What are Incoterms?

A brief introduction to Incoterms® - the International Commercial Terms used for international shipping.

Shipping and receiving may seem like simple enough concepts but once goods start to move across international borders, any pretense of simplicity vanishes. As more entities get involved (think of everybody from freight brokers to Customs agents), and more modes of transportation are used, the level of complexity multiplies. That’s why it’s absolutely vital to negotiate—and especially to understand—the terms that define the delivery transaction. And that’s also where Incoterms® come in.

The formalities of Incoterms^®

Officially, Incoterms® are a set of internationally agreed upon and recognized rules for governing trading interactions—specifically those transactions that deal with the shipping and receiving aspects of a deal. They were established by the International Chamber of Commerce and the code of principles and responsibilities it devised and named the Uniform Customs and Practice for Documentary Credits (UCP). Incoterms®, or more formally International Rules for the Interpretation of Trade Terms, fall under the UCP. The first version was released in 1936. The most recent update is called Incoterms® 2020. 

Incoterms® are not, in and of themselves, legally binding. They can be included in contracts and then their interpretation becomes a matter of contract law, assuming there is a dispute or a need for clarification.

Even though the point of Incoterms® is to facilitate international shipments, Canadian companies that deal with American partners may find that Incoterms® are not used. Instead, American companies often turn to what is known as the Domestic Uniform Commercial Code (UCC), usually referred to as FOB. Canadian companies, therefore must be extremely careful to understand which guidelines are being applied. They should also keep in mind a cautionary note: the acronym FOB also exists as an Incoterm®, so companies must take care to define exactly what they mean by FOB.

The Essence of Incoterms^®

Incoterms^® have a very tight and narrow focus. They only address how the seller will deliver the goods and how the buyer will receive them. As a part of that understanding, Incoterms® spell out which risks, costs and obligations the seller assumes and which ones are the buyer’s responsibility. They specify which notices must be given and when. They detail who is responsible to provide appropriate documentation. Incoterms® also address who is responsible for dealing with both export and import Customs clearance. That’s it. That’s all.

Incoterms® do not account for other aspects of the trading deal including how or when the transfer of title or ownership takes place, details about how or when the payment is made, or information relating to the existence of a contract of sale, or anything about the specification of the goods.

And while it may be surprising, Incoterms® don’t deal with the consequences of a shipping or delivery delay, and (except for two specific instances) they have nothing to do with how or whether the goods are insured during transit.

How Incoterms^® work

Incoterms^® 2020 are generally divided into two categories: Marine-Only Incoterms^® and Multimodal Incoterms^® (which can also be applied to goods being shipped via marine transport). The Marine-Only terms tend to be most used for break bulk cargo.

For both Marine-Only and Multimodal shipments, Incoterms® define what happens at every stage before, during and after the main transport of the goods. They do this through the lens of who is responsible for the shipment at a specific point of time: the exporter (the seller) or the importer (the buyer).

Incoterms® 2020 includes 11 basic that describe who—the importer or the exporter—is assigned the obligation of overseeing each stage of the shipping process. Those terms are:

• EXW: ExWorks
• FCA: Free Carrier
• CPT: Carriage Paid To
• CIP: Carriage and Insurance Paid To
• DPU: Delivered Place Unloaded
• 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

As can be seen from the names themselves, Incoterms® cover almost every scenario from what happens if the buyer picks up the goods at the seller’s facility (EXW) to what happens if the seller is responsible for delivering the shipment right to the buyer’s door (DDP).

In every case, the Incoterm® defines the seller’s obligation, the buyer’s obligation and indicates where the transfer of risk occurs. Typically, these details change depending on where the goods physically are along the transit route. For example, under FCA, the exporter is responsible for the merchandise (including paying for all of the associated costs and handling the paperwork) up to the point where the shipment clears country-of-origin Customs. Then, the risks and responsibilities for the cargo are transferred to the buyer. In comparison, under DPU, the seller is responsible for the goods up until they are delivered to the staging area prior to being presented to the country-of-destination Customs. Then, the buyer takes over and becomes responsible for clearing Customs and getting the goods to their final destination.

As noted earlier, there are only two Incoterms®, CIP and CIF, that include mention of insurance, and as such they are the only two terms that have insurance coverage built into the costs and obligations. In both of those cases, the seller will buy the insurance in its home country on behalf of the buyer.

Choosing the right Incoterm®

There are no right or wrong Incoterms®. There are only Incoterms® that are most suitable for the specific transaction and for the nature of the relationship between the buyer and the seller.

There are, however, a few things to keep in mind:

• The more responsibility that is awarded the seller, the higher the transportation and handling costs are likely to be.
  
  
• The point at which risk is transferred may not be the same point at which the buyer takes responsibility for moving the goods (for example, under CIP and CPT, the transfer of risk happens after the shipment clears export Customs, even though the seller has made the arrangements for the transportation of goods up to the pre-import Customs staging area).
  
  
• Foreign sellers looking to pay Customs and import duties to the Canada Border Services Agency need a business account set up with the government. If a seller is new to exporting to Canada or does not do a lot of business with Canadian customers, the company may not have an account or understand the Canadian Customs procedures, and as such, it might be a better choice for a Canadian buyer to take responsibility for the shipment prior to it being presented to Customs.
  
  
• Businesses wishing to use Incoterms® should clearly specify which version of Incoterms® the contract of sale is governed by (for example, Incoterms® 2020). The release of new versions of Incoterms® does not eliminate the use of older versions. In fact, they are all still valid rules, and they will continue to be used for many years.

Again, because Incoterms^® are details to be negotiated and included in a contract, there is no reason why a buyer and a seller cannot modify an existing Incoterm^® to suit their particular circumstance or business deal.

Incoterms® is a registered trademark of the International Chamber of Commerce. Further details and the official text relating to Incoterms® rules can be found at the official International Chamber of Commerce (ICC) website.