In international trade the Free on Board (FOB) Incoterms rule is only used for ocean shipments of goods. So, never use it for air shipments, for example. Importers and exporters need to know the costs and risks when shipping goods. The FOB is one of the 11 terms of the latest Incoterms ® 2010 rules, the one we refer to in this article.
Incoterms are rules for the interpretation of the trade terms enabling global commerce. It is a global standard helping traders to establish responsibilities and duties during goods transactions. This interpretation is a consequence of the trade practices that buyers and sellers over the centuries developed to ease the exchange of goods.
These rules were developed by the cooperation of 134 countries with the support of the International Chamber of Commerce (ICC) and recognised by the United Nations Commission on International Trade Law (UNCITRAL).
The following outline is a summary of the topics we cover in this article:
- FOB Shipping Point
- FOB Destination
- FOB Shipping Point:
- Shipping Point Freight to Collect
- Shipping Point Freight Allowed
- FOB Destination:
- FOB Destination, Freight Collect
- FOB Destination, Freight Prepaid and Allowed
- FOB Destination, Freight Collect and Allowed
- FOB Destination, Freight Prepaid and Added
- Why Use Marine Insurance: a typical scenario
Within Incoterms some terms have a specific meaning. The delivery of goods from one country to another may need several modes of transport. Thus, it’s necessary that you – as a seller or buyer – understand where risks, charges and responsibilities apply at each segment of the transportation. So, you must ensure you know what terms stand for to avoid any misinterpretations and disrupt your supply chain. The following definitions state that:
Delivery is the point where the seller transfers the risk of loss or damage of the goods to the buyer.
Delivery Document is any document such as a transport receipt or note proving that delivery occurred.
Carrier is the party performing the carriage of the goods according to its contract using one mode of trasport, e.g. sea.
Carriage is the movement of goods from the port of loading to the that of destination that a carrier performs, e.g. the shipping vessel operator.
To make sure that you use FOB correctly, you must provide the documents that are part of the transaction. They are:
- the contract
- proforma invoice
- purchase order
- carriage contract
- insurance contract
The FOB stands for Free on Board and it means that the seller delivers the goods on board of the named vessel at the named port and obtains export clearance. The act of delivery transfers the risk but not the ownership upon crossing the ship’s rail. Thus, the seller delivers the goods when they are “loaded on board” the vessel docked at the designated port the buyer indicates.
It’s the seller’s responsibility to ensure that the physical delivery on board of the vessel occurs. It’s not enough handing the goods over to the carrier. In fact, the seller is still responsible for the goods if they are sitting in a warehouse or stowed in containers waiting at the port terminal. In these cases, it’s better you use the FCA Incoterms rule.
When goods are packed into a container, Incoterms rules do not apply. This is due to the different control you have over loading the goods inside of it. So, if you are an importer ensure that the sales contract states the responsibilities on how goods will be loaded in the container.
Besides, beware that Incoterms in general do not specify ownership transfer, prices or method of payment. As a seller you must specify these in your sales contract. Said that, another important Incoterms aspect is insurance cover. When using FOB you must agree with the other party how much to cover and who’s providing the insurance.
Note that under Inconterms, the only valid FOB term is FOB (seller’s sea port), e.g. “FOB Rotterdam”. Also, “Freight On Board” is a not valid term. It’s not mentioned in neither the Incoterms and the UCC and is not recognised as industry term either.
In United States and Canada, FOB is also used as shipping term for domestic shipments and inland waterway transport.
In contrast to what the Incoterms states, in the United States it’s the buyer who deals with export documents. Yet and license although they can appoint a third-party to handle this. There are two types of use. FOB Shipping Point and FOB Destination.
Unless you are in one of these two countries, you should never use them for international shipments. Incoterms 2010 FOB rule states you must define the port of loading at seller’s side. No other format is valid.
a) FOB Shipping Point
The suffix Shipping Point means that goods ownership passes to the buyer at the origin shipping point. The sale of goods you ship to your buyer completes when they reach your shipping dock. As a seller you pay the costs of transport up to the shipping dock and the goods loading on the vessel. Instead, the buyer bears the cost of transport to destination.
b) FOB Destination
The suffix Destination is when the title passes to the buyer at destination port. The seller bears the cost of transport all the way to the buyer’s receiving dock.
The FOB Shipping Point and FOB Destination indicate up to which point the seller bears the shipping cost. If you are a New York based seller and issue an invoice “FOB New York”, you bear the costs of transport up to the docking facilities at that port. If you instead sell your goods under “FOB Los Angeles”, you will bear the costs up to that port of destination.
Free On Board Shipping Point
The buyer will record the transportation cost as Freight-In. This adds to your inventory and contributes to costs of goods sold (COGS) calculation. In particular we have:
1) Shipping Point Freight to Collect
This is when ownership of goods passes to the buyer upon leaving the seller’s dock. The buyer bears the costs of freight and pays for them upon their receipt.
