The inter-se relationship among
ICC Incoterms 2010, marine cargo insurance and management of the risks
associated with the transit of goods from the seller’s warehouse to the
buyer’s, is a complicated one. For the layman, more often than not, it’s
confusing too. Add just a few dollops from the Contract Act, the Sale of Goods Act,
the UNCISG or the Hague/Hague-Visby Rules to this mixture of apparently
unrelated subjects, and the cocktail that we get may appear like a riddle
wrapped in a mystery inside an enigma (with apologies to Mr. Churchill!). This
article focuses on some of the issues that come up frequently at almost every
seminar or workshop on the aforementioned subjects.
The Incoterms Rules
The ‘Introduction’ to ICC Incoterms
2010 states, “Incoterms® rules explain a set of three-letter trade terms
reflecting business-to business practice in contracts for the sale of goods.
Incoterms rules describe mainly the tasks, costs and risks involved in the
delivery of goods from sellers to buyers.” It is clear that these are simply ‘rules’
reflecting business practices. These are not
laws, say, like the Indian Contract Act 1872, the Sale of Goods Act 1893 (UK)
or the Negotiable Instruments Act 1881(India). Consequently, the Incoterms
Rules – unlike statutory obligations – are not
enforceable automatically, by default. If the parties wish the Incoterms 2010 rules to apply
to a contract, this fact should be made clear in the contract or agreement.
Once the Incoterms rules are incorporated in a contract, the Rules have a firmer
basis for enforcement in a court of law than in their stand-alone capacity as merely
‘rules’.
Modifying the Incoterm Rules
A contract is defined as an
agreement valid in law, executed between two or more parties capable (as defined
by contract laws) of entering into such contracts. The corollary is that, as
long as the parties are in agreement and act within the perimeters of the applicable
law, they are free to create or modify the terms of the agreement or contract.
The Incoterms rules are no
different. The responsibilities of the parties defined in the Incoterms Rules
are the default options. Where the parties want to alter an
Incoterms rule, such alteration is not prohibited. However, the ‘Introduction’ to
the Incoterms 2010 Rules sounds a word of caution here. It says, “…there are
dangers in so doing. In order to avoid any unwelcome surprises, the parties
would need to make the intended effect of such alterations extremely clear in
their contract.”
Thus, for example,
if the allocation of costs in the Incoterms® 2010 Rules is altered in the
contract, the parties should also clearly state whether they intend to vary the point at which the risk passes from
seller to buyer. One must remember that the Incoterms rules are the result
of years of intensive work by the ICC. Making changes
to the ‘Rules’ are not prohibited, but care should be taken to avoid ‘unintended
consequences’.
Incoterms Rules and the laws of contract
As we are aware, a
sales contract addresses a whole range of issues depending on the nature and
the complexity of a transaction. Its size and contents may vary accordingly. The
Incoterms Rules cover only a tiny segment of a contract, focusing only on the matters
related to the transportation of a consignment. The Rules allocate responsibilities for contract of carriage or insurance
arrangements, which costs each party is responsible for, and a lot more. In
this manner, the ‘Rules’ effectively shorten
a contract, but do not replace it. Thus, for example, the Incoterms rules say
nothing about the price to be paid, the terms or the method of payment, or the
consequences of a breach of contract, legal jurisdiction or remedial process and
so on. These matters ought to be dealt with through express terms in the
contract of sale or in the laws governing that contract.
