Incoterms explained (incl. best practices) - Weagree

INCOTERMS explained

Incoterms (‘international commercial terms’) are a series of pre-defined set of rules related to the delivery of sold products and are published by the International Chamber of Commerce (ICC), where full text and explanations can be purchased in print or as an app. Incoterms are usually abbreviated to three letters (e.g. FOB, CIF, DDP, EXW). Incoterm rules are generally accepted worldwide for the interpretation of most commonly used sets of terms and conditions, and are primarily intended to clearly communicate:

  1. the tasks, costs and risks associated with the transportation, and
  2. point of delivery of goods.

An Incoterm operates as a set of predefined parameters related to transportation, transfer of risk, insurance and delivery of sold products. While usually found in sales agreements (strategic or long-term supply or one-off sales), it may well be that if tangible goods are to shipped in the context of providing service such shipment is arranged by reference to the Incoterms. A contractual reference to an Incoterm implies the incorporation (by reference) of the parameters of the chosen Incoterm into the sales contract. There is no need to expressly stipulate that the Incoterm rules are indeed incorporated by reference, as that is how this is commonly understood. While non-English contracts might use translated wording for the selected Incoterm, it is strongly recommended not to abbreviate the such translated wording but to refer to the official (English) three-letter abbreviation. For example, while a French contract might refer to Coût Assurance Fret for Incoterm Cost Insurance Freight, do not refer to CAF but instead use CIF.

If the parties provide differently as regards one or more of those parameters, this would be deemed to ‘overrule’ the relevant parameters of the Incoterm. For example, the retention of title that ownership passes upon payment overrides the Incoterm’s parameter that risk passes upon handing over the sold goods at a port of shipment.

Delivery and risk-passing. A key characteristic requirement of the Incoterms is to give a precise definition of the contractual place of delivery of the sold products. Under the Incoterms, the place of delivery is also the place (under the sales contract) where the risk of loss of or damage to the goods transfers from the seller to the buyer. Paragraph A4 of each Incoterm specifies the place of delivery.

Point of delivery. By incorporating an Incoterm into a sales contract, the parties clarify precisely where the seller performs its obligation to deliver the goods. For an Incoterm to work properly, it is essential to identify a precise location as the place of delivery. Do not stipulate a point of delivery that does not fit the selected Incoterm: it makes no sense to agree on EXW (Ex Works, delivery at the warehouse of the seller) and provide for a location in the buyer’s country – rather, that gives rise to disputes.

Under most Incoterms, delivery takes place where the goods are handed over, not directly to the buyer, but to a third party (e.g. a carrier) at a pre-determined place. The practicalities for handing over goods to carriers may vary, depending on the location. Clearly identifying the place of delivery will make it impossible for different possible applicable laws to assign the passage of risk to multiple locations.

Cost implications. Choosing an Incoterm determines not only the transportation and delivery obligations of the parties, but also the answer to the question: “Who bears which costs?” Accordingly, to the extent that the seller takes responsibility for transportation and delivery costs, those costs are presumed to be incorporated into the purchase price of the goods.

Application. The Incoterms have traditionally been used for international sale contracts even though some geographical areas, such as the European Union (or even the WTO), have minimised import formalities. Incoterms 2010 can now also be used for domestic sales. This change may encourage greater use of the Incoterms in the U.S.

History of the Incoterms #

Versions. The idea for the Incoterms goes back to 1921, and the International Chamber of Commerce published the first set in 1936. The current version is Incoterms 2010, published on 1 January 2011, which updates (albeit to a limited extent) Incoterms 2000.

Refer to the right version. Because changes are made to Incoterms from time to time, it is important to ensure that an express reference is made to the then-current version of the Incoterms wherever the parties incorporate Incoterms into their contract. This may easily be overlooked when, for example, a reference has been made to an earlier version in standard contract forms or in order forms used by merchants. A failure to refer to the current version may then result in disputes as to whether the parties intended to incorporate that version or an earlier version into their contract. Merchants wishing to use Incoterms 2000 should therefore clearly specify that their contract is governed by “Incoterms 2000”.

Incoterms 2000, 2010 and 2020. Incoterms 2010 defined 11 rules (down from the 13 used in Incoterms 2000), introducing two new rules (“Delivered at Terminal”, DAT; and “Delivered at Place”, DAP), which replace four rules in Incoterms 2000 (i.e. “Delivered at Frontier”, DAF; “Delivered Ex Ship”, DES; “Delivered Ex Quay”, DEQ; and “Delivered Duty Unpaid”, DDU). By way of clarification, in Incoterms 2020, the term DAT was renamed to DPU (“Delivery at Place Unloaded“).

