International Trade (Intl Trade) 101: Incoterms 2020 - Common Mistakes in Using, Incoterms Mixing with Contract Terms Assuming Insurance Coverage in CIF

What This Is

Using Incoterms correctly is crucial in international trade, as it determines the responsibilities and risks of buyers and sellers. A common mistake is mixing Incoterms with contract terms, leading to confusion and disputes. For example, a shipment from China to the US under CIF (Cost, Insurance, and Freight) terms might be misinterpreted as CIP (Carriage and Insurance Paid To), resulting in the buyer assuming additional costs and risks.

Key Terms & Rules

• Incoterms 2020: International commercial terms for the sale of goods – 11 rules governing the delivery and transfer of risks.
• CIF (Cost, Insurance, and Freight): Seller bears costs and risks until goods are on board the vessel – buyer assumes risks and costs from there.
• CIP (Carriage and Insurance Paid To): Seller bears costs and risks until goods are delivered to the buyer's premises – buyer assumes risks and costs from there.
• FOB (Free on Board): Buyer bears costs and risks from the seller's premises – most buyer-friendly Incoterm.
• EXW (Ex Works): Seller bears no costs or risks – buyer assumes all costs and risks from the seller's premises.
• UCP 600 (Uniform Customs and Practice for Documentary Credits): Governed LC transactions globally – sets rules for documentary credits.
• LC (Letter of Credit): A payment guarantee issued by a bank – ensures payment to the seller upon presentation of compliant documents.
• DPU (Destination Port Unloaded): Seller bears costs and risks until goods are unloaded at the destination port – buyer assumes risks and costs from there.
• DAT (Delivered at Terminal): Seller bears costs and risks until goods are delivered to the terminal – buyer assumes risks and costs from there.
• DAP (Delivered at Place): Seller bears costs and risks until goods are delivered to the buyer's premises – buyer assumes risks and costs from there.

Step-by-Step Process

1. Determine the Incoterm: Identify the Incoterm used in the sales contract to determine the responsibilities and risks of the buyer and seller.
2. Understand the Contract Terms: Review the sales contract to ensure it aligns with the Incoterm used and does not introduce conflicting terms.
3. Identify the Risks and Costs: Determine who bears the risks and costs associated with the shipment, including transportation, insurance, and customs clearance.
4. Verify the LC Terms: Review the LC terms to ensure they align with the Incoterm used and do not introduce additional risks or costs.
5. Monitor the Shipment: Track the shipment to ensure it is delivered in accordance with the Incoterm and contract terms.

Common Mistakes

• Mistake: Assuming CIF includes insurance coverage for the buyer's interest.
• Correction: CIF only includes insurance coverage for the seller's interest until the goods are on board the vessel. The buyer must arrange their own insurance coverage for their interest.
• Mistake: Confusing CIF with CIP.
• Correction: CIF requires the seller to arrange and pay for the insurance, while CIP requires the seller to arrange and pay for the carriage and insurance.
• Mistake: Misusing "free on board" with air freight.
• Correction: "Free on board" is typically used with sea or inland waterway transport, not air freight. Use "CPT" (Carriage Paid To) or "CIP" for air freight.

Exam / Certification Tips

• Tricky Distinctions: Be able to distinguish between FOB and FCA, confirmed and unconfirmed LC, and DPU and DAT.
• Memory Aids: Use the acronym "FOB" to remember that the buyer bears costs and risks from the seller's premises.
• Common Question Patterns: Expect questions on Incoterm allocation, LC terms, and contract terms.

Quick Practice Scenario

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

Answer: The buyer (US importer) pays for the main carriage.

Explanation: FOB (Free on Board) means the buyer bears costs and risks from the seller's premises, which includes the main carriage.

Last-Minute Cram Sheet

• Incoterms 2020 governs international commercial terms.
• CIF includes insurance coverage for the seller's interest only.
• FOB means the buyer bears costs and risks from the seller's premises.
• CIP requires the seller to arrange and pay for the carriage and insurance.
• LC (Letter of Credit) is a payment guarantee issued by a bank.
• UCP 600 governs LC transactions globally.
• DPU (Destination Port Unloaded) means the seller bears costs and risks until goods are unloaded at the destination port.
• DAT (Delivered at Terminal) means the seller bears costs and risks until goods are delivered to the terminal.
• DAP (Delivered at Place) means the seller bears costs and risks until goods are delivered to the buyer's premises.
• Under FOB, risk transfers when goods are on board the vessel – not at the port gate or on the dock.
• CIF does not include insurance coverage for the buyer's interest.
• CIP requires the seller to arrange and pay for the carriage and insurance.