What are Incoterms? Our guide to what they are, how to use them and how to avoid common mistakes when using them (2024)

Click here to listen to the audio.

Incoterms, or International Commercial Terms, are a set of contract terms for international freight delivery. While the word itself creates some mystique, they are in fact simple - entirely concerned with the delivery of goods, especially in an international environment.

Our Incoterms expert David Lowe, who is also global co-chair of the Incoterms 2020 drafting group, gives an overview here of these important contract terms and how to use them to best effect.

Transcript

Thank you for joining Gowling WLG for this podcast. We are an international law firm working in major sectors including energy, life sciences, infrastructure, financial services, real estate and technology. Our episodes cover the latest developments relevant to you across different sectors and services. Make sure you subscribe to receive the latest episodes of this podcast. Visit our website gowlingwlg.com for all of our latest insights.

David Lowe: Hi, welcome to this podcast about Incoterms. I am David Lowe, I lead Gowling WLG's Commercial Contracts team and I have a close interest in Incoterms. I am the global co-chair of the Incoterms 2020 drafting group. In other words I have literally written Incoterms. In this podcast I am going to give an overview of Incoterms, what they are, how to use them and the common mistakes made with them.

Incoterms are obviously part of international trade and they create a mystique around them. Who uses that word "Incoterms" out on the high street? But actually, Incoterms are simple; they are all just about delivery of goods, especially in an international environment. If I am based in London and I am selling goods to Cape Town then obviously between me and the buyer, we need to agree where the delivery point is; at which point is my job done as seller and the buyer takes over? And that is what Incoterms does; setting out just where that delivery point is and the responsibilities of the seller and the buyer.

Now, they are no law, they do not magically apply to your contract. They are just a set of standard terms that you can refer to and therefore it is really important in your contract that if you want to use an Incoterm you do need to use that word "Incoterm" and refer to it; so that people, and more importantly, a Judge or an Arbitrator knows that you intended to incorporate the Incoterms. I mentioned that they are about international delivery but they do not have to be, they can be used for domestic delivery. It is just that, obviously, many of the aspects of Incoterms are about international things such as export duties which are not relevant to domestic transactions, but that does not stop you from using domestic transactions. So if you are creating some standard terms that are sometimes used for international sales, sometimes for domestic sales, there is nothing wrong with using an Incoterm for those standard terms.

Incoterms go back a long way. They were originally drafted in 1936 but they do go back actually much further than that. Freight delivery terms like "free on board", FOB, go back to the 15thCentury in London when London was a busy medieval international port. It was in 1936 that the International Chamber of Commerce decided that now is the time to codify them, so that we could establish a consistent international practice around the world and that led to the first edition of Incoterms. And Incoterms have been updated roughly every decade since then to reflect changes in trade practice.

Now, I said that Incoterms are all about delivery and defining the delivery point, and therefore what they do is they then allocate the risks and the costs. If the goods get damaged before the delivery point, that is going to be the seller's problem. If the goods get damaged after the delivery point, that is going to be the buyer's problem. Similarly, all the costs incurred before delivery are for the seller. All the costs after delivery are for the buyer.

Incoterms also deal with who is going to deal with the export and import formalities: Who fulfils the customs declaration? Who needs to get the export licence? Who needs to pay the import duty? And so each Incoterm sets out who is responsible for that. For all Incoterms, except Ex Works, the seller is responsible for all the export formalities. In Ex Works the seller does not even deal with export formalities and that is left for the buyer. In all the Incoterms, except for Deliver Duty Paid, DDP, the buyer deals with the import formalities. In DDP - it is the only Incoterm where the seller also deals with the import requirements.

And finally, the other important element of Incoterms; they are documents. In international trade there are often lots of documents, as the goods are transferred from person to person, delivery receipts are generated and maybe things like bills of lading and all of those dockets might be needed for the seller in order to get payment; especially from a bank under a letter of credit. And so Incoterms also detail some of the documents that the parties need to provide to the other.

So using an Incoterm helps you fix the delivery point, helps deal with the responsibilities before and after delivery, but it is important to bear in mind that Incoterms are not everything. The Incoterms, obviously, do not tell you what the goods are that are being sold. That might be obvious, but I can tell you that I have seen contracts where it is not clear what the goods are and somebody has just assumed that by saying, "I am going to sell to you FOB Incoterms…" that somehow the Incoterms would define what they were selling; and, of course, that cannot happen. So it is really important that the goods are specified.

