China Shipping Terms: Ignorance is NOT Bliss

International shipping terms are way more complicated and important than most realize and companies far too often get this wrong. My law firm has had multiple cases where BOTH sides of a dispute chose the absolute worst shipping terms possible for themselves. In these situations, each side makes various arguments as to why the other side’s choice of shipping terms should prevail.

A few weeks ago, my Uber driver on a very long ride in Spain told me he had been a logistics coordinator and had lost that job during Spain’s financial crisis. Desperately wanting to improve my Spanish, I asked him all sorts of questions regarding logistics and at one point he mentioned that “almost nobody except the Germans” understands what shipping terms mean. He then laughingly regaled me with stories where companies from all over the world were dead wrong (to their detriment) about what they thought they had agreed to by way of shipping terms.

If you purchase product from China, you typically should not use FOB as your shipping term. Use FCA or CIF or even EXW instead. Get a copy of Incoterms and learn what the above shipping terms mean and use them exactly as specified. Do not use the UCC. Use Incoterms only and do not edit the terms.

In 2015, there was a massive explosion at the Tianjin Port with supply chain losses of approximately $9 billion. Who bore the loss of that destruction. The product sellers or the product buyers? Did any insurance company pay for the losses? Or did they escape the obligation to pay because in fact no insurance covered the items sitting in the port waiting for delivery? Sure, incidents as big as the Tianjin port explosion are rare, but there are all sorts of other things that can make shipping terms determinative, ranging from sanctions to theft to tariffs.

If you purchase products from China pursuant to a contract manufacturing arrangement your completed product is probably packed into a container at the factory in China, then transported from the factory to the port by truck. The container sits in a processing yard at the port for a week or so and then is finally loaded onto a ship.

A lot can go wrong in this process. Consider risk of loss. Who gets paid if the container is lost? What if the truck carrying the container to the port has an accident and the entire shipment is destroyed? What if the container is stolen from the port? What if there is an explosion at the port and the container is destroyed? What if the ship sinks in a storm in the Gulf of Alaska? What if the container is offloaded and the same misadventures happen before the container is delivered to you, the buyer, at your facility in North America or Europe or Australia?

Your shipping terms will typically determine risk of loss. International shipping terms have been carefully developed over many years and they are embodied by Incoterms. What is Incoterms? I will let Wikipedia explain:

The Incoterms or International Commercial Terms are a series of pre-defined commercial terms published by the International Chamber of Commerce (ICC) relating to international commercial law. They are widely used in international commercial transactions or procurement processes and their use is encouraged by trade councils, courts and international lawyers. A series of three-letter trade terms related to common contractual sales practices, the Incoterms rules are intended primarily to clearly communicate the tasks, costs, and risks associated with the global or international transportation and delivery of goods. Incoterms inform sales contracts defining respective obligations, costs, and risks involved in the delivery of goods from the seller to the buyer, but they do not themselves conclude a contract, determine the price payable, currency or credit terms, govern contract law or define where title to goods transfers.

The Incoterms rules are accepted by governments, legal authorities, and practitioners worldwide for the interpretation of most commonly used terms in international trade. They are intended to reduce or remove altogether uncertainties arising from different interpretation of the rules in different countries. As such they are regularly incorporated into sales contracts worldwide.

Incoterms cover virtually all important issues related to international shipping of goods and selecting a single Incoterms shipping term typically will resolve all important issues related to a shipment. For this reason, every buyer and seller involved with international shipping must decide what term will be used and then comply with the selected term.

The choice of shipping terms determines who bears the risk of loss transfer. Many buyers make the mistake of choosing Free On Board (FOB) as their shipping term. They chose FOB to ensure the price of the product does not include the price of insurance and freight to ship the product from China. But when chosing FOB, these inexperienced buyers do not usually realize they are not accounting for risk of loss. Under FOB, risk of loss passes only after the product has been loaded onto the vessel (crosses the rail). Since risk of loss transfers when the product crosses the rail, the buyer purchases insurance that covers the product at that point. Now ask yourself: who has the risk of loss from when the product leaves the factory until it is loaded onto the ship? The answer is that the factory has the risk of loss.

But Chinese factories almost never purchase insurance for the brief period between when the product leaves their factory and is loaded on the vessel. The Chinese factory just assumes the buyer has purchased insurance as if the risk transfers when the carrier takes delivery. But this is not true.

This means that during the period between delivery to the carrier and loading on the vessel, the risk of loss for the product is uninsured. If the buyer is aware that the product in uninsured, that is a risk that the buyer willingly assumes. The problem is that hardly any buyers understand that they are taking this risk with product they already have paid for — at least in part. Many Chinese factories demand full payment at the time the product is put into the control of the carrier. They do not want to wait until the product is loaded on the vessel since they can never be sure when this will happen.

The solution to this problem is simple. Use the right shipping term. As the drafters of Incoterms clearly state, for modern shipping by sea, the FOB term should never be used. The proper term is Free Carrier (FCA). Under FCA terms, risk of loss passes when the shipment is put into the custody of the carrier. It does not matter where the carrier takes delivery. It may be at the factory or it may be at the port. Since the buyer can be certain where risk of loss passes, the buyer can be certain it has obtained the appropriate insurance. The issue of insurance is not left to the seller. The responsibility and benefit of insurance rests on the buyer where it belongs.

Another problem our international lawyers often see are buyers that seek to create their own shipping terms. We see contracts where buyers provide that the shipping term will be FOB but risk of loss transfers only after the product is delivered, inspected and accepted. But because FOB means risk of loss transfers when the shipment is loaded on the vessel, this self-created language makes no sense. There is no shipping term that provides for transferring risk of loss under these terms and these buyers confused risk of loss with acceptance of the goods, two unrelated concepts. By providing internally incoherent contract language the buyers harm themselves. If the shipment is lost, will the insurance company pay? If it pays, will it pay the factory or the buyer? Who knows? If you want expensive litigation create your own shipping terms!

Bottom Line: Failing to use standard Incoterms shipment terms in the standard way will decrease predictability, Choose the right Incoterms shipment term for your situation and don’t modify it.