International contracts for the sale of physical goods often make reference to Incoterms, a set of three-letter shorthand terms defined by the International Chamber of Commerce. They are commonly used in international sales contracts and purchase orders to describe how the seller and buyer will allocate responsibility for shipping and delivery. Understanding these terms is critical for any professional involved in international trade.
What Incoterms Cover
Incoterms cover the allocation of responsibility for loading, shipping, unloading, customs duties and clearances, insurance, and risk of loss in transit. They are typically used by referring to the three-letter Incoterm together with a location, such as “EXW Seller’s factory,” “FOB Port of Shanghai,” or “DDP Buyer’s nominated delivery point.”
There are many other very important provisions in international sales contracts, such as payment, title transfer, inspection, sales and income taxes, defect liability, and dispute resolution. All of these are commonly addressed through a sales contract, which may either be a stand-alone document, or incorporated in a purchase order or confirmation. The sales contract may flesh out or even overwrite the Incoterms rules on a particular topic, so Incoterms must always be interpreted in the broader context of the contract.
The “E” Term
EXW (Ex Works) is the most “seller-friendly” of the Incoterms. It requires the seller to place the product, suitably packaged, in a location in the country of origin where the buyer can load it and take it away (usually a loading dock at the seller’s facility). It is great for boxed cargo, machinery, and other large and discrete items, but is usually impractical for liquid and bulk products, for which the seller would have to provide loading support.
The “F” Terms
These terms require the buyer to arrange transportation from a designated loading point, but place more responsibilities on the seller than the EXW term.
FCA (Free Carrier) is similar to EXW, but adds a seller obligation to load the product onto a vehicle arranged by the buyer and to clear the goods for export. It is a popular choice for containerized goods, as the buyer gets a pre-packaged container which can then be easily transported to anywhere. The point of delivery is usually in the country of origin, and may be either a seller facility or a transshipment point such as a port.
FOB (Free on Board) requires the seller to bring the product to a named seaport, and then load the product onto a ship arranged by the buyer, with delivery taking place as the product passes “over the ship’s rail.” It is a popular choice for goods shipped by tanker or bulker, such as oil, gas, and coal. This is probably the most misused of the Incoterms, one reason being that the Uniform Commercial Code (which applies to US law contracts that do not incorporate Incoterms definitions) has a different definition of “FOB” that is much broader and that is not limited to ships.
FAS (Free Alongside Ship) is similar to FOB, except that the buyer takes delivery of the goods alongside the ship it arranged, and the buyer then has to arrange loading.
The “C” Terms
The “C” terms require the seller to arrange shipping for the product, but the risk during shipment shifts to the buyer. The buyer is usually considered to take delivery and ownership of the product at the loading point, though this may vary depending on the terms of the contract.
CPT (Carriage Paid To) and CIP (Carriage and Insurance Paid To) are similar to FCA, except that the seller arranges shipping to a named destination (and, in the case of CIP, insurance for the shipment). The buyer then has to unload the product at that destination. Mirroring FCA, the destination may be either a buyer facility, or a port or other transshipment point where the buyer is capable of unloading the product.
CFR (Cost and Freight) and CIF (Cost, Insurance and Freight) are likewise similar to FOB, except that shipping (and, in the case of CIF, insurance) is provided by the seller. In the case of CFR and CIF, the shipping is to a destination port, and the buyer has to unload the cargo there.
Under CIP and CIF terms, the insurance must be for 110% of the price, and the buyer must be the beneficiary since they are directly bearing the risk of loss.
The “D” Terms
The “D” terms require the seller to take the product to a destination at the seller’s risk. The buyer is usually considered to take delivery and ownership of the product at the destination, though this may vary depending on the terms of the contract. These terms have undergone fairly extensive reorganization over the years, and Incoterms 2020 currently defines the following three terms:
DAP (Delivered at Place) requires the seller to hand over the product, loaded on a vehicle, for the buyer to unload at the destination. This makes it similar to CIP or CIF terms, with the buyer also assuming risk of loss until the destination is reached.
DPU (Delivered at Place Unloaded) requires the seller to hand over the product unloaded at the destination. It may be used with reference to a port, in which case the buyer would load and transport the product from the port (similar to an EXW arrangement). It may also be used with reference to a final destination. It is the only Incoterm that makes the seller responsible for unloading at the destination.
DDP (Delivered Duty Paid) requires the seller to hand over the product loaded at the final destination, with all import clearances completed and duties paid by the seller. It is the only Incoterm that makes the seller responsible for import clearances and duties, thus making it necessary for the seller to be familiar and comfortable with import procedures in the destination country.
In past iterations, the Incoterms contained other “D” terms. DEQ (Delivered Ex Quay) and DAT (Delivered at Terminal) were forerunners of today’s DPU term. DEQ was replaced by DAT in 2010, and DAT was replaced by DPU in 2020. DAF (Delivered at Frontier), DES (Delivered Ex Ship), and DDU (Delivered Duty Unpaid) were all forerunners of today’s DAP term. DAF was used for overland shipments, and provided for delivery aboard the vehicle upon crossing an international border. DES was used for maritime shipments, and provided for delivery aboard the ship at a destination port. DDU was a multimodal term that could be used with any delivery point. All three were merged into the DAP term in 2010, and now DAP can be used for each of these scenarios. The older terms may still be used in contracts that refer to older versions of Incoterms.