Terms of Sale

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Terms of sale are a widely misunderstood aspect of international business among many U.S. exporters and importers. They are integral to an efficiently structure transaction.

Using terms of sale correctly does not guarantee a profitable transaction. Yet, like many instances of a mistake in the basics, a mistake here can almost guarantee time wasted, inefficient logistics, and lower profits. Sometimes an initial sale will be so thoroughly bungled as a result that a seller will permanently lose a buyer and, hence, the stream of possible future cash flows and profits.

Terms of sale must be distinguished from terms of payment. They are both necessary for a well-structured transaction, but are different subjects.

Domestically, our terms of sale are in the Uniform Commercial Code, which has been adopted by all states and the District of Columbia to cover many subjects of transactions involving the sale of goods domestically. It is important to note that since this is U.S. law and applies only to domestic sales, it therefore has no effect on international transactions. Yet many U.S. companies have used our UCC terms of sale so exclusively that they attempt to use them internationally, hence causing confusion and difficulties.

Our two principal terms of sale domestically are based on the initials "FOB" which stand for "Free on Board."

FOB Origin means "the seller must at that place ship the goods...and bear the expense and risk of putting them into the possession of the carrier." In short, he must load the goods onto the carrier.

FOB Destination means "the seller must at his own expense and risk transport the goods to that place and there tender delivery."

Typically, FOB Origin denotes "freight collect" where the buyer will name the carrier and pay the freight.

Typically, FOB Destination denotes "freight prepaid" where the seller will name the carrier and pay the freight.

Typically, because of this custom and the fact that the seller is responsible for loss or damage up to destination, the FOB Destination price is usually higher than the FOB Origin price.

Note that exceptions are possible: seller and buyer can negotiate other combinations between themselves, for example:

These have their places but are not as common. Most common is "FOB Origin, freight collect" and the majority of U.S. domestic business is done this way. A problem resulting from this, when a company begins to sell internationally, is that "FOB Origin" is shown on their catalog and sales literature which then causes immediate problems beginning with the first international sale.

So, what to do internationally? By custom, not by law, the International Commercial Terms of Sale have come into use. They are abbreviated as "Incoterms."

Most important to note immediately is that buyers and sellers in the rest of the world, not having the UCC rules, understand and use Incoterms. Some have a general idea that the U.S. internally uses a different system. Many do not. There is therefore an assumption outside the United States that, when a term of sale is from the current Incoterms version.

When a U.S. business is thinking UCC and the foreign business is thinking Incoterms, there is confusion as to how the agreement will be carried out. This is especially true in the use of "FOB Origin," so widespread in the United States, because it also exists as a possible Incoterm, but with a considerably different meaning.

There are 13 possible Incoterms, although most businesses will find themselves gravitating to just a few that will turn out to be most useful for them.

Many U.S. sellers quickly adopt "Ex Works Seller's Premises" as a term of sale because it appears to be the easiest from the seller's point of view. In catalogs and literature, EXW is excellent, as a starting point for negotiations. However, it is usually not a good term of sale to use on an actual transaction because contractually the seller and buyer are agreeing that the buyer will handle export clearance, but under the U.S. laws and regulations, the U.S. seller is typically responsible. The U.S. seller has therefore now put himself in a position where he is contractually giving up control of U.S. export clearance to his buyer, but is legally responsible to the U.S. government for how it was done.

These charts show the primary responsibilities for seller and buyer under Incoterms :

Seller or Buyer (Depending On Incoterm Used)

Export Clearance

Payment of Freight

Loading/Unloading at Point of Delivery

Import Clearance

Insurance

As a general caveat, I recommend to clients that they avoid any Incoterm which:

For a transaction to run smoothly, it is almost a given that each party in the transaction should be dealing with their own government regulations and procedures, and leave the foreign procedures to the foreign party. Enough said on that, right there.

Remembering that under the Uniform Commercial Code procedures, the most common is FOB Origin and that the seller normally will ship freight collect. The next most commonly used is FOB Destination and the seller normally ships freight prepaid. Therefore, there is a mindset among many U.S. companies that "whomever pays the freight is responsible for any loss or damage en route." Technically, this is not 100% true because of the alternate terms possible in the U.S., but it is commonly true in practice.

If we take this interpretation from U.S. practice, and match it with the fact that FOB exists in both UCC and Incoterms but has different meanings, here are situations that U.S. companies can easily find themselves in.

A seller in Provo, Utah, using the FOB Origin term on its sales literature has contractually obligated itself to load the goods onto a vessel sailing out of Provo, Utah. Ultimately, the company delivers incorrect documents under a letter of credit and is never paid.

A buyer in the United States has purchased goods from a foreign supplier where the foreign supplier has paid the freight all the way to the buyer's door under the Incoterm selected. The U.S. buyer believes all risk of loss or damage is on the seller's side because "they have paid the freight." But the shipment is damaged in transit and the seller correctly disavows any responsibility.

A United States seller ships under an Incoterm to a foreign buyer and pays the freight to destination. Damage occurs in transit. Under the term of sale as agreed, the U.S. seller is responsible for replacing the goods.

It is not that Incoterms are difficult, it is that they are different from what U.S. companies are accustomed to.

1) One term, "FOB," as discussed, is used in both sets of rules but very differently.

2) Once the distinctions are understood, both FOB methods can be used quite efficiently by a U.S. company, one domestically and one internationally.

B) It is set up in a mirror format. That is to say, each term of sale is explained with the seller's responsibilities on the left hand page and the buyer's responsibilities on the right hand page.

D) Typically, transactions between Seller "A" and Buyer "B" will use one agreed-upon Incoterm. It is easy to adjust to the use of one term of sale.

E) As business increases, still only a few Incoterms will probably be used. The odds that an average seller or buyer will use all 13 Incoterms is very, very small.

So in conclusion: Incoterms are often neglected by U.S. companies, but are neglected at a business' peril.

It is important for a U.S. company doing business internationally to become familiar with Incoterms. It is not difficult. It will increase efficiencies, enable you to write more profitable contracts more easily, and perhaps most important for the long run, save arguments between the seller and buyer over who agreed to do what. No one ever wins those arguments, and it is easier for the buyer to find another source than for the seller to find a new customer.

Addendum: Incoterms, originally adopted in 1936, it has been revised six times. The current version is Incoterms 2010. This is the seventh revision and therefore the eighth version of Incoterms. Incoterms is discussed in chapter five of Export-Import. The full Incoterms 2010 text is readily available.

Seller (Always)	Buyer (Always)
Deliver Goods	Accept Delivery of Goods
Provide Invoice
Provide Packing List
Provide "Other" Documents Needed