9. CHAP Incoterms.pdf

CHAPTER 9: INCOTERMS  Learning objectives Familiarize students with the process of international and domestic trade procedures. Integrate concept in international business concepts with functioning of global trade To apprise them of the documentation procedures and its sanctit...

CHAPTER 9: INCOTERMS  Learning objectives Familiarize students with the process of international and domestic trade procedures. Integrate concept in international business concepts with functioning of global trade To apprise them of the documentation procedures and its sanctity in Intl’ Business. Analyze the principle of international business and strategies adopted by firms to expand globally  Introduction Contractual terms developed by the International Chamber of Commerce (ICC) in Paris A standard three-letter abbreviated terminology Translated into various languages Cover eleven main options (Incoterms 2010) The purpose is to clearly describe the key obligations of sellers, buyers and carriers.  Incoterms specify: The buyer and seller obligations The licenses, authorizations, security clearances and other formalities to export and import The contracts of carriage and insurance The point of delivery The point of transfer of risks The point of transfer of costs The notices to the seller or the buyer The delivery documents  The checking, packing and marking The assistance with information and related costs Incoterms do not deal with the transfer of ownership/title to the goods or with details on payment obligations.  Incoterms 2000 are governed by the International Chamber of Commerce (ICC) in Paris and are grouped into four different categories. In Groups E and F the seller’s obligations are minimal and the buyer must do most of the work and assume maximum risk. As we move to Group C the supplier’s obligations become more extensive, however the buyer still assumes risks  As we move to group D the supplier makes most arrangements and assumes maximum risk, whereas the buyer must pay for and arrange import customs clearance and un- loading from the forwarder’s vehicle at the final. According to the destination we classify incoterms as follows: Category Description E The seller only makes the goods available to the buyer at the seller’s premises. F The seller delivers the goods to a carrier or place appointed by the buyer C The seller has to contract at his costs for carriage (and insurance for CIF and CIP). D The seller must assume most costs, obligations and risks needed to bring the goods to the place of destination (except import customs clearance and un-loading at the final destination). No INCOTERM EXIPLANATION EXPLANATION 1 EXW Ex Works When the goods are at the disposal of the buyer 2 FCA Free Carrier When the goods have been delivered to the carrier at the named place 3 FAS Free Alongside Ship When the goods have been placed alongside the ship 4 FOB Free Onboard Vessel When the goods pass the ship’s rail, at the port of export (origin) 5 CFR Cost & Freight When the goods pass the ship’s rail, at the port of export (origin) 6 CIF Cost Insurance & Freight When the goods pass the ship’s rail, at the port of export (origin) 7 CIP Carriage Insurance Paid When the goods have been To delivered to the main carrier, at the port of export (origin) 8 CPT Carriage Paid To When the goods have been delivered to the main carrier, at the port of export (origin) 9 DAF Delivered At Frontier When the goods have been delivered to the carrier 10 DES Delivered Ex Ship When the goods are placed at the disposal of the buyer on board the ship 11 Delivered Ex Quay When the goods are placed at DEQ the disposal of the buyer on the quay 12 Delivered Duty Unpaid When the goods are placed at DDU the disposal of the buyer 13 Delivered Duty Paid When the goods are placed at DDP the disposal of the buyer  INCOTERMS Incoterms is the short form for International Commercial terms. These terms relates to the sales contract and are used worldwide. INCOTERMS were first introduced in 1936 by International chamber of Commerce (ICC). These Incoterms were revised several times, latest being Incoterms 2010.  Why incoterms?? A cargo may move several days before it arrives at its destination. Even though shipping is safer these days, many cargoes still do not reach their destination or reach in bad shape. And when that happens, one should know who had the title of the goods lost. For that reason, It is important for buyer and seller to pre- define the responsibilities and obligations for transport of the goods. INCOTERMS are all the possible ways of distributing responsibilities and obligations between two parties.  What entails in Incoterms? 1. Point of delivery: Incoterms defines the point of delivery of the goods by seller to buyer. The meaning of delivery here is "transfer of risk and responsibility”. So the INCOTERMS defines the point of change of hands (passing of risk) from seller to buyer. 2. Transportation Costs: Incoterms defines which party pays for the transportation cost. There may be more than one means of transportation and INCOTERMS defines who pays for which leg of the transportation. In case of sea transport, it also means which party will act as shipper of the cargo.  Con’t 3. Export and import formalities: Incoterms outlines which party arranges for export and import formalities. 4. Insurance costs: Incoterms outlines who bears the insurance costs.  