Transfer of property and the
Incoterms rules
There is a common
misconception that Incoterms rules cover the transfer of ownership of, or title
to, the goods. Actually, these ‘Rules’ do
not. Issues regarding transfer of ownership or the passing of title must be
addressed separately in the contract of sale or purchase. Section 17 of the UK
Sale of Goods Act, 1893 states,
“(1) Where there is a contract for the sale of
specific or ascertained goods the property in them is transferred to the buyer
at such time as the parties to the contract intend it to be
transferred. (Emphasis mine)
(2) For the purpose of ascertaining the intention of
the parties regard shall be had to the terms of the contract, the
conduct of the parties, and the circumstances of the case.” (Emphasis mine)
Section 19 of the
(Indian) Sales of Goods Act 1930, sub-titled “Property passes when intended to
pass” is a mirror image of the UK Act on the subject. Therefore, issues about
transfer of property or title are not within the ambit of the Incoterms Rules –
it’s a contractual arrangement. Therefore, it would be pointless to look at the
Incoterms Rules for an answer on this score. Sales of Goods Act 1930 states
that the risk on the goods may also pass with the transfer of property, but not necessarily along with
their delivery. From the section
quoted below it would be abundantly clear that ‘delivery’ is altogether
different from the ‘transfer of property’. A part of Section 26 is quoted below
for ready reference (note the first three words, ‘unless otherwise agreed’):
26. Risk Prima facie passes with property-
Unless otherwise agreed, the goods remain at the
seller’s risk until the property therein is transferred to the buyer, but when
the property therein is transferred to the buyer, the goods are at the buyer’s
risk whether delivery has been made or
not. (Emphasis added)
Makes
a lot of sense, doesn’t it?
Cost and risk
Before we proceed further, let us
understand something very clearly. The fact is that costs (towards freight
charges, THC etc.) have no direct relation with the passing of risk. As far as
the Incoterms Rules are concerned, risk passes only with delivery. One typical
example should make the point crystal clear.
Let’s consider CFR Incoterms
2010. Under this rule,
“the seller fulfils its obligation to deliver when the seller hands the goods
over to the carrier in the manner specified in the chosen rule” and not when they reach the buyer at the
place of destination, even though the seller is required to pay the freight
charges till the destination port.
Hence, this rule has two critical points – quite distinct and different from
each other. The first is the point of delivery where the risk passes. The other
is the unloading point up to which freight is paid by the seller.
This distinction brings to the
fore several issues of great importance to both the parties. In order to avoid
ambiguities, risks, additional costs and possible disputes (say, where a single
port may have a very large number of docks spread over several kilometres) the
port of loading should be defined as clearly as possible in the contract
itself. The Incoterms ‘Guidance Note’, an extremely useful section that
precedes every set of tables defining the obligations (A1 to A10, and B1 to
B10) in the ICC publication makes this abundantly clear about CFR:
“While
the contract will always specify a destination port, it might not specify the
port of shipment and that is the place at which risk passes to the buyer. If
the shipment port is of particular interest to the buyer, the parties are well
advised to identify it as precisely as possible in the contract.”
In sum, we may note that as far
as CPT (Carriage Paid To), CIP (Carriage and Insurance Paid To), CFR (Cost and
Freight – paid to…) and CIF (Cost,
Insurance and Freight – paid to…) are
concerned, the named place (the point
up to which freight is paid by the seller)
is always different from the
place where ‘delivery’ takes place.
In contrast, under the Incoterms
rules EXW (Ex Works), FCA (Free Carrier), DAT (Delivered at Terminal), DAP
(Delivered at Place), DDP (Delivered Duty Paid), FAS (Free Alongside Ship), and
FOB (Free on Board), the named place is
the place where delivery effectively takes
place. It is also the place where risk passes from the seller to the buyer.
Therefore, one need to clearly understand what ‘delivery’ means in the context
of the Incoterms Rules.
Delivery and the Transfer or
Risks
The most critical
issue that Incoterms rules actually deal with is the matter of delivery (of the
goods). The Incoterm Rules define precisely when and where ‘delivery’ by the seller
to the buyer effectively takes place. As may be surmised from the foregoing, the
issue is of extreme importance both from the seller’s and the buyer’s point of
view, because risks over the consignment are transferred from the seller to the
buyer simultaneously with the ‘delivery’
of the goods.
For confirmation, and for our own
satisfaction we may, once again, take recourse to the Sale of Goods Act of
India or of the UK. I am selecting only those sections that deal with delivery of
the consignment to a carrier because the major, if not almost all, the export
activities follow this mode. The Sale of Goods Act 1979 of the UK states:
Section
32[2]
titled Delivery to Carrier:
1) Where, in pursuance of a contract of sale, the seller
is authorised or required to send the goods to the buyer, delivery of the goods to a carrier (whether
named by the buyer or not) for the
purpose of transmission to the buyer is prima facie deemed to be a delivery of
the goods to the buyer.