Incoterm delivery obligations of the parties visualised #

The differences among Incoterms are best understood when depicted in a table. The table below shows which action (if applicable) must be undertaken by the seller and which by the buyer. Obviously, this is a cost/price influencing element. However, the choice of one or another Incoterm is often determined by the more practical question: which party is more used to arranging for transportation or insurance, the availability of warehousing to the buyer, or more familiar with local transportation particularities.

Incoterms obligations and actions by buyer and seller

Note that the above and below tables relate to Incoterms 2010 (DAT is now called DPU).  The transfer of the risk regarding the sold goods somewhat deviates from the overview of obligations to be performed by which party, as shown below:

Incoterms transfer of risk in the delivered goods

Structure of the Incoterms #

Categorisation of Incoterms according to the letter. In Incoterms 2000, a categorisation was made based on the place of delivery. Although this approach has now been abandoned, the categorisation still helps in distinguishing the Incoterms from one another.

The “E”-term (‘departure contracts’) is the term under which the seller’s obligation is at its minimum: the seller has to do no more than place the goods at the disposal of the buyer at the agreed location – usually a distribution centre or the factory or assembler of the seller.

The “F”-terms (‘main carriage unpaid contracts’) require the seller to deliver the goods for carriage as instructed by the buyer. The delivery point under FOB is the same under CFR and CIF.

The “C”-terms (‘main carriage paid contracts’) require the seller to contract for carriage on usual terms at its own expense. Therefore, a point up to which he would have to pay transport costs must necessarily be indicated after the respective “C”-term.[1] Under the CIF and CIP terms, the seller also has to take out insurance and bear the insurance cost. The “C”-terms contain two ‘critical’ points (not one, as opposed to the other Incoterms): one indicating the point to which the seller must arrange and bear the costs of a contract of carriage, and another indicating the point for transfer of the risk. A characteristic of the “C”-terms is that the seller is relieved of any further cost and risk once it has discharged its obligations by contracting for transportation, handing over the goods to the carrier, and, in case of CIF or CIP, by providing for insurance. Accordingly, adding obligations of the seller to the “C”-terms, which extend its responsibility beyond the point of transfer of the risk, requires great caution.

The “D”-terms (‘arrival contracts’) are essentially different from the “C”-terms, because under the “D”-terms the seller is responsible for the arrival of the goods at the agreed place (or at a destination at the border or within the country of import). The seller must bear all costs and risk in bringing the goods there. Hence, the “D”-terms signify arrival contracts, while the “C”-terms denote departure (shipment) contracts.

Categorisation in Incoterms 2010. In Incoterms 2010, the 11 Incoterms are subdivided into two categories based only on method of delivery. The larger group of seven rules applies regardless of the method of transport, but the smaller group of four is applicable only to sales that solely involve transportation over water.

Subdivision of Incoterms from A1 to B10. Each Incoterm is systematically structured, dividing all the elements of delivery into ten numbered entries, each of which is sub-labelled “A” for the seller’s obligations or “B” for the buyer’s obligations. Accordingly, each Incoterm contains the following captions:

A1                    – Provision of goods in conformity with the contract
B1                    – Payment of the price
A2 & B2            – Licences, authorizations and formalities
A3 & B3            – Contracts of carriage and insurance
A4                    – Delivery
B4                    – Taking delivery
A5 & B5            – Transfer of risks
A6 & B6            – Division of costs
A7                    – Notice to the buyer
B7                    – Notice to the seller
A8 & B8            – Proof of delivery, transport document or equivalent electronic message
A9                    – Checking – packaging – marking
B9                    – Inspection of goods
A10 & B10        – Other obligations

Incoterms for any mode of transportation. #

The seven rules defined by Incoterms 2010 for any mode(s) of transportation are:

EXW: Ex works (named place of delivery)
The Ex Works Incoterm is typically used in an initial quotation for the goods without any costs included. The seller makes the goods available at its premises. This term places the maximum obligation on the buyer and minimum obligation on the seller. EXW means that on the agreed date, the seller makes the goods available at its premises (factory, warehouse, plant). To put it simply, the seller opens the doors of its premises. The buyer pays for transportation and bears the risks for taking the goods to their final destination. The seller does not load the goods on collecting vehicles and does not clear them for export. If the seller does load the goods, it does so at the buyer’s risk and cost. If the seller should be responsible for loading the goods on departure and bear the costs and risk of such loading, this must be made explicit in the sales contract.