Important points to make 1. Arranging for the main transport does not mean the risk is with the arranging party. Seller may arrange for the main transportation even when the consignment is already delivered (that is risk has passed to buyer). In this case the risk has passed to the buyer and seller is just acting as the shipper without any risk to him. 2. Arranging for the insurance does not mean that risk is with the party arranging the insurance. In few of the INCOTERMS, seller arranges for insurance to cover buyer’s risk. In these cases, seller is only required to cover minimum risk as defined in the minimum risk clause in respective incoterm. Buyer must take more insurance to cover any extra risk that he wishes to insure against.  Cargo Insurance Insurance is an arrangement by which a company or the state undertakes to provide a guarantee of compensation for specified loss, damage, illness, or death in return for payment of a specified premium. Cargo insurance provides coverage against physical damage or loss of goods during shipping, whether by land, sea or air. Because of the many dangers inherent in shipping, most individuals and businesses choose to insure their goods while they are in transit.  Cargo Insurance However, many different types of cargo insurance are available, and it is important that you know exactly what you want before taking the insurance, or you may not be covered for every eventuality.  Why taking Cargo Insurance Cargo insurance reduces shippers’ exposure to financial loss. Yet, so many shippers choose to risk importing and exporting goods without getting cargo insurance. Many shippers have suffered great loss for taking this risk. Some of the reasons are dangers that can cause loss or damage to cargo, but the list actually goes well beyond that.  1. Cargo Theft Rising Cargo theft, especially through identity theft and fictitious pickups, is on the rise. We’re not even counting piracy, which is a major risk of cargo theft and loss in modern international shipping.  2. Cargo insurance against Loss More Containers get lost at Sea Every Year which calls for insurance that can compensate for this loss. The World Shipping Council conducts surveys to find out approximately how many shipping containers are lost to sea in a year. Their 2014 update reveals a very significant rise in cargo containers lost to sea from their 2011 survey.  Cargo Insurance against Loss The survey of the years 2011, 2012 and 2013 estimates that there were approximately 733 containers lost at sea on average for each of these three years, not counting catastrophic events.  3. Catastrophic Events Happen The World Shipping Council defines a catastrophic loss “as a loss overboard of 50 or more containers in a single incident.” Storms, shipwrecks, explosions, pirate attacks… we’ve had past information on all of these events, which have caused the loss of many, many shipping containers. In one event, an entire shipload or more of cargo containers can be lost.  Catastrophic Events Happen …. Catastrophic events like the Tianjin explosions in China’s port city last month or container ships taken by pirates wouldn’t even likely be included in the totals above because, while very large numbers of shipping containers of goods are lost, the cargo containers are not necessarily lost overboard to sea. Every year, catastrophic losses happen that affect many, many shippers. Those affected without cargo insurance, deeply regret their decision not to get insured.  4. Cargo Damage This is a Common Occurrence as cargo theft or loss has become, even more common is cargo damage. UK Club is a mutual marine protection and indemnity organization that actually represents ship owners rather than shippers hiring their goods to be imported and exported. However, UK Club has shared that they spend a considerable proportion of their time handling container cargo claims.  Reasons for damage Bad shipment and shore error are the largest contributors to damaged cargo according to UK Club, but they list many, other reasons for damage: Lack of export packaging. Increased use of weak retail packaging. Wrong choice of container. Poor condition of container. Lack of effective container interchange inspection. Ineffective sealing arrangements. Lack of clear carriage instructions.  Reasons for damage Ineffective internal cleaning. Wrong temperature settings. Condensation. Overloading. Poor distribution of cargo weight. Wrong air flow settings. Wrongly declared cargo. Organized crime.  11 INCOTERMS defined by the ICC 11 INCOTERMS are based upon the consideration of least responsibility of the seller to least responsibility of the buyer. For example INCOTERM EXW (ex-work) considers least responsibility for the seller. Same way INCOTERM DDP (Delivered duty paid) considers least responsibility for the buyer. We can say that all other nine INCOTERMS lies between these two extremes.  Basis of Incoterm 1. Incoterm is based upon mode of transport that they are using. 