Also, Incoterms do not deal with price or payment and therefore it is really important in a contract that the price of the goods and how they are going to be paid for is set out. Now, I have mentioned that Incoterms deal with risk - who has responsibility for the goods - but Incoterms do not deal with title and title means ownership of the goods. The reason for that is ownership of the goods is all tied up in insolvency law, which varies around the world country to country, and therefore there is no real consistent international practice. Therefore, Incoterms does not deal with title and therefore it is really important in your contract that you make it clear when title passes. Is it at the same time as delivery? Or, maybe the seller retains title so that it has got some security over the goods, should they not be paid. That will need to be made clear in the contract.

And importantly Incoterms do not deal with the law and their jurisdiction and that is really important in international contracts, because in an international contract if you are not clear which law and jurisdiction applies then you are probably going to have a dispute. In my example of the seller in the UK selling to the buyer in Cape Town in South Africa, which law is going to apply? English law or South African law? If you do not say it in your contract, Incoterms is not going to fill the gap for you and if you do not say it in the contract you could end up having a dispute about a dispute; arguing about which law is going to apply. And that is a very expensive dispute to be having when it is not even about the substance of the real dispute you are having. So always make sure that your contract has a law and jurisdiction clause.

Now, what Incoterms are there? There are 11 Incoterms. From the seller delivering Ex Works being the most basic, where the seller simply makes the goods available for delivery and does not even load them onto the arriving means of transport and does not clear for export. That is at one end. At the other end, the other extreme from Ex Works, is delivery duty paid, DDP, where the seller does everything including clearing import duties. The only thing the seller will not need to do is unload the goods from the transport at the buyer's premises. That is the only thing the buyer will need to do - unload them.

In between those two extremes of Ex Works and DDP there are nine other Incoterms. Now, traditionally these Incoterms are grouped into four groups. The "E"-terms, the "F"-terms, the "C"-terms and the "D"-terms. The only "E"-term is Ex Works, which I have already explained. By the "F"-terms I mean Free Carrier, FCA, which can be used for any form of transport and then other terms which can only be used with ships, FOB, Free On Board and FAS, Free Alongside Ship. If you are selling FCA Southampton then what that means is that I, as the seller, need to get my goods to the port on the transport, ready for unloading. It is also possible to sell FCA sellers' premises where, again, the seller will need to load the goods onto the back of the truck. In any of the "F"-terms, the seller clears for export so they are export contracts and that is really important because often the seller needs to prove they are selling the goods internationally, exporting them to deal with tax and VAT issues.

The next group of Incoterms are the "C"-terms but I am going to come back to those in a second, and I will explain why, and then the final group of Incoterms are the "D"-terms. "D"-terms mean they are delivered and there are three of those: DDP, which I have already mentioned, Delivered Duty Paid, DAP, Delivered at Place, and DPU, Delivered at Place Unloaded. In each of those the seller has transported the goods to somewhere, probably to the buyer's country; maybe the port, maybe a terminal, maybe the buyer's warehouse. So all of the costs and risks of the transport are with the seller. However, with DPU and DAP the seller is not required to clear import. That is an obligation on the buyer. DDP, as I have mentioned, is the only Incoterm where the seller does clear for import.

So, we have Ex Works, we have got the "F"-terms such as FCA, we have got the "D"-terms such as DPU, DAP and DDP. The last group is the "C"-terms. By the "C"-terms I mean things like Carriage and Insurance Paid, CIP, CPT, CFR and CIF, Carriage Insurance Freight. In all of the "C"-terms, the seller pays for carriage and therefore looks attractive to the buyer. However, the seller arranges for carriage on behalf of the buyer and what that means is that risk in the goods passes early from seller to buyer. So if I was to sell goods CIF, which can only be used if I ship, then risk has passed when I load the goods onto the ship at the port. I might pay for carriage, I might pay for the ship then to travel to somewhere, but if the goods are damaged in transit that is going to be the buyer's problem. So the "C"-terms are complicated. Risk passes early but cost passes late and most people do not properly understand that and therefore the "C"-terms are often badly used. If you are going to use a "C"-term please do make sure that you are using the right term and check that the "C"-terms are appropriate.

So let us give you an example. I am buying, I am a retailer in the UK and I am buying goods from a Chinese seller. The Chinese seller is going to sell to me FCA, free carrier, Hong Kong Port, Incoterms 2020. So in that arrangement under FCA the seller needs to load the goods into a container, load the container onto a container truck, take the container truck to Hong Kong Port, clear port security so they can drive the truck into the port and pull up near the container stack. The seller will then unbolt the container so it is ready for unloading and at that point the seller has fulfilled all of its responsibilities, dealing with the physical movement of the goods.

