Saturday, April 22, 2017

Incoterms 2010, Insurance and Risk Management[1]

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) 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:
  1. 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.
  2. 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:
  1. A physical loss to the cargo.
  2. 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:
  1. Have financial interest in the goods.
  2. Are uncertain as to the quality of coverage provided by the other party’s insurance.
  3. 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

[1] First published in Trade Services Update, Ontario, Canada, Volume 19, Issue 1, January-March 2017
[2] (UK) Sale of Goods Act, 1893. , Chapter 71, 20th February, 1894,
[3] The term is now obsolete; today a wharfinger is usually called a ‘harbourmaster’.
[4] Very similar to the Marine Insurance Act 1903 of UK.
[5] An estimate suggests that around 80% of the world trade is on ‘open account’ or on ‘collection’ (i.e. non-LC) basis. 

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