Sunday, July 6, 2014

Selecting The Right Incoterms Rule (delivery term)


For those individuals who may not be familiar with Incoterms®, they are a set of rules published by the International Chamber of Commerce in which responsibilities of the parties are established based upon the specific rule (delivery term) selected and the delivery point. Each Incoterms® rule (delivery term) addresses which party (the buyer of seller) has the responsibility for certain costs or tasks:
• Loading on truck at origin
• Export Customs declaration form completion
• Carriage to port of export
• Export clearance
• Unloading at port of export
• Loading onto vessel at the port of export
• Carriage to port of import
• Unloading charges at port of import
• Import customs clearance
• Import taxes and duties
• Loading on carrier at port of import
• Carriage to place of destination
• Responsibility for insurance

Incoterms® are silent as to title transfer, and title transfer can be an important consideration in shipment of goods. Normally ownership is directly tied to risk of loss or damage. The party that owns the goods has the risk of loss or damage in the goods. The exception is that when you use Incoterms they define the point where the risk of loss passes from the seller to buyer. If there is no transfer of title or ownership there is no sale. For example the Uniform Commercial Code that has been adopted by all states in the U.S. presumes that title transfers at the specified delivery point unless there is language in the agreement to the contrary. CISG makes no reference to title transfer and looks to the Incoterms® to establish where the risk of loss transfers.

There are two different groups of Incoterms. The following Incoterms apply to any mode of transportation: EXW (Ex Works), FCA (Free Carrier At), CPT (Carriage Paid To). CIP (Carriage and Insurance Paid To), DAT (Delivered at Terminal), DAP (Delivered at Place), DDP (Delivered Duty Paid). Incoterms that only apply to sea and inland waterway transport are: FAS (Free Alongside Ship). FOB (Free on Board), CFR (Cost and Freight), CIF (Cost, Insurance, and Freight).

If you negotiate contracts involving international trade you should own a copy of the Incoterms. They can be ordered at http://www.iccwbo.org/products-and-services/trade-facilitation/incoterms-2010/. For a very good description of all the individual rules (delivery terms) you can also visit: http://www.inhouseblog.com/international-shipping-terms/.

In negotiating contracts deciding which Incoterms® rule to accept there are many things to take into consideration. The first thing to remember is only the owner of the goods or their representative (a customs broker) can apply for an export license and clear export customs. In some locations like the EEU, non-resident companies cannot clear customs. In the U.S. non-resident companies can apply for export licenses and clear export customs. They are responsible for complying with U.S. export regulations. The U.S. export restrictions may limit some classifications of goods to a limited number of countries. There are also countries where restrictions apply to export all goods to those named countries. Similarly, only the owner of the goods or their representative, are able to apply for an import license and clear import customs.

When goods are shipped a Bill of Lading is completed. A bill of lading could is clearly stated transfer ownership. In most cases what the bill of lading does is transfer possession of the goods. The goods are consigned to the carrier or freight forwarder. The carrier or freight forwarder has certain rights with respect to the goods, but they do not have title or ownership in the goods. For a bill of lading to transfer title/ownership in the goods either the contract or bill of lading would need to clearly show the intent to transfer title/ownership. Otherwise the recipient of the goods has only the legal right to possess the goods subject to the terms of the consignment.

The point at which title or ownership transfers is an important consideration and is not controlled by the specific Incoterms® rule selected. Ownership is tied to the risk of loss or damage. If you fail to specify where title / ownership passes in the contract or other document, applicable laws may do that for you. If you had a contract that specified any state in the United States as the applicable law, the Uniform Commercial Code UCC Section 2-401 would apply. Under the UCC title transfers upon delivery at the agreed delivery point that is defined by the delivery term and delivery point selected. For examples Ex-Works Seller’s dock in New York, New York would mean that title transfers at the point the seller makes the goods available for delivery at their loading dock in New York, New York. That means that from that point onward the risk of loss or damage belongs to the buyer. It would also mean that it becomes the the buyer’s responsibility to either assume that risk or purchase insurance to cover that risk from that point forward. There are only two Incoterms rules that require the seller to provide insurance to protect against loss or damage. Those two are CIF (Cost insurance freight) and CIP (Carriage Insurance Paid to). For all other Incoterms® rules the risk of loss is with the owner of the goods.

