What Are Trade Terms And Incoterms?

Internatinal trade is the lifeblood of the global economy. Having the whole world as a potential market, the export and import trade not only allows you to grow your business, but also to diversify from the domestic market, should an economic crisis occur.

So it must be great to have found a buyer, a supplier, or a commercial party abroad. However, have you thought about what is going be the contract between you and your new counterparty?

For example, who is going to be in charge of carriage, of covering the insurance, what is going to happen to the goods if they are stolen or damaged during the transportation?

These are some of the issues that trade terms and Incoterms help us to solve.

What are trade terms

First of all, trade terms are standard contracts for the international sale of goods: they are derived from mercantile customs, because, in the end, the import and export of goods between countries has been going on for centuries, right?

Imagine trade between the UK and France, or Germany and Belgium, the U.S. and Japan, just to name a few; at some point, countries incorporated into their domestic laws the standard contracts that merchants used for trade, the so-called trade terms. Therefore, we must distinguish between the standard trade terms according to domestic laws and Incoterms.

Why is this distinction important? To give you a simple answer, it is the very reason why Incoterms were created in the first place.

The issue with trade terms is that, while they tend to be similar among countries because they have a common source, i.e. mercantile customs, they still incorporate significant differences. For example, if a country used to have more exporters than importers, the same trade term under that domestic law might have been used to protect a little bit more the seller (i.e. the exporter), whereas in an import oriented country the same provision would have been more protective of the buyer (i.e. the importer).

As a result, it is very important to choose a body of law that protects your party in the best way. For explanatory purposes only we chose English law because it is widely used worldwide, because it is centuries old, therefore very complete, and because it is in English, so it is accessible to anyone.

Trade terms vs Incoterms

What Are Incoterms

After this discussion about trade terms, we can state what Incoterms are: Incoterms are rules of interpretation.

Because trade terms used to be interpreted every time in a different way (depending on whether it was more convenient), and parties had to go to courts every time, the International Chamber of Commerce in 1936 published its first set of Incoterms. The term stands for international rules for the interpretation of trade terms, shortened in international commercial terms, or, Incoterms.

At the risk of sounding redundant, I will say it again: there are trade terms according to a certain body of law, and then there are Incoterms that are international rules for the interpretation of these trade terms.

What is paramount is that, to be effective, Incoterms must be incorporated in the contract, otherwise the interpretation will occur under the domestic law of the state whose law you chose to use.

At the end of the day what trade terms and Incoterms do is defining the obligations of the parties and the transfer of risk: they state who must do what, and when does the transfer of risk happen. Tip: the transfer of risk as per Incoterms may be completely different from physical delivery.

The 11 official Incoterms 2020

Now, Incoterms are divided into four categories and they start from a situation whereby the obligations and the risk on the seller’s side are the least to one where obligations and risk for the seller are the most.

Incoterms 2020 list

The first and only Incoterm of the E group is the EXW Ex Works, then we go to the F terms: FCA Free Carrier, FOB Free On Board, FAS Free Alongside Ship. The C group, the trickiest one (we wrote an ad-hoc article about this group of Incoterms, also called Group C Shipping Contracts, to deal with their unique characteristics): the four Incoterms in this group are CIF Cost, Insurance And Freight, CFR Cost & Freight (actually the old term was C&F, it was changed to CFR but in many contracts it is still used C&F Cost & Freight), CPT Carriage Paid To, and CIP Carriage And Insurance Paid To.

Finally, the D terms; that D stands for delivered (meant as physical delivery at destination; more on that in our articles about the D-group Incoterms), that is a common feature throught all this group: DAP Delivered At Place, DPU Delivered At Place Unloaded, DDP Delivered Duty Paid; from the name already we can imagine that this latter plays quite some burden on the seller.

As a final word, the most important thing in Incoterms is that you understand what you are entering into, i.e. what you are signing up for. There could be situations where you are not aware of the costs that you have to incur because, for example, under a CIF (Cost, Insurance, Freight), the seller has to arrange for transportation and insurance whereas for an Ex Works the buyer has to do everything: he has to come and collect the goods, so it is very important that you understand what you’re signing up for, what your costs are going to be, what are the services that you can provide and if you are able to negotiate, so if the incorporation of the service or the provision of the service into the contract might place you in a better position to negotiate with your counterparty or if you’re able to incorporate the service under your initial quote and ask for more.

Globartis Research

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