Coming to terms with Incoterms

I believe it’s safe to say that among all of the aspects of international trade, the most misunderstood and misused element of an international transaction is the correct application of shipping Incoterms.

In fact, some of my earliest and most valued reading in The Journal of Commerce dates back to Frank Reynolds’ “Export ABCs” column, and his monthly submissions on the subject, although they didn’t start out that way. After reading my first article and as I struggled with this new lexicon, I vaguely recall mumbling something to the effect of, “What in the world is this guy talking about?”

It wasn’t long, however, before I would be clipping those columns and saving them in a dedicated folder as part of my own continuing education on the subject.  

As background, Incoterms are a series of three-letter trade terms that establish uniform rules for defining the tasks, costs, risks and responsibilities of buyers and sellers in international transactions. Its origins can be traced to the 1920s, by which time international traders had developed a set of short abbreviations as replacements for lengthy contract provisions dealing with a party’s rights and obligations to the sale and transportation of goods. 

But the early terms weren’t interpreted uniformly, which led to frequent disputes between trading parties. As a result, the International Chamber of Commerce stepped in and developed INternational COmmercial TERMS, or “Incoterms®.” First published in 1936, these rules have been revised periodically to account for changing modes of transportation, delivery, business practices and security, with the most recent update in 2010.

One of the most common misunderstandings of Incoterms that I encounter is the misconception that Incoterms also define when title transfers between parties — likely due to the additional misunderstanding that clearing customs as the importer of record only can be made by the owner of the goods. Instead, the terms of title transfer should be detailed separately within the purchasing contract because there can be multiple variations of ownership transfer within the same Incoterm.

Take, for example, a shipment purchased under a Vendor Managed Inventory (VMI) arrangement where components are to be used for production at the buyer’s manufacturing premises. The goods could be purchased under EX Works (EXW), which would make the buyer responsible for all of the activities and costs associated with getting the merchandise from the foreign seller’s dock to the buyer’s production site, and yet by contract would have the seller agree to hold title to the goods until such time that they are physically pulled for production.

Other things that Incoterms don’t do, include:

  • Application to services.
  • Define contractual rights and obligations other than for delivery.
  • Specify details of the transfer, transport and/or delivery.
  • Protect a party from risk of loss.
  • Define the remedies for breach of contract.

Another problem I see routinely is where a U.S. buyer places an international order in which it has simply used an incorrect term for the intended shipment, or has combined terms that result in a confusing hybrid, such as “EXW-Duty Paid.”

I also have seen — with rather surprising frequency — a buyer placing a domestic order with a domestic vendor (at a fully landed-cost price), but he includes an international Incoterm, such as FCA, on the purchase order.

In several of these instances, this resulted in an international shipment arriving from the domestic vendor’s foreign manufacturing plant, which not only made the buyer responsible for clearing customs, but also for paying (again) the entry fees, duty and tax — something akin to ordering a new TV from Best Buy, only to learn later that your TV has arrived at the Port of Los Angeles and now requires you to perform the customs clearance.

In essence, Incoterms help to define how little, or how much, you want to be involved with the international movement — from controlling everything under EXW, to having the goods simply arrive at your door under Delivered Duty Paid (DDP); understanding the costs and risks of each are critical.

If you’re looking for some help, a great job aide I recommend highly is the “Illustrated Guide to Incoterms® 2010,” published by World Trade Press (http://www.worldtradepress.com). Also available within their popular “Dictionary of International Trade,” the visual format used is especially helpful in quickly understanding the roles and responsibilities of each term.

Jerry Peck is a licensed customs broker and global trade management expert with more than 30 years experience in regulatory compliance and GTM optimization solutions. Contact him at 469-235-5229, or at wmjerrypeck@gmail.com.

For the full story: Log In, Register for Free or Subscribe