Incoterms Supplement
This supplement incorporates the recent changes made to Incoterms. Please replace
Chapter 2 with the following.
Two
Chapter outline
2.1 Introduction and learning objectives
2.1.1 Introduction
2.1.2 Learning objectives
2.2 Contract of sale
2.2.1 Conclusion of the export contract
2.2.2 Form of the export contract
2.2.3 Agreements
2.2.4 Law and disputes
2.2.5 International sales law
2.2.6 Effective sales agreements
2.3 Trade terms in foreign trade Incoterms and documentary credits
2.3.1 Introduction
2.3.2 The 11 Incoterms
2.3.3 An Incoterms case study
2.3.4 Implications of Incoterms 2010 for documentary credits
2.3.5 Electronic developments
2.4 Methods of payment
2.4.1 Methods of payment
2.4.2 Bills of exchange/promissory notes as instruments of negotiation and as
instruments for avalisation or forfaiting in collections and documentary credits
2.4.3 The documentary credit as a method of payment and the autonomy of
documentary credits (the independence principle)
to understand who is involved in the sales agreement and to appreciate that the
agreement supersedes the payment obligation;
to understand why the sales agreement is important in order that the exchange of goods
for money can be effected smoothly;
to obtain a clear understanding of Incoterms, as applicable to an international trade
transaction;
to be able to compare the basic methods of payment; and
to understand when the documentary credit is a preferred method of payment and to
understand the principle of the autonomy of a documentary credit.
contracts still differ from one country to another, in accordance with the different laws of
each country.
In general terms, the buyer and seller conclude a legally enforceable export contract by
agreeing on the goods to be sold and the price to be paid for them. Usually, their agreement
will, in addition, cover related items such as the time period for delivery, the method of
payment and how the goods are to be delivered (the trade terms). It may also specify what
law is applicable to the contract and which court or arbitration system has jurisdiction to hear
any claims in the event of a dispute.
2.2.3 Agreements
Export sales are usually concluded between professional buyers and sellers acting in the
course of their business rather than between private individuals. In this situation, buyers and
sellers frequently maintain their own set of standard conditions of sale and purchase, setting
out the terms on which they normally conduct business. Typically, these are included by
reference in the contracts.
Problems sometimes arise when the buyer and seller send their standard conditions to each
other during the pre-contract negotiations. It is then frequently unclear which set of
conditions (if either) applies to the transaction and whether the parties have effectively come
to an agreement at all. In extreme cases, the uncertainty created by this practice leads to a
dispute that ends in court. In this event, the judge or arbitrator may decide that no contract
was ever concluded because the buyer and seller failed to agree on the conditions
applicable. More often, the judge or arbitrator will try to save the contract by determining, for
example, that one or the other set of conditions applies or that both sets of conditions apply,
to the extent that they do not conflict.
The most common method of minimising the risk of dispute arising in the sales contract is to
incorporate Incoterms (see below). But it is not only important for the seller and the buyer to
agree to trade terminology as covered by Incoterms: it is even more important for there to be
a clear understanding on their application. It is only when these objectives have been
achieved that an effective sales agreement is created.
countries, but Incoterms are now the accepted international standard for trade terms referred
to in commercial contracts.
The latest version of Incoterms came into effect on 1 January 2011 and is titled Incoterms
2010. Full details can be found in ICC Publication No. 715E. It is worth mentioning here that
Incoterms are confined to the rights and responsibilities of parties relating to delivery of
goods sold under the contract of sale. They do not extend to other contracts, such as
insurance, carriage and payment, although the implications of the particular Incoterms used
may have links to such contracts. An example of this would be if the Incoterm CFR (cost
and freight) were to be incorporated in a contract this would imply that carriage would be
by sea and therefore that either bills of lading or sea waybill documentation would be
needed. Taking this example a stage further, if payment were to be made under a
documentary credit, the type of transport document called for by such a credit would have to
comply with the Incoterm stated otherwise, at the very least, advising of the credit or
payment thereunder may be delayed.
It can be readily seen from the above Incoterm groupings that the obligations of the seller
with regard to costs and delivery risks escalate from the minimum EXW to the maximum
DDP.
When incorporating an Incoterm into the sales contract, the parties should take care to
ensure that the term selected is appropriate to the agreed point of delivery and the mode of
transportation to be used. For example, CFR, CIF, FAS and FOB apply only if a ship is used
for delivery, ie for transportation by sea or inland waterway. All of the other terms may be
used as applicable for any mode of transportation.
