International trade is a complex process that involves multiple parties, different countries, and intricate legal and logistical challenges. To facilitate smoother and clearer transactions between buyers and sellers across borders, the International Chamber of Commerce (ICC) created a standardized set of rules known as Incoterms, short for “International Commercial Terms.” These terms define the responsibilities of sellers and buyers in international shipping, focusing on the delivery of goods, transfer of risk, and allocation of costs.
The latest edition, Incoterms 2020, came into effect on January 1, 2020. These rules provide a universal framework for international trade, clarifying obligations related to transportation, customs clearance, insurance, and other key aspects of the shipping process. Understanding Incoterms 2020 is critical for businesses engaged in cross-border trade to ensure that transactions are carried out efficiently and to avoid misunderstandings, disputes, and unexpected costs.
This guide will provide a comprehensive breakdown of Incoterms 2020, focusing on the key changes from previous editions, the different types of Incoterms, and how businesses can use these rules to improve their international shipping operations.
What Are Incoterms?
Incoterms are a set of 11 internationally recognized terms that define the responsibilities of sellers and buyers during the shipment of goods. They cover important aspects of the shipping process, such as:
- Who is responsible for transporting the goods?
- Who handles customs clearance and related documentation?
- At what point does the risk of loss or damage transfer from the seller to the buyer?
- Who pays for shipping, insurance, and other logistical costs?
Incoterms are not legally binding on their own, but they are commonly incorporated into contracts and purchase orders to ensure clarity and mutual understanding between trading partners. Each Incoterm consists of three-letter abbreviations that represent specific rules, such as FOB (Free on Board) or DAP (Delivered at Place).
Key Changes in Incoterms 2020
While the core principles of Incoterms remain the same, the ICC introduced several updates in the 2020 version to reflect modern shipping practices and to make the rules more accessible and user-friendly. Some of the key changes in Incoterms 2020 include:
1. FCA and On-Board Bill of Lading
Under the Free Carrier (FCA) rule, the seller is responsible for delivering goods to the carrier specified by the buyer. In Incoterms 2020, an important update was made to address the issue of bills of lading with an “on-board” notation. In many cases, the buyer needs an on-board bill of lading to satisfy their letter of credit, but the seller doesn’t have access to it since the goods are handed over to the carrier before loading onto the vessel.
Incoterms 2020 allows the buyer and seller to agree that the carrier will provide the seller with an on-board bill of lading once the goods are loaded onto the vessel. This document can then be transferred to the buyer, even if FCA is used. This change helps avoid complications in financing and improves the efficiency of FCA transactions.
2. DAT Renamed to DPU
Incoterms 2020 renames Delivered at Terminal (DAT) to Delivered at Place Unloaded (DPU) to better reflect the actual transaction. Under this rule, the seller is responsible for delivering and unloading the goods at the buyer’s chosen destination. The change clarifies that delivery can take place at any location, not just at a terminal, as the old term might suggest.
3. More Flexibility with Insurance Requirements
Under Cost Insurance and Freight (CIF) and Carriage and Insurance Paid To (CIP), the seller is responsible for purchasing insurance to cover the buyer’s risk during transit. Incoterms 2020 introduces more flexibility in this regard:
- CIF still requires the seller to provide minimum insurance coverage as outlined by the Institute Cargo Clauses (C), which covers basic risks.
- CIP now mandates higher insurance coverage under the Institute Cargo Clauses (A), which provides more comprehensive protection unless otherwise agreed between the buyer and seller.
This change acknowledges that goods shipped under CIP are often higher-value items, and the increased insurance requirement reflects the need for more robust coverage.
4. Increased Focus on Security
Incoterms 2020 places more emphasis on security-related obligations, reflecting the growing importance of safety in international trade. It clarifies which party is responsible for security requirements, such as screening of goods and handling the documentation needed for customs security checks. This adjustment is important given the heightened global focus on supply chain security and the need for compliance with international regulations, such as the U.S. Customs-Trade Partnership Against Terrorism (C-TPAT) or the European Union’s Authorized Economic Operator (AEO) program.
