If you buy and sell goods internationally for your small business, then you probably use Incoterms. They are a voluntary set of contract terms that can be used by organizations for the sale of goods both internationally and domestically.
Everyone involved, such as freight forwarders and the person you are buying from or selling to, will expect you to use them.
The Incoterms rules are changing in January 2020—so how does this affect small business owners?
What are Incoterms?
Incoterms define the delivery point for the goods and the resulting allocation of responsibilities, costs and risks between buyer and seller. Incoterms are split into two groups: terms that can be applied to all methods of transportation and terms that must only be used for maritime transport (see pictures below for an overview of the various Incoterms).
Why do small businesses use Incoterms?
Incoterms are used because they establish a common international reference point, consistently understood by whoever and wherever you are trading. If you use an Incoterm, it will be understood by the other party what you mean and will make sure that it is clear where the costs and risks fall between seller and buyer. That means fewer disputes and also better protection of your margin. That will also help with any trade finance arrangement you enter into.
Why are the Incoterms® rules changing?
The International Chamber of Commerce (ICC) reviews and updates the Incoterms every ten years – the last edition was published in 2010. It responds to concerns raised by users of Incoterms and to changes in the market to ensure the terms are relevant and suitable to both domestic and global trade
The changes made in this latest edition - the ICC's Incoterms® 2020 - address, amongst other things, increased security requirements, improved clarity on cost allocation as well as tackling insurance concerns. Incoterms® 2020 come into force in January 2020; however, you can start using them in your trade agreements now.
What are the main changes in Incoterms® 2020 that are relevant to you?
FOB (free on board) should not normally be used for container shipments. This is because a seller usually loses control of the container once the container arrives at the port of export before the container is loaded. However, FOB means the seller takes all the risk and cost of the export, port terminal handling charges and loading costs/risks. Sellers should then use FCA (Free Carrier).
However, many sellers still use FOB because the letter of credit from the bank often requires an onboard bill of lading for the seller to get paid. As under FOB the seller is responsible for loading, they have a higher chance of getting an onboard bill of lading.
Therefore, to try and help people to use FCA, FCA has changed to allow the buyer and seller to agree that the seller will get an onboard bill of lading.
2. Insurance under CIF (carriage insurance and freight) and CIP (carriage and insurance paid to)
The Incoterm CIP means that the seller is only responsible for delivery of the goods to the carrier but pays for the carriage and insurance of the goods to the named destination. CIF is the same, except that it can only be used for maritime transport (delivery is onto a ship and the destination needs to be a port).
In Incoterms® 2020, CIF keeps the same insurance requirements as in Incoterms 2010, but CIP has increased the level of insurance required to be obtained by the seller. This is due to the fact that CIF is more often used with bulk commodity trades, and CIP is more often used for manufactured goods, and manufactured goods tend to require a higher level of insurance.
Although CIF and CIP require the seller to obtain insurance, it is recommended that parties consider whether additional insurance coverage is required to reflect the potential risk of damage to the goods during transport.
If you use CIF or CIP, you need to review to see if that is still the correct approach.
3. DAT (delivered at terminal) has changed to DPU (delivered at place unloaded)
In Incoterms® 2010, DAT means the goods are delivered once unloaded at the named terminal. As DAT limits the place of delivery to a terminal, in Incoterms® 2020, the reference to terminal has been removed to make it more general. DPU means delivered at place unloaded (which can now be used for all modes of transportation). There is no other change.
If you use DAT Incoterms 2010, then change over to DPU Incoterms 2020.
4. Security Requirements
In recent years, transport security requirements have become more prevalent in international trade, and Incoterms® 2020 reflects such a change by detailing security requirements for each Incoterm. For example, CPT (carriage paid to) includes a specific requirement that the seller must comply with any security-related requirements for transport to the destination. These security requirements bring cost and risk delay if not fulfilled by the parties.
Buyer (and Seller) Beware…
Take the time to thoroughly understand both the preferred mode of transport for the delivery of your goods and the destination of delivery. Using an Incoterm that is incompatible (e.g. naming an airport as a destination but using an Incoterm that only caters for transport by water) may result in increased costs and uncertainty as to the allocation of risk between the parties.
Incoterms do not constitute the entire trade agreement between the parties and do not cover contractual terms such as pricing and payment, ownership of intellectual property and which law and/or jurisdiction governs the agreement. You will therefore need to ensure you include all the wider commercial contractual terms in your trade agreements.
What are the eleven Incoterms® 2020 rules?
Below are the eleven Incoterms® 2020 rules and an explanation of their proper uses.
Learn more about Incoterms® 2020 and how they affect your small business.