AN EVALUATION OF THE STANDARD F.O.B AND C.I.F CONTRACTS FOR SELLERS AND BUYERS
Abstract
The C.I.F and the F.O.B are contracts that deal with international sale of goods and export transactions. In most cases, the F.OB contract is utilized in local commercial transactions. These terms are used in international transactions to maintain certainty, uniformity and predictability in international trade agreements. These contracts harbor both benefits and risks that need to be considered by both the buyer and seller before they decide to take either the FOB or ICF contact in their business transactions.
There are legal implications for sellers and buyers in preferring an F.O.B or C.I.F contract terms. These implications may be based on the legal rights and obligations of the seller and buyer under these types of contracts. In this perspective, the buyer under the F.O.B contract has to bear the fluctuation risk related to insurance premiums and freight rates. In both the F.O.B and C.I.F contract, both the seller and the buyer have some obligations which they have to abide by. These obligations have both the disadvantages and advantages related to them. Therefore, the contract provisions sometimes appears beneficial to the seller and at other times to the buyer. Most of the disadvantages associated with this type of contracts are mainly related to the mode of transit under these contracts, which are only by sea transport. However, sellers and buyers could use alternative contracts, which may not be based on sea transport. These may include EXw Contracts, Delivery at Place, Delivery at Terminal, and FCA contracts.
Introduction
The C.I.F contract which stands for ( Cost, Insurance and Freight) and the F.O.B ( Free on Board) are contracts that deal with the international export transactions and sale contracts. However, the FOB contract is in most cased utilized in local commercial transactions. The purpose in the use of these terms in international transactions is to maintain certainty, uniformity and predictability in international trade agreements ([1]).
Currently, these terms have not been regarded as a binding standard to the participants in the export contract as they could be modified by a necessity or agreement since the parties have their specific rights and freedom in the contract. The F.O.B and C.I.F agreements are only part of the standardized trade terms created by the International Chamber of Commerce (ICC) in 2010. Apparently, these terms have been regularly customized so as to fit in with the changing commercial practices of the time. The trade terms are significant to contracts involving international export sales since they stipulate the obligations and duties of each party in the contract including delivery method, price as well as other incidental charges that may be related to the export transaction([2]).
According to Goode ([3]), three types of F.O.B contacts exist. These include the classic or strict F.O.B contract, F.O.B with extra services and simple F.O.B. With regard to the classic contract, the seller is not obligated to pay freight or insurance fees but has a right to choose the port of shipment and a nominated vessel for his cargo. On the other hand, the buyer is responsible for nominating the vessel, and clearing freight and insurance costs. The C.I.F contract on the other hand, is the most popular and comprehensive contract involving the international export trade. Similar to its F.O.B counterpart, it also embodies three various types of contracts include marine insurance contract, contract of carriage and the contract of sale between the buyer and the seller ([4]). The purpose of this paper is to evaluate the advantages and disadvantages of the standard FOB and CIF contract for both seller and buyer. The paper also aims to evaluate some of the alternative business transaction forms that can be effectively utilized by the buyers and sellers.
Discussion
F.O.B
Advantages to the seller
For this type of contract, the seller is in a good position to recover the goods before boarding the vessel or the goods reach the buyer especially when the buyer breaches the terms of contract or defaults payments for the transported cargo. Apparently, the seller is under this contract, obligated in the loading stage operation up to when the cargo passes the ship rail. In normal cases, the property and risk are passed on shipment. This terms also ensure that the seller does not use high transport costs and has limited liability for the cargo being transported ([5]).
Advantages to the buyer
Among the benefits of the FOB contract to the buyer is that he is in a position to control the movement of goods from the seller and can be able to negotiate the freight or insurance costs when they do contracts with companies which they regularly interact with. Again, the buyer is the controller of the shipping document since he is the one to choose the ocean vessel and keeping all payment papers in the whole process of transporting the cargo. In the case when a buyer realizes damages or shortages in the shipped merchandize, a situation referred as a “breach”, he has a right in taking steps in reverting the good’s ownership to the seller until the situation is amicably resolved. In the case when a buyer notices such a “breach”, he has a right as we have noted above to revoke acceptance of the goods and pass on the freight claim to the carrier who will then be obligated to pay for the damages or loss([6]).