Some companies watt to retain title / ownership of the goods until they are paid. They do that to allow them to recover the goods if not paid under what is called replevin. One problem with that is unless the specific Incoterms rule selected transfers the risk of loss, by continuing to own the goods they also continue to own the risk of loss or damage. Other companies choose to transfer title (and risk of loss or damage) to the buyer at an earlier point subject to a security interest in the goods (a lien against the title / ownership). Each approach has their advantages or disadvantages. In many sales the goods may be consumed or converted quickly so retaining ownership rights in the goods may not provide any protection. The specific type of Bill of Lading can also impact title. For example, if you used a negotiable intermodal bill of lading you are agreeing that title is transferred to the freight forwarder and are also agreeing that proof to the contrary shall not be admissible when the FBL has been transferred to the consignee for valuable consideration who in good faith acted thereon. For non-negotiable bills of lading the freight forwarder gets prima facie title in which, you could introduce evidence of title (such as retained title conditioned upon payment or a security interest.

Whether the buyer or seller manages the transportation is also a consideration. There are good and bad carriers. Some shipping lanes carry higher risks due to weather and piracy and theft. One question to ask is which is more important for me, getting the goods when I need them or getting compensated for the loss or damage? The more you want or need the products to be delivered when you need them the more you either want to control or approve the carrier and shipping lanes.

In working for large companies with very competitive shipping costs we always felt that our costs would be less than our Sellers so the majority of our purchases were made under delivery terms where the bulk of the transportation expense was under our control. There can be times when it may make sense to buy an item delivered to the destination such as with an DAP term or have delivery be from a Seller’s local subsidiary. That occurs mostly when you are importing it into a country with high duties. If you buy and import a product your duties will be based upon your purchase price and transportation costs. If the Seller subsidiary purchases it, their duty will not be based upon the purchase price. It will be based upon what’s called the “transfer price” or the amount the company sells the product to the subsidiary for which is less than your purchase price. That means the duty they will pay will be less. The same would apply to buying from a distributor as the distributor is buying it less their discount, but then you need to take into consideration that your contract would then be with the distributor and not the Seller. The one thing you never want to do is leave the cost of transportation totally open ended to the Seller. Either get a price that includes all cost or manage the transportation yourself.

Revenue recognition is another consideration. Revenue recognition is when under the accounting rules for the jurisdiction the seller can classify it as a sale. In the U.S. there are strict rules (Sarbanes-Oxley) issued by the Security and Exchange commission that prevents companies from taking credit for a sale if it can be returned to the seller. Most U.S. Sellers will want terms where title transfer is early so they don’t have to wait for deliver at some other location to occur before they can count it as revenue. They also try to avoid any right of the buyer to return the product and want to only be responsible to either repair or replace they product so it can be considered sales revenue. Revenue recognition is important to companies balance sheets and to sales organizations that are measured and compensated based upon meeting sales goals within a financial period.

Another thing you need to consider is the specific delivery point. INCOTERMS® doesn’t establish the actual delivery point and the parties are free to also establish a deliver point that makes sense between them. Even though a product may be made in one location, it may also be stocked in another. For example many company supply chains want the Seller to have stocking points close to the point of use so they can operate under a pull replenishment program. If the Seller has those, you use them. If the Seller doesn’t have local stocking points you could have stocking at different locations such as a third party warehouse or even a stockroom on the buyer’s site. In doing that you need to select the right INCOTERM and delivery point. Pull replenishment types of arrangements require additional terms regarding pull, replenishment and loss or damage to the product while stored. When I talk about selecting the right delivery point you need to take other things into consideration. For example I’ve written contracts where delivery was to a third party warehouse in a free trade zone prior to import customs clearance because the supplier refused to sell the product within the country of import. If the seller wanted to assume all costs and risks to get it to that point they could sell the product ex-works at that point. The could also select CIP, CIF or DAP to that warehouse but have the title and risk of loss transfer at an earlier point When the buyer wanted to make a “pull” that was the location they pulled from. The buyer then had to arrange for import and transportation from that point. An additional advantage for the Seller was if the materials weren’t pulled, they could have them shipped anywhere. Since the goods were never imported into that country they would not need to do any export clearance or get export licenses.

There can be tax and other implications depending upon which rule you select. Except for situations where ownership/title is transferred “on the high seas” or in a free trade zone, the transfer of title/ownership constitutes a sale at the point of delivery. Deliver point that are between the export and import frontiers are considered international sales. Deliveries within a free trade zone are also considered international sales. For international sales the seller does not have to be registered to do business in the country of import. The seller is not subjected to the laws of the country of import. The seller is also not subject to taxes on the sale of the goods. If you were to agree to sell on a DDP basis that means that the seller is responsible for preparation of the import license and import. The seller is responsible for payment of any applicable duties. From a legal perspective doing those actions within that country means that you are conducting business within that country. To conduct business within a country you must be legally registered to do business within that country. The sale within that country becomes a local sale. As a local sale, that subjects the seller to the import country’s laws and income taxes on that sale. Free trade zones are controlled areas prior to import clearance where warehouses are built and materials may be shipped. As part of tax management many companies want to avoid having sales occur within the country of import because of the tax impact.

