Incoterms – which stands for international commercial terms – are globally-accepted shorthand codes used to specify the details agreed between a buyer and seller in international and domestic trade contracts. They were developed by the International Chamber of Commerce (ICC) and launched in 1936 in an attempt to help all parties understand their duties and responsibilities during freight forwarding transactions. Incoterms are periodically updated to keep pace with the way trade is changing, with the most recent update happening in 2020.
In this guide, we explain how Incoterms work in international shipping, highlight the different types of code, explain how to select the correct one in different circumstances, and, crucially, explain to what extent these codes are legally binding.
What are Incoterms in shipping?
Designed to facilitate global trade, Incoterms are widely used in shipping to plan and negotiate the terms of a shipment between a buyer and a seller. They help to provide clarification and avoid misunderstandings on a wide range of logistical issues, such as how the goods will get from A to B, who is responsible for paying for individual legs of the journey, who will arrange insurance, and who bears liability for any potential loss or damage to the goods.
Incoterms are only one part of a shipping contract as they do not:
- Address all conditions of sale
- Specify the goods being sold
- List the contract price
- Set out how or when payment should be made
- Identify when ownership of the goods passes from the seller to the buyer
- List the documents the seller must give the buyer to aid with customs clearance
- Address liability if the goods are not delivered according to the contract of sale.
What are the different types of Incoterms?
There are 11 types of Incoterms in total. Of these, seven apply to all types of transport. These are:
- EXW - Ex works <insert place of delivery>
The seller is responsible for packaging the goods and making them available to the buyer. Responsibility for the risk of loss transfers to the buyer once they are made aware the goods are ready for collection. The buyer is responsible for collecting the goods and covering the cost of shipping, exporting, and importing. - FCA - Free carrier <insert named place of delivery>
This Incoterm places the majority of responsibility on the seller, who is required to deliver the goods to a specified carrier/location as stated by the buyer. The seller is also required to clear the goods for export and pay any applicable charges to do so. After this, responsibility for the goods transfers to the buyer. - CPT - Carriage paid to <insert place of destination>
It is the seller’s responsibility to transport the goods to a named destination (including paying customs, export, and shipping costs). However, the seller is not responsible for insuring the goods. - CIP - Carriage and insurance paid to <insert place of destination>
While this Incoterm is similar to CPT, it differs in that with CIP the seller takes responsibility for insuring the goods. - DAP - Delivered at place <insert named place of destination>
The seller is responsible for delivering the goods at the destination, but not for unloading them once they arrive there. Once the goods arrive at the agreed location, the buyer then becomes liable for overseeing unloading and covering the cost of import duties, taxes, and customs clearance fees.
- DPU - Delivered at place unloaded <insert place of destination>
The seller is responsible for unloading the goods at the destination. Following this, the buyer assumes responsibility for import duties, taxes, and customs clearance fees. It is worth noting that the DPU Incoterm code is new, being introduced in 2020 as a replacement for the previous DAT Incoterm. It includes an extra requirement on the seller to unload the goods at the place of destination. - DDP - Delivery duty paid <insert place of destination>
The seller bears the highest risk with this Incoterm and is liable for the cost and risk of delivering the goods to the buyer’s place of destination. This means the seller is responsible for overseeing unloading, as well as for paying export, shipping, and customs fees.
There are an additional four types of Incoterms, which apply specifically to sea and inland waterway transport. These are:
- FAS - Free alongside shop <insert name of port of loading>
The seller is responsible for clearing the goods for export. They bear the risk from when the goods leave the port of shipment to when they are cleared for import. - FOB - Free on board <insert named port of loading>
The seller is responsible for the goods until they reach the buyer’s vessel, meaning they bear the risk until the goods are loaded onto it. - CFR - Cost and freight <insert named port of destination>
The seller bears the risk until the goods reach the delivery port, at which point the risk transfers to the buyer. The seller must pay for the goods as well as the cost of freight to their destination. - CIF - Cost insurance and freight <insert named port of destination>
The seller bears the risk until the goods arrive at the destination. Both parties agree the insurance prior to shipping.
Are Incoterms legally binding?
Incoterms are not compulsory. That means buyers and sellers do not have to use them in their agreements. Having said that, if a buyer and seller decide to use Incoterms in their sales contract, they then become legally binding. In other words, Incoterms are only legally binding when they are included as part of a signed commercial contract, which itself is a legally binding document. It is also important to note that Incoterms do not override a country’s local laws.
How to select the most appropriate Incoterm
If you decide to include Incoterms in a sales contract, it is important to ensure you select the most appropriate terms. If you are wondering how to choose the best Incoterm, you may want to ask yourself the following questions:
1. Is the Incoterm best suited to import or export?
The term EXW is well-suited to exporters as the seller’s responsibilities end when the goods are ready to be collected from their facility. Conversely, DAP, DUP, and DDP are good options for importers as it gives them control of moving the goods through customs after arrival.
2. What mode of transport is the Incoterm best suited to?
Certain Incoterms are more suited to certain types of transport. For example, the FAS, FOB, CFR, and CIF Incoterms are appropriate for sea and inland water transport, whereas EXW, CIP, CPT, DDP, and DAP are best suited to air freight.
3. What type of goods are being traded?
The nature of the goods themselves will determine the best type of Incoterm to use. For example, if the goods need immediate delivery, only certain Incoterms will be appropriate. Similarly, for cargos which are unable to fit into a container – known as out-of-gauge cargoes (OOG) – the FAS Incoterm is likely the best to use.
4. What level of experience do the parties have?
DAP, DDP, and DPU are well-suited to importers with little previous experience. EXW, on the other hand, is less suitable for importers and better for buyers who already have experience importing goods.
5. Who do you want to have control over the goods, operations, and costs?
If the importer wants more control over the goods, EXW might be most appropriate. On the other hand, the Incoterms CPT and CIP do not give the importer control over the cost and other operational aspects.
6. What kind of relationship do the buyer and seller have?
How well the parties know one another will influence the best type of Incoterm to choose. If the importer does not know the seller well, a FAS, FOB, or FCA are probably most appropriate as these ensure the importer controls the cost and logistics of the goods from when they are loaded, until when they reach their destination.
7. Who will be responsible for insuring the goods?
If the seller is taking responsibility for insuring the goods, a CIF may be most appropriate. On the other hand, a CPT Incoterm means the buyer has no responsibility for insuring the goods.