A similar Indian law, the Sales
of Goods Act 1930, states:
39.
Delivery to carrier or wharfinger[3]:
1) Where, in pursuance of a contract of sale, the seller
is authorised or required to send the goods to the buyer, delivery of the goods
to a carrier, whether named by the buyer or not, for the purpose of
transmission to the buyer, or delivery of the goods to a wharfinger for safe
custody, is prima facie deemed to be a delivery of the goods to the buyer.
Section 33 of the Indian Sales of
Goods Act 1930 states:
33.
Delivery.-
Delivery
of goods sold may be made by doing anything which the parties agree shall be
treated as delivery or which has the effect of putting the goods in the
possession of the buyer or of any person authorised to hold them on his behalf.
Article 69 of the United Nations Convention on
Contracts for the International Sale of Goods (1980) [CISG] deals with the
passing of risk when delivery of the goods is at a location other than the
seller’s place of business or to a carrier. This interesting article states,
(1)
…. the risk passes to
the buyer when he takes over the goods or, if he does not do so in due time,
from the time when the goods are placed at his disposal and he commits a breach
of contract by failing to take delivery.
(2)
However, if the buyer
is bound to take over the goods at a place other than a place of business of
the seller, the risk passes when delivery is due and the buyer is aware of the
fact that the goods are placed at his disposal at that place.
Delivery, as we may have noted by
now, takes several forms, broadly divided into ‘physical’ delivery and
‘constructive’ delivery. This could be the reason why the Incoterms 2010, in
its ‘Introduction’ to Incoterms 2010, has chosen to define ‘delivery’ thus:
“Delivery:
This concept has multiple meanings in trade law and
practice, but in the Incoterms® 2010 rules, it is used to indicate where the
risk of loss of or damage to the goods passes from the seller to the buyer.”
The ICC booklet Incoterms 2010,
Sub-section A4 (titled Delivery) under each and every Incoterms Rule clearly
defines what will constitute ‘delivery’ by the seller under that Rule, and his responsibilities for effecting delivery. Similarly,
sub-section B4 (titled Taking Delivery) under every Incoterms Rule defines the
responsibilities of the buyer for taking
delivery of the consignment. This is supplemented by sub-sections A5 and B5
titled ‘Transfer of risks’ which define to what extent the parties bear the
transit risks. Nothing has been left to chance or misinterpretation in this ICC
publication.
For our limited purpose, we
should be very clear as to what we are talking about when we refer to “delivery”
and the transfer or risks with reference to the Incoterms Rules in general or
Incoterms Rules 2010 in particular. Of course, several ‘i’’s are yet to be
dotted, several ‘t’s are yet to be crossed – especially where the respective
costs and responsibilities are concerned. For that, we need not look no further
than ICC Incoterms 2010.
Transit insurance
It’s been emphasized that under
Incoterms rules, risk passes from the seller to the buyer simultaneously with
the ‘delivery’ of the goods. Till the risk has passed, the seller must ensure
safety of the goods. After the risk has passed, the buyer must take over
responsibility for the safety of the goods. Cover for the risk exposure to the
goods in transit is available under marine insurance. Section 4 of the (Indian)
Marine Insurance Act 1963[4], states,
“A
contract of marine insurance (is)......to protect the assured against losses on
inland waters or on any land risk which may be incidental to any sea voyage.”
Two important points need to be
noted. The first is that while marine insurance offers cover for losses against
hull, liability, income and cargo, our interest is restricted to marine cargo insurance. The second point of
note is that a contract of marine insurance protects the seller or the buyer against
losses in transit – not only over the sea but also over land or inland
waterways which may be ‘incidental to any
sea voyage’. This aspect requires a more detailed explanation, as below.
Warehouse to warehouse
The concept of the familiar ‘warehouse
to warehouse’ clause was modified after the revised version of Institute Cargo
Clauses 2009 came into effect. Clause 8.1 reads as follows:
“Subject
to Clause 11 below, this insurance attaches from the time the subject-matter
insured is first moved in the warehouse or at the place of storage (at the
place named in the contract of insurance) for the purpose of the immediate
loading into or onto the carrying vehicle or other conveyance for the
commencement of transit, continues during the ordinary course of transit and
terminates either….”