Table 2.1 Incoterms 2010 case study: Group 1 Rules for any mode or modes of transport of goods
Incoterm
Ex works
[named place,
eg Tettun
Road factory,
Denby]
Standard
ICC
Abbreviation
EXW
This term may be used irrespective of mode of transport selected and may
be used where more than one mode of transport used.
The seller makes the goods available for collection from Tettun Road,
Denby, by Imcro Inc. Once Imcro Inc has collected the goods, Excro Ltds
responsibility is at an end. A commercial invoice, or equivalent electronic
record or procedure (if this is customary or has been agreed between the
parties) will be provided for Imcro Inc. Goods should be suitably packed for
transportation, unless it is the norm for the goods involved to be delivered
unpacked.
The seller must at its own expense provide other documents, eg quality and
quantity certificates, which are necessary for the delivery of the goods.
The seller must provide other documents, eg quality and quantity certificates,
if required by the buyer at additional cost to the buyer.
The seller must deliver the goods on the agreed date or within the agreed
period.
The seller must give notice of the availability of the goods to the buyer to
enable the buyer to take delivery of the goods.
Incoterm
Standard
ICC
Abbreviation
Free carrier
[named place,
eg Denby
inland
container
depot]
FCA
This term may be used irrespective of mode of transport selected and may
be used where more than one mode of transport is used.
Goods must be suitably packaged for transportation unless it is the norm for
the goods involved to be delivered unpacked or the buyer has notified the
seller of specific packaging requirements before the contract of sale is
concluded.
The seller, Excro Ltd, makes the goods available to Denby Containers at the
inland container depot or at the buyers named place of delivery. The delivery
would be incomplete until the goods had been loaded onto the carriers own
transport.
Excro Ltd must advise delivery of the goods at Denby Containers to Imcro
Inc.
Excro Ltd clears the goods for export, where applicable; it completes export
and customs requirements, including obtaining an export licence and paying
any costs, duties and taxes in respect of export.
The seller bears all risks of loss or damage to the goods until they have been
delivered to the carrier or another person nominated by the buyer.
The seller supplies the buyer with a commercial invoice or equivalent
electronic record or procedure (if this is customary or has been agreed
between the parties), and a transport document (delivery note) with proof of
delivery to Denby Containers, ie a document in accordance with the terms of
sale contract.
The seller has no obligation to buy insurance to cover loss or damage to
goods.
However, the seller must (at the buyers expense) provide the buyer, if
requested, with information that the buyer needs in order to obtain insurance
cover.
The seller must deliver the goods to the carrier or another person nominated
by the buyer at the agreed point or named place on the agreed date or within
the agreed period.
The seller must notify the buyer that the goods have been delivered to the
carrier named by the buyer to enable the buyer to take delivery of the goods.
Incoterm
Standard
ICC
Abbreviation
Carriage Paid
To...[named
place of
destination]
CPT
Incoterm
Standard
ICC
Abbreviation
Carriage and
Insurance
Paid To...
[named place
of destination]
CIP
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Incoterm
Delivered At
Terminal...
[named
terminal at
port or place
of destination]
Standard
ICC
Abbreviation
DAT
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Incoterm
Delivered At
Place [named
place of
destination]
Standard
ICC
abbreviation
DAP
12
Incoterm
Delivered
Duty Paid
[named place
of destination]
Standard ICC
abbreviation
DDP
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Table 2.2 Incoterms 2010 case study: Group 2 Rules for transport of goods by sea and inland waterway
Incoterm
Free
Alongside
Ship (named
port of
shipment)
Standard ICC
abbreviation
FAS
This term is to be used only for sea or inland waterway transport of goods.
Free Alongside Ship means the seller places or delivers the goods
alongside the vessel, eg on the quay or on a barge nominated by the buyer
at the named port of shipment.
The seller fulfils its obligation to deliver when the goods have been placed
alongside the vessel on the quay or in lighters at the named port of
shipment.
The seller provides export-quality packing of goods and bears the cost of
transport of goods from its warehouse or factory to the port of shipment for
loading on the ship.
If the goods are in containers the seller will provide the goods to the carrier
at a terminal and not alongside the vessel. In such cases the term FCA
would be more appropriate.
The sellers obligations are to:
obtain at its own risk and expense an export licence and other legal
documents required for export of the goods;
give notice to the buyer that the goods have been delivered or placed
alongside the vessel at the named port of shipment;
deliver the goods on the agreed date or within the agreed period.
