The Hidden Risks Of Using FOB In The Wrong Way

FOB

There are two main reasons why FOB Free On Board Incoterms 2020 is so widely used:

  1. It is a maritime term (and 90% of global trade runs on the oceans).
  2. It provides certainty as per when the transfer of risk occurs.

Under FOB, delivery takes place when the goods are loaded on the vessel sent by the buyer for transportation. Accordingly, the risk of loss or damage to the goods shifts from the seller to the buyer at that particular point: after the goods are placed on the ship, anything that happens to them (damage, loss, theft) is on the buyer.

Suppose that a South African trader of agricultural products sells under FOB (port of Durban). The trader knows for sure that after the goods are loaded on the vessel sent by the buyer at the port of Durban, the risk shifts to the buyer: the trader is relieved from anything that happens to the goods after that moment.

This certainty applies in a similar way to FAS Free Alongside Ship, yet it is not that straightforward with the other F-rule, FCA Free Carrier.

In fact, under FCA the place of delivery could be anywhere at origin, and therefore it must be clearly specified in the contract.

It could be the seller’s premises, a warehouse, a port, an airport, etc.

In order to avoid misunderstandings (and unwanted bills or disputes if something goes wrong), most of the times the parties prefer FOB over FCA.

Yet, they may be wrong. There are mainly two situations where using FOB over FCA may cause additional risks for the parties:

  1. When they use FOB with any means of transport.
  2. When they use FOB for containerized cargo.

FOB Used With Any Means Of Transport

The main problem with using FOB with any means of transport is that the parties are essentially using an Incoterms rule designed only for waterway transport.

The ICC writes FOB as follows:

FOB Free On Board (named port of shipment).

Therefore, the place of delivery must be a port. Additionally, paragraph A2 requires that the seller places the goods on board the vessel sent by the buyer. Therefore, the means of transport must be a ship.

Suppose that a Czech maker of automotive parts sells under FOB to a German buyer. The German company will send a road-haulier to pick up the goods at a logistics hub in Prague.

Therefore, the contract states FOB (Prague).

Now, the seller may believe that, once the goods are loaded on the truck sent by the German buyer, it will be relieved from any risk and obligation, as delivery has already occurred.

Yet, that is not the case. In fact:

  • Where is the port? Is the buyer obliged to arrange and pay for transport if the place of delivery does not exist?
  • Where is the vessel? Has delivery really occurred if the seller has not loaded the goods on the right carrier?

In case of dispute, the parties may find out that, since the requirements of an FOB contract are not in place, that Incoterms rule does not apply. Consequently, they would be left with solving the dispute according to domestic laws and to the facts and circumstances of the case.

Hardly a situation where legal certainty is provided.

FOB Used For Containerized Cargo

As one of the original Incoterms published in 1936, FOB was introduced before the invention of the container. As a consequence, it was never meant for containerized cargo.

The issue here stems from a somehow nuanced yet important technicality: when the seller delivers, what is that is actually being delivered?

The answer is, of course, the goods.

That would be the case with the South African grower when it places the commodities on the vessel.

What about the Czech maker of autoparts? Suppose that it ships from the port of Hamburg, and that the goods are containerized.

The Czech company physically delivers the goods when it places them in the container yard of the port of Hamburg. When the container containing the goods is then loaded on the vessel, it is the container which is being loaded, not the goods!

As a consequence, the seller cannot comply with the terms of an FOB contract because it cannot physically deliver the goods on board the ship. It can only make them available in the container yard of the port.

I know, it is somehow subtle, but it makes sense. And the problem that occurs is similar to the ones we saw in the previous paragraph:

  • If the goods are not placed on board the vessel, does delivery really take place?
  • Who is responsible for loss of damage to the goods from the time these are placed in the container yard until they are loaded inside the container on the vessel?

Technically, the seller is still on the hook even if it might think that it has delivered the goods already.

The Solution: Use FCA Instead

FOB, with the place of delivery occurring when the goods are loaded on the vessel, provides a level of certainty that allures many buyers and sellers. However, it is not an intermodal Incoterms rule and is not meant for containerized cargo.

As we just saw, using FOB in those cases does not provide legal certainty and exposes the parties to unwanted risks.

A practical solution is to use FCA:

  • It can be used with any mode of transport.
  • It is meant for containerized cargo.

In fact, under FCA, the seller places the goods at the disposal of the carrier sent by the buyer at the named place of delivery.

If the Czech firm had used FCA, it would have delivered the goods just by making them available for collection (unloaded) at the container yard of the port of Hamburg.

Globartis Research Team