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Incoterms® 2010: Should banks change their L/C application forms?


by Roberto Bergami

 

Incoterms® 2010 provide a timely reminder about the use of delivery terms that may be less than appropriate for the maritime transport of goods. This article focuses on international transactions and not domestic sales, even though it is recognized that Incoterms® 2010 may apply to domestic contracts.

It is generally accepted that the majority of maritime consignments in international trade are transported inside shipping containers. The practices surrounding the movement of cargo in containers do not fit easily with the term FOB, and banking practices in letters of credit do not appear to have kept pace with modern transport practices and the correct use of Incoterms. It is hoped, however, that the introduction of Incoterms® 2010, with a revised layout, may be a catalyst for a change in future banking practices.

It is generally accepted that the majority of maritime consignments in international trade are transported inside shipping containers. The practices surrounding the movement of cargo in containers do not fit easily with the term FOB, and banking practices in letters of credit do not appear to have kept pace with modern transport practices and the correct use of Incoterms. It is hoped, however, that the introduction of Incoterms® 2010, with a revised layout, may be a catalyst for a change in future banking practices.

FOB

The term Free On Board (FOB) was coined at least two centuries before the first edition of Incoterms 1936. When containers were introduced for maritime trade, beginning in the 1960s, somehow FOB was subsumed into this new method of handling cargo, with little consideration given to the changed risk and cost profile of container consignments and FOB. The previous notion of the ship's rail as the imaginary demarcation line that transfers risk from seller to buyer did not sit easily with container traffic as, in reality, the seller lost physical control of the consignment prior to the goods crossing the ship's rail. This was recognized in Incoterms 1990, and again in Incoterms 2000. As clearly stated in the guidance notes to FOB, Incoterms® 2010 do not recommend the use of this term for container traffic.

The FOB Incoterms® 2010 also introduces a change in the risk transfer point. The notion of the ship's rail has been replaced by the requirement to have the goods loaded on board. If we consider the movement of goods from the seller's premises to the export wharf, it is not difficult to imagine that a number of parties may be handling the goods along this journey. Up to ten lift-on and lift-off movements could take place between the seller's premises and the loading of the goods on board the nominated vessel.

The goods may leave the exporter's premises destined for a container packing depot, and subsequently the container may be taken to the freight forwarder's premises. From there, the container may go to the export wharf, where it is lifted from the delivery vehicle and placed on a stack in the port marshalling area. From here, it may be transferred within the wharf to several different spots, for operational reasons (such as port congestion) before it is finally loaded on board the vessel. Under these conditions, the seller using the term FOB for container traffic has a higher risk exposure than necessary.

The term FCA in these circumstances would be a more appropriate term to use. Under FCA, the delivery and risk transfer points could then be structured to occur simultaneously, more accurately reflecting the point at which the seller loses physical control over the consignment.

It should be remembered that FOB does not place an obligation on the seller to enter into a contract of carriage, pursuant to Incoterms® 2010 Article A3(a), although it does require the goods to be placed on board. The Incoterms® 2010 state that the seller may, by choice, decide to enter into a contract of carriage on "usual terms at the buyer's risk and expense". This is an important consideration, because the party that contracts for carriage is issued with the transport document, a point that will be discussed later in the article.

An L/C is meant to be based on the underlying contract of sale, but is an independent instrument of trade finance to the contract of sale, pursuant to article 4 of UCP 600, that embodies the principle of independence, also known as the autonomy principle. Article 5 of UCP 600 states that "banks deal with documents and not with the goods, services or performance to which the documents relate". In issuing the L/C, the bank holds itself liable to settle the beneficiary's claim for payment, provided, of course, that a compliant presentation is made. A compliant presentation, in essence, is one in which all the documents and their data contentbmatch the demands of the L/C.

Questions

Two questions arise in the discussion in this article: 1) Why does a bank continue to condone the use of FOB (and by implication CFR and CIF) for maritime container traffic?; and 2) Why does a bank insist on the presentation of a transport document when clearly there is no obligation for the seller (beneficiary) to provide one?

In attempting to answer the first question, one proposition is that bankers have not kept up to date with the changes in transport practices and have thereby contributed to the continuing inappropriate use of terms such as FOB, CFR and CIF where clearly more appropriate terms should be used, that is, FCA, CPT and CIP. The evidence proferred for the claim that banks are not current with changing transport practices in their L/C clauses is from the L/C application forms currently in use. As an example, in Australia, at the time of writing this article, only one of the four major local banks had changed its L/C application form to incorporate the multimodal terms FCA, CPT and CIP. The other three are still showing FOB, CFR and CIF with an extra box titled "Other".