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Incoterm
Free On
Board
[named port of
shipment]
Standard ICC
abbreviation
FOB
deliver the goods on board the ship (this requirement is fulfilled when
the goods have passed over the ships rail at the named port of
shipment);
obtain, at its own risk and expense, quality and quantity certificates, if
required in the sale contract;
give notice to the buyer that the goods have been delivered on board
the named ship at the port of shipment.
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Incoterm
Cost and
Freight
[named port of
destination]
Standard ICC
abbreviation
CFR
16
Incoterm
Cost,
Insurance and
Freight
[named port of
destination]
Standard ICC
abbreviation
CIF
This term is to be used only for sea or inland waterway transport of goods.
The seller has the same obligation as under CFR but with the addition that it
has to procure marine insurance against the buyers risk of loss or damage
to the goods during carriage.
The seller contracts for insurance and pays the insurance premium. CIF
requires the seller to clear the goods for export and pay duties and taxes.
Cover should comply with the minimum provision of Clause (C) of Institute
of Cargo Clauses (LMA/IUA). It should cover 110% of the contract value in
the currency of the contract.
The seller provides a commercial invoice, or an electronic record or
procedure if this has been agreed between the parties, quality and quantity
certificates if required in the sale contract, a marine insurance policy, a
clean on board bill of lading freight paid or prepaid.
The seller must deliver the goods to the ship nominated by the buyer at the
port of shipment on the date or within the period agreed in the sale contract.
The seller must give notice to enable the buyer to arrange to take delivery
of the goods when they arrive at the port of destination.
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The seller may be unwilling to ship goods to the country of the buyer for reasons of
country risk.
The buyer may wish to encourage the seller into a long-term trade relationship.
The seller may not have finance with which to buy or prepare the goods for shipment.
The buyer feels comfortable with its relationship with the seller and with both credit and
country risk.
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19
documentary evidence covering the goods and their shipment. The role of a documentary
credit as a method of payment is discussed in Section 2.4.3 of this chapter.
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International Trade Law (UNCITRAL) has developed a model law for international negotiable
instruments.
Negotiable instruments have special legal effects that concern the rights and obligations of
third parties, as well as the parties who originally created the instrument. For this reason,
documents have to conform to strict formal requirements in order to be legally accepted as
negotiable instruments. These requirements are established in national legislation and in the
applicable international conventions. Typically, the requirements include written form,
signature and the need for the payment undertaking or order to be expressed in
unconditional terms.
Under a bill of exchange, the drawer writes and signs the bill instructing the drawee a bank,
in the case of bills under documentary credits to pay a specified sum of money either to a
third party or to the drawer (the payee). The bill may either call for payment on presentation
(a sight draft) or on a specified future date or a determinable event (a tenor or usance
draft).
The payment order must be unconditional. A tenor draft may be presented to the drawee for
acceptance. The drawee accepts the draft by signing either on the back or front, according
to local custom and law. Acceptance constitutes an unconditional undertaking to pay the
draft at maturity. The payee and subsequent holders can negotiate (discount) the bill. This
means that they can sell their rights in the bill to a third party, who then becomes the holder.
In return for making immediate cash payment, the party buying the bill often pays a
discounted amount, which is less than the face value of the bill. This difference between the
amount paid and the full amount payable on the bill at a later date represents the buyers
interest charge, opportunity costs and assumption of risk.
Drafts are normally made payable to a particular party and, if so, are transferred by
endorsement and delivery. (The latter is the legal term for the physical handing over of the
document.) But they can also be made payable to bearer that is, the person duly holding
the bill at any particular time. In this event, they do not name the bearer and they are
transferred by delivery alone.
The legal structure of a cheque is similar to that of a bill of exchange. Unlike a bill of
exchange, however, a cheque must be drawn on a bank and it is payable upon presentation
to that bank.
A promissory note also has most of the same features as a bill of exchange. The essential
difference is that it is not an order to another party to pay, but a direct promise of payment by
the party who signs the note (the maker). In the same way as the bill of exchange, it must
be drawn up in unconditional terms.
2.4.2.2 Avalisation
In some countries, a bank or other party can guarantee payment of a draft or promissory
note by giving its aval. By signing the note in this way on the back, the bank or other
organisation commits itself unconditionally to pay should the maker or drawee default. The
practice is well established by legislation in most European countries in particular, those
that have adopted the Geneva Convention but there is no precise equivalent in legal
systems based on English law.
