Incoterms, and the Transfer of Risk and Title in Sale of Goods Transactions
In 1936, the International Chamber of Commerce (ICC) developed a set of three-letter acronyms known as Incoterms for use in sale of goods contracts to allocate risk of loss and expenses between buyers and sellers. Each acronym reflects a time or place for delivery and when placed sequentially in a table for ease of comparison, the set graphically creates staircases depicting the respective obligations of each party in the movement of goods from origin to destination. Perhaps the most familiar of these acronyms is FOB, meaning free on board. For example, if a contract of sale includes the term FOB vessel, the seller must load the goods aboard the vessel free of cost to the buyer. There the risk of loss passes to the buyer, who must then undertake to transport the cargo to destination and pay for all attendant expenses, including export and import fees, stevedore charges to unload the goods at destination, and destination terminal charges and storage there, if necessary.
In 2020, the ICC issued its latest set of Incoterms, which consists of seven terms that apply to any mode of transport: EXW (Ex Works), FCA (Free Carrier), CPT (Carriage Paid To), CIP (Carriage and Insurance Paid To), DAP (Delivered at Place), DPU (Delivered at Place Unloaded) and DDP (Delivered Duty Paid). It also announced four terms that apply to sea and inland waterway transport: FAS (Free Alongside), FOB (about which we have spoken), CFR (Cost and Freight) and CIF (Cost Insurance and Freight). These terms are remarkably useful in sorting out quickly which party handles what aspects of the movement of goods from origin to destination.
Surprisingly to some, these terms do not establish when title transfers. Instead, title transfer is a function of what the contract of sale says and whether the governing bill of lading is a negotiable bill. While the contract of sale governs the relationship between buyer and seller, the bill of lading governs the carriage of goods relationship between the carrier and shipper, who may be either the buyer or seller or even a third party in any given transaction. A negotiable bill of lading (that is, one made “to order” or stamped “negotiable”) is a document of title and whoever possesses it, possesses title to the goods until the bill has been negotiated at destination, meaning presented to the vessel for delivery of the goods. A contract of sale may also address when title transfers, for example, for liquid cargo when the product passes the vessel’s permanent flange connection at the load or discharge port. When both a title clause exists in a contract of sale and a negotiable bill of lading are used in the carriage of goods, a conflict may arise as to who owns title to the goods. The contract of sale governs as between parties to the contract, but a third party, who comes into possession of a negotiable bill of lading for those same goods likely would not be bound by the contract of sale having no notice of the transfer of title clause therein. Parties need to be aware of the risks that exist when both a contract title clause and a negotiable bill of lading are employed with respect to the carriage of the same goods.
A further complicating issue is that with advances in technology, parties no longer want to be constrained by the delays and risks attendant to physically transporting the bills of lading to the destination port for presentation to the vessel. For example, when the required negotiable bills of lading are not available at the discharge port at the time of scheduled delivery (due to loss or delays in transit), vessel owners will often require charterers to issue a letter of indemnity holding owners harmless in the event of mis-delivery. Instead of requiring formal presentation of the original bills of lading at the discharge port, parties are using what are known as telex and express releases. While telex machines have long since been replaced, the nomenclature remains to describe a procedure by which the buyer’s agent at the load port conveys confirmation via email to the buyer’s agent and vessel at the discharge port that the original negotiable bills of lading have been issued at the load port and the vessel may release the cargo to the party identified in the telex release. A telex release is used exclusively in concert with negotiable bills of lading while an express release is used with non-negotiable or seawaybills of lading. An express release supplies the same information as a telex release, but does not afford the same level of assurance that the party identified to receive the cargo actually possesses title to it. The use of an express release is especially problematic when the purchase of the goods is financed and sold in transit. The financing bank must carefully consider the risks it faces in the event that its borrower goes insolvent during transit and the bank seeks recourse against the goods as collateral.
Another layer of complexity exists when the seller requires payment upfront and the buyer arranges for a letter of credit to acquire the goods. In this case, the buyer as importer arranges for the issuance of a letter of credit with its import bank, which then conveys the letter of credit to the seller or exporter’s bank. The seller then need only deliver the goods to the vessel, and in return receives the original bills of lading, which it then presents along with required documents listed in the letter of credit (for example, commercial invoice, certificate of origin, insurance certificate, packing list and certificate of inspection) to the export bank to receive payment for the goods. A letter of credit is also negotiable and requires the bank to make payment once the required documents are submitted without the bank confirming that the goods have actually been shipped. The export bank then presents the documents to the import bank to receive reimbursement for the payment made to the seller. This process allows parties, who do not know each other, to sell and purchase goods while minimizing the risks attendant to passing title and making payment.
As you might expect, efforts are underway to convert the entire bill of lading presentation process to an electronic blockchain platform with the goal of eliminating the various risks described above and creating a verifiable chain of custody and presentation. That process of digital conversion remains a work in progress as of this writing.
In sum, parties need to be cognizant of the risks each assumes with the respect to the transfer of title, risk of loss and expenses that each assumes throughout the sales process and transportation of goods in commerce, as well as knowledgeable about the interplay between Incoterms, bills of lading, and contract of sale terms and conditions.
“Incoterms, and the Transfer of Risk and Title in Sale of Goods Transactions,” by Keith B. Letourneau was published on April 13, 2023, in Texas Lawyer.
Reprinted with permission from the April 13, 2023, edition of the Texas Lawyer © 2023 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited.