International Trade (Intl Trade) 101: Incoterms 2020 - Choosing the Right Incoterm Buyer vs. Seller, Friendly Practical Considerations

What This Is

Choosing the right Incoterm is crucial in international trade as it determines the responsibilities and risks of buyers and sellers. A misselected Incoterm can lead to costly disputes, delays, or even losses. For example, consider a shipment of electronics from China to the US. If the seller selects EXW (Ex Works) and the buyer selects FOB (Free on Board), they may have different expectations about who bears the costs and risks of transportation, leading to a payment dispute.

Key Terms & Rules

• EXW (Ex Works): Buyer bears all costs and risks from seller’s premises – most seller-friendly Incoterm.
• FOB (Free on Board): Seller bears costs and risks until goods are on board the vessel – most commonly used Incoterm.
• CIF (Cost, Insurance, and Freight): Seller bears costs and risks until goods are delivered to the buyer's destination – includes insurance.
• CIP (Carriage and Insurance Paid to): Seller bears costs and risks until goods are delivered to the buyer's destination – includes insurance, but not the main carriage.
• DAT (Delivered at Terminal): Seller bears costs and risks until goods are delivered to the terminal – commonly used for inland waterways.
• DPU (Delivered at Place Unloaded): Seller bears costs and risks until goods are delivered and unloaded at the buyer's destination – commonly used for inland waterways.
• UCP 600: Uniform Customs and Practice for Documentary Credits – governs LC transactions globally.
• Incoterms: International commercial terms – standardized rules for the sale of goods between countries.
• LC (Letter of Credit): A payment guarantee issued by a bank – ensures payment to the seller upon presentation of compliant documents.
• Duty: A tax on imported goods – calculated based on the Harmonized System (HS) code and the country of import.

Step-by-Step Process

1. Determine the Incoterm: Based on the sale agreement, determine which Incoterm is most suitable for the transaction.
2. Identify the Parties' Responsibilities: Understand who bears the costs and risks under the selected Incoterm.
3. Classify Goods: Classify the goods using the Harmonized System (HS) code to determine duty rates.
4. Obtain LC: If applicable, obtain a Letter of Credit (LC) to ensure payment to the seller.
5. Prepare Documents: Prepare the necessary documents, including the commercial invoice, bill of lading, and certificate of origin.
6. Verify Compliance: Verify that the documents comply with the LC terms to ensure payment.

Common Mistakes

• Mistake: Confusing CIF and CIP.
• Correction: CIF includes insurance, while CIP does not. Example: A seller selects CIF, but the buyer expects insurance to be included, leading to a payment dispute.
• Mistake: Assuming "open account" is risk-free.
• Correction: Open account transactions do not involve a Letter of Credit, leaving the buyer exposed to payment risks. Example: A buyer purchases goods on open account, but the seller fails to deliver, leaving the buyer with no recourse.
• Mistake: Misusing "free on board" with air freight.
• Correction: FOB is typically used for sea or inland waterway transportation, not air freight. Example: A seller selects FOB for an air freight shipment, leading to confusion about who bears the costs and risks.

Exam / Certification Tips

• FOB vs FCA: FOB transfers risk when goods are on board the vessel, while FCA transfers risk when the goods are handed over to the carrier.
• Confirmed vs Unconfirmed LC: A confirmed LC is guaranteed by the buyer's bank, while an unconfirmed LC is not.
• DPU successor to DAT: DPU is the successor to DAT, with the same meaning but with a more specific definition.

Quick Practice Scenario

A Chinese exporter sells goods under FOB Shanghai. Who pays for the main carriage?

Answer: The buyer pays for the main carriage. Explanation: Under FOB, the seller bears costs and risks until the goods are on board the vessel, but the buyer bears costs and risks for the main carriage.

Last-Minute Cram Sheet

• Under FOB, risk transfers when goods are on board the vessel – not at the port gate or on the dock.
• EXW is the most seller-friendly Incoterm.
• CIF includes insurance, while CIP does not.
• Open account transactions do not involve a Letter of Credit.
• FOB is typically used for sea or inland waterway transportation, not air freight.
• DPU is the successor to DAT.
• A confirmed LC is guaranteed by the buyer's bank.
• The Harmonized System (HS) code determines duty rates.
• A commercial invoice is required for LC transactions.
• The bill of lading is a document of title.