INCOTERMS: What They Are & How Mistakes Cost Millions
As international business lawyers, we get all kinds of questions—some quick, some complex, some oddly specific, and others so common they come up almost weekly. One recurring question we hear from clients across industries goes something like this:
Quick Question: What Are INCOTERMS, and How Important Are They in Our International Contracts?
Short Answer: INCOTERMS (short for International Commercial Terms) are a fundamental part of cross-border goods contracts. They standardize how cost, risk, and responsibility are allocated between buyer and seller. Used correctly, they streamline negotiations, reduce legal disputes, and prevent costly misunderstandings. Getting them right can save your business significant money and protect you from serious legal liabilities. Used incorrectly—or left ambiguous—they can lead to major financial and legal trouble.
Let’s unpack what INCOTERMS are, why they matter, and how to use them strategically.
What Are INCOTERMS?
INCOTERMS are globally recognized trade terms published and maintained by the International Chamber of Commerce (ICC). Their purpose is to simplify international transactions by clarifying key responsibilities related to the shipping and delivery of goods. They are updated periodically, with the most current version being Incoterms 2020.
These terms aren’t laws, but they carry significant legal and practical weight because they’re accepted by courts, customs authorities, freight forwarders, insurers, and businesses around the world. Understanding INCOTERMS rules is essential for anyone involved in global trade.
Why INCOTERMS Matter
1. They Define Risk Transfer
Each INCOTERM specifies the exact point at which the risk of loss or damage passes from the seller to the buyer. Misunderstanding this point can result in finger-pointing—and lawsuits—if cargo is lost, damaged, or delayed.
2. They Allocate Costs Clearly
INCOTERMS specify who pays for freight, insurance, loading/unloading, export/import duties, and more. When not properly addressed, cost disputes can turn profitable deals into financial losses.
3. They Streamline Negotiations
Instead of negotiating the logistics terms from scratch each time, parties can use widely understood terms like FOB Shanghai (Incoterms 2020) to set expectations quickly. This speeds up contract drafting and reduces ambiguity.
4. They Support Compliance
Customs authorities and regulators around the world rely on INCOTERMS. Using them appropriately helps ensure smoother customs processing and accurate documentation.
Common INCOTERMS and What They Mean
While there are 11 different INCOTERMS, here are three of the most frequently used in international contracts:
1. EXW (Ex Works)
The buyer assumes all responsibilities and costs starting at the seller’s facility. Risk transfers when the goods are made available for pickup.
2. FOB (Free on Board)
The seller covers costs and risk until the goods are loaded onto the vessel at the named port. The buyer assumes responsibility from that point forward. See Beware FOB Shipping Terms.
3. CIF (Cost, Insurance, and Freight)
The seller pays for transport and insurance to the destination port, but risk transfers to the buyer once the goods are loaded onto the vessel.
Each term fits a particular shipping strategy. Choosing the wrong one—or failing to agree on one—can lead to major confusion and liability.
Best Practices for Using INCOTERMS in Your Contracts
1. Specify the Version and Place
Always cite both the INCOTERM version (e.g., Incoterms 2020) and the named place of delivery or transfer. For example:
“Delivery shall be made FOB Shanghai, Incoterms 2020.”
Failing to specify the version may result in the wrong default rules applying—especially if one party is relying on Incoterms 2010.
2. Avoid Conflicts in the Contract
Ensure your INCOTERM clause doesn’t contradict other parts of the agreement. Misalignment between delivery terms, risk allocation, and insurance provisions undermines the clarity INCOTERMS are designed to provide.
3. Customize Where Necessary
INCOTERMS provide a baseline, but they don’t cover every detail. If your deal involves compliance testing, specialized packaging, or third-party inspections, those terms should be addressed elsewhere in the contract—not assumed by the INCOTERM alone.
4. Negotiate from a Position of Strength
Standard forms—such as purchase orders, invoices, or pro formas—often default to one party’s preferred INCOTERM. We’ve seen cases where each party unknowingly accepted terms that worked against their own interests. Always confirm the INCOTERM before shipping begins.
What INCOTERMS Do Not Cover
INCOTERMS are critical—but they’re not comprehensive. They do not:
- Establish ownership or title transfer
- Govern payment terms or schedules
- Address force majeure events or government interventions
- Replace the need for a detailed written contract
They also don’t automatically cover port congestion fees, demurrage, or extended storage unless specifically negotiated. Think of INCOTERMS as the logistics framework—not the entire agreement.
Real-World Examples: When INCOTERM Mistakes Cost Millions
Example 1: Conflicting Terms and a Costly Dispute
A client of ours became embroiled in litigation after relying on a standard purchase order that included EXW terms. The supplier’s invoice, however, stated CIF. Neither party reconciled the discrepancy, and when the goods were damaged in transit, both sides blamed the other.
The case dragged on for two years and cost our client ~$150,000 in legal fees.
Takeaway: Align on INCOTERMS upfront. Don’t assume your forms speak for both parties.
Example 2: Sanctions, Mismatched Terms, and a $3 Million Misstep
We represented a mid-sized U.S. company that had contracted with a Fortune 500 supplier to purchase food products for delivery to Russia. During shipment, the U.S. imposed sanctions in response to Russia’s invasion of Ukraine. Our client quickly diverted the goods to China—incurring a $3 million loss.
Here’s where it got messy. Our client used a purchase order with an INCOTERM that placed all risk on our client. The supplier’s invoice used an INCOTERM that placed the same risk on themselves. Yes, each party had chosen the worst possible term—for their own side.
We argued the invoice controlled, since it came last and was never rejected. We also argued to the other side that a jury would likely favor our smaller, local client over a global mega-corporation.
