01. incoterms and trade documents

The question

The international sale of goods requires the goods to be carried, often over great distances and through several hands, and it raises questions that the local sale does not: who arranges and pays for the carriage, who bears the cost and risk at each stage of the journey, who insures the goods, and at what point the seller's responsibility ends and the buyer's begins. These matters could be spelled out at length in every contract, but commerce has developed standardised terms that allocate them concisely, and documents that govern the carriage and represent the goods in transit. This sub-unit examines these standardised terms, the Incoterms, and the principal trade documents, asking how they allocate the responsibilities and risks of the international sale and how the documents operate. The answer presents another instance of the pairing of a universal concept, the standardised allocation of the responsibilities of carriage, with a specific instrument, the Incoterms published by an international body.

The Incoterms and the allocation of responsibilities

The Incoterms, short for International Commercial Terms, are a set of standardised trade terms, published by the International Chamber of Commerce and revised periodically, the current version being the Incoterms 2020, that define the respective responsibilities of seller and buyer in an international sale of goods for the delivery, carriage, insurance, and clearance of the goods. Each Incoterm is a short code, such as a three-letter abbreviation, that the parties incorporate into their contract, and that carries a defined allocation of responsibilities, so that by choosing an Incoterm the parties adopt, in a single term, a complete and standardised allocation of the tasks and costs of getting the goods from seller to buyer.

The Incoterms connect to the value of commercial certainty and to the function of standardisation that runs through this course. Without standardised terms, the parties to each international sale would have to negotiate and spell out the many responsibilities of carriage, an onerous and error-prone task; the Incoterms allow them to adopt a tested and widely understood allocation by a single code, reducing the cost of contracting and the risk of misunderstanding, particularly between parties of different languages and legal traditions who share an understanding of the Incoterms. Each Incoterm allocates, in a defined way, the responsibilities for arranging and paying for carriage, for export and import clearance, for insurance, and for the other tasks of delivery, ranging from terms under which the seller's responsibility ends when the goods are made available at its own premises to terms under which the seller is responsible for delivering the goods to a destination in the buyer's country. The Incoterms are incorporated by the parties' agreement, an expression of the party autonomy examined in the orientation unit, and they govern the matters they address while leaving other matters to the general law of the sale, so that an international sale is commonly governed by an Incoterm for the allocation of carriage responsibilities and by the CISG or a national law for the remainder.

Consider a seller and buyer in different countries who agree on an international sale. Rather than spell out who arranges carriage, who clears the goods for export and import, who insures them, and where the seller's responsibility ends, they incorporate an Incoterm into their contract, which allocates all these responsibilities in a defined and standardised way understood by both. The parties thereby adopt a complete allocation of the tasks of carriage by a single, tested term. The example shows the Incoterms allocating the responsibilities of the international sale concisely and reliably through a standardised term.

The Incoterms are therefore a set of standardised trade terms, published by the International Chamber of Commerce and incorporated by the parties, that allocate the responsibilities of seller and buyer for the delivery, carriage, insurance, and clearance of goods in an international sale, allowing the parties to adopt a complete and tested allocation by a single code and so serving the certainty and economy of cross-border contracting.

The Incoterms and the passing of risk

Among the responsibilities the Incoterms allocate, one is of particular legal importance and connects this sub-unit directly to the sale-of-goods module, namely the passing of risk. Each Incoterm fixes the point in the journey of the goods at which the risk of their loss or damage passes from seller to buyer, so that the choice of Incoterm determines, among much else, who bears the risk if the goods are lost or damaged at each stage of the carriage.

This function connects to the analysis of the passing of risk in the sale-of-goods module, where it was noted that the parties may determine when risk passes and that the Incoterms are the principal means by which they do so in international sales. The sale-of-goods module distinguished the passing of risk from the passing of property and observed that the party bearing the risk suffers the loss if the goods perish without fault; the Incoterms make this allocation precise for the international sale by fixing the exact point at which risk passes. Under some Incoterms the risk passes early, when the goods are handed to the carrier or pass a defined point, so that the buyer bears the risk of the carriage; under others the risk passes later, when the goods reach a named destination, so that the seller bears the risk of the carriage. The precise point of the passing of risk under each Incoterm is defined by the term, and the parties, by choosing the term, choose who bears the risk of loss in transit, a matter of the first importance given the hazards of international carriage. The passing of risk under the Incoterms is, moreover, connected to the trade documents and to the documentary credit examined in the previous module, for the documents evidence the delivery of the goods to the carrier at the point the Incoterm specifies and so evidence the passing of risk and the seller's performance.