The benefit of an aval is transferred automatically when the note is negotiated. Accordingly,
the use of an aval is a particularly convenient way of dealing with commercial paper
underwritten by banks in the secondary markets. Each person in the chain can claim against
previous holders and the drawer, if the draft is not honoured, whether or not it has been
accepted. A party negotiating a draft thus acquires a right of recourse, in case of dishonour,
against the party endorsing the draft and to previous endorsers. The mere drawing up of a
bill of exchange does not oblige the drawee to pay. The drawee is bound by the bill only
upon acceptance.
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2.4.2.4 Dishonour
All legal systems establish precise formalities to be observed in case of dishonour (ie nonpayment). English law provides for notice to be given to all parties affected. Many other
countries provide a procedure called protest. Where this applies, the act of non-payment
has to be officially established and stamped on the instrument by a public notary.
2.4.2.5 Forfaiting
The term forfaiting describes the formal arrangement or agreement between a seller and a
lender by means of which the seller is to receive payment for export receivables from the
lender, without recourse on the seller against the security of bills of exchange avalised
(guaranteed by a bank) acceptable to the lender. This device also sometimes referred to
as a forfait financing has a number of applications. Its single greatest use is for the
medium-term financing of exports of capital goods and equipment in cases in which official
export credit support is not available. It provides a flexible means whereby a bank or other
institution in the sellers country can extend credit to the buyer, backed by the guarantee of a
bank in the importing country.
Essentially, forfaiting works as follows.
The seller and buyer agree the terms of sale, including the granting of medium-term credit to
the buyer for example, over a period of five years with quarterly repayments. At the same
time, the seller checks with the forfaiter a bank or specialist institution in its own country
that finance will be available for the transaction. The buyer accepts a series of drafts or signs
a set of promissory notes corresponding to the instalment dates for repayment of the agreed
credit. These bills or notes are guaranteed by the buyers bank. This takes the form either
ofa separate guarantee or of a special endorsement on the bill or note, known as an aval.
(Rights to payment under documentary credits are also sometimes accepted as security in
forfaiting deals.)
The seller presents these bills or notes to the forfaiter. The latter buys them from the seller
for an immediate discounted cash payment. The discounted sum received by the seller
corresponds to the sale price agreed with the buyer. The difference between that amount
and the total for which the bills or notes have been drawn up corresponds to the interest
payment to be made by the buyer in return for being granted credit terms. The forfaiter
makes its profit on the transaction out of the difference between the discounted price paid
and the total sum payable to the forfaiter under the bills or notes. The forfaiter can either
hold onto the bills or notes and present them for payment on the maturity dates, or sell them
in the secondary markets that exist for trading in such instruments.
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An essential element of forfaiting is that the forfaiter buys the bills or notes from the seller
without recourse to the seller. This means that the forfaiter and not the seller bears the loss if
the buyer and the guaranteeing bank default or if, for any reason, funds cannot be
transferred out of the buyers or guaranteeing banks country. Moreover, the seller will have
obtained a commitment from a forfaiter before concluding its deal with the buyer.
Accordingly, the seller obtains a similar type of bank undertaking to that obtainable under a
confirmed irrevocable documentary credit, but in a situation in which longer-term credit is
being granted to the buyer.
2.4.3
The documentary credit as a method of payment, and the
autonomy of documentary credits (the independence principle)
The principal four methods of payment outlined in Section 2.4.1 above may be summarised
briefly as follows.
Advance payment
Open account
Documentary collection
In all of the above cases, either the buyer or the seller has to depend upon the good faith
and performance of the other for the smooth exchange of goods for payment. In contrast, the
documentary credit provides the buyer and seller with independent assurance in the
exchange of goods for payment. The seller has the irrevocable undertaking of the issuing
bank (and the separate irrevocable undertaking of the confirming bank, in the case of a
confirmed documentary credit) that it will receive payment, provided the following conditions
are satisfied:
The issuing bank or confirming bank undertaking is addressed directly to the seller
(beneficiary) and is a legally binding undertaking. The issuing bank or confirming bank
effects payment without recourse to the seller (beneficiary), which means that the payment is
final and there can be no claim upon the seller (beneficiary) for refund or repayment. The
buyer, as applicant of the documentary credit, has the undertaking of the issuing bank that
no payment will be made under the documentary credit unless the beneficiary has:
The applicants mandate to the issuing bank is on the above basis. In view of the comfort
provided to both the beneficiary and the applicant by the independent undertaking of a bank,
documentary credits are often a preferred method of payment in international trade.
