Commercial Aspects in International Contracting notes

COMMERCIAL ASPECTS IN INTERNATIONAL CONTRACTING

Learning outcomes

Upon completing this topic, you should be able to:

  • identify the use of INCOTERMS in international trade as well as the different rules under INCOTERMS 2010.

 4.1 Introduction

The Incoterms 2010 rules (International Commercial Terms) were developed the International Chamber of Commerce (ICC) as a uniform set of rules to clarify the costs, risks and obligations of buyers and sellers in international commercial transactions. Because they address issues relating to import and export, Incoterms 2010 rules are most appropriate for use in international shipping.

Incoterms 2010 rules are periodically revised and multiple versions are available for use contracting parties. The Incoterms 2010 rules became effective January 1, 2000, and remain in effect. The Incoterms 2010 rules are effective as of January

4.2 International Commercial terms (INCOTERMS)

The INCOTERMS rules were developed International chamber of commerce (ICC) as inform set of rules to clarify the costs ,risks and obligation of buyers and sellers in international commercial transactions. Because they address issues relating to import and export.

The terms are structured to increase incrementally the obligations (control, risk and cost) one  party while decreasing the obligations of the depending on the specific term chosen. Each term clarified which party is responsible for:

-Inland freight (transportation within the organization country

– Forwarder selection

– Export clearance

– Carrier selection and scheduling

-International freight

-Import clearance

-On-carriage (transportation within the destination country)

4.3 Terms used in INCOTERM of any mode of transport

  • EXW(Ex-warehouse /ex-store)-named place of loading

The seller makes the goods available at their premises. This term places the maximum obligation on the buyers and minimizes obligation on the seller.

Exw means that a buyer incurs the risks of bringing the good to the final distribution

  • FCA(free carrier)-named place of delivery

The seller delivers the goods, cleared for export at a named place

  • CIP (carriage and insurance paid)

The seller is required to obtain insurance for the goods in transit

  • DAT (delivered at terminal)

Named terminal at part or place of destination. This means that the seller covers all the cost of transport i.e (export fees, carriage etc) from mail carrier at the destination port

  • DDP (Delivered duty paid)-Named place of destination)

Seller is responsible for delivering the goods to the named place in the country and pay all costs for goods

4.4 Rules of sea and Inland water transport

 (a) FAS (free alongside ship)

The seller delivers when the goods are placed alongside the buyer vessel at the named part of Shipment. This means that the buyer has to bear all costs and risks of loss or damage to the goods from that moment. This term allows the seller to clear the goods from export on the b

(b)FOB (free on board)

Means that the seller pays the delivery of goods to the vessel including loading. The seller must also arrange for export clearance

(c) CFR(cost and freight)

The seller pays for the carriage of the goods up to the named part of destination. Risk transfers to buyers  when goods have been loaded on board the ship in the country of export.

(d) CIF(cost, insurance and freight )

The seller is required to obtain insurance for the goods while in transit to the named part of destination

4.4.1 The responsibility of the supplier the current EXW (Ex-works)

-He or she makes the goods available to their premise

-He or she is responsible for off-loading the goods to their premise

– He or she is in-charge of the transport charges when ship is approved

4.4.2 The responsibilities of buyer under the current EXW Incoterm

Buyer is the one to incur the risk of bringing the goods at final destination

-The buyer arranges the pick- up of freight from the supplier designated ship site

-Buyer is responsible for clearing goods through customs

– Buyer is responsible for completing all the export documentation

 

4.4.3 The responsibility of the supplier if the goods were DDP (delivered duty paid)

Supplier to distribute the good to the port of destination

-Pay all the cost in bringing the goods to the destination eg transportation

– Pay taxes and import duties for bringing the goods to the named place of destination

-Pay risk for off-loading the good to the place of destination

 

4.5 Commodity Markets

Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts.

The commodity trade can be conveniently categorized commodity type as:

  • Food products from agriculture and fisheries (e.g. grains, tea, meat, fish);
  • Agricultural non-food products (e.g. cotton, rubber, tobacco);
  • Ferrous metals (iron, steel, etc);
  • Non-ferrous metals (e.g. tin, gold);
  • Industrial raw materials (e.g. non-metallic chemicals); and
  • Energy (e.g. coal, oil).

4.5.1 Aspects to be considered in commodity markets

(a)Nature of the commodity

(b) Type of the market

(c)  Technological advancement

(d) Distance or nearness to market

(f) Price

(g) Purpose of the commodity

(h) Urgency of the need.

 

4.6 Issues involved in international contract negotiation

Government regulation

– Quantity and quality of goods

-Method of delivery e.g road, rail etc

– Carriage charge cost

– Delivery time and lead time

– Terms of payment e.g extended payment

 

 4.7 Financial arrangements in international purchasing

4.7.1   Financial and financing documents

The financial documents, bills of exchange and promissory notes are listed below. A short description then follow:

(a) Bills of exchange

The legal definition (Bills of Exchange Act 1882, Section 3) of a bill of exchange is an unconditional order in writing, addressing one  person (drawer ) to another (drawee),signed the person giving it (drawer) , requiring the person to whom it is addressed (drawer),requiring the person to whom it is addressed (drawee) to pay on demand, or fixed or determinable future time , a certain sum in money to, or to the order of , a specified person (payee) or to bearer.