Suppose goods sold under an international sale are lost during the sea carriage. Whether the seller or the buyer bears that loss depends on the Incoterm chosen: if the term passed the risk to the buyer when the goods were handed to the carrier, the buyer bears the loss and must still pay the price; if the term kept the risk with the seller until the goods reached the destination, the seller bears the loss. The choice of Incoterm thus determined who bore the risk of the very loss that occurred. The example shows the Incoterms fixing the passing of risk and so allocating the risk of loss in transit between the parties.

The Incoterms therefore fix the point at which risk passes from seller to buyer in the international sale, making precise the allocation of risk that the sale-of-goods module described, so that the parties, by choosing an Incoterm, determine who bears the risk of loss or damage to the goods at each stage of the carriage, a determination connected to the trade documents that evidence the goods' delivery to the carrier.

The trade documents and the bill of lading

The international sale generates a set of documents that govern the carriage of the goods, evidence their delivery and condition, and enable payment, and these trade documents are central to the operation of cross-border trade, as the documentary credit examined in the previous module illustrated. The principal trade documents include the transport document evidencing the carriage, the commercial invoice stating the goods and the price, the insurance document evidencing the insurance of the goods, and various certificates concerning the goods, and these are characteristically the documents against which payment is made under a documentary credit.

The most important of the transport documents, and the one of greatest legal interest, is the bill of lading, a document issued by the carrier of goods by sea that performs several functions at once. It connects this sub-unit to the law of negotiable instruments and of documents of title. The bill of lading is, first, a receipt by the carrier for the goods, acknowledging that the carrier has received the goods described in the bill in the condition stated; it is, second, evidence of the contract of carriage between the shipper and the carrier, recording the terms on which the goods are carried; and it is, third and most remarkably, a document of title to the goods, a document whose transfer can transfer the right to the goods themselves, so that the holder of the bill is entitled to demand the goods from the carrier at the destination and the transfer of the bill can operate to transfer the goods while they are at sea. These functions make the bill of lading the key document of sea-borne trade, and the third in particular gives it a character resembling the negotiable instruments examined earlier.

Consider goods shipped by sea under an international sale. The carrier issues a bill of lading to the seller, acknowledging receipt of the goods, recording the terms of carriage, and serving as a document of title. The seller presents the bill, with the other documents, to obtain payment under a documentary credit, and the bill passes to the buyer, who uses it to claim the goods from the carrier at the destination. The bill has served as receipt, as evidence of the carriage contract, and as the document by which the right to the goods is transferred and the goods are claimed. The example shows the bill of lading performing its several functions in the international sale.

The trade documents, and pre-eminently the bill of lading, are therefore central to cross-border trade, the bill of lading serving at once as a receipt for the goods, as evidence of the contract of carriage, and as a document of title whose transfer can transfer the right to the goods, functions that make it the key document of sea-borne trade and connect it to the documentary credit and the negotiable instruments examined earlier.

The bill of lading as a document of title

The function of the bill of lading as a document of title merits separate examination, for it is the feature that most distinguishes the bill and that performs a remarkable commercial office. A document of title is a document the possession of which is treated by the law and commercial practice as equivalent, for certain purposes, to possession of the goods it represents, so that dealing with the document operates as a dealing with the goods, and the transfer of the document can transfer rights in the goods themselves.

This function connects to the problem, recurrent in this course, of dealing with goods that are distant or in transit, and it solves that problem in an ingenious way. Goods carried by sea are, for the duration of the voyage, beyond the physical reach of both seller and buyer, yet commerce requires that they be dealt with while in transit: sold, used as security, and paid for. The bill of lading, as a document of title, makes this possible by embodying the right to the goods in a document that can be physically transferred, so that the goods at sea can be sold by transferring the bill, pledged as security by transferring or depositing the bill, and claimed at the destination by presenting the bill. The party who holds the bill controls the goods, in the sense that it can claim them from the carrier and can transfer the right to them by transferring the bill, and this control of distant goods through control of a document is what allows the financing and trading of goods in transit, including the operation of the documentary credit, under which the bank holds the documents, and with them control of the goods, as security until the buyer pays. The bill of lading as a document of title thus performs for goods in transit a function analogous to that which the negotiable instrument performs for money obligations, embodying a right in a transferable document.

Imagine goods at sea that the buyer wishes to resell, or to use as security for finance, before they arrive. By transferring the bill of lading, the buyer can sell the goods in transit to a sub-buyer, who acquires the right to claim them on arrival, or can pledge the bill to a financier as security, all without the goods being physically moved or available. The bill of lading, as a document of title, enables these dealings with goods that are physically beyond reach. The example shows the bill of lading as a document of title enabling the goods to be dealt with while in transit.

The bill of lading as a document of title is therefore the feature by which possession of the document is treated as equivalent to possession of the goods, enabling goods in transit to be sold, secured, and claimed through the transfer of the document, a function that solves the problem of dealing with distant goods, underpins the documentary credit, and gives the bill of lading a character analogous to the negotiable instrument.