FCA: Free carrier (named place of delivery)
The seller hands over the goods, cleared for export, putting them at the disposal of the first carrier (named by the buyer) at the named place. The seller pays for carriage to the named point of delivery, and risk passes when the goods are handed over to the first carrier.

CPT: Carriage paid to (named place of destination)
The seller pays for carriage. Risk transfers to the buyer upon handing goods over to the first carrier.

CIP: Carriage and insurance paid to (named place of destination)
CIP is the containerised transport or multimodal equivalent of CIF. The seller pays for carriage and insurance to the named destination point, but risk passes when the goods are handed over to the first carrier.

DPU: Delivered at place unloaded (named terminal at port or place of destination)
The seller pays for carriage to the terminal, except for costs related to import clearance, and assumes all risks up to the point that the goods are unloaded at the terminal. Note that DPU is renamed from Incoterms 2010 term DAT.

DAP: Delivered at place (named place of destination)
The seller pays for carriage to the named place, except for costs related to import clearance, and assumes all risks prior to the point that the goods are ready for unloading by the buyer.

DDP: Delivered duty paid (named place of destination)
The seller is responsible for delivering the goods to the named place in the country of the buyer, and bears all the costs in bringing the goods to the destination, including import duties and taxes. This Incoterm places the maximum obligation on the seller.

Incoterms for sea and inland waterway transport. #

The four rules defined by Incoterms 2010 for international trade where transportation is entirely conducted over water are:

FAS: Free alongside ship (named port of shipment)
The seller must place the goods alongside the ship at the named port. The seller must clear the goods for export. FAS is suitable only for maritime transport but not for multimodal sea transport in containers. This term is typically used for heavy-lift or bulk cargo.

FOB: Free on board (named port of shipment)
The seller must load the goods on board the vessel named by the buyer. Cost and risk shift to the buyer once the goods are actually loaded on board the vessel (this clarification is new). The seller must clear the goods for export. The term is applicable for maritime and inland waterway transport only but not for multimodal sea transport in containers. The buyer must instruct the seller as to the details of the vessel and the port where the goods are to be loaded, and there is no reference to, or provision for, the use of a carrier or forwarder. This term has been greatly misused over the past three decades, ever since Incoterms 1980 explained that FCA should be used for container shipments.

CFR: Cost and freight (named port of destination)
The seller must pay the costs to transport the goods to the port of destination. The risk transfers to the buyer once the goods are loaded on the vessel (this is a ‘clarification’ of Incoterms 2000). Maritime transport only and insurance for the goods is not included. This term is formerly known as CNF (C&F).

CIF: Cost, insurance and freight (named port of destination)
The term is same as CFR, except that the seller must in addition arrange (and pay) for insurance.

[1]           Since the point for the division of costs is fixed at a point in the country of destination, the “C”-terms are frequently mistakenly believed to be ‘arrival contracts’, in which the seller would bear all risks and costs until the goods have actually arrived at the agreed point. It must be emphasised, however, that the “C”-terms are of the same nature as the “F”-terms: the seller fulfils the contract in the country of shipment or dispatch.

A few particularities #

Ship’s rail as delivery point. In Incoterms 2010, the “ship’s rail” as the point of delivery has been omitted in favour of the goods being considered as delivered when they are “on board”. This more accurately reflects commercial reality and avoids the rather dated image of the risk transferring across an imaginary line.

Terminal handling charges. The carriage costs sometimes include handling and moving the goods within a port or container terminal facility. The carrier or terminal operator may well charge these costs to the buyer who receives the goods. In these cases, the buyer must not be obliged to pay twice for the same service: once to the seller (as part of the total selling price) and once independently to the carrier or the terminal operator. The Incoterms 2010 rules seek to avoid this by clearly allocating these costs in paragraphs A6/B6 of the applicable Incoterm.

E-mails, etc. Articles A1/B1 of Incoterms 2010 give electronic means of communication the same effect as paper communication, as long as the parties so agree, or where such communication is customary.


Note: this chapter is also included in the e-book Cross-border contracting – How to draft and negotiate international commercial contracts, written by Weagree-founder Willem Wiggers and published by the ITC (the joint agency of the U.N. and WTO) and downloadable free of charge.

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