The Bottom Line: Successfully managing Incoterms–Part 1

   All companies and executives engaged in global trade must deal with the use of Incoterms for their purchase orders and export sales agreements.
   Though Incoterms have been around since 1936, they are often misunderstood, misused and cause significant problems in international and domestic business.
   Incoterms are managed by the International Chamber of Commerce (ICC) in Paris. It’s a structure that attempts to standardize contractual terms of trade between countries. Incoterms are updated about every 10 years, with the last one in 2010, when they were opened up to include domestic trade.
   In some countries, they are part of their legal structure, but not here in the United States directly. Or in other words, Incoterms by themselves have little legal standing here in the United States. It is only their role within purchase orders and sales contracts, which are legally binding, that their presence and weight is felt and measured.
   Thus it’s important to differentiate between domestic and international Incoterm use. In the U.S. domestic trade, terms similar to Incoterms are governed by the Uniform Commercial Code (UCC), where the F.O.B. (freight-on-board) term dominates shipping domestically with F.O.B. origin and F.O.B. destination being the two primary options. 
   When the ICC in 2010 opened international use of Incoterms to domestic trade, a lot of confusion occurred.
   In the UCC, the F.O.B. term relates to any conveyance—air, rail, truck, or ocean. In the Incoterms version, F.O.B. can only be used with sea and inland waterway transport. That distinction can create some confusion, if not clearly discerned within sales and purchase order wording.
   This author recommends that domestically the UCC terms are followed, and for international the Incoterms are maintained. At some point following state ratification, there is the potential that the UCC terms will be eliminated, but not anytime soon.
   To understand Incoterms, it’s important to comprehensively understand what they are and are not. Incoterms are a set of guidelines and not an “end-all,” but to be used to define a point in time in trade where the responsibility and liability is transferred from a seller to a buyer, or an exporter to an importer, or in other words the point at which risk and cost passes.
   They do not address areas such as, but not limited to, dispute resolution, governance, payment, ownership, etc. These other areas of contractual concern need to be addressed in documentation, such as invoices, agreements, contracts, purchase orders, etc.
   Incoterms can cause as much risk as they do to minimize exposure. A primary intent of Incoterm is to define risk and cost. But Incoterms are not an “end-all” in an international trade. Incoterms are a component of the transaction. Other variables apply.
   For example, a U.S. exporter based in Chicago ships five pieces of heavy equipment, valued at $450,000 to a buyer in Japan via ocean freight. The goods will be containerized, shipped by truck to Long Beach, placed on a vessel at Long Beach bound for Kobe, and trucked to its final destination in Japan. The terms of sale are “F.O.B. Long Beach.” The terms of payment are 10 percent paid upon purchase order acceptance and the balance once the goods arrive in Japan. The F.O.B. Long Beach term means that once the goods are placed on board the vessel, the responsibility for loss and damage is passed to the buyer.
   In this case, Long Beach is the last port of call in the United States and Kobe will be the first port of call in Japan. The 40-foot container is secured in a top stow on deck. This allows efficient use of port resources, and will help turn the vessel around quickly in Kobe. Six days later at sea, the vessel hits heavy weather and five containers are lost overboard, one being for this shipment.
   When the shipper and consignee are both notified, that’s when the more serious problem occurs. Legally, the buyer in Japan has responsibility for loss and damage, as the goods were sold F.O.B. Long Beach and they were secured successfully on board the ship. However, there are two issues: the goods never arrived in Japan and the shipper or exporter’s terms of payment on the 90 percent balance was to be paid once the goods arrived in Japan.
   Common sense would say the buyer needed to insure the shipment, but in actuality failed to do so in this case. And this is where the dilemma begins. You have a legitimate issue tied into a legally binding purchase order and sales invoice stating “F.O.B. Long Beach”—the quandary created by a term of payment that depends on the good faith of the buyer. Though an attorney would probably be able to sue and collect, how expensive would that be over the destruction of a good business relationship?
   To have prevented this issue from the beginning was not to change the Incoterm or payment term, but to build a business standard operating procedure into the sales process that would have identified this risk and made sure ocean cargo insurance on a primary or contingent basis was acquired by one or both of the parties to offer protection in the case of a marine peril.