Unfortunately, instances are far
too many to enumerate where the start of the cover is described as “when the
goods leave the warehouse”. This is
no longer the position. Note the conjunction of the three expressions (a) ‘first
moved’, (b) ‘for the purpose of immediate loading into or onto the carrying
vehicle’, and (c) ‘for the commencement of transit’. The ICC Drafting Group
gave two examples to explain the situation, thus:
- If the goods are shipped on 1 September and insurance is effected
on 4 September, the inclusion of a warehouse-to-warehouse clause will not
backdate coverage to 1 September.
- If insurance is effected on 27 August for a shipment expected to
take place on 1 September, the goods will not be covered if destroyed by a
fire in the warehouse on 30 August. For cover to be retrospective, there
has to be an express provision to that effect.
The implications, therefore, could
be further clarified as follows:
a) If the goods (meant for shipment) are simply sitting
in the seller’s warehouse, then these are not
covered by transit risks insurance, marine cargo insurance or the Institute
Cargo Clauses 2009.
b) The consignment is not covered by transit insurance if
the cargo is being arranged, rearranged or moved within its area of storage or
the warehouse – even if the purpose is eventual loading on to the transport
vehicle or shipment to destination, unless the initial movement is part of its
journey towards its destination.
c) The transit risk cover is triggered, becomes applicable
or operational, only when the consignment begins
its journey towards its destination. The goods do not have to leave the warehouse for the transit
insurance cover to apply. The cover is triggered immediately when the goods are
“first moved in the warehouse or at the place of storage”. The risk cover is thus
coterminous with the transit (journey) of the goods – all the way till the end
of the voyage, over land, sea or inland waterways.
d) The journey should not be interrupted by anyone other
than those responsible for its carriage, until terminated as defined by clauses
8.1.1 to 8.1.4 (whichever is earlier).
Caution areas:
a) Those who are still using the ‘warehouse to warehouse’
clause need to re-examine the status of the transit insurance cover vis-à-vis
the changes since 2009.
b) The mere showing of a shipment date in a policy
document is not considered evidence that the cover commenced from that date.
c) Care: “An insurance document that indicates coverage
has been effected from “warehouse-to-warehouse” or words of similar effect, and
is dated after the date of shipment, does
not indicate that coverage was effective from a date not later than the date of
shipment (emphasis added).” (ISBP 745, paragraph K10.c).
d) Such a transit insurance document must, therefore, clearly
state that coverage was effective at
least from the date of shipment.
CIP, CIF Incoterms 2010
Sub-sections A3(b) and B3(b)
under each of the Incoterms rules define the obligations of the seller towards transit insurance. CIP and CIF are the
only two of the eleven Incoterms rules that enjoin the seller to procure insurance.
Under no other rule is the seller or the buyer under any obligation to procure
insurance cover for the cargo in transit. The obligations of the seller under
CIP are as follows:
1) The seller must obtain at its own expense cargo
insurance complying at least with the minimum
cover as provided by Clauses (C) of the Institute Cargo Clauses (LMA/IUA) or
any similar clauses.
2) It should entitle the buyer, or any with an insurable
interest in the goods, to claim directly from the insurer.
3) The insurance shall cover, at a minimum, the price
provided in the contract plus ten per cent (i.e., 110%) and shall be in the
currency of the contract.
4) The insurance shall cover the goods from the point of
delivery to at least the named place of destination.
5) The seller must provide the buyer with the insurance
policy or other evidence of insurance cover. Moreover, the seller must provide
the buyer, at the buyer’s request, risk and expense (if any), with information
that the buyer needs to procure any additional insurance.
The clauses under CIF Incoterms
2010 are very similar to CIP as outlined above. The provisions of Article 28 of
UCP 600 are also reflected in the above.
Which party should arrange cargo insurance?
The simplest answer is, it
depends. Anyone who has an insurable interest in the cargo shipment – anyone
who would suffer a loss if the cargo was damaged or destroyed, or who would
benefit from its safe arrival – needs the protection of cargo insurance cover.
The parties closest to the transaction are the seller and the buyer.
