If you're shipping freight—especially internationally—you may have run across something called "Incoterms™." But what are Incoterms, and how do they apply to you as a shipper? Here's what you need to know.
Understanding Freight Incoterms
International commercial terms for freight—more commonly known as Incoterms—are simply the standard contract terms used to define the responsibilities and liabilities for shipments between sellers and buyers. In other words, they lay out who is responsible for the shipment at each stage of its journey as well as the tasks, costs and risks involved. They clearly define for both parties provisions for transportations costs, insurance, liabilities, delivery times and other critical factors in international shipping.
Incoterms are published by the International Chamber of Commerce and accepted by most countries in every region of the world. They are widely used in import/export transactions. Used correctly, they can smooth the way for international commercial shipments and ensure that everyone clearly understands what is happening and who is responsible at every transaction point. These terms cover:
- Individual tasks involved in shipping, the associated costs, and who is responsible for each
- Which parties hold contract at each stage of the process
- Who holds responsibility of risk at each stage of the process
- Insurance duties (e.g., who is responsible for insurance at each stage and what type of insurance must be provided)
- Point of delivery (where good change hands from buyer to seller)
- Who is responsible for customs, taxes and other import/export formalities
Commonly Used Incoterms
The ICC last updated the incoterms in 2010, and these terms are still used today to govern international freight shipments. There are 11 main terms, which fall into two main groups.
Group one applies to ANY mode of transport. These include:
- ExWorks (EXW): The seller packages the goods and makes them available for pickup at a specified place (usually the seller's place of business). The buyer is responsible for loading the goods onto a vehicle and for all transportation logistics, costs and liabilities after pickup. This has maximum risk for the buyer and minimum risk for the seller.
- Free Carrier (FCA): Seller arranges carriage to a designated place (e.g., terminal or transport hub, warehouse, etc.), where responsibility transfers to the carrier. The seller is responsible for export clearance and the buyer is responsible for risks and costs after the transfer takes place. This is a flexible term often used when the buyer arranges for the main carriage method.
- Carriage Paid To (CPT): The seller is responsible for getting the goods to a designated place, but is not obligated to insure the shipment. Risk transfers to the buyer when the shipment changes hands at the designated place.
- Carriage and Insurance Paid To (CIP): The seller is responsible for getting the goods to a designated place, and also for insuring the shipment during carriage. Risk transfers to the buyer when the shipment changes hands at the designated place.
- Delivered at Terminal (DAT): The seller not only has to get the goods to the designated place, but also unload them. Risk transfers once the goods have been unloaded from the seller's conveyance. The buyer is responsible for local taxes, import duties and import clearance.
- Delivered at Place (DAP): The seller is responsible for getting the goods to a designated place, but is not responsible for unloading. Risk transfers as soon as the goods arrive at the place, before they have been unloaded. The buyer is responsible for local taxes, import duties and import clearance.
- Delivered Duty Paid (DDP): The seller not only has to get the goods to the designated place, but is also responsible for ensuring that the shipment is cleared for import and all applicable taxes and duties are paid. The buyer is responsible for unloading and assumes risk as soon as the goods are made available for unloading at the designated place.
Group two rules apply only to goods transported by sea or inland waterway. These include:
- Free Alongside Ship (FAS): The seller arranges to get the goods cleared for export and delivered alongside a cargo ship at a designated port. The buyer is responsible for loading the goods onto the ship and assumes all future costs and responsibilities at this point.
- Free On Board (FOB): The seller not only gets the good to the port but also loads them onto the ship. They also arrange for export clearance. The buyer is responsible for all risks and costs after the goods are loaded.
- Cost and Freight (CFR): The seller not only ensures that goods are cleared for export, gets them to the ship and loads them, but also pays the freight cost for the shipment to the buyer's designated port. However, the seller is not responsible for insuring the shipment during its sea voyage; the buyer assumes all risk after loading.
- Costs Insurance and Freight: The seller arranges and pays for everything: getting the goods to the ship, loading them, clearing them for export, and paying for transport and insurance. The buyer takes responsibility once the shipment arrives at their designated port.
In addition to the main Incoterms, there are a number of secondary rules that buyers and sellers should understand before shipping internationally. You can find more information about the Incoterms at Export.gov.
It pays to understand these terms before negotiating your freight contract for importing or exporting goods. Some terms are more beneficial for the seller, and some are more beneficial for the buyer. Both parties need to clearly understand what is happening and who is responsible at every stage of the shipment's journey from the seller's warehouse or factory to the buyer's final destination. Failing to understand the terms will lead to miscommunication that may result in lost shipments or financial losses from uninsured (or underinsured) goods.
It's also important to understand what Incoterms do NOT cover. For example, they do not specify how much insurance must be purchased for a shipment beyond a minimum amount. They also do not specify how goods must be packaged to protect them during shipment—for example, the types of shipping cartons to be used, void fill materials, or methods of bundling or palletizing. These and other details not covered by the Incoterms must be negotiated separately in the contract.
Understanding the Incoterms is essential for anyone engaged in importing or exporting goods. These are legal terms, and the nuances can be complex. Companies who do not have legal expertise on staff may want to consult with a lawyer when negotiating their first contracts. But once you understand how they work, the Incoterms can ensure smooth sailing for your goods, wherever they are headed.
This blog is provided for informational purposes only and does not constitute legal advice.