In attempting to answer the second question, the issue is rather more complex. The bank has an inherent requirement to protect its risk exposure. This claim would have little ground when the financial exposure of the bank is essentially zero, because the applicant (buyer) is required to provide 100% security against the L/C value, as is the case for importers in Australia. Consequently, the argument of financial risk exposure on issuing an L/C can only be accepted in cases where the applicant provides less than 100% security.

In these cases, the bank carries limited risk exposure, as represented by the shortfall between the amount of security provided by the applicant and the par value of the L/C. For example, if only 50% security was requested by the applicant, the issuing bank would have 50% exposure against the par value of the L/C, not the full value.

The banker would also claim that in demanding the presentation of a transport document, he is additionally protecting the risk exposure of the applicant (buyer). The bank would claim that the presentation of a transport document is clear evidence that the goods have been shipped. Leaving the issue of fraud aside for the purposes of this discussion, the provision of a transport document does not guarantee that the correct goods were shipped in any event, particularly, as is often the case, where the consignment is handed to the maritime carrier packed in a sealed container "ready for carriage".

Proof of dispatch

The legal strength of the transport document is another issue linked to the "proof of dispatch" argument. The classical bill of lading (B /L), issued in sets, consigned to order, requiring the presentation of one original to the carrier at destination to obtain the release of goods is being increasingly replaced by the non-negotiable sea waybill (NNSW) in its various forms. The attraction of the NNSW is that it can be easily produced in electronic format and, as there is no negotiability attached to it, an original document is not required to obtain the goods at destination.

Additionally, the traditional role of the B/L is changing. Recent clauses on this document indicate that, unless required by local laws, the carrier reserves the right to discharge the consignment at destination without the surrender of an original bill. The banker is not in a position to examine terms and conditions of carriage on transport documents according to UCP sub-article 20 (a )(v), in line with ICC Opinion TA.675 (rev), and it is questionable whether statements on the B/L about how goods are released render documents discrepant.

Conclusion

In conclusion, there is no reason for bankers to continue the use of FOB terms in an L/C where it is known that the cargo will be transported by maritime trade in containers. Instead, the term FCA should prevail, as discussed earlier. The provision of a transport document, when dealing with FCA contracts, is questionable, as Incoterms® 2010 do not place any obligation on the seller to enter into a contract of carriage. It is argued here that "forcing" a beneficiary to provide a transport document under either FCA or FOB may blur the risk transfer point and the cost structure of the transaction. The seller may incur unexpected costs that he may need to attempt to recover later. This may strain cash flows, making it more expensive to service the contract because carriers demand immediate payment, and that may not be recoverable until sometime later.

The "evidence of dispatch" requirement could be obtained through the provision of the FIATA Forwarders Certificate of Receipt (FCR), or similar document. The FCR is not a transport document, but it does evidence that the freight forwarder has received the consignment in order to arrange for its carriage. Given that the freight forwarder is nominated by the buyer in FCA Incoterms® 2010 contracts, the banker should not be concerned about its risk exposure or that of the applicant.

Some thought should be given by banks to change their L/C application forms to reflect the more appropriate Incoterms® 2010 multimodal terms. The ICC Banking Commission should consider issuing a position paper on the issues raised in this article, to bridge the gap between the correct usage of Incoterms and banking practices relating to L/C transport clauses.

INCOTERMS 2010: Standard Trade Definitions Used In International Freight Transactions

 

For those involved in international freight transactions, the following explanations of international standard trade definitions are useful in outlining risks and responsibilities between buyers and sellers.

This page highlights the Incoterms 2010 changes from Incoterms 2000.

Incoterms 2010
The International Chamber of Commerce has released the table of contents to the Incoterms 2010. Incoterms 2010 consists of only 11 Incoterms, a reduction from the 13 Incoterms 2000.

 The Incoterms 2010 are organized into two categories:

Incoterms for any Mode or Modes of Transport:

  • EXW - Ex Works
  • FCA - Free Carrier
  • CPT - Carriage Paid To
  • CIP - Carriage and Insurance Paid
  • DAT - Delivered At Terminal (new)
  • DAP - Delivered At Place (new)
  • DDP - Delivered Duty Paid

Incoterms for Sea and Inland Waterway Transport Only:

  • FAS - Free Alongside Ship
  • FOB - Free On Board
  • CFR - Cost and Freight
  • CIF - Cost, Insurance and Freight

The reduction in Incoterms from 13 to 11 different terms was accomplished by substituting two new Incoterms, DAT (Delivered at Terminal) and DAP (Delivered at Place), for DAF (Delivered at Frontier), DES (Delivered Ex-Ship), DEQ (Delivered Ex-Quay) and DDU (Delivered Duty Unpaid).