Institutions, including the seller’s or the buyer’s bank financing against the
cargo, would also have beneficial interest in the safe transit of the cargo.
Between the seller and the buyer
it would depend on what these two parties mutually agree on about cargo
insurance, and so include in the contract. Where ICC Incoterms Rules are used
as reference points in the contract, the Rules become legally binding upon all
parties.
Irrespective of whether it’s the
exporter or the importer that buys cargo insurance, there are distinct
advantages in having control over who buys the cover. There are several reasons
for doing so. For example, if it’s the exporter, he is more likely to have
complete and necessary knowledge of technicalities and problems pertaining to
the goods, rates of insurance and other matters. Where the exporter has sold
the goods on extended credit terms, he is financially at risk while the goods
are in transit to the overseas destination, and hence more concerned about the
safety of the cargo.
That apart, there may often be
different insurance contracts in effect for different sections of the cargo’s
movement from the seller’s warehouse to that of the buyer’s. In the case of
loss or damage, particularly concealed loss or damage, or for determining
‘general average’, it could become exceedingly difficult to determine which
insurer is responsible and to what extent. ‘Warehouse-to-warehouse’
(end-to-end) cover with a single underwriter eliminates this possibility.
Generally speaking, the party
procuring the cover is naturally free to choose its own insurance company, deal
through its own broker or agent; and also negotiate the rates for
competitiveness – thus reflecting the assured’s own turnover and experience.
Protection is provided with proper terms of insurance specifically designed for
the assured’s goods and methods of shipment. Such insurance provides coverage
for the full exposure, at proper values and adequate limits.
Depending on who has the primary
insurable interest, or has taken out the original cargo insurance cover, the
counterparty should take out a contingent insurance policy.
Contingency
insurance
This type of insurance cover is
also known as “seller’s or buyer’s interest” coverage. It is insurance coverage
taken out by a party to an international transaction to insure against
insurance coverage taken by the counterparty if it is geared more towards the
latter. Contingency insurance protects importers or the exporters, allowing
them to insure their cargo on a “contingent” basis in situations where
Incoterms Rules or the purchase contract dictates the other party to provide
cargo insurance. The contingent insurer, in effect, advances payment to its
beneficiary and attempts to collect from primary insurer.
Contingency insurance is a backup
insurance. It does not replace primary
insurance. It works only when the counterparty provides primary cover – the
other having no control over the insurance arrangement, thereby exposed to
risks in transit – and the primary insurer fails to pay a covered loss.
Contingency insurance is
triggered by:
- A physical loss to the cargo.
- The other party’s insurance being non-responsive and/or the other
party refusing to pay for the goods.
Who should buy contingency
coverage? It is available to both the importers and exporters who:
- Have financial interest in the goods.
- Are uncertain as to the quality of coverage provided by the other
party’s insurance.
- Want reassurance knowing their trusted insurance provider will
assist if things do not go as planned.
Importers who buy on credit terms
may also want to consider contingency coverage. For exporters, the need for
contingency insurance is even more if they sell on FOB or FAS terms or provide
open account credit terms[5] to their buyers.
Contingency insurance cover comes
with a strict condition stating that the insured cannot divulge the existence
of the contingency coverage to any party. The fear is that, otherwise, the
responsible party may neglect to secure insurance on the cargo, or fail to put
in his best efforts to retrieve the situation, if aware the other party has
backup insurance.
A passing thought
On 31 August 2016, Hanjin
Shipping filed for bankruptcy protection. Hanjin was stated to have 141 ships. As
of 5 September, reportedly, 79 Hanjin vessels including 61 container ships and
18 bulk carriers were stated to have been denied port access. According to
Korea International Trade Association, Hanjin vessels were then carrying cargo
worth 16 trillion won (US$14.5 billion) belonging to some 8,300 cargo owners.
Payment terms would be as varied as the colours in a rainbow – including LCs,
collections bills, and delivery on open account basis. Settlement of huge
amounts was at stake.
This sudden development is a
testing time for the entire international trade community. The question is, if
the buyer or the seller had availed of contingency insurance cover, would that
have made a difference to their financial interest in the given situation?
*****
04- Sept-2016
