Incoterms: What a Trade Lender Reads in Them

An exporter whose bank has funded an order must make the goods and deliver them where the contract says before it is paid. Until that point the goods are the exporter's risk. If a container is dropped on the wharf before delivery, the buyer owes nothing for it, and the loan that paid for its contents must be repaid from elsewhere, usually the exporter's insurance.

The trade term is where the file finds that point. Three things follow from it for the lender: how long its pre-shipment finance rests on goods physically reaching delivery; whether the exporter's insurance runs for that whole period, with the bank's interest noted; and which transport and insurance documents the exporter will hold when it presents for payment.

Incoterms 2020, the current edition, has eleven rules. Seven can be used for any mode of transport: EXW, FCA, CPT, CIP, DAP, DPU and DDP. Four are for sea and inland waterway only: FAS, FOB, CFR and CIF. Each is written with a named place, such as FOB with the port of loading, and the named place does much of the work.

The C rules are the ones that mislead. Under CFR and CIF the seller pays the freight to the destination port, but the risk has already passed at the port of loading. Under CIF the seller must also buy cargo insurance for the buyer, at a minimum of Institute Cargo Clauses (C), a cover against named major casualties, for at least the contract price plus ten per cent. The 2020 edition raised the CIP minimum to Clauses (A), the wider form. In both, the contract can ask for a different level.

FOB, CFR and CIF suit goods loaded straight onto a ship. A container handed to a terminal days before it is loaded fits FCA, CPT or CIP better, because under FOB the exporter stays on risk while the box sits in a yard it does not control.

A maker of irrigation pumps, constructed for this page like every figure in it, sells US$420,000 of pumps to an overseas buyer, payable by a sight letter of credit that allows partial shipments. Its bank has advanced US$250,000 of pre-shipment finance to make the order, to be repaid from the credit. The contract is FOB. Four containers reach the port's terminal on day 1 and are due to be loaded on day 6. On day 3 one container, holding US$105,000 of the order, is crushed in the yard.

Under FOB the lost container is the exporter's problem. The credit pays for what was shipped, and the US$105,000 has to come back from a replacement shipped before the credit's latest shipment date, an insurance claim, or a claim against the terminal, which the terminal's own terms are likely to limit. The file's question was not only whether the buyer's bank is good, but who insures the goods between the factory and the ship's deck, and whether the bank is noted on that policy as loss payee.

Had the contract been FCA at the terminal, the crushed container would have been the buyer's loss from day 1. But the buyer would owe its price under the sale contract, not under the credit, which pays only against the documents it calls for. A loss can be the buyer's in law and still leave the exporter, and its bank, collecting on open account.

On CIF terms the exporter would also have insured the voyage for the buyer, for at least 110% of the price: US$462,000 at the minimum level, unless the credit or the contract asked for more.

The Incoterm is often taken for two things it does not do. It is not the payment term: FOB says nothing about whether the buyer pays by letter of credit, collection or open account. And it is not the passing of ownership, which the ICC's rules leave to the sale contract and the law that governs it. The UN Convention on Contracts for the International Sale of Goods can govern an export sale from New Zealand or Australia, both parties to it, unless the contract excludes it; the UK has not joined it. The Convention does not decide property in the goods either.

For a lender, control of goods in transit comes through the documents rather than the trade term. A bill of lading made out to order and held by the bank controls who can take delivery at destination. A sale financed under a letter of credit gives the bank that control; an open-account sale with the bill sent straight to the buyer gives it none, whatever the contract says about risk.

DEFINED IN ONE PARAGRAPH → · HOW BANKS READ EXPORTERS → · THE BILL OF LADING →

The trade term turns up three times in an export file. In the credit paper, it sets how long the pre-shipment exposure rests on the exporter's performance and insurance. In the conditions, it says which policy to see. And when a letter of credit is checked against the contract, it shows whether the documents called for match the term: a credit asking for an insurance document on an FOB sale, or an on-board bill of lading for containers sold FCA without the 2020 option that provides for one, is a problem waiting for presentation day.

A change in the term is a change in the risk. An exporter that moves from CIF to FOB hands the voyage insurance to the buyer. One that moves to DAP carries the goods to the buyer's country at its own risk, and the bank's exposure travels with them. Neither is a reason to decline. Each is a reason to read the policy again.

PRE-SHIPMENT FINANCE → · LOSS PAYEE → · PRODUCT FILE: TRADE LOAN →