Also under F.O.B contract, the buyer has an advantage in that he is the one to determine the cost and speed in transporting the cargo. Moreover, the buyer does not need to evaluate the goods once delivered but reserves the right to reject them. If there is an agreement allowance between or among the parties involved and there appears to be a defect cause that deviates from this agreement, the buyer has a right to reject the documents or goods altogether. This may become a demerit on the part of the seller ([7]).
Disadvantages of FOB
To buyers
To buyers, F.O.B presents burdensome duties especially on those buyers who doesn’t possess sufficient expertise and knowhow in undertaking these tasks themselves. Again, the buyer can greatly suffer if the merchandize get lost or is damaged while on transits. The buyer is expected to bear for the consequences of any occurrence in the merchandize once the cargo has crossed the ships rail. Apparently, the buyer is mandated to select the vessel or ship for loading. If he does not succeed in doing so, it may lead to a repudiation of the simple F.O.B contract. Again, if there comes a need for substituting the ship or its vessels, the buyer is mandated to bear all the added charges ([8]).
Sellers
Sellers have to bear full liability for the safety and cost of the goods until they successful pass through the ship’s rail. In addition, there is a low possibility (if any) for the seller to recover the goods after the cargo has successfully passed over the ship’s rail. In addition, the seller may not be able to recover the good’s price in the case when a buyer fails to select an effective ship ([9]).The FOB contract cannot be regarded as a documentary sales as say, the same way as in C.I.F contracts. Although a seller under F.O.B contracts may have documentary duties, the documents does not act as substitutes for his or her physical obligation in loading the merchandize the same way as CIF documents are used for the physical delivery of the goods at the discharge port. If there is an agreement allowance between or among the parties involved and there appears to be a defect cause that deviates from this agreement, the buyer has a right to reject the documents or goods altogether([10]).
Also in the case when a buyer takes out insurance for the merchandize, the seller will in this situation not be privy to the contract. Secondly, if the goods being transported are damaged or lost in the process, the buyer may decide to reject the goods altogether including its validity and the seller will be obligated to bear for the loss incurred in the process. Consequently, if a seller had taken out insurance under the extended terms of F.O.B, the rights in the insurance claims will be transferred to the buyer ([11]).
General Disadvantages of F.OB
In general, commercial trend has over time changed. This has led to F.O.B contract clause that are more sophisticated and which aims to satisfy the requirements and needs of traders. Although there are some benefits associated with these changes, they are definitely poised to create confusion between the contractual parties there is a dispute. This confusion may come along when the contract provisions are not clear with regard to the time limitation of the actual contract. For instance, confusion may occur where the provision of time is applied to one particular party or where a particular terminology is lifted into sale contracts ([12]).
C.I.F
Advantages to the buyer
In most cases, the price paid by the buyer includes all the costs involved up to the destination point. The buyer only expects to receive the goods. This contract frees the buyer from the local customs of the seller. In addition, it makes it easy for the burden of work on the part of the buyer since he will not be involved with freight and insurance costs as these issues may be a cumbersome process in a foreign nation. The buyer is also protected against damages or loss of goods through the insurance policy, and lading bill, which gives a contractual right against the carrier. The insurance policy is responsible for taking care of accidental losses and damages ([13]).
Additionally, under C.I.F contract, the buyer is in a good position to know right from the contract date, the actual price he or she will pay for the merchandize to reach him or her. These include the insurance and freight charges. Apparently, the use of documents in the whole process of the contract in the representation of the merchandize enables the parties to effectively deal with the goods afloat. This becomes an advantage to the buyer as he or she may decide to resell the goods even before they reach the destination. Documentation in the contract process makes it easy for financial institutions to be involved. These documents have the prospects being directly transferred to the buyer’s bank and act as security for the price advance. With these documents, most financial institutions will be willing to pay price advance by holding the documents in situations when they are not ready to take possession of goods and when the documents are to be made using the banker’s documentary credit([14]).