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The autonomy of the documentary credit has been upheld in the courts of many countries.
As a general rule, courts in most countries are reluctant to interfere with the concept of the
autonomy of documentary credits and any party seeking to obtain an injunction preventing a
bank from honouring its obligations under a documentary credit would have an onerous task
in convincing the court of many matters even including that there has been fraud and that
the granting of an injunction is the correct course to follow in the circumstances. It will be
seen that the autonomous nature of documentary credits is:
The autonomy of documentary credits is evidenced in the following articles of UCP 600, the
extracts and texts of which are shown below.
A credit by its nature is a separate transaction from the sale or other contract on which it
may be based. Banks are in no way concerned with or bound by such contract, even if
any reference whatsoever to it is included in the credit. Consequently, the undertaking of
a bank to honour, to negotiate or to fulfil any other obligation under the credit is not
subject to claims or defences by the applicant resulting from its relationships with the
issuing bank or the beneficiary. A beneficiary can in no case avail itself of the
contractual relationships existing between banks or between the applicant and the
issuing bank.
An issuing bank should discourage any attempt by the applicant to include, as an integral
part of the credit, copies of the underlying contract, proforma invoice and the like. Attention is
drawn to sub-article 4(a) above, which provides indisputable evidence that sales and other
contracts have nothing to do with the credit transaction, which is separate. Sub-article 4(a)
also protects the independence of the issuing banks undertaking further by indicating that
such undertaking is not, in any way, affected by the applicants relationship with either the
issuing bank or the beneficiary. Sub-article 4(b) enforces the position that it should be the
contents of the documentary credit to which the beneficiary is required to adhere and that
any conditions in the sales or other contract that are pertinent to the actions of the
beneficiary must be incorporated into the documentary credit and must not form part of any
integral attachment.
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Provided that the stipulated documents are presented to the nominated bank or to the
issuing bank and that they constitute a complying presentation, the issuing bank must
honour if the credit is available by:
i. sight payment, deferred payment or acceptance with the issuing bank;
ii. sight payment with a nominated bank and that nominated bank does not pay;
iii. deferred payment with a nominated bank and that nominated bank does not incur
its deferred payment undertaking or, having incurred its deferred payment
undertaking, does not pay at maturity;
iv. acceptance with a nominated bank and that nominated bank does not accept a draft
drawn on it or, having accepted a draft drawn on it, does not pay at maturity;
v. negotiation with a nominated bank and that nominated bank does not negotiate.
b.
An issuing bank is irrevocably bound to honour as of the time it issues the credit.
c.
A confirming bank is irrevocably bound to honour or negotiate as of the time it adds its
confirmation to the credit.
c.
A confirming bank undertakes to reimburse another nominated bank that has honoured
or negotiated a complying presentation and forwarded the documents to the confirming
bank. Reimbursement for the amount of a complying presentation under a credit
available by acceptance or deferred payment is due at maturity, whether or not another
nominated bank prepaid or purchased before maturity. A confirming banks undertaking
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If a bank is authorised or requested by the issuing bank to confirm a credit but is not
prepared to do so, it must inform the issuing bank without delay and may advise the
credit without confirmation.
Note especially the reiteration of the liabilities of the issuing bank and the confirming bank:
to honour, provided that the stipulated documents are presented and that the terms and
conditions of the documentary credit have been complied with (sub-articles 7(a)(iv),
8(a)(i)(ae); and for a confirming bank, to negotiate without recourse (sub-article
8(a)(ii)).
2.5 Questions
1. What are the essential issues upon which the buyer and seller should agree in a sales
agreement?
2. Why is it important that both buyers and sellers understand the three-letter Incoterm
abbreviations used in their sale agreement?
3. If they do not understand them, where and how would you direct them to find out their
meaning?
4. Are there any Incoterms that you do not fully understand?
5. Who is not involved in a sales agreement?
6. Can you recall the four methods of payment? Can you recall the basic features of each
method?
7. Can you recall the parties to a bill of exchange?
8. What is an aval?
9. What is forfaiting?
10. Can you recall why documentary credits are a preferred method of payment in
comparison with advance payment, open account or documentary collection?
11. Can you quote the relevant UCP articles to beneficiaries and applicants that will show
that you, as a documentary credit specialist, are not concerned with the sales
contract/goods/services or performance?
12. What are possibly the only grounds upon which courts should uphold an application for
an injunction?
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