5. Internal Organization and Presentation Improvements
To make the rules more accessible, Incoterms 2020 improved the overall structure and presentation of the terms. Each term now has clear explanations of the seller’s and buyer’s obligations, including detailed notes on delivery, risk transfer, and cost allocation. The enhanced clarity helps users better understand the rules and apply them correctly.
The 11 Incoterms 2020 Rules
The Incoterms 2020 are divided into two categories based on the mode of transport:
- Incoterms for Any Mode of Transport
- Incoterms for Sea and Inland Waterway Transport
Incoterms for Any Mode of Transport:
- EXW – Ex Works
The seller makes the goods available at their premises (factory, warehouse, etc.). The buyer assumes all risks and costs for transporting the goods to the final destination. EXW is the term that gives the buyer maximum responsibility and the seller minimum responsibility. - FCA – Free Carrier
The seller delivers the goods to the carrier or another party nominated by the buyer at a specified location. The buyer assumes risk and responsibility from that point forward. - CPT – Carriage Paid To
The seller pays for the transportation of the goods to a specified destination, but the risk transfers to the buyer once the goods are handed over to the carrier. - CIP – Carriage and Insurance Paid To
Similar to CPT, but the seller must also provide insurance coverage for the goods while in transit. As mentioned earlier, Incoterms 2020 requires the seller to purchase higher-level insurance under this term. - DAP – Delivered at Place
The seller is responsible for delivering the goods to the buyer’s specified location, but the buyer is responsible for unloading the goods. Risk and cost transfer to the buyer upon delivery. - DPU – Delivered at Place Unloaded
The seller delivers and unloads the goods at the buyer’s specified location. This Incoterm places maximum responsibility on the seller for delivery and unloading, while the buyer assumes risk and responsibility once the goods are unloaded. - DDP – Delivered Duty Paid
The seller is responsible for delivering the goods to the buyer’s location, including handling customs duties, taxes, and other import-related charges. This term places maximum responsibility on the seller.
Incoterms for Sea and Inland Waterway Transport:
- FAS – Free Alongside Ship
The seller delivers the goods alongside the vessel at the named port. From this point, the buyer assumes responsibility for loading the goods and all subsequent costs and risks. - FOB – Free on Board
The seller is responsible for delivering the goods on board the vessel at the named port. Risk and cost transfer to the buyer once the goods are loaded onto the vessel. - CFR – Cost and Freight
The seller arranges and pays for the transportation of the goods to the destination port, but the risk transfers to the buyer once the goods are loaded on the vessel. - CIF – Cost, Insurance, and Freight
Similar to CFR, but the seller also pays for insurance coverage while the goods are in transit. Incoterms 2020 retains the requirement for minimum insurance coverage under CIF.
How to Choose the Right Incoterm
Choosing the right Incoterm is crucial for defining the obligations, risks, and costs for both the buyer and the seller. The appropriate Incoterm depends on several factors:
- Mode of Transport: Determine whether the goods are being shipped by sea, land, or air, as some Incoterms apply only to sea transport (FAS, FOB, CFR, CIF).
- Level of Risk: Consider how much risk each party is willing to assume during the shipment process.
- Cost Responsibility: Evaluate which party will be responsible for paying shipping, insurance, customs clearance, and related fees.
- Customs Clearance: Some Incoterms (such as DDP) place customs responsibility on the seller, while others (like EXW) leave it to the buyer.
Conclusion
Incoterms 2020 provides a critical framework for international trade, helping businesses navigate the complexities of shipping, risk management, and cost allocation. By clearly defining the responsibilities of sellers and buyers, Incoterms prevent misunderstandings and ensure smoother transactions. Understanding the changes introduced in Incoterms 2020, such as the new DPU term, more flexible insurance requirements, and increased emphasis on security, is essential for any business involved in cross-border trade. By selecting the appropriate Incoterm for each transaction, businesses can reduce risk, control costs, and improve operational efficiency in the global marketplace.