7 common errors when using INCOTERMS®
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If you had a full tool box, you wouldn’t dream of tightening a screw with a saw, or cutting a piece of wood with a screwdriver. It is abundantly clear that in each case you would use the correct tool, making your job easier and preventing unwanted situations.
International trade provides us with a series of tools which, when used correctly, make certain procedures much easier, just like the two examples above. Such procedures include drafting contracts, clarifying clauses and, above all, minimising the risks associated to this type of transactions.
Within this series of tools that can be used for international trade transactions are Incoterms®. Every ten years, the International Chamber of Commerce publishes a new update of these three-letter terms, which are used in commercial transactions throughout the world.
It is often thought that these terms are part of the transport contract, or even the insurance contract, but that is not the case. Although Incoterms® define, among other things, the distribution of transport costs and of customs procedures, along with the compulsory, or non-compulsory, nature of taking out insurance to cover the risks to which goods are subject during transport, Incoterms® are part of the sales contract, in which sellers and buyers stipulate a wide variety of terms and conditions.
Incoterms® simplify the drafting of such contracts in a way that, thanks to the use of these three letters, followed by the place of delivery, the following four circumstances can be perfectly defined:
Point of transfer of risk associated to the goods
Distribution of the transport costs
Responsibilities in terms of export and import customs procedures.
As we explained above, the tools must be used for the purposed intended. The use of Incoterms® is not compulsory. However, once you agree to use them with the other party to the sales contract, it must be done correctly, using the appropriate term for each specific transaction.
Having said that, it is important to point out that there is always one, and only one, Incoterm® for each transaction. When deciding on the Incoterms® to include in a sales contract, it must be taken into account that they all provide different clauses and, therefore, different rights, obligations and responsibilities for each party.
We will now go over the seven errors or capital sins that are most often committed when using Incoterms®:
- The use of Incoterms® that do not exist
- The use of Incoterms® for national sales contracts
- The incomplete use of Incoterms®
- Not referring to the version of the Incoterms®
- Including clauses that are incompatible with those defined by the Incoterms® selected in the sales contract
- The use of Incoterms® that are not envisaged for the selected mode of transport
- Not evaluating the risks for the company of each Incoterm®
The use of Incoterms® that do not exist
In 2010, the International Chamber of Commerce published a total of eleven different Incoterms®. Eleven and only eleven, not one more. They are as follows:
EXW: Ex – Works. Delivered to the premises.
FCA: Free carrier. Delivered to the carrier.
FAS: Free along side. Delivered alongside the vessel.
FOB: Free on board. Delivered on board the vessel.
CFR: Cost and freight. Cost and freight must be paid by the seller.
CIF: Cost, freight and insurance. Cost, freight and insurance must be paid by the seller.
CPT: Carriage paid to. Carriage paid to named destination.
CIP: Carriage and insurance paid to. Carriage and insurance paid to named destination.
DAT: Delivered at terminal. Delivered to a named terminal.
DAP: Delivered at place. Delivered to a named place.
DDP: Delivered duties paid. Delivered to a place with the duties paid.
There are no others. Any group of three letters other than those listed above does not represent an Incoterm® and will not be recognised by any jurisdiction in the case of legal proceedings. Therefore, any stipulations including the “supposed” Incoterms® will not be valid.
It is clear that the use of these invented Incoterms® is quite common. They include expressions such as EXW Docks, C+F, C&F, FOT… Seemingly, they are based on one of the eleven Incoterms®, in an attempt to intentionally modify their stipulations, rights and responsibilities, with the elimination, substitution or incorporation of a certain addition.
In some case it is not even done on purpose, but rather the literal lack of knowledge of the eleven Incoterms® in force is the reason for the use of a non-existing Incoterm®. It is worth remembering that Incoterms® are not a law and, therefore, their use is not compulsory. However, if they are used, they are legally binding in the context of a commercial contract signed between two parties. In short, it is difficult to comply with the terms and conditions established by a non-existing Incoterm®.
The use of Incoterms® for national sales contracts
This is another common mistake. Incoterms® are designed for international sales contracts. This has been defined as follows by the International Chamber of Commerce: Incoterms® must be used in sales contracts in which the goods have their origin and destination in different countries.
So much so, that Incoterms® are divided into four different groups, coinciding with the initial letters of each of them, E-F-C-D. This classification corresponds to the country in which the goods are delivered, in other words, the point of origin or destination.
Thus, in the case of Incoterms® that start with E and F, delivery of the goods takes place in the country of origin. In other words, the seller will not assume any costs once the goods have exited the country of origin. Furthermore, depending on the Incoterms® selected corresponding to these two letters, the seller may even be exempt from paying certain costs before this exit takes place. In the case of Incoterms® that start with the letters C and D, goods are delivered in the country of destination.
Another point that determines the use of Incoterms® is who will be responsible for customs clearance in the case of exports and imports. Obviously, if no borders are crossed, as is the case of the delivery of goods within the same country, it makes no sense to use Incoterms®.
In Spain, the fact that there is sufficient legislation means that the use of Incoterms® is not necessary, and they exceed requirements in national transactions. For example, if goods are sold in Málaga to be delivered in León, it is sufficient to indicate in the sales contract who will pay the transport expenses. In the event that the goods are lost or damaged, the Law Governing Overland Transport (L.O.T.T.) and its Implementing regulation (R.O.T.T.), clearly determine the rights and obligations of each party with regards to transport. The code of commerce will do the rest if necessary.
