Q166: Modifying Incoterms – when & how?

A166: As often noted, Incoterms rules are best considered to be ready-made suits. Sometimes they fit; but sometimes they might fit better if they were given a slight adjustment.

Technically, any Incoterms rule may be modified automatically (often accidentally) by the terms of the sales contract. What this means is that a relevant, even contradictory, clause within a contract will always override the Incoterms rule definition. This can be convenient, but it also carries a risk. For example, consider a sale using the Incoterms rule CIP (Carriage and Insurance Paid To) where the sales contract is elsewhere claused “buyer to arrange insurance”.

Clearly such a contradiction is to be avoided, but the point to bear in mind in this example is that the contract clause, that the buyer should arrange insurance, is superior to the commercial term definition (where the seller is obligated to arranged insurance cover for the buyer). However, this is an example of unintended modification.

Intentional modifications are best contained in or around the area of the contract where the applicable rule is to be found. But a modification will involve writing words and phrases that are not directly defined in the official text of the rules. This creates a risk of misinterpretation, which is further aggravated whenever the buyer and seller have different home languages.

For example, consider a model where the buyer wishes to collect from the seller’s premises, and where the seller is not obliged to act as exporter of record, or required to arrange export clearance. These are two of the central conditions of the Incoterms rule EXW (Ex Works). But under this term too, the seller has no obligation to load the collecting vehicle and it might be required that they do so.

The parties might therefore look to the FCA (Free Carrier) rule, where the seller’s obligations include the risk and cost of loading the collecting vehicle. But then that rule (the FCA rule) also requires the seller to export clear the goods, which is not a requirement in this example contract.

Modification of either term might work, but this entails making a choice. The parties could ‘increase’ EXW to obligate the seller to load the vehicle e.g., “EXW (seller’s address) including loading, Incoterms 2020”, or they might ‘decrease’ FCA to exclude the customs clearing obligation, “FCA (seller’s premises) excluding export customs clearing, Incoterms 2020”.

But note how both of these modifications create ambiguity. For example, what is meant by the word ‘loading’ in the modified EXW expression? Does it mean the cost of loading, the risk of loading – or both? Equally, what is meant by the word ‘clearing’ in the modified FCA expression? This might be resolved by the parties defining the word, and the scope of its intended meaning, in the contract terms.

But given that in the FCA model the requirement is to subtract from, or to reduce the scope of, the seller’s obligations, it is possible and perhaps more desirable to write the modified phrase “FCA (seller’s premises) Excluding A7 & B7, Incoterms 2020”. Sections A7 and B7 of each Incoterms rule deals with the distribution of risk and cost for both export and import clearance between the parties. No new words or phrases are being brought to bear on the official definition.

From the above, it may appear that the better option is to ‘decrease’ a given rule, by excluding otherwise applicable clauses, rather than to ‘increase’ the scope of an Incoterms rule by bringing in external wording i.e., words and phrases not contained in the original Incoterms rules text, and as a general proposition, whenever this is possible, it is true.

However, often the required modification is not as clear cut as this FCA example.

Imagine a model where the seller wishes to supply to the buyer’s door, assuming all risks. This would fall into the D-prefixed terms. Further, it is the seller’s intention to cover all destination landside costs, initially in the manner of DDP (Delivered Duty Paid) however the seller has no importer’s code with the destination customs authority, although the buyer does. There is a need then to express that the seller will take the cost of the import customs clearance process, but that the buyer must take the risk and act as importer of record. But further in this model, there is an applicable import VAT which if incurred by the seller cannot be recovered, but which if incurred by the buyer (in the role of importer/vendor) may be recovered by the buyer.

In the expression DDP the seller acts as importer of record and incurs the import VAT, whereas with the expression DAP (Delivered At Place) the buyer incurs the import VAT, acts as importer of record, but also incurs the cost of import clearance.

Again, the example illustrates that the preferred model falls somewhere in between two formal Incoterms rules, where neither of these options fits the model exactly.

Using the ‘decrease’ rule, the parties would be better advised to modify the DDP option, to exclude recoverable import taxes and to obligate the buyer to act as importer, albeit with the seller carrying the costs of the clearance operation (and the import duty). But note that there isn’t a single section in the Incoterms definitions which will allow for this modification.

By this, I mean that the parties cannot write “DDP (buyer’s premises) excluding A7 Incoterms 2020”, for while A7 covers the import customs risk (and by excluding it from the expression means that the buyer must act as importer), it also covers the import customs clearance cost, which the parties still wish the seller to pay – along with any applicable import duties, but excluding any recoverable taxes due on importation, such as import VAT.

In essence, modification would require only the partial exclusion of certain of the risks and costs associated with section A7, which could only be achieved by bringing in an elaborate description of who does what. Of itself, there’s nothing wrong with this, but the more elaborate the modification, the more probable that words or phrases may be misinterpreted or misunderstood.

In this example then, the seller and buyer might be better advised to ‘increase’ DAP. For example, “DAP (buyer’s premises) seller’s costs to include customs clearance and import duties as applicable, Incoterms 2020”. It would still be prudent that a descriptive clause is added to the contract terms, expressing more completely the intention of the parties, and defining the scope of the phrase “seller’s costs to include customs clearance and import duties as applicable”, given the opening observation above, that a clause within the sales agreement will always augment an Incoterms rule definition, as and if applicable.

Ideally it is better not to modify the terms at all, but as ready-made suits, sometimes the parties will have no better choice as not every model fits exactly into the Incoterms definitions.

But importantly, as ready-made suits, sometimes the definitions may not fit at all, and the merchants will need to visit the tailor, by which I mean that they will need to write out in longhand, in full, their intentions, avoiding the use of the Incoterms rules ‘shorthand’ system entirely. And, of course, if not managed correctly, this can lead to further complications unless the parties drafting the terms and conditions are mutually agreed on the meaning of the words and phrases they intend to employ.

In all matters of trade: mind your language.

Remaining Public Courses for 2021

21st October – Incoterms 2020

26th October – Export Exchange Control and VAT

10th November- Merchanting & Cross Trade