Incoterms 2010 also addresses duties to provide information regarding security-related clearances, such as Importer Security Filings and other chain-of-custody information.

Contrary to some predictions, Incoterm FAS remains in Incoterms 2010, since that Incoterm is important in bulk and break-bulk trade.

This interpretation is provided as a guide only.

 Incoterms 2010: Expanded Summary

Note: an Incoterm must be accompanied by a "named place" ex. "FOB Sydney", "EXW Tahiti"

 

EXW
(Ex Works)

The buyer bears all costs and risks involved in taking the goods from the seller's premises to the desired destination. The seller's obligation is to make the goods available at his premises (works, factory, warehouse). This term represents minimum obligation for the seller. This term can be used across all modes of transport.   

FCA
(Free Carrier)

The seller's obligation is to hand over the goods, cleared for export, into the charge of the carrier named by the buyer at the named place or point. If no precise point is indicated by the buyer, the seller may choose within the place or range stipulated where the carrier shall take the goods into his charge. When the seller's assistance is required in making the contract with the carrier the seller may act at the buyers risk and expense. This term can be used across all modes of transport.   

CPT
(Carriage Paid To)

The seller pays the freight for the carriage of goods to the named destination. The risk of loss or damage to the goods occurring after the delivery has been made to the carrier is transferred from the seller to the buyer. This term requires the seller to clear the goods for export and can be used across all modes of transport.   

CIP
(Carriage & insurance Paid to)

The seller has the same obligations as under CPT but has the responsibility of obtaining insurance against the buyer's risk of loss or damage of goods during the carriage. The seller is required to clear the goods for export however is only required to obtain insurance on minimum coverage. This term requires the seller to clear the goods for export and can be used across all modes of transport.   

DAT
(Delivered At Terminal)

New Term - May be used for all transport modes
Seller delivers when the goods, once unloaded from the arriving means of transport, are placed at the disposal of the buyer at a named terminal at the named port or place of destination. "Terminal" includes quay, warehouse, container yard or road, rail or air terminal. Both parties should agree the terminal and if possible a point within the terminal at which point the risks will transfer from the seller to the buyer of the goods. If it is intended that the seller is to bear all the costs and responsibilities from the terminal to another point, DAP or DDP may apply.

Responsibilities

  • Seller is responsible for the costs and risks to bring the goods to the point specified in the contract
  • Seller should ensure that their forwarding contract mirrors the contract of sale
  • Seller is responsible for the export clearance procedures
  • Importer is responsible to clear the goods for import, arrange import customs formalities, and pay import duty
  • If the parties intend the seller to bear the risks and costs of taking the goods from the terminal to another place then the DAP term may apply    

DAP
(Delivered At Place)

New Term - May be used for all transport modes
Seller delivers the goods when they are placed at the disposal of the buyer on the arriving means of transport ready for unloading at the named place of destination. Parties are advised to specify as clearly as possible the point within the agreed place of destination, because risks transfer at this point from seller to buyer. If the seller is responsible for clearing the goods, paying duties etc., consideration should be given to using the DDP term.

Responsibilities

  • Seller bears the responsibility and risks to deliver the goods to the named place
  • Seller is advised to obtain contracts of carriage that match the contract of sale
  • Seller is required to clear the goods for export
  • If the seller incurs unloading costs at place of destination, unless previously agreed they are not entitled to recover any such costs
  • Importer is responsible for effecting customs clearance, and paying any customs duties    

DDP
(Delivered Duty Paid)

The seller is responsible for delivering the goods to the named place in the country of importation, including all costs and risks in bringing the goods to import destination. This includes duties, taxes and customs formalities. This term may be used irrespective of the mode of transport.   

FAS
(Free Alongside Ship)

The seller has fulfilled his obligation when goods have been placed alongside the vessel at the port of shipment. The buyer is responsible for all costs and risks of loss or damage to the goods from that moment. The buyer is also required to clear the goods for export. This term should only be used for sea or inland waterway transport.   

FOB
(Free On Board)

Once the goods have passed over the ship's rail at the port of export the buyer is responsible for all costs and risks of loss or damage to the goods from that point. The seller is required to clear the goods for export. This term should only be used for sea or inland waterway transport.   

CFR
(Cost and FReight)

The seller must pay the costs and freight required in bringing the goods to the named port of destination. The risk of loss or damage is transferred from seller to buyer when the goods pass over the ship's rail in the port of shipment. The seller is required to clear the goods for export. This term should only be used for sea or inland waterway transport.   

CIF
(Cost, Insurance & Freight)

The seller has the same obligations as under CFR however he is also required to provide insurance against the buyer's risk of loss or damage to the goods during transit. The seller is required to clear the goods for export. This term should only be used for sea or inland waterway transport.   

 

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