Alphabet Soup - Why It's Important to Get Your Trade Acronyms Right 


February 2008 - (Business in Vancouver)

Business in Vancouver
Why it's important to get your trade acronyms right

You've heard it yourself and may have used it in business documents – but do you really know what it means? Because getting it wrong can have significant legal ramifications. 

The term "FOB" – arguably one of the most abused terms found in commercial documents and agreements – is an acronym for the phrase "free on board". 

However, it seems that few people who use the term actually understand its meaning. It is so frequently misused that it might be argued to have acquired an entirely new – albeit completely incorrect – meaning. 

Parties to agreements or commercial documents in which the term is used, however, would be wise to ensure it is used properly. 

In 1936, the International Chamber of Commerce (ICC) published what are called the International Commercial Terms or "Incoterms" to codify a number of trade terms that had been in common use for over two centuries. The ICC's objective was to create an international protocol for the uniform interpretation of commonly used trade terms from country to country.
The current Incoterms 2000 set out the correct meaning of FOB and 12 other common trade terms.
Collectively, these terms establish a shorthand method used to describe obligations related to the delivery of goods and responsibility for insurance and the payment of duties and other incidental costs, as well as for the transfer of risk. Incoterms are periodically revised and updated. 

Despite the intention of the ICC to bring uniformity and predictability to the interpretation of these commonly used trade terms, the terms are often used inappropriately. 

The most common example is the term FOB, which is frequently used to imply delivery on a truck, railcar or at a manufacturer's plant. Each of those applications is incorrect. The term actually means free on board a marine vessel. According to Incoterms 2000, FOB requires the seller to deliver the goods on board a ship named by the buyer. The seller fulfills its obligations once the goods have passed the ship's rail at the designated port of shipment. Thus, FOB is only applicable when the goods are to be transported by sea or inland waterway. 

Further confusion may arise when it is not clear that the acronyms or trade terms comprised in Incoterms are to be governed by the most recent version of Incoterms, currently Incoterms 2000.
To avoid ambiguity, parties wishing to incorporate Incoterms into a sales contract should include an express statement that the contract is governed by Incoterms 2000. If Incoterms are not expressly incorporated into the sales contract, the contract will generally be governed by the proper law of the contract, which will be either the law of a jurisdiction chosen by the parties to govern the contract, or the law of the jurisdiction with the closest connection to the contract. 

Interpretation of these trade terms can vary from jurisdiction to jurisdiction, which may lead to misunderstandings. Thus, if Incoterms are to achieve the objectives for which they were created, it is important the sellers and buyers relying on these terms have an understanding of their proper use. 

The 13 Incoterms are organized by the degree of obligation put on the seller. 

In the first category, the "E" term, EXW (ex works), represents the minimum obligation on the part of the seller. The seller has to do no more than place the goods at the disposal of the buyer at the agreed place such as the seller's factory. 

The "F" terms, FCA (free carrier), FAS (free alongside ship) and FOB (free on board) generally provide that the seller has fulfilled its obligations once goods are delivered to a carrier appointed by the buyer. 

The "C" terms, CFR (cost and freight), CIF (cost, insurance and freight), CPT (carriage paid to…) and CIP (carriage and insurance paid), require the seller to contract for carriage of the goods and the seller is relieved of any further risk and cost once the goods are handed over to the carrier and, in some cases, provided for insurance while in transit. 

The "D" terms are: DAF (delivered at frontier), DES (delivered ex ship), DEQ (delivered ex quay), DDU (delivered duty unpaid) and DDP (delivered duty paid). Incoterms 2000 elaborate of each of these "D" terms which generally impose responsibility for the safe transportation to, and delivery of the goods at, the agreed delivery point. This may even involve the seller clearing the goods through customs for import. 

Parties incorporating Incoterms into a sales contract should consult Incoterms 2000 for a detailed explanation of the rules.