At the same time, the seller will also need to make sure the goods are cleared for export and so will have needed to have submitted a customs declaration. If they need an export licence they will need to obtain that, if they need to pay export duty they will need to pay that. And so those export formalities will be done in parallel with the physical delivery of the goods, so that the buyer can take delivery of goods, load them on the ship and bring them to the UK. Therefore the buyer will have to unload the container from the truck, put it into the container stack, pay the terminal handling charges, move the container to the quayside, and load it onto the ship. The buyer then arranges for the ship, pays for the shipping, pays for the insurance, unloads them at Southampton, or whichever port it has come into, and then move the goods to their warehouse so the buyer does have quite a lot to do from that point of delivery.

So I have explained what Incoterms are. I have explained what they do not do. I have talked about what each Incoterm is and the different groups of Incoterms. It is really important though that the Incoterm is actually used properly. I touched on, at the beginning, how Incoterms are standard terms, they need to be incorporated, you need to refer to them. So if you are selling goods FCA David Lowe's premises, you need to then go on and say Incoterms to make it clear that you are using Incoterms and you also need to go on to say which edition of Incoterms. Do you mean to use Incoterms 2020, 2010, or older Incoterms? You can, if you really want, even use Incoterms 1936; although the problem is that very few people have got copies of those, so I would not encourage that.

So, always say "Incoterms" and say which edition. Obviously it is really important you use the right Incoterm and then it is really important that you specify the place of delivery as precisely as you can. If I sell to you FCA UK then that means I can deliver anywhere in the UK and, as a buyer, that is practically difficult as I do not even know where to take delivery. And obviously there could be a big difference in cost between delivering in northern UK, Scotland, than it is in southern UK. So best practice is to set out specifically the address where the delivery point is, or if that is not clear at the time of contract signature, include in the contract how the place of delivery is going to be specified.

I am often asked, "Which Incoterm should I use?". Of course, which Incoterm you use will very much depend on the commercial deal, the nature of the goods, are the goods going by sea or road or rail, who is insuring the goods and so on. So it is important to fully understand what the commercial arrangement is before settling onto your Incoterm. I tend to start with assuming that the right Incoterm is going to be FCA, Free Carrier, where the seller is obliged to either deliver its premises onto the buyer's transport or, if it is delivering somewhere else ready for unloading, on the back of its transport having cleared export. Then I ask myself, "Is this the right Incoterm for this environment?" Actually if I, the seller, are arranging carriage and taking the risk of delivering and arranging delivery; actually maybe FCA is not right, maybe I should use a "D"-term.

I tend to avoid the "C"-terms because in my experience they are badly understood and therefore often I have ended up using FCA or DAP. Now, at this point you might ask why am I not recommending the use of either Ex Works, which is the most pro-seller Incoterm, or DDP, which is the most pro-buyer Incoterm and, yes, I often see those in contracts because people have assumed that they want to do as little as possible or as much as possible. The reason I do not encourage the use of Ex Works or DDP is that if you sell Ex works as a seller you often - for local tax reasons, such as in the European Union, VAT - need to be able to prove to the customs authority that you have exported the goods. But under Ex Works you have not exported the goods, you have not cleared for export, you cannot prove the goods had gone out of the country. You might, therefore, find yourself liable for a VAT liability and that therefore causes practical problems. And that is not just an issue in the EU, every country has some version of sales tax or tax issue which is impacted by whether the goods have been sold for domestic or international use. So often Ex Works is not the right Incoterm.

The other end of the spectrum, DDP, for a buyer looks great, the buyer does nothing but that is quite hard for a seller because the seller is going to need to clear for import. Now normally to be able to clear for import you need to be present in the country of import. If you are not a resident of that country, or not present in some way, typically it is very difficult, if not impossible to clear for import and therefore it becomes impossible, or very difficult or expensive, to use. So actually it is usually easier for the buyer to be the importer. They are present in that country and therefore they can arrange the importation much more easily and that is why Ex Works and DDP are often not the right Incoterms. Sometimes they are, there are correct uses of those Incoterms, but often they are not and it is often better to use one of the other Incoterms.

It is also important to remember that some of the Incoterms can only be used where there is a ship, so FOB, Free On Board, FAS, Free Alongside Ship, CFR and CIF, Carriage Insurance Freight, are all Incoterms that require delivery onto a ship. So it is not possible to deliver something to, say, FOB Heathrow Airport. There is no ship at Heathrow Airport, there is no port, it is an airport and therefore I encourage people not to use the maritime terms but to use the other terms which you can use via any form of transport, because it is then less likely you are going to make a mistake.

So hopefully that has helped give you an introduction to Incoterms, how they are all about delivery, how they allocate the risk and cost between seller and buyer, what the key Incoterms are, how they should be used correctly and which probably are the best Incoterms for you to use.

Thank you for listening to this Gowling WLG podcast. If you liked this episode, please be sure to check out our website, gowlingwlg.com, for more useful podcasts and articles or please leave us a review on iTunes. Make sure you subscribe to the podcast to join us for our next episode.