FOB – demystifying terms of trade for buyers and sellers

 Free on Board or FOB

Free on Board is just one of a whole range of what are called Incoterms, but it’s the most commonly used and most easily misinterpreted so this blog post is devoted to making clear what FOB does or doesn’t cover, how it should be used, and what alternatives there are.

FOB and Incoterms – the language of international commerce

Incoterms are the official but voluntary definitions that explain the terms of trade. Since the first Incoterms in 1936, they have been a global set of ‘rules’ that allow both buyers and sellers to understand their responsibilities for the delivery of goods. Incoterms apply to both domestic and international commerce. They were most recently updated in 2010 to cover new methods of global transportation and take account of e-commerce requirements.

What Incoterms don’t cover

While Incoterms are a useful tool to help business communicate they are only a portion of the entire business contract. Things they don’t cover include:

• Prices to be paid
• Methods of payment to be used
• Transfer of ownership
• Breach of contract
• Product liability.

In addition, Incoterms don’t outrank any national or international laws.

Incoterms in a nutshell

There are seven Incoterms that apply to any method of transport, anywhere in the world:

1. EXW (Ex Works)
2. FCA (Free Carrier)
3. CPT (Carriage Paid To)
4. CIP (Carriage and Insurance Paid To)
5. DAT (Delivered at Terminal)
6. DAP (Delivered at Place)
7. DDP (Delivered Duty Paid)

There are a further four terms that apply purely to sea/inland water transport:

1. FAS (Free Alongside Ship)
2. FOB (Free on Board)
3. CFR (Cost and Freight)
4. CIF (Cost, Insurance, and Freight)

Free On Board (FOB) – the definition

Free On Board (FOB) – simply put, is used to state that in the contract the supplier is paying shipping costs – usually including insurance costs unless they are separately covered in the contract – from the point of production to a specified destination. On arrival at destination, the buyer assumes responsibility.

The first confusion arises where FOB is used, as it frequently is, to cover containerised goods. Strictly speaking the seeker should have direct access to the vessel they are loading as they do in bulk cargoes, but for containerised goods it is often preferable to use the term Free Carrier (FCA) which can be used for any transport mode, including containerisation, and for contracts where there is more than one form of transport being used.

Benefits of FOB

The major advantage to FOB for buyers is that they can specify their own freight carrier, which gives them more power over the route taken, port of receipt and transport time. By comparison CIF (Cost, Insurance, and Freight), gives the shipper total control over the shipment, deciding which carrier to use and transit times – this means that many different companies may be involved  in the transportation of the goods and none of those carriers have any requirement to communicate with the buyer because their contract is with the seller.

When to use FOB

The main benefit of FOB shipping is that it divides the costs, responsibilities and risk for any shipment between the buyer and the seller. The seller’s responsibility is to pay the entire costs relating to a shipment until the goods are on the vessel at the outbound port. At that point, once the goods are loaded onto the vessel, the responsibility shifts to the buyer. This means the seller takes on the costs for:  shipping documentation, Entry Summary Declaration (declaring the goods the the shipping line), terminal handling charges related to loading the vessel with your goods, any licences required to export, customs clearance and transport costs to the agreed departure point, as well as any other local charges. The buyer then has responsibility for import documentation, terminal handling relating to disembarking goods at the receiving port, customs clearance on receipt and onward transportation costs.

Problems with FOB

• Free on Board is most often problematic when a freight claim needs to be registered, because this is the point when both buyers and sellers often discover that written terms of sale override FOB terms. For example, where a purchasing agreement (aka terms of sale) is in place, it will often contain elements that determine who to handle freight damage. It is only if a purchasing agreement or terms of sale does not exist, that standard FOB terms apply.

• As already described, a further problem with FOB arises when the term FCA should have been used instead, because goods are containerised or using more than sea or inland waterway transportation. In these situations, FOB, strictly speaking, doesn’t apply to the contract and can’t be used, for example, to determine responsibility for damage if the goods have been transported by rail or road as those are not FOB modes of transport.

• In America there is a common tendency to use FOB in situations where it cannot necessarily be enforced, this is because the Uniform Commercial Code (UCC) in the USA permits the use of the term for any transportation, however because Incoterms 2010 limits the use of the term to ocean/inland waterway transport only, any buyer or seller entering into a international contract where part of the contract will be shipped into, out of, or via the USA can find that the term FOB is contested if they have to dispute any part of their contract agreement.

Who pays when things go wrong with FOB?

The seller’s responsibility ends when the buyer (or their agent) signs receipt for the goods at the destination port. Where there has been damage or loss, the parties involved in the contract usually agree who will file a freight claim, as any party to the contract can file. However, the party who paid the freight bill is usually the only one which can received reimbursement or compensation for freight charges, which is why it is generally the case that they will be the party who files the freight claim.