This article has been written by Janki Joshi pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution LawSikho.
India’s merchandise export witnessed a huge jump of 58% year-on-year and touched a record $34 billion in March of this year, indicating a recovery in demand, preliminary data released by the government showed. Sequentially, the growth in merchandise export was 21%. Indian export of goods and services, as a percentage of GDP is 18.41% and import is 21.14%.
With this much import and export, it is important to know about the important International Commercial Terms (Incoterms). In the course of international trade, it is complex to understand the extent of liability of seller and buyer towards the traded goods. The incoterms provide clarification in that matter. FOB is one of the 11 terms of the latest Incoterms 2010 rules. It was developed by the cooperation of 134 countries with the support of the International Chamber of Commerce (ICC) and recognized by UNCITRAL.
This article will provide you with information about one of such incoterms: Free On Board (FOB). In simple terms, FOB means the seller has the responsibility to load the shipment in a particular vessel. After that all the responsibility of the shipment is of the buyer.
The article will also give you a brief insight in the area of marine insurance and the types of marine insurance policies.
Incoterms and their meaning
- EXW (Ex Works): This means that the seller will hand over the ownership of goods to the buyer at a point agreed by both the parties. And after the transfer of ownership all the responsibility of shipping the goods will be on the buyer.
- FCA (Free Carrier): The seller makes the goods available on his own place of business or at some other location agreed by the parties and after that the buyer has to clear all the obligations, starting from the clearance of export.
- CPT (Carriage Paid To): The same responsibilities and terms apply with this term as with the FCA, but in this case the seller also pays all delivery costs to a certain location.
- CIP (Carriage and Insurance Paid): It is the same as CPT and the seller will have the same responsibilities. But, in addition to that, the seller has to pay the insurance charges and the coverage of that insurance should be broad. However, the parties can come to an agreement about the limitation of the coverage.
- DAP (Delivery at Place): Here, the seller is responsible for all the charges that need to be paid until the goods reach a certain location agreed by the parties and after that the responsibilities are transferred to the buyer.
- DPU (Delivery at Place Unloaded): The seller covers all costs and risks to bring the goods to an agreed location. There they can be unloaded and moved to other – or similar – modes of transportation. The seller organizes customs and unloading, but the buyer is responsible for customs clearance and any associated rights.
- DDP (Delivery Duty Paid): All the responsibilities of export, import and everything related to shipment and delivery are of the seller. The responsibilities of the seller are complete only when the goods reach the delivery address of the buyer and are ready to be unloaded.
- FAS (Free Alongside Ship): The seller’s responsibility is to deliver the goods near the loading point. Thereafter, all the duties and responsibilities of import-export clearance transfers to the buyer.
- FOB (Free On Board): The seller’s responsibility is to load the goods on the vessel. Also, the seller is liable to clear the export. After the loading and export clearance, the liability transfers to the buyer.
- CFR (Cost and Freight): The same conditions apply as with FOB but the seller must also pay for transportation of the goods to the port of shipment.
- CIF (Cost, Insurance, and Freight): It is the same as CFR. The only difference is the seller needs to pay minimum insurance charges for marine insurance of the shipment.
Free On Board: what does it imply?
FOB is used to bifurcate between the liability of the buyer and the seller. The term is used only in cases where the trade is happening by way of the sea. Let’s understand the situation through an example.
For instance, the seller is a resident of country A and the buyer is a resident of country B. Now, the goods need to be transported via a sea route, starting from port x, in country A and port y, in country B.
Here, the seller has the liability to pay for warehouse services, loading from the place of origin, inland transportation, custom, and terminal charges and loading the goods in the vessel. After the loading, freight charges, insurance, loading and unloading, transportation, customs clearance, import duties, and taxes shall be borne by the buyer.
In a simpler form, from the warehouse to the vessel loading on port x, the responsibility is on the seller and after that all the responsibility is on the buyer.
In the case of B. K. Wadeyar v M/S Daulatram Rameshwarlal , the respondent firm claimed sales tax exemption under Article 286(1)(b) of the Indian Constitution in respect of sales made by them, on the ground that sales were made on FOB basis. According to that FOB they continued to be the owners till those cross the customs barriers and entered the export stream. The court exempted the respondents from payment of tax under Article 286(1) on the ground that the goods remained the seller’s property till those had been brought and loaded on board the ship.
In yet another case, Jiangsu Trigiant Technology Co. v Space Telelink Limited, the petitioner is a supplier of feeder cables and the respondent approached the petitioner with an offer to purchase the goods on a credit of 60 days from the bill of lading. The respondent placed three orders after that and the petitioner contended that they have sold, supplied and delivered the goods to the respondent accordingly. However, only one of the shipments got clearance at the destination port. Due to some internal issues, other shipments did not get clearance. The respondent conveyed via an email that they will pay the due amount, however, they did not do so and because of that petitioner sent a legal notice under Section 433 and 434 of the Companies Act, 2013. In response, the respondents said that they will pay the amount after the delivery of the other two shipments. The court mentioned that, “in case of FOB contracts, the goods are delivered free onboard the ship. Once the seller has placed the goods on board, the responsibility of the seller ceases and the delivery of the goods to the buyer is complete. The goods from that stage onwards are at the risk of the buyer.”
Who will pay the freight in case of FOB origin?
Before going any further we need to understand two terms.
- FOB Origin; and
- FOB destination.
FOB origin means the buyer will take ownership of goods once the goods are shipped in the vessel. After that, all the liability of goods are transferred to the buyer.