2. Incoterm is based upon the point of delivery. Incoterms used in multimodal transport is made of the following : Ex works (EXW) Carriage and Insurance Paid (CIP) – common in Rwanda Carriage Paid to (CPT) Delivered at Terminal (DAT) Free Carrier (FCA) Delivered at Place (DAP) Delivered Duty Paid (DDP) Incoterms used in sea water transport is made up of the following: (only water transport- Class C & F) Free on Board(FOB) Free alongside (FAS) Cost and Freight( CFR) Cost Insurance and Freight(CIF) The first group includes 7 incoterms which can be used in any mode of transport. These can be used even when there is no sea transport used. Incoterms EXW, FCA, CPT, CIP, DAT, DAP and DDP belongs to this group. The second group includes four incoterms which are used in sea or inland waterways only. This is because in these incoterms the point of delivery and the destination place are both sea ports. Incoterms FAS, FOB, CFR and CIF belongs to this second group. Incoterms groups based upon point of delivery Incoterms can also be grouped together in 4 categories based upon the point of delivery. In group “E” (Ex-works), the delivery point is seller’s premises. In group “F” (FOB, FAS & FCA), the delivery point is before or up to the main carrier, with main carried unpaid by seller. In group “C” (CFR, CIF, CPT & CIP), the delivery point is up to and beyond the main carrier with carrier paid by seller. And finally in group “D” (DAP, DAT & DDP), the delivery point is the final destination.  1. EXW (Ex-Works): With Ex-works the seller has the least responsibility. Seller has the responsibility to deliver the goods to the buyer at seller’s premises, depot or any other agreed places. From there on, all responsibility and risks are with the buyer. It means:  The delivery point is seller’s premises buyer pays for the export from seller’s premises and import into the destination. The buyer arranges for all modes of transport. The Buyer pays for the insurance  C’nt Ex-works is often used while making quoting initial prices for sale contracts. In practice, this incoterm can have practical difficulties specially in cross border assignments. These difficulties may include buyer’s inability to arrange for export formalities.  Delivered duty paid (DDP): Delivered duty paid is just the opposite of Ex- works. Seller has the most responsibility. Seller has the responsibility to deliver the goods at buyer’s premises, depot or any other place as agreed. It means that from seller’s premises to buyer’s premises or any other agreed places  C’nt The delivery point is buyer’s premises or other place agreed. Seller handles the cargo and pays for export as well as import dues and Seller arranges the transport of the cargo. Which also means that in case of sea transport, seller will be the shipper of the goods. Seller pays for the insurance  Co’nt As in Ex-works, DDP can also have practical difficulties in cross border assignments. In DDP, seller is responsible to clear the import formalities but the seller may not have the local knowledge & expertise to clear import formalities.  Free Carrier (FCA) Free carrier means the delivery point is carrier or other person nominated by the buyer at the seller’s premises or other agreed place. If the agreed place is seller’s premises, delivery takes place when the goods load on the truck. If the agreed place is not seller’s premises then the delivery takes place when truck arrives at this place and is ready for unloading. In Free carrier (FCA), The delivery point is seller’s premises or any other place agreed. Buyer pays for the export from seller’s premises and import into the destination. buyer arranges for all modes of transport  C’nt The FCA incoterm, the agreed place has implications on the loading of the carrier. If the agreed place is seller’s premises then seller handles the loading. If the agreed place is other than seller’s premises, then seller has delivered the goods once the carrier arrives at the agreed place. “FCA seller’s premises” might look similar to Ex- works but there is one main difference. In FCA, seller has the obligation to load the goods on the carrier.  Free Onboard Free onboard means the seller delivers the shipment to the carrier nominated by the buyer. There is only a slight difference between FCA and FOB. One difference is the mode of transport. While FCA is applicable for multimodal transport, FOB is used only for sea transport. In FOB, the seller passes the risk to the buyer when shipment crosses ship’s rail. In FCA, the seller has the obligation to load the shipment on to the carrier arranged by buyer which is prior to the main carrier.  Cost and Freight (CFR) By cost and freight, it means while seller bears cost and freight of shipment to the destination but the risk is with the buyer. And that is also the main difference between CFR and FOB incoterm. In FOB, seller delivers the shipment and passes the risk to buyer when shipment crosses ship’s rail. But, in CFR, he also pays for the costs and freight until the shipment reaches to the destination. Arranging for the transport does not mean that the risk is with the party arranging the transport. In this case, seller arranges the main transport (Seller is the shipper), but he has already delivered the shipment or passed the risk to the buyer upon shipment crossing the ship’s rail.  Cost , Insurance and Freight (CIF) There is only one but obvious difference between CFR and CIF and that is addition of Insurance. Seller passes the risk to the buyer when the shipment is loaded on the carrier. But the seller also arranges for the main carrier (Seller is the shipper). Apart from that seller also pays for the insurance for covering the buyer’s risk during carriage of the shipment. As seller would be paying to cover the buyer’s risk, he would of course wish to have least insurance just to cover his obligations. Buyer must take this into account and buyer take extra insurance if he wish to.  Free Alongside Ship (FAS) As simple as it sounds. The seller delivers the shipment to buyer when the goods are alongside ship. Risk passes from seller to buyer when the good are brought alongside the ship. Buyer arranges for the main carrier (Buyer is the shipper). Buyer pays for the all the insurance after this point.  