There can be liability considerations depending upon the term that’s selected. For example in the U.S. the Patriot Act and the Trade Act of 2002, makes the importer liable if the container contains any illicit goods.

The point of sale can subject the party to the laws of the country of sale as the sale is occurring within that location. The exception to that is when delivery occurs and the sale is completed after the export customs frontier and prior to the import customs frontier. In that situation it would become an international sale and the transaction would be governed by only the applicable law and jurisdiction stated in the contract.

The last thing to consider is your knowledge of the laws of the importing country. There are two general types of laws to be concerned with respect to import. One is environmental laws and does the product comply with local environmental laws which will be a condition on import. The second set of laws are homologation laws. Homologation laws deal with compatibility of a product with local systems or networks it may be connected to. For example, a telecommunications product being imported into a country may need to compatible with local communications systems. If you sell on a delivered term within the import country it is your responsibility to ensure compliance so it can be imported. If you sell on a term where the responsibility for import is passed to the buyer before import, it is their responsibility to ensure that what they buy meets both environmental laws and homologation laws.

The advantages of using Incoterms® and specifying the specific Incoterms delivery rule (delivery term) and date of the Incoterms® publication is:

1. In comparing quotes from different Sellers, if they quote a different delivery terms or points, you should take any cost differences into account in deciding who to award the business to as you want the Seller with the lowest landed cost. One thing I also like to do was to have Sellers quote or bid based upon multiple delivery points and have those costs included in their price. That way I can see how competitive their transportation costs would be which may help decide what’s going to create the lowest landed cost for me.

2. From a contracts perspective, when you incorporate them by reference into the contract the responsibilities of each party from the Sellers dock to the buyers dock for all the activities involved such as loading, transport, preparation of paperwork, export, import, customs clearance, payment of duties and insurance are defined for you. If you didn't use them, you would need to address all of the applicable portions of those in your agreement’s delivery section.

3. Each of the responsibilities has a cost involved. Some costs of those costs may be small (such as completing the export declaration). Other responsibilities such as shipping and duties can be significant. When you use the INCOTERM and specify the delivery point it's clear which party is bearing those costs. That way you know what the true cost of the purchase or sale is and who is insuring the shipment against risk of loss or damage while in transit.

I use the 2010 version. When I use them, I do it by including language such as: “The delivery term shall be Ex-Works (as defined in Incoterms 2010) Seller’s Dock in Taipei, Taiwan”. The ICC periodically updates Incoterms and sometimes eliminates or changes definitions as occurred when Incoterms 2010
replaced Incoterms 2000. While Incoterms 2000 is no longer the current Incoterms rule parties to a contract are still free to use whichever version they want. The key in using prior versions or terms that may have been deleted or changed is you need to refer to the specific Incoterms date. For example, "For example delivery shall be DDU as defined in Incoterms 2000" would correctly create a DDU term. If you said DDU Incoterms or DDU Incoterms 2010 you have a problem as DDU (Delivered Duty Unpaid) doesn't exist in Incoterms 2010. New terms of DAP (delivered at place) or DAT (delivered at terminal) exist. In drafting it's best to refer to the specific date of the Incoterms you want to use to eliminate any confusion.

Like anything else, there may be a number of times where a specific INCOTERM does not match your exact needs. INCOTERMS are not fixed in stone so if none of them fit exactly what you need you can still incorporate the closest one to what you need and then modify it to meet your needs. For example:
“The delivery term shall be Ex-Works (as defined in INCOTERMS 2010 except as modified below) Seller’s Dock in Taipei, Taiwan. The modifications to INCOTERMS 2010 shall be ......” An example of a modification is the buyer could agree to pay insurance to a specific point.

There may be times when you are purchasing capital equipment where you want the Seller to manage the installation and start up of the equipment. In those situations you probably need to separate delivery from installation. You can always have title, risk of loss and the delivery point be outside of the country from a sales perspective, and still have the responsibility to install, test and accept be a separate contract. If you did that the sales agreement should have monies retained, a bond or bank guarantee linked to successful installation, test and acceptance.

The selection of the INCOTERM isn’t just about who is responsible for certain actions, you need to consider all the costs and risks in selecting your term and have those and these other factors drive your selection. For example, as a Seller I would never want to agree upon a delivered term at any place other than a free trade zone prior to the import frontier without having title pass far before that. You see I don’t want to be waiting for a product to clear customs before I can invoice and get paid for the product and I don’t want the buyers inability to import the product to impact their obligation to make payment. As a seller if they cannot import a product I might help them sell the product to a customer in another location where it can be imported. As a Buyer, unless I had a legal presence in the country of export that could manage it, I would avoid EXW (ex-works) delivery terms and would want the seller to be responsible for export clearance.

One final comment, your agreement needs to address when title transfers and payment terms as Incoterms does not address those issues.

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