FOB destination, on the other hand, means that the seller will transport the goods to a destination port provided by the buyer and the ownership of goods is transferred to the buyer on that destination port.
In the given example, the seller is loading the vessel on port x and his job is done. The ownership is transferred to the buyer. This is called ‘FOB origin’. However, if the arrangement was such that the seller needs to transport the goods to port y then it would be called as “FOB destination”.
Thus, in case of ‘FOB origin’ the freight is paid by the buyer and in the case of ‘FOB destination, the freight needs to be paid by the seller.
FOB in Ocean Marine insurance
During transportation what if the goods are lost or damaged? In such cases, the marine insurance policies help you recover the damages incurred.
Marine Insurance is a type of insurance policy that provides coverage against any damage/loss caused to cargo vessels, ships, terminals, etc. in which the goods are transported from one point of origin to another.
Types of Marine Insurance
- Marine cargo insurance: it is insurance that covers the damage caused to the cargo in the course of transportation.
- Liability insurance: this type of insurance protects the ship in case of a crash, collision, and other such things that is not foreseeable by the policyholder.
- Hull Insurance: this insurance policy provides insurance to furniture and other stuff on the vessel against any accident.
- Freight insurance: it insures the policyholder in case freight is lost.
Difference between FOB and CIF
Under Cost, Insurance, and freight, the cost of insurance and freight needs to be borne by the seller. CIF contract terms mention the extent of liability of the seller towards the shipment and from where the liability of the buyer comes into picture. In this type of contract, the seller delivers the goods, makes arrangements for the clearance for export, gets the goods loaded on the vessel and also pays for the freight and insurance. And the buyer is responsible for the transportation, costs, and risk from the port of destination.
Generally, this type of contract is entered into by a seller who has direct control or ownership of a vessel. The seller’s responsibility includes purchasing export license for the product, Covering the cost and contracts of moving or carrying the goods, insurance to protect the value of the order, providing inspections of products, covering the cost of any damage or destruction to the goods. This sounds similar to ‘FOB destination’, however, there is a difference between the two.
The main difference between the two is the claimant of the insurance. In case of FOB destination, the cost of insurance is borne by the seller and in case the goods are damaged in the course of transportation, the seller himself can claim the insurance. While in case of CIF, even if the cost of insurance is borne by the seller, it can be claimed by the buyer.
Problems with FOB
- It creates confusion for contractual stakeholders in the event of a dispute. Such disputes are prone to confusion when the parties misunderstand the nature of the Incoterms FOB and related contracts such as contract of sale, contracts of carriage, and letter of credit.
- If you are a new buyer- especially with international shipping, FOB might not be the option best suited for you. FOB places a lot of responsibility on the buyer, as they need to comprehend the complexity involved with an international shipment.
- FOB is most often problematic when a freight claim needs to be registered because this is the point when both buyers and sellers often discover that written terms of sale override FOB terms.
- Another problem with FOB contracts arises when the term FCA should have been used instead because goods are containerized or using more than sea or inland waterway transportation. In these situations, FOB, strictly speaking, does not apply to the contract and cannot be used.
Here is a list of important clauses that you don’t want to miss while drafting your FOB contract.
- Term and Termination: this clause will mention the term of your contract, the commencement date. The clause may also mention the reasons and methods for early termination of the agreement.
- Quality and quantity of the goods: mention the agreed-upon terms for the quality of the goods also how much quantity the buyer is purchasing.
- Pricing: Price can be predetermined by the parties and shall be clearly mentioned in the agreement to avoid further discrepancies.
- Shipment schedule: this clause should mention whose responsibility it is to book the shipment. The schedule as to when the shipment will reach the port for the loading, when will it leave the port, when will it reach the destination port; all such details shall be mentioned in this clause.
- Force majeure: this clause is one of the most important clauses for any agreement. This will define the situations that are unforeseeable by both parties. And in case any damage happens to the vessel or goods in the course of transportation because of any of those situations then what will be the course of action for both parties.
- Indemnification: there are instances when one of the parties fails to perform their duties and obligations and due to which the other party suffers losses. In such a situation, this clause can help decide who is liable to make amends to loss of the other party and to what extent losses are covered.
- Dispute resolution: the parties may agree to resolve any future dispute by ways other than court proceedings. This clause will cover other such ways through which parties can resolve these disputes.
- Governing laws: this is also a very important clause while drafting any international contract or agreement because this clause will decide the law that will be applicable to the transaction in place.
Apart from these, general clauses of amendments, assignments, confidentiality, etc. should be complied with without fail.
The main objective of this article is to make you familiar with the terms FOB. Now, here is a quick summary.
- Indian import and export business is increasing and for that, there is a need to understand international trade. Because of this reason, it is important to understand the terms given by the international chamber of commerce.
- FOB is one such inconvenience. It defines the liability of the buyer and the seller and where the ownership is transferred from the seller to the buyer.
- Also, we understood the two terms, i.e., FOB origin and FOB destination.
- Ocean marine insurance is also important while dealing with international trade. And one should know the types of insurances are provided to the policyholder.
- There are similarities and differences between several different terms and we understood the difference between FOB and CIF.
- One needs to understand the terms of FOB very clearly. In case of ambiguity, one should seek clarification from the other party or seek appropriate counsel. Otherwise, one can face many problematic situations in the future.
- Also, make sure that you have included all the important clauses in your agreement before signing and finalizing.
While doing international trade it is important to know and understand the terms of the contract. Because of the lack of understanding, it becomes very difficult to enter into a contract. It might be harmful to you and your business as well. Thus, make sure you understand everything written in the contract before signing it.
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