Advantages to the seller
On the part of the seller, the C.I.F contract is also advantageous to him or her since in most cases, he is in a position to understand the local export customs. In addition, he or she will be able to negotiate reduced rates on freight and insurance as a constant exporter and therefore, making the cost low for the importing party. Again, the seller is sure of receiving payments from the transaction as well as in receiving goods. This is in spite of if the merchandize were damaged in the process of transportation or they never reached the intended destination provided he presents the contract documents[15].
The C.I.F contract term is able to serve the seller’s interest since he is the person behind the shipping and the one who was issued with the lading bill. This means that little queries if any should arise on the seller’s right to possession of the goods. Further, the seller is also sure that the insurance for the merchandize has been procured and therefore, does not have much worry on the good’s safety. The seller is able to recover the good’s value in the case of damage or loss before payment is issued. In this perspective, it becomes easier to arrange credit and banking facilities where some of the benefits will also go to the buyer in the form of easier credit and financial facilities([16]).
Disadvantages
Among the disadvantages associated with C.I.F contracts are that the buyer will be left with nothing in his hands except the contract documents while the goods are on transit. This ultimately makes the buyer’s condition to be insecure as he is only left with the carrier and insurer to deal with and he may find it hard in recovering the goods from them. Secondly, if the goods have been damaged or become deteriorated in the transit process, the loss is transferred to the buyer and not the seller ([17]).
Another disadvantage associated with the CIF contract is that most of the risks are passed on to the buyer in the entire contract process. The 1979 sales of goods act stipulates that after the goods have been delivered, all the associated risks are transferred to the buyer. Apparently, the risk passes to the buyer immediately the seller ships the goods. These requirements appear to be harsh on the part of buyers in comparison to sellers. In addition, the risk is passed to the buyer in the shipment process. These includes if the merchandize is lost or damaged while being loaded onto the cargo. This is irrespective of whether the seller was aware of the probability of such risks or not. Again in a case where the goods cannot be unascertained, as when they are shipped in bulky, the documents cannot be used in proving the goods sold([18]). This makes the CIF contract to be at other times, vague.
Another disadvantage associated with this type of contract is that a buyer is not given the right to reject the documents or goods if they are in good condition and matches his specifications. Rather, he is simply expected accepted them in that condition and duly pay for them. The process involved in the passing of property and the separation of risk shows some natural potential problems. This is because the buyer may not be in a position of claiming a right of ownership for the goods or instigate a tort action against the loss or damages that occurred to the goods before he actually receives the goods([19]).
There are requirements for CIF contracts for very strict compliance. For instance, if there is a stipulation for a tendering date, failure for either party to adhere to this date will give a right to the buyer not to accept the documents, regardless of whether he suffered a loss or not. Again, the seller has no obligations in ensuring that the documents arrive prior to the arrival of the vessel ([20]). This may lead to delay and as such, there needs to be found a faster way of exchanging these documents. Owing to these factors, it can be argued that the CIF terms seems to be appealing and beneficial to both the buyer and the seller but better serves the interest of the seller more than the buyer([21]).
Alternative Means of International Business Transactions
. FCA
FCA contract which stands for Free Carrier is a description of an obligation for delivering goods to the buyer under international sale of goods, carriage contracts and shipping. In the free carrier contracts, the party selling the goods is obligated to deliver them to the place suggested by the buyer such as a shipping terminal, airport and so on. In the case where delivery takes place in the seller’s premise, the seller has an obligation of loading the goods. On the other hand, the buyer is mandated to unload the goods once the seller has delivered them[22].
Among the benefits for FCA over other contracts such as FOB OR CIF are that they can be utilized where more than one means of transport are used in delivering the goods. Additionally, the seller will be responsible in ensuring that the goods reach the buyer. The buyer also chooses the destination where he wants the goods delivered. As can be seen, this method eliminates some of the disadvantages associated with F.O.B and C.I.F contracts.
