Lord Arcamo

Lord is responsible for the TFG Weekly Trade Briefings at Trade Finance Global (TFG). He is curious about the world of payments and macro-economics, with a specific focus on supply chains in Asia.

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6 common mistakes when using Incoterms [UPDATED 2024]

1. Misinterpreting the scope of Incoterms

One of the most common mistakes is misinterpreting what Incoterms cover. Incoterms define the responsibilities for transportation, risk, and costs, but they do not cover other aspects such as payment terms, ownership, or the conditions of the sale contract. 

Traders often assume that Incoterms address all aspects of the trade agreement, leading to confusion and disputes.

Example

A buyer might assume that by using a certain Incoterm, the seller is responsible for any payment delays or product quality issues, which is not the case. 

For instance, using CIF (Cost, Insurance, and Freight) does not mean the seller is responsible for ensuring timely payment or addressing product defects upon arrival.

How to avoid

Clearly distinguish between Incoterms and other contractual terms and ensure that all aspects of the trade agreement are covered in the sales contract and separate from Incoterms. 

Explicitly define payment terms, product specifications, and quality assurance measures within the main contract.

2. Incorrectly assigning responsibilities

Another common error is incorrectly assigning responsibilities between the buyer and seller. 

Each Incoterm defines who is responsible for transportation, loading, unloading, and customs duties. Misallocating these responsibilities can lead to additional costs and delays.

Example

Using EXW (Ex Works) when the buyer lacks the capability to manage the entire logistics process can result in unexpected expenses and logistical challenges. 

EXW places the maximum burden on the buyer, including collecting goods from the seller’s premises and handling all subsequent transportation, export, and import duties.

How to avoid

Thoroughly understand the responsibilities assigned by each Incoterm and choose an Incoterm that aligns with both parties’ logistical capabilities and preferences. 

For instance, if the buyer lacks logistics support, consider using FCA (Free Carrier), in which the seller delivers goods to a specified carrier, simplifying the process for the buyer.

3. Misunderstanding risk transfer points

A crucial aspect of Incoterms is the point at which risk transfers from the seller to the buyer. The third common mistake is misunderstanding when this transfer of risk takes place. This can result in disputes if goods are damaged or lost during transit.

Example

Under FOB (Free on Board), the risk is transferred to the buyer once the goods are on board the vessel. If the buyer is unaware of this and assumes the seller covers the risk until arrival, disputes can arise if the goods are damaged during shipping. 

For instance, if goods are damaged while being loaded onto the vessel, the buyer, not the seller, must handle the insurance claim.

How to avoid

Identify and communicate the risk transfer points defined by the chosen Incoterm and ensure both parties know when and where the risk transitions. 

Document these details in the contract to avoid misunderstandings and provide a clear reference point.

4. Failing to specify the place or port

Failing to specify the exact place or port of delivery can lead to confusion and disputes. 

Each Incoterm requires precise information about the delivery location to ensure smooth logistics and clear responsibilities.

Example

Using FCA (Free Carrier) without specifying the exact location can create confusion about where the goods should be handed over, leading to delays and additional costs. 

The buyer might assume the goods will be delivered to a nearby facility, while the seller may have a different location in mind.

How to avoid

Always specify the precise place or port in the Incoterm agreement and provide clear details to avoid ambiguity and ensure both parties have a shared understanding. 

For example, instead of stating ‘FCA’, specify ‘FCA – Carrier’s Warehouse, 123 Shipping Lane, Port City’.

5. Overlooking insurance requirements

Certain Incoterms, like CIF (Cost, Insurance, and Freight) and CIP (Carriage and Insurance Paid To), require the seller to provide insurance coverage. 

Overlooking or inadequately addressing these insurance requirements can result in insufficient coverage and financial losses.

Example

A seller might arrange minimal insurance coverage under CIF, not meeting the buyer’s expectations for comprehensive coverage. 

If the goods are damaged or lost, the buyer may find that the insurance payout is insufficient to cover the full value of the shipment.

How to avoid

Verify the insurance requirements of the chosen Incoterm to ensure adequate coverage is arranged and communicate clearly with the other party about the level of insurance provided. 

For CIP, ensure the insurance covers the value of the goods at least 110% of their price, as per Clause A of the Institute Cargo Clauses.

6. Ignoring local trade regulations 

Each country may have specific regulations that affect the responsibilities and costs outlined by Incoterms, and not following these local trade regulations can lead to legal issues and delays.

Example

A seller might choose DDP (Delivered Duty Paid) without understanding the import regulations in the buyer’s country, leading to unexpected legal and financial complications. 

The seller may face delays and penalties for failing to comply with local customs procedures.

How to avoid

Research and comply with local trade regulations in the buyer’s and seller’s countries and consult with customs experts if necessary to ensure compliance. 

For instance, in some countries, specific documentation or pre-approval is required for certain types of goods, which must be considered when choosing DDP.

Practical tips to avoid common Incoterms errors

There are several general tips to avoid these and other Incoterms mistakes. 

• Education and training: Ensure all parties involved in the trade understand Incoterms. Provide staff training to prevent misunderstandings. Regular workshops and refresher courses can keep the team updated on the latest Incoterm rules and applications.
• Clear documentation: Use precise language in contracts to define responsibilities, risk transfer points, and delivery locations. Detailed contracts help prevent disputes and ensure clarity. Include specific clauses that outline the exact responsibilities and expectations of each party.
• Regular review: Periodically review and update Incoterm agreements to reflect any changes in trade practices or regulations. Regular audits of trade agreements help identify and rectify potential issues before they escalate.
• Consult experts: Seek advice from trade and logistics experts to choose the most suitable Incoterm and ensure compliance. Expert consultation can provide insights into the best practices and help navigate complex international trade scenarios.

By being aware of common Incoterms mistakes and taking proactive steps to avoid them, traders can ensure clearer agreements, reduce risks, and foster more successful international transactions. 

Proper use of Incoterms facilitates smoother logistics and enhances trust and cooperation between trade partners.

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