Carriage paid to (CPT) Seller pays for the main carriage to bring the shipment at agreed place. However the seller passes the risk to the buyer upon delivery to the main carrier. This is the point that we highlighted earlier. “Arranging for the main transport does not mean the risk is with the arranging party”. Here even when the seller arranges for the main carrier, risk has already passed to the buyer. Buyer also arranges for the insurance from the point of delivery.  Carriage and insurance paid (CIP) CIP, Seller delivers the goods and passes the risk to the buyer upon delivery to the main carrier. Seller arranges and pays for the main carrier (Seller is the shipper) to bring the shipment at agreed place. Seller also arranges for insurance on behalf of buyer to cover buyer’s risk. The main difference between CPT and CIP is that the insurance is also paid by the seller. Again this point was highlighted earlier. “arranging for the insurance does not mean that risk is with the party arranging the insurance”. Here Seller pays for the insurance but the risk is not with him. Seller arranges for the insurance to cover buyer’s risk. of the cargo value under minimum insurance claim. Buyer must insure himself against any additional risk he thinks need insuring against.  Delivered at place (DAP) DAP means seller delivers when shipment arrives at final destination, ready for unloading from the arriving mode of transport. Seller bears all the costs and risks in bringing the goods to this place. 1) Seller handles export fees, carriage, insurance and destination port charges. 2) Buyer handles import fees and unloading of goods.  Delivered at terminal (DAT) Seller delivers the shipment and passes the risk to the buyer when shipment is put at the disposal of buyer at the terminal of final destination. Seller handles export fees, carriage, insurance, destination port charges and unloading of the goods. The main difference between DAT and DAP is that in DAT, seller handles the final unloading of the goods.  Common mistakes in incoterms 1. Failure to include the precise place along with the destination. The use of Incoterms need to specify the precise place. For example FCA does not specify the precise location. Incoterm must mention the exact location 2) Use of DDP incoterm without considering if the seller has the knowledge and expertise or if local regulations allows him to clear import formalities in buyer’s country.  Con’t 3. Use of EXW incoterm without considering if the buyer has the knowledge and expertise or if local regulations allows him to clear export formalities in seller’s country.  Validity of Incoterms Incoterms apply only if incorporated in the contract of sale or if they are, for example, mentioned in the offer, the sales conditions, the purchase order, and the confirmation of an order or if they are stipulated by the parties in separate agreement. Parties wishing to use Incoterms should clearly specify that their contract is governed by Incoterms.  Scope of Incoterms: In summary, as far as the seller’s obligation to deliver conforming goods is concerned, the Incoterms rules determine when the seller has fulfilled his obligation to deliver the goods on time but no more. The consequences following from the seller’s non-performance must be found elsewhere. Ideally, the simultaneous use of the Incoterms(ICC Guide to Incoterms,2010)rules and the ICC Sale Form should provide most of the answers required  The Incoterms rules and contracting practice The Incoterms rules standardize contract practice by enabling the parties to  use generally recognized key words;  agree on the most common understanding of such key words; and  Avoid misunderstandings in the use of them. Problems remain because  commercial practice is inconsistent;  variations of the basic key word may be not appropriate or sufficiently clear;  Comparison of Incoterms 2000 and Incoterms 2010 As per the changing needs and trends, INCOTERMS are updated periodically and the latest version, the 18th one is known as INCOTERMS 2010. These came into effect from 1st Jan 2011 and have 11 defined terms, down from the 13 in the previous version. Three of the pervious terms DAF, DES and DDU have been merged to form a new term DAP. Also, DEQ has been renamed a DAT.  Assignment QUESTION 1: Incoterms 2010 Under which list of the incoterms rules has the seller the obligation to insure the goods? FOB, CFR, FCA, CPT CIF, CIP CIF, CIP, DAT, DAP, DDP CPT, CIF, CIP, DDP QUESTION 2: Incoterms 2010 In which incoterms rule is there no requirement for the seller to arrange the export clearance of the goods. DDP , FCA, CPT,EXW QUESTION3: Incoterms 2010 In the context of the incoterms 2010 rules, which two of the following elements are included in the definition of packaging? The packaging of the goods to comply with any requirements under the agreed contract of sale. The packaging of the goods so that they are fit for transport The stowage of the packed goods within a container or other means of transport. Question 4. According to the incoterms rule CIF the amount of insurance cover required is: proposed solutions The price provided in the contract The price provided in the contract plus 110% The price provided in the contract plus 10%  References Yarbrough, Beth V. and Robert M. Yarbrough (1997), The World Economy: Trade and Finance, Dryden Press, New York. Woodland, A.D. (1982), International Trade and Resource Allocation, North-Holland, New York. Torrens, Robert (1844), The Budget: On Commercial and Colonial Policy, London, Smith, Elder.