When it comes to international trade, establishing clear contracts can help outline the responsibilities of shippers and freight forwarders and pave the way for a smooth partnership. Incoterms® (International Commercial Terms) are an essential component of those agreements. Simply stated, the Incoterms® rules are a set of standardized rules issued by the International Chamber of Commerce (ICC) and designed to help clarify the responsibilities of both the buying and selling parties in an international trade agreement. Per the ICC, they can also help both parties reduce risk and avoid potentially costly mistakes by defining ownership of key components in the agreement, including risk transfer, cost allocation, and logistics responsibilities.
By understanding the Incoterms® rules and how they impact a partnership, shippers, and freight forwarders can be better positioned for success – working together to avoid potential misunderstandings and costly delays.
Why Are Incoterms® Rules So Important?
Incoterms® are a set of 11 internationally recognized rules that outline the responsibilities of buyers and sellers in an international trade transaction. The ICC created these rules to clarify specific responsibilities, expenses, and risks to be assumed by each party within a transaction. This level of definition helps buyers and sellers facilitate smoother transactions by making it clear who is responsible for costs associated with transportation, insurance, customs clearance, and delivery. However, while they are internationally recognized as the standard for international trade, the terms being used must also be explicitly included within contracts to ensure compliance and accountability of all parties.
Understanding the Most Common Incoterms® Rules
While 11 Incoterms® rules are defined, those that shippers and freight forwarders opt to include within their contracts will depend on the nature of each shipment. Four of the most common Incoterms® rules and their applications include:
- EXW (Ex Works): EXW is a term by which the buyer assumes the majority of the responsibility. With EXW, sellers are responsible for ensuring that the goods are available for collection at an agreed-upon location (often the seller’s warehouse), while the buyer assumes responsibility for transportation and insurance costs for the shipment, in addition to any other costs that may be incurred from the time of pickup to arrival at the final destination.
- FOB (Free on Board): Under the FOB incoterm, the seller assumes responsibility for the shipment until it is loaded onto the cargo ship, at which point the buyer takes responsibility. The seller is required to clear the shipment for export with customs, deliver the goods to the agreed-upon port, and assume responsibility for any inspection and loading charges. Once the goods are loaded onto the ship, the buyer pays for the goods and must also pay any import duties or inspection fees. FOB applies only to ocean and inland waterway shipments — typically bulk or oversized/overweight cargo.
- CIF (Cost, Insurance, and Freight): The CIF incoterm applies only to shipments that are transported by ocean and inland waterways. Under CIF, the seller is responsible for transportation and insurance costs until the shipment arrives at the destination port, at which point the risk transfers to the buyer.
- DAP (Delivered at Place): Under the DAP rules, the seller assumes the majority of the risk and responsibility for the shipment and remains liable for any costs associated with the shipment until it reaches the final destination. The buyer assumes responsibility from the time of unloading — including import duties — to final delivery.
Avoiding Pitfalls: Selecting the Right Incoterms® Rule for a Shipment
As noted above, not all Incoterms® rules apply to all types of shipments, so it is important to consider the type of shipment being transported and understand which specific terms may apply to select those that are most appropriate. Different Incoterms® rules also come with varying levels of risk and financial responsibility, so shippers need to understand the regulations involved around importing and exporting, in addition to insurance costs and their operational capabilities (e.g., whether or not they are capable of delivering shipments to a port if they were to utilize the FOB Incoterm).
Some of the most common mistakes associated with using the Incoterms® rules include:
- Not fully clarifying what is covered: Not all Incoterms® rules apply to all types of shipments, and some assign more risk to the seller than the buyer (and vice versa). Additionally, while an Incoterm will define responsibility for risk, costs, and transport, they are not to be used in place of a sales contract to define payment terms or contract conditions. Payment terms should be outlined within the contract to avoid financial risk.
- Misunderstanding risk transfer points: Knowing when the risk shifts from the seller to the buyer is among the most critical factors to review. If all parties are not aligned, this can result in disputes if the shipment is damaged, as well as unexpected costs associated with the damage.
- Failing to consider local trade regulations and documentation requirements: Every country has its own regulations and requirements that must be followed to avoid shipment delays, potential compliance issues, and additional costs or penalties that may result from noncompliance. Researching the requirements upfront can avoid additional costs and delays.
Best Practices
To avoid the potential pitfalls associated with misunderstandings around the Incoterms® rules , shippers and freight forwarders can take a proactive approach to ensure alignment by following three key guidelines:
- Educate and train teams: Ensuring that all parties involved understand the different Incoterms® rules can help avoid misunderstandings about what is covered, who assumes responsibility, and when responsibility is transferred from shipper to buyer. When the Incoterms® rules are updated, hosting updated training sessions to outline the differences and clarify questions can ensure everyone is on the same page. Click here to access the latest Incoterms® rules.
- Clearly define responsibilities: The Incoterms® rules are not a substitute for contracts, so while they should be included within the contract, it’s also critical to ensure that contracts and shipping documents themselves use clear and precise language around the expectations of each party and their responsibilities.
- Collaborate with legal and logistics experts: If any outstanding questions arise, it’s always best to consult experts who can clarify them to ensure alignment around risks and responsibilities. Working with a trusted logistics partner like EFW can also help avoid compliance issues by providing their expertise in navigating various international trade regulations and requirements.
Trust the Experts
International trade is complex, and every country has different rules and regulations that can be difficult to understand. EFW has worked to become a trusted partner for global shippers and can help provide clarity and understanding around shipping rules and requirements — including Incoterms® — so that teams can proactively manage their risk and ensure they know what to expect. By achieving alignment from the start and creating clear agreements, shippers can benefit from reduced risk and smoother operations with their international partners.
Click here to learn more about EFW’s freight forwarding solutions and how they can help your team manage risk and foster strong international shipping operations.
The Incoterms® Rules are protected by copyright owned by ICC. Further information on the Incoterm® Rules may be obtained from the ICC website iccwbo.org. Incoterms® and the Incoterms® 2020 logo are trademarks of ICC. Use of these trademarks does not imply association with, approval of or sponsorship by ICC unless specifically stated above.