We settled quickly for over half the amount—but better forms and clearer INCOTERM choices undoubtedly would have led to a much better outcome.
Don’t Wing It with INCOTERMS
INCOTERMS aren’t just shipping lingo. They’re foundational tools for reducing risk, assigning responsibility, and ensuring predictability in international sales contracts. Used correctly, they create clarity. Used poorly—or not at all—they create chaos.
If you’re involved in global trade, don’t rely on guesswork or boilerplate. Understand the INCOTERMS you’re using, and make sure your contracts reflect your intentions.
FAQs About INCOTERMS
INCOTERMS Basics and Misconceptions
Q: What happens if we don’t specify INCOTERMS in our contract?
A: Without INCOTERMS, you’re left to rely on local laws, trade customs, and contract interpretation—which can vary widely from one country to another. This creates major uncertainty about cost allocation, risk transfer, and logistics responsibilities. Courts may apply default rules that neither party intended, often resulting in costly disputes where legal fees exceed the value of the shipment.
Q: Are INCOTERMS mandatory for international trade?
A: No, INCOTERMS are voluntary—but not using them often creates more confusion than clarity. Customs authorities, freight forwarders, insurers, and courts worldwide recognize and rely on them. Drafting your own delivery terms typically reintroduces complexity that INCOTERMS are designed to eliminate.
Q: Do INCOTERMS determine who owns the goods?
A: No. INCOTERMS govern delivery obligations, cost allocation, and risk transfer—but not ownership or title. These are determined by your contract and applicable law. It’s entirely possible for title to pass to the buyer while the seller still bears the risk, or vice versa.
Q: Can we modify INCOTERMS in our contract?
A: Yes, but use caution. You can add provisions—like “FOB Shanghai + buyer arranges additional insurance”—without contradicting the core term. But heavily modifying INCOTERMS defeats their purpose of standardization. If you’re making substantial changes, consider using a different INCOTERM or drafting custom delivery terms altogether.
INCOTERMS in Practice
Q: How often do INCOTERMS change, and do I need to update my contracts?
A: INCOTERMS are updated roughly every 10 years. The most recent version is Incoterms 2020, and the next update is expected around 2030. You don’t need to revise existing contracts unless you’re amending them, but all new contracts should reference the current version. Using outdated terms—like Incoterms 2010—can lead to confusion or disputes.
Q: What should I do if my supplier’s invoice shows different INCOTERMS than my purchase order?
A: Consider stopping the shipment and resolve the discrepancy immediately. Conflicting INCOTERMS create legal uncertainty about cost and risk allocation. Document the agreed-upon terms in writing before the goods move. Courts can apply various doctrines to “battle of the forms” cases, but proactive clarification beats post-dispute litigation every time.
Q: Can we use more than one INCOTERM in a single contract?
A: Not for the same shipment. Each shipment should have one clearly defined INCOTERM that applies from departure to delivery. If your contract involves different types of shipments—e.g., sea freight and air freight—you may use different INCOTERMS for each, as long as they’re clearly documented and don’t contradict each other.
Q: Should small businesses worry about getting INCOTERMS wrong?
A: Absolutely. Small businesses often have tighter margins and less room for error. A single misunderstood INCOTERM can turn a profitable sale into a significant loss. Fortunately, understanding and correctly applying INCOTERMS is a manageable skill that can help small companies compete globally with much larger players.
Modes of Transport and Version-Specific Guidance
Q: What’s the difference between FOB and CIF, and which should I use?
A: FOB (Free on Board) means the seller covers costs and risks until the goods are loaded on the ship. The buyer assumes responsibility after that. CIF (Cost, Insurance, and Freight) means the seller pays for shipping and insurance to the destination port, but risk transfers to the buyer when the goods are loaded. Choose FOB if you want more control over shipping and insurance; choose CIF if you want the seller to manage logistics but are comfortable assuming the shipping risk.
Q: Are there INCOTERMS specifically for air freight or truck transport?
A: Yes. Some INCOTERMS, like CPT (Carriage Paid To) and DAP (Delivered at Place), are multimodal and work for any form of transport. Others, like FOB and CIF, are sea- and inland waterway-specific and should not be used for air, rail, or truck shipments.
Q: Can INCOTERMS be used for domestic shipments?
A: Technically, yes. While INCOTERMS are designed for international trade, they can be used domestically. However, in many countries—including the U.S.—local trade terms like those under the Uniform Commercial Code (UCC) are often better suited for domestic transactions.
Legal Gaps and Edge Cases
Q: Do INCOTERMS cover force majeure events like pandemics or sanctions?
A: No. INCOTERMS are designed for commercial risks during delivery, not extraordinary events. They don’t cover pandemics, sanctions, natural disasters, or government intervention. These scenarios should be addressed in your contract’s force majeure, sanctions, or general risk allocation clauses.
Q: If something goes wrong with the shipment, do INCOTERMS determine who gets sued?
A: Not directly. INCOTERMS help clarify responsibility by defining risk transfer and cost allocation, which may inform liability. But they don’t override your contract’s dispute resolution clause, limitation of liability provisions, or governing law. They’re a tool, not a full legal framework.
Q: How do INCOTERMS relate to customs declarations and documentation?
A: INCOTERMS directly impact customs declarations by determining who is responsible for export and import formalities, duties, and taxes. For example, under DDP (Delivered Duty Paid), the seller handles all import customs and tax obligations. Under EXW (Ex Works), the buyer must manage both export and import processes. Using the right INCOTERM ensures accurate documentation and smoother customs clearance.
