A Fiery Illustration of Why You Must Learn and Use Incoterms

Ready, set . . . burn? 

Luxury car aficionados are mourning the loss of nearly 4,000 vehicles that set ablaze in the middle of the ocean. Yes, dear reader, you read that correctly: cars have caught fire on water.  (This, incidentally, is proof that the universe has a sense of humor.)

On Wednesday, February 16, 2022, the Felicity Ace, a Portuguese cargo ship carrying thousands of Volkswagen Group vehicles, caught fire.  This led to a military-sponsored evacuation of its 22 crew members, and the loss of cars, many branded as Porsche, Audi, and Lamborghini. Many were destined to arrive at the Port of Houston, but none would eventually accrue to this firm’s account.

While this unusual fire made global headlines for its inherent absurdity, there are genuine questions of law to consider.

• Who is liable for the damages and losses caused by the fire?
• What recourse exists for the importer of the vehicles? The shipper?  The manufacturer?  The dealer?  The insurer(s)?
• What kind of contractual provisions would address these very real concerns?

Enter the gloriously utilitarian Incoterms (International Commercial Terms). Incoterms are a set of 11 rules set forth by the ICC (International Chamber of Commerce) that defines the common contractual relationships between buyers and sellers in international transactions involving the sale of goods. Updated every ten years, Incoterms provide a universal set of contractual terms for parties to simplify contract negotiations and drafting. Complimentary resources on our website include an easy “cheat sheet” here.

There are two groups of Incoterms: “any mode of transport,” and “rules for sea/inland waterway transport.” Aptly named, the terms are split based on which method of transportation is chosen for the goods. However, why are these terms important? Because they are globally accepted contractual standards for determining costs, risk, and loss associated with shipments.

(Between COVID-19, CARFIRE-22, and various land invasions of sovereign countries, supply chain breakdowns are now a regular occurrence.)

For example, should a seller of goods want the lowest amount of liability and responsibility in a contract, they would want to utilize the “Ex Works” (EXW) Incoterm. This rule states that a seller delivers the goods when it places the goods at the buyer’s factory, warehouse, or other predetermined facility. The seller is not responsible for loading the goods into the shipper’s vessel or vehicle, nor are they responsible for handling any export requirements. Thus, the seller is not responsible for the transportation or insurance of the goods.

In contrast, a purchaser might insist on “Carriage and Insurance Paid To” (CIP), another Incoterm. CIP assigns most of the liability and responsibility to the seller, who under this term is contractually responsible for transportation and insurance of the goods.

Using our burning buddy Felicity Ace as an example, where would liability fall? While there are many details sure to come out during the coming investigation, we can make some initial assumptions. Since the goods in transport were (at least in part) luxury vehicles, it is likely that the parties used the CIP Incoterm. While this is for the buyer’s ease of mind, it is also a quasi-requirement if the parties used a letter of credit to finance the transaction. In CIP, the seller quotes a price to the buyer that includes the cost of broad insurance coverage. Thus, liability would fall upon the seller as they are responsible for transporting and insuring the goods until they reach their ultimate destination (or, at least, the destination the parties determined is the seller’s ultimate destination for liability and responsibility purposes). Since the Incoterm designated the seller is responsible for transportation and insurance, it will be the seller (read: the seller’s insurance issuer) that is liable for any loss or damage to the vehicles.

So, what does this all mean in practical terms? It does not mean incorporating a wide variety of contractual clauses around wildly improbable events.  Rather, it simply means that contracts involving shipments should incorporate Incoterms to determine from the contract’s outset who is liable for what at a given moment in the shipment lifecycle.

Incoterms can radically alter how risky or valuable a contract becomes. How can you ensure the most favorable terms? Contact us today!