DAT
This term which means Delivered at terminal is a type of contract which mandates the seller to deliver goods at the buyer’s premises or destination named by him. The risks involved in transporting the goods to the final recipient are rested on the seller ([23]).
DAP
DAP which stands for delivered at place is also a type of contract that can be used in any mode of transport or in the case when more than one form of transport is involved in the transport of goods. Again in this contract, the seller is mandated to arrange for the carriage and delivery of goods to the buyer’s destination. This term does not require payment of duties. The seller is however, not mandated to unload the goods in the final terminal ([24]).
EXW contract
EXW is the short form for Ex Works. In this contract, the seller avails the goods at his or her premises. The buyer is expected to upload the goods when they reached his destination. In this contract, term puts much responsibility on the part of the buyer while the seller has very minimal obligations. In most cases, the Ex Works contract terms is utilized during the making of the initial goods quotation without including any extra costs. The essence of the contract term is that the buyer to be responsible for most of the risks involved in transporting the merchandize to his or her destination. The seller has no obligation in loading the goods on collecting vessels or vehicles neither is he obligated in clearance of this goods for sales. If he decides to do the loading anyway, the cost and risk involved in doing so will be transferred to the buyer ([25]).
Apparently, if the parties would wish the seller to be obligated for the loading of the merchandize during departure as well as bearing all the related costs and risks, explicit wording could be added to this contract term with regard to this effect on the contract sale. The buyer is expected to arrange for the picking up of freight in the site designated by the seller/supplier. He or she is responsible in the entire transits freight as well as clearance of the merchandize through customs. On the other hand, the supplier/ seller complete all the documentation with regard to export. This is the time when the cost of goods sold is transferred to the buyer from the supplier/seller. In this perspective, the buyer has to take responsibility in bringing the goods from the seller. This type of contract can also be used even when different means of transport including air, rail, road or water is employed. This becomes an advantage over the use of other contract terms such as FOB or CIF, which are only used in water transport ([26].)
The International Joint Venture or Strategic Alliance
Joint Ventures are currently very popular structure in many international business transactions around the world. In the past years, there existed another form of joint structure that was more complex in the form of strategic alliance. This has also come to be popularly used by many entities in the present perspective. We may wish to assume that a client based in U.S wishes to enter into a joint venture with another client in another country. It should be noted that there are some countries where joint ventures are the only realistic means in doing business in that country. Apparently, laws and regulations of the local nations are designed in such a way they tend to favor local organizations over international firms ([27]). An example can be derived from the people’s republic of China where the authorities encourage joint ventures with foreign organizations with high technological products and are ready to contribute the technology to the venture. Such entities are supported by the government authorities and local laws over activities that are wholly owned.
Many benefits abound for and entity or individual in participating in joint venture. It makes good sense for and individual or entity to collaborate with another business having complimentary capabilities such s distribution channels, finance, technology and other resources. These and many others are the reasons on why joint venture is currently becoming popular as a form of business transaction. Since the parties in the joint venture are meant to compliment with one another, this form of business makes it easy for either party obtain what he or she needs in an easy and faster way, without many legal implications.
Unlike in a limited or general partnership, the main reason why parties form a joint venture is to realize individual gain. In most cases, this may include a share of the objective of the whole project. Other advantages of this type of businesses include offering the parties with an opportunity in acquiring new expertise and capacity. Enable organizations to enter new geographical markets or link them to related businesses. It may also lead to access to more resources including enhanced technology. Unlike the FOB or C.I.F contract, the venture business also makes it easy for the parties to share risks. Moreover, it is flexible whereby; the ventures lifespan is limited and ends once the objectives of the partners are realized. This means that the joint venture does not aim for profit making but to acquire a specific goal by the parties. In this time of consolidation and divestiture, JV has been regarded as offering creative ways for organizations to exit from non-essential businesses.
