Incoterms Rules - What are Incoterms?

Article posted by Sandra Strong, on behalf of Strong and Herd LLP

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Sandra Strong is one of the founding partners of Strong and Herd LLP, a widely respected import/export consultancy, and has nearly 30 years’ experience in international trade. She was awarded a Fellowship of the Institute of Export (IoE) in 2011 for services to UK companies. She is also a Certified International Trade Advisor and a member of the International Chamber of Commerce (ICC).

What are incoterms?

It stands for International Commercial Terms and they are an internationally recognised system of establishing clearly, in sales contracts, the legal obligations of the buyer and seller with regard to the DELIVERY OF GOODS.  It is beneficial to all parties involved, in international transactions especially, to have any vagueness, misunderstandings and confusion in international contracts removed.  Incoterms have been written to do just that in this important area of delivering the goods. Incoterms 2010 are the most recent rendition.

History up to Incoterms 2010

It was in the 1930’s that the International Chamber of Commerce (ICC) decided that a codified, internationally recognised set of delivery terms – known as contract or commercial terms – was essential to encourage, support and facilitate international trade.  The first set of the International Commercial Terms – given the name INCOTERMS - was introduced in 1936 taking the most commonly used delivery terms and giving them clear definitions with clearly stated obligations of both the seller and the buyer that were recognised worldwide and, if necessary, could be up-held in a court of law if disputes did arise.  It used as its basis shipping terms already being used internationally such as FOB, ExWorks and – in existence from at least the C17th – CIF, but the important thing the ICC did was to give a single definition of these terms to avoid local and national legal interpretations that would cause problems when disputes arose.

How Incoterms help you you

INCOTERMS, therefore, provide a list of terms from which one is selected that meets both the buyer’s and seller’s needs.  They are a genuine set of working rules that can be used by export salesmen and procurement specialists when negotiating contracts.  They deal with matters relating to the rights and obligations of the parties in the contract of sale with respect to the delivery of goods.  Incoterms, therefore, must relate to the “real world” of international trade and the ICC have amended the terms 7 times over the last 75 years to keep them up-to-date with trade developments and common practice.

The current edition of Incoterms (the 8th issue – Incoterms 2010) came into effect on 1.1.2011 when the terms were up-dated from the previous set (2000) to take into account the recent spread of customs- free zones (e.g. EU, SACU, Russia), the increased opportunites in emerging markets (e.g. eastern Europe, Brazil, China), the increased use of electronic communications in business transactions and changes in transport practices, in particular supply chain security issues.  International terms of delivery have generally been used in international contracts to state a) where the sellers were deemed to have fulfilled their obligations in delivering goods to an agreed point and b) where in the delivery chain the buyer assumes responsibility for the goods.  Incoterms 2010 rules may be the current set of terms but previous sets do not go out of date – also, something that may seem odd at first, you don’t have to use them.  Use of Incoterms is a commercial decision based on the need to protect the parties in case of dispute.  They are badly misused around the world and, unless something goes wrong, businesses tend not to worry about them … but boy when things go wrong!  Careful use of the terms in the correct way may save you one day from a very expensive problem arising.

The main aim of the Incoterms Rules is to clearly establish the “delivery point” in the contract.  Deciding on the delivery point is very important and it must be a point that is acceptable to both the buyer and the seller.  Only when the seller knows to where they have to deliver the goods can they accurately calculate a selling price.  Only when the buyer knows where they have to take responsibility for the goods and any additional charges after that point can they accurately know the “cost of ownership”.  For example, the delivery point may be at the seller’s premises in which case the buyer would be paying all shipment costs so the seller’s export price would only be the selling price of the goods plus any extra for packing but the buyer would have to organise transport, pay all costs to bring the goods to their door and take the maximum risk.  If the seller has to deliver to the buyer’s premises overseas then the costs of transportation, etc should be added to the price of the goods to get to a true selling price.The “delivery point” is important in international transactions because once the seller has delivered the goods they, generally:

  • can claim payment;
  • have no further shipment costs to pay;
  • have no further responsibility for the goods if they are lost or damaged after that specific point named.

There are 11 terms within the Incoterms® 2010 rules and the main differences between the terms relate to establishing the:

  • delivery points;
  • division of costs;
  • transfer of risk;
  • mode of transport;
  • obligations of buyer and seller.

With something this important, buyers and sellers cannot leave the terms of delivery vague; vagueness can lead to disputes and unexpected costs.  Also, in international trade, because of language, culture and national differences between the buyer and seller (as well as the physical distance between the two parties) misunderstandings may arise.  The exporter may think they have made the delivery point clear but, when the contract is translated into the buyer’s language and interpreted against their country’s commercial practices they may define the delivery point in a different way.  This type of misunderstanding only comes to light if things go wrong – not a good time to find out the buyer actually  expected you to pay all import clearance charges, for example.  Disputes like this may cost the exporter time and money to resolve and, if the dispute is more serious, it may even involve going to law to seek a resolution.

List of incoterms

  • EXW – Ex Works
  • FCA – Free Carrier
  • CPT – Carriage Paid To
  • CIP – Carriage And Insurance Paid To
  • DAT – Delivered At Terminal
  • DAP – Delivered At Place
  • DDP – Delivered Duty Paid
  • FAS – Free Alongside Ship
  • FOB – Free On Board
  • CFR – Cost and Freight
  • CIF – Cost, Insurance and Freight

For more information on quoting Incoterms when arranging payments, read this Incoterms overview written by DHL for Open to Export.

For more information about trade in general, read this Open to Export article on how world trade works.