(b)Promissory notes

Whilst not bills of exchange, these are largely subject to the same rules and are used for a somewhat similar purpose, the settlement of indebtness.Instead of being drawn like a bill of exchange the person expecting to be paid, they are made the person who owes the money, in favor of the beneficiary.

(c)  Inspection and sampling order

Prospective buyers frequently need to inspect and sometimes sample the goods before buying them, and it is necessary to be able to authorize a warehouse to permit this to take place.

 (d)Delivery order

This is an order on a warehouse instructing it to deliver goods to the bearer or a party named in the order. Banks issue such orders when goods stored in their name are to be delivered to a buyer or are to be reshipped and have to leave a warehouse.

 (e) Warehouse receipt

This is a receipt for goods issued a warehouse. The document is not negotiable and no rights in the goods can be transferred under it. Delivery orders may be issued against the receipt for the goods which relate to it.

 (f) Trust receipt

When a bank wishes to release documents of title, or the goods themselves, to a customer of undoubted integrity, whilst still retaining its security rights in those goods and / or the proceeds of their sale, it may obtain a complete trust receipt from its customer to whom a loan has been made.

4.7.2 Export financing

There are various methods used in the international sale of goods to pay the purchase price. These are as follows

(a) Drafts covering exports

These may be on sight basis for immediate payment or drawn to be accepted for payment 30, 60 or 90 days after sight.

 (b)Sales against cost advances

These are used where credit is doubtful, exchange restrictions difficult, or unusual delays may be accepted. They are very little used today

(c)  Sales on a consignment basis

No tangible obligation is created consignment sales. In countries with free port or free trade zones, it can be arranged to have consigned merchandise placed under bonded warehouse control in the name of a foreign bank. Sales can then be arranged the selling agent and arrangements made to release partial lots out of the consigned stock against regular payment terms. The merchandise is not cleared through customs until after the sale has been completed.

(d) Collection arrangements

Where a collection arrangement is organised the seller hands the shipping documents including the bill of lading to his own bank, the remitting bank, which passes them on to a bank at the buyers place, the collecting bank. The collecting bank then presents the bill of exchange to the buyer and requests him to pay to accept the bill.               

(e) Letters of credit

These are of particular importance. A letter of credit arrangement will be agreed upon in the contract of sale. The buyer instructs a bank in his own country ( the issuing bank) to open a credit with a bank in the seller’s country ( the advising bank ) in favour of the seller, the specifying the documents which the the seller has to deliver to the bank for him to receive payment.

(f) The doctrine of strict compliance

Under this doctrine, the seller, to obtain payment, must tender documents which strictly comply with specifications the buyer, otherwise the correspondent bank will refuse to honour the credit. The banks which operate the documentary credit act as agents for the buyer, who is the prinicipal and as such they should not pay against documents that are different from the specified.

4.8 Ethical issues in international purchasing

Ethic is the moral principles governing or influencing conduct. It is the branch of knowledge concerned with moral principles

4.8.1 Some ethical concept and principles that relate to procurement are

(a)Conflict of interest

(b)Fraud

(c)  Corruption i.e direct and direct

(d)Coercion

(e)Collusion (scheme or arrangement of two or more suppliers without or with knowledge of an organization

(f) Illegal /Immoral activities in the host country such as pollution the environment

(g)Pricing e.g unfair differential pricing

(h)  Products /technology

4.8.2The four common fraud scenarious in procurement include:

  • A person with responsibility for buying defrauds his / her employed
  • Supplier defraud their customers
  • Buyer makes personal gain at the expense of the supplier
  • Suppliers buyers work together to defraud the buyers employers

4.8.3 Indicators of frauds in international purchasing

  • Excessive supplier hospitality in selected staff
  • A buyer life-style changing dramatically
  • Pricing schedules being completed in pencil
  • Supplier payments going unchallenged
  • Suppliers and contractors being very familiar with senior staff
  • Budget holders pressurizing buyers to place work with named suppliers
  • No supplier visits or audits
  • Specifications favouring or particular supplier
  • The absence of supplier approval data

4.8.4 Measures to control fraud

  • Separate the purchasing department from the user department
  • Separate recording from storekeeping duties
  • Purchasing authority should be based on seniority
  • Have an ethical code of conduct in place
  • Carry out internal and external spot auditing
  • Develop a company culture of honesty leadership example

 

Revision Questions

Example_. INCOTERMS 2010 clarify the responsibilities of parties. Elaborate.

Solution: The terms are structured to increase incrementally the obligations (control, risk and cost) on one party while decreasing the obligations of the other, depending on the specific term chosen. Each term clarifies which party is responsible for:

  • Inland freight (transportation within the origination country)
  • Forwarder selection
  • Export clearance
  • Carrier selection and scheduling
  • International freight
  • Import clearance
  • On-carriage (transportation within the destination country) Delivery occurs (and risk of loss transfers) at the point designated the term selected. Transfer of title is NOT covered any of the Incoterms 2010 rules and must be separately specified parties

EXERCISE 1. Define the term INCOTERMS and describe the history and origin of  INCOTERMS

EXERCISE 2. Describe clearly the role of INCOTERMS in international trade

EXERCISE 3. Define the 4 rules of incoterms 2010 for inland and water transport only

Further reading

1.International Chamber of Commerce (1999), Incoterms 2010, ICC Publication No 560

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