2) Shipping Point Freight Allowed
Here ownership of goods behave as in Shipping Point Freight to Collect but it is the seller who bears and pays the costs of freight. However, it’s the buyer who owns the goods during transportation.
Free On Board Destination
The seller will record the transportation cost as Freight-Out. You report this as a selling expense which you subtract from gross profit in calculating net income. In particular we have:
1) FOB Destination Freight Collect
Ownership of goods passes to the buyer upon arrival at buyer’s destination point. Therefore, the seller owns the goods during transit. Also, the buyer bears the cost of freight and paying for them.
2) FOB Destination Freight Prepaid and Allowed
The seller bears and pays the cost of the freight and owns the goods during transit. Ownership of goods passes upon arrival at the buyer’s destination point.
3) FOB Destination Freight Collect and Allowed
The buyer acquires ownership of the goods upon their receipt at the buyer’s destination point. Also, the buyer pays for the freight charges and deducts their amount from the seller’s commercial invoice.
4) FOB Destination Freight Prepaid and Added
Ownership of goods passes to the buyer when they arrive at the buyer’s destination point. Here the seller pays for the freight charges by adding their amount to the invoice.
Image credit: Courtesy of Washington University in Saint Louis (link)
Importing always requires an analysis of the most convenient Incoterms rule to use. This is to reduce costs and have more control over your shipment. For example, you should know when to choose FOB or CIF. In fact, the former is better for buying whereas the latter is for selling.
An ocean marine insurance policy provides coverage during transportation. This may cover loss, damage to goods and the vessel. In the 2012 Marine Claims Trends report, the Nordic Association of Marine Insurers (CEFOR) shows that since 2006 the individual loss claim averaged about 270,000 USD. But if you are the seller do not assume that the buyer will purchase the ocean marine insurance coverage.
In international shipments this is important. Regardless of whether you sell or buy, both parties should agree on who pays for the coverage, its amount and who is the beneficiary. Also, there should be a clear procedure for disclosing any occurrence of goods damage and loss.
If you are selling goods on open account, you may have most to lose from an accidental damage during transportation. You have less control of the main carriage shipment and the documents. If you are selling using a Letter of Credit (L/C), you will have troubles receiving the Bill of Lading (BoL) from the carrier. It’s the buyer stipulating the main carriage contract with the carrier, not you. The BoL is evidence of a contract of carriage with the vessel operator. This serves the purpose for the buyer to claim ownership as well as for compensation of damages and loss of goods.
Why use Ocean Marine Insurance
Without going into much details how Marine Insurance works, let’s see a typical scenario to understand how things unfold following damage or loss.
You, the seller, ship 100 boxes of goods to your buyer who took insurance coverage during main carriage. That is, from port of origin to destination. During transportation the goods inside 30 boxes suffer damages.
Upon receipt and inspection of goods, the buyer makes notice of the damage on the BoL claiming compensation from the insurance. The insurer will then pay the compensation to the buyer, the insured. Finally, the insurer may proceed to claim compensation from the carrier, the vessel operator responsible for the damage or loss.
For more export opportunities in a country, you could use one of the import export databases available on the web. You can find detailed data per Incoterms based on the port of loading of your interest or per HS Code. This way you can check the volume of goods traffic of interest to you.
- Give precise specification of the place or port to avoid doubt or argument
- Specify the Incoterms rule you intend to use in the relevant documents. E.g. the contract of sale, proforma and transport documents. State which Incoterms e.g. Per Incoterms 2010
- Ask for a copy of the insurance contract from the party handling the insurance
- FOB is always followed by a geographic location on the seller side. e.g. FOB Rotterdam
- If you are selling goods to a US buyer and want to follow Incoterms FOB rules, get the buyer to appoint you to handle the export procedure
- FOB presents less risk for the seller since its responsibilities end when the goods are loaded on the named vessel at the designated port. Therefore transactions conducted using documentary collections or L/C may not be convenient to you as a seller because buyer retains control over documents during goods transit. The carrier may not necessarily release the BoL because it is the seller entering into a carriage contract. The BoL is issued by the shipping vessel operator under main-carriage contract.
- As a buyer, the main-carriage bill may include loading vessel charges even if it’s the seller’s responsibility to ensure loading is complete.
You always have to consider on which side of the trade you are. FOB is generally better for importing because you have control over the shipping and its costs. Also, contracting with a sea freight operator enables you to know transit times and choose the insurance policy that suits your needs.
If you export you take advantage of not having to pay for transportation beyond the port of loading, reduce risks but no control. That’s why exporters should use CIF as it gives similar advantages of importers using FOB and control over the costs. Anyway, as international trader you can find yourself in either position now or in the future. The important is to know what to use each time for your own benefit.
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This article contains general legal information and material for informational purposes only which are not intended and should not be taken as legal advice. Recoupera is not a collection agency and it is not a law firm or a substitute for an attorney or law firm. All informational material provided may not reflect changes in the law. For legal advice, contact a lawyer.