The incomplete use of the selected Incoterm®
Incoterms® are designed with a name and two surnames, just like many of us... An Incoterm® that is missing any of the three components will be devoid of content and could even lead to extremely unpleasant situations in the case of legal proceedings, as we will analyse below.
The first three letters that make up an Incoterm® must be followed by a delivery destination. Often, only the first three letters are included, leaving the Incoterm® devoid of meaning.
Now that it is clear that a place of delivery must be indicated, it is also worth mentioning how this place must be specified. If we have stipulated the Incoterm ® CPT in a sale with the place of delivery being Granada, it would be common to find CPT Granada within the terms and conditions.
Taking into account that over 130 towns across the world are called Granada, it is necessary to be more specific. The country, at least, must be specified. However, continuing with the example, Granada is also a province measuring over 12,700 square kilometres, so it is also necessary to specify the place of delivery within Granada.
The most correct manner of doing this would be to indicate the full delivery address after the three letters of the Incoterm®, whether the kilometre point of a motorway, a street number, or a postcode... in short, the most precise information possible. In this manner, the place of delivery of the goods would be unequivocally determined.
Not referring to the version of the Incoterms®
As mentioned above, the International Chamber of Commerce edits a list of Incoterms® every ten years, including modifications of those in force up to that time. And in certain cases, such changes are significant.
The differences between the 2000 Incoterms® and the 2010 Incoterms® serve as an example. From 2000 to 2010 there were thirteen Incoterms®. This was changed to eleven in the latest modification, with significant changes in those maintained, and substantial modifications with regards to the point of transfer of risk. It goes without saying that an Incoterm® from the most recent revision by the International Chamber of Commerce must always be used.
In order to establish the version of Incoterms® on which the terms and conditions of the sale are based, the “second surname” must be added after the three letters and the exact address of the place of delivery. Therefore, a perfectly defined Incoterm® would be as follows: CPT + Exact delivery address + Incoterms® 2010.
Including clauses that are incompatible with those defined by the Incoterms® selected in the sales contract
A great deal of sales contracts include stipulations that are incompatible with the Incoterms® selected voluntarily. In the event of legal proceedings, the judge would find it difficult to decide which of the two written conditions must be taken into account in order to pass judgment, thus creating an unwanted situation.
It is not that clauses that are incompatible with the selected Incoterms® cannot be included, but rather it must be made clear in the contract that the terms are based on an Incoterm® of which part of its clauses have been added or removed in a consistent manner. In any event, it is worth remembering that there is always an Incoterm® that can be used in any international sale, without having to apply any additions or eliminations.
The use of Incoterms® that are not envisaged for the selected mode of transport
Another classification that can be found in any table listing the specific Incoterms® is the mode of transport used for the delivery of the goods from the seller to the buyer.
There are basically two groups: Incoterms® that must be used for multimodal transport (a combination of several modes of transport for the same delivery) and those that must be used for deliveries carried out exclusively through maritime transport (or inland waterways).
In reality, goods are not often delivered exclusively by sea or river. The majority of deliveries require a combination of two or more modes of transport, and road transport is most often used in combination with train, air and maritime transport.
The Incoterms® CFR and CIF are a clear example. These terms are designed for use in transactions in which the entire transport process is carried out by sea or inland waterways. In other words, its use would be reserved to goods produced in port terminals or those travelling to port terminals through pipes or tubes, as is the case of solid and liquid bulk cargo and gasses. The alternative to CFR and CIF is the use of CPT and CIP respectively.
Not evaluating the risks for the company for each of the Incoterms®
Playing with statistics poses a risk that, sooner or later, could become a real headache. And the mindset that “it is almost never a problem” should not put your mind at rest either. It is necessary to take rapid action, evaluating the risks associated to the use of each Incoterm®, and selecting another one that is better adapted to the transaction or that frees the company from the greatest number of risks possible.
Each and every one of the Incoterms® has advantages and disadvantages for buyers and sellers, but things will go much more smoothly and there will be fewer possible consequences if attempts are made to minimise risks for the company and if you are aware of the risks that are involved.
A simple example: the use of EXW, which seemingly frees the seller from any liability during delivery, also implies tax and customs liabilities that should be taken into account when selecting the term, given that the effective departure of the goods from the customs territory of the Union must be demonstrated by presenting a customs document, a SAD, and a transport document, a BL or CMR for example, even though it is not the seller who is responsible for hiring the transport or making the delivery, but rather the buyer. If such documents cannot be presented, it will not be possible to issue the sales invoice without VAT.
Lack of knowledge of the clauses of Incoterms® is the main reason for the errors that we have mentioned in the seven points above.
As is often the case in everyday actions, in order to undertake such actions with guarantees and security, it is essential to be aware of each and every one of its different aspects... just think about driving, operating a machine or playing an instrument. There are certain things that it is best not to do if we lack in-depth knowledge, especially in the case of international commercial transactions, which entail responsibilities of delivery, custody and payment for both parties.
Therefore, Incoterms® must always be placed in responsible hands to minimise the risks of an improper or incomplete use... or just ask yourself if you would give a gun to a monkey... (and if it happens to be loaded...)