Conclusion
In conclusion, it should be noted that there are risks, which both the seller and buyer ought to consider before deciding to take either the FOB or ICF contact. In this perspective, they should take into consideration all the necessary factors and assess the contract with regard to the benefits and security. Before a contract is drafted, the parties should consider some factors. Each part has an obligation to consider if F.O.B or CIF contract will be more advantageous on his side that other contract types, in accordance to the subjective circumstances of the parties, shipping conditions and the economic condition of the time. In essence, the general use of F.O.B and C.I.F contract terms should be grounded on how they benefit the concerned parties.
There are legal implications for sellers and buyers in preferring an F.O.B or C.I.F contract terms. These implications may be based on the legal rights and obligations of the seller and buyer under these types of contracts. In this perspective, the buyer under the F.O.B contract has to bear the fluctuation risk related to insurance premiums and freight rates. In both the F.O.B and C.I.F contract, both the seller and the buyer have some obligations which they have to abide by. These obligations have both the disadvantages and advantages related to them. Therefore, the contract provisions sometimes appears beneficial to the seller and at other times to the buyer.
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[1] Bradgate R, Commercial Law, Third Edition, (Butterworths Lexis Nexis, 2003)
[2] Dobson P, Commercial Law, Third Edition, (Cavendish Publishing, 2003)
[3] Goode, Commercial Law, Third Edition, (Butterworths, Lexis Nexis, 2004)
[4] Worthington S, Commercial Law and Commercial Practice, (Har, 2003)
[5] Todd, Paul, Cases and Materials on International trade, (Sweet & Maxwell, London, 2002)
[6] Atiyah, P, Sale of Goods,( Pearson Education,England, 2005).
[7] Schnitzer, Simone, Understanding International Trade Law, (Law Matters Publishing ,UK, 2006).
[8] Benjamin S, Sale of Goods, (Sweet and Maxwell.London,England, 2007).
[9] See the case of Petraco ltd v. petromed International
[10] Bridge, Michale, The International sale of Goods Law and Practice,(Oxford University Press,GB, 2007)
[11] Sassoon, D.M, CIF and FOB contracts,(Sweet & Maxwell, London,England,2005)
[12] Bradgate, R, Commercial Law,(Butterworths ,London, 2010)
[13] Carr, I, International Trade Law,(Cavendish Publishing Ltd,London, 2005)
[14] Feltham J, CIF and FOB Contracts and The Vienna Convention on Contracts For the
International Sale of Goods, (Journal of Business Law September 413-425, 2004).
[15] Dance M, Loss Damage and Expense to Cargo – Avoiding and Reducing The Risks, Due Diligence and Risk Management 3.3(7), 2005
[16] Bridge M, The Carriage of Goods By Sea Act 1992, Journal of Business Law July 379-383, 2003
[17] Bradgate R, Publication Review the International Sale of Goods: Law and Practice (2008) 19 I.C.C.L.R. 305
[18] Reynolds F, Managing Exports, Navigating the Complex Rules, Controls, Barriers and Law (New Jersey, John Wiley& Sons, Inc, 2006).
[19] Seyoum B, Export-Import, Theory, Practices, and Procedures (International Business Press,
2011)
[20] Todd P, Cases and Materials on International Law, (1stedn, Sweet& Maxwell 2002)
[21] Sellman P, Law of International Trade (4thedn, Old Bailey Press 2008)
[22] Drukker,, FCA Free Carrier, 2013, Available from
http://www.drukker.co.uk/publications/reference/fca-agreements/#.UtD39qyMBFs
[23] Ramberg, J,,International Chamber of Commerce Guide to Incoterms, ICC Publication No. 720 2011 Edition
[24] ibid
[25] Bridge, Michale, The International sale of Goods Law and Practice,(Oxford University
Press,GB, 2007)
[26] ibid
[27] Alberta, B, Advantages and Disadvantages of a joint Venture, (2012) Available from
http://www.businessbrokeralberta.com/uploads/9/5/9/4/9594203/wp8-pros_and_cons_of_jv.pdf
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