Incoterms are a pre-defined global standard for allocating risk of loss, customs clearance, and transit insurance in sale of goods contracts. The International Chamber of Commerce (ICC) established Incoterms in 1936 and updates the definitions every ten years, with the most recent version adopted earlier this year.
Incoterms are an amazing tool for contract drafters to succinctly manage the liabilities and responsibilities relating to transit and logistics. However, drafters must be careful not to create more problems by misuse. Here are three common mistakes made using Incoterms.
1. Using the Wrong Format
Incoterms are always a three-letter acronym, such as EXW or DDP. Never spell out Incoterms in the contract. It creates confusion about whether you intend to use the ICC-defined term or if you wrote out the word because you want a different concept.
Also, the ICC prescribes how to use the Incoterm in a sentence. The proper use is, “Seller will deliver the goods DDP buyer’s facility in Miami, Florida.” Note that we don’t use the word “to” between the Incoterm and the delivery point.
Finally, always identify the Incoterms definition set with your use. After the delivery location, always add “(Incoterms 2020).” This insertion addresses any confusion about which version controls in the event of a rule change.
2. Including Other Contradicting Concepts in the Contract
Your contract has a problem if it identifies the applicable Incoterm and has other provisions on risk of loss, transit insurance, and customs clearance. Incoterms already include most shipment-related rights and obligations, so you end up with two provisions covering the same concept.
So providing “Buyer shall deliver the Goods EXW Seller’s Shanghai Factory (Incoterms 2020),” and then adding “Seller retains risk of loss until the Goods are delivered to Buyer’s warehouse in San Jose, California,” creates an internal conflict in the contract. The Incoterm EXW passes risk of loss in Shanghai but the other term provides that risk of loss passes in San Jose.
If you use an Incoterm, you should let it do its job and be the only provision addressing those issues.
3. Not Talking to Your Logistics and International Tax Team
Where risk of loss and delivery occur can have a significant impact on your company’s operations and risks. If the seller is in a different country from the delivery point, someone will be facing import and tariff risks and requirements.
Many buyers don’t realize that by agreeing to EXW, they will be the importer of record into the U.S. and responsible for compliance with U.S. import rules. In addition, if you take possession in a foreign country, there could be tax implications due to your company owning assets there.
Always vet the Incoterms with your teams to make sure your choice works within the company’s operational requirements.
* * *
Incoterms appear simple to use, but we always need to take care not to create more problems by using Incoterms improperly.
Laura Frederick is a technology transactions attorney with 25 years of experience in large law firms and technology companies. After leaving her role as commercial counsel with Tesla in 2019, she opened up her own law firm in Austin, Texas focused on helping businesses with vendor contracts. Follow Laura on LinkedIn for her daily contract tips.