Incoterms rules are used by importers and exporters to ensure that they’re on the same page about their respective responsibilities relating to the carriage of goods.

Our insurer partner NMU explains the importance of Incoterms rules.

Over centuries, the obligations that sellers and buyers owe to each other in relation to the carriage of goods have been refined into what are now known internationally as the Incoterms rules.

Published by the International Chamber of Commerce, the Incoterms rules allow buyers and sellers to transact business with the certainty that each understands:

• the various obligations of the seller and the buyer,
• the point at which the risk of loss of or damage to the goods passes from the seller to the buyer, and
• which party bears the various costs associated with the shipment.

Why do we need the Incoterms rules?

In the days of horses, carts and sailing ships, if a merchant wanted to export goods, they only really had control over two main things:

• getting the goods to a port, and
• handing them over to the master of a ship bound for their intended destination.

Crucially, once the goods were on board the ship, it was impossible for the seller to have any further control over what happened to them.

Essentially, the goods became the buyer’s problem, and by custom of trade, the risk of loss or damage transferred to the buyer at that point.

Today, however, things are more complex; but the fundamental principle of defining the point at which risk transfers from the seller to the buyer remains a key element of the rules, and specific consideration needs to be given to ensuring that the risk transfer point aligns with the method of carriage, particularly for containerised goods.

The Incoterms rules comprise eleven separate terms of sale, split into two groups.

Seven designed for pretty-much every type of goods, transported by any mode or modes of carriage, and four designed specifically for the port-to-port shipment of certain types of goods – typically bulk and break-bulk cargo – by sea or inland waterway only.

How goods are transported and which Incoterm rule is appropriate

For the majority of goods:

• International trade is not just by sea, it can be by road, rail, or air as well, and a single movement of goods often uses more than one of these methods of carriage.
• About 60% of all world trade is transported in containers.
• Contracts of carriage are mainly arranged on a warehouse-to-warehouse basis, rather than port-to-port only.
• The method or methods of carriage may not even involve a ship at all.

If FAS, FOB, CFR or CIF are used for containerised goods, and then those goods are damaged in the country of origin, there may be a dispute about whether the seller or the buyer bears that loss.

Choosing the right Incoterm rule and using it in the right way is essential

Using terms that are designed for modern, multimodal carriage means that sellers and buyers can be confident that they both have the same understanding about exactly where the risk of loss or damage passes from the seller to the buyer.

The risk transfer point, which is called the “delivery” point in the Incoterms rules, is important in relation to marine cargo insurance underwriting and claims, because it is a factor in establishing insurable interest. (Another factor is title; but the Incoterms rules do not deal with payment or the passing of title.)

Because banks will only release funds to sellers on presentation of documents that match the applicable terms of sales, where sales are made against letters of credit, care should be taken to ensure that the incorporated terms are appropriate for the method of carriage.