supply chain disruptions continue, delivery delays mount, and contract penalties come to bear — particularly for parties charged with completing deliveries to remote destinations by specified delivery deadlines. Depending on which side of the equation you find yourself on, you could be in for a long wait or a large delay penalty, unless your contract contains an unusually broad force majeure clause.
Consider contacting a customs broker. These landing costs can, of course, vary dramatically, depending on the country of origin and the country of destination, a fact that, when combined with the vast and confusing array of differing import/export and customs requirements adopted by many countries, continues to motivate even the most sophisticated shippers to engage customs brokers whose job it is to navigate the resulting maze and ensure that such matters are handled in the most timely and cost-effective manner possible. Overlooking any of these can be financially disastrous. If you’re considering any large cross-border transactions, engaging an experienced customs broker can be a lifesaver.
In general, think of Incoterms as one potentially valuable tool in your belt, but don’t rely solely on them. Couple them with properly drafted contract provisions covering at least the above topics every time you enter into a contract for the sale and purchase of equipment — and make sure you use all of them properly.
Despite their popularity, Incoterms remain something of a mystery to even seasoned equipment professionals. The seemingly straightforward nature of the shipping process can, however, result in dangerous complacency, particularly with respect to international shipments, making it a little like learning which string on your parachute is the rip cord. It seems simple when you see it on the diagram, but when you need it, you’d better get it right.
James Waite is a business lawyer with more than 25 years in the equipment and event rental industry. Don Galvez is an associate attorney with James Waite Law. They can be reached at 866-582-2586 or firstname.lastname@example.org.