Commerce department international trade

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Step 3: Transport

The first question about transport is howl What mode of transport is most appropriate? From an island like Verbena, two modes of transport are available: ships and aircraft. It is unlikely that Mino will ask Aziz to ship the shampoo by air: air transport is too expensive. Sea transport is, then, the more appropriate. When goods travel by sea, they are often shipped by container. The advantages of containers are well known (lower risk of pilferage, easy traceability, smoother handling), but the economics of containerization depend largely on the size of the consignment. In prac­tice, each consignment should be roughly one container load: a little more, and two containers will be needed at double the cost; somewhat less and the carrier is paid to transport thin air. 200 cartons of shampoo are not a large enough order to justify a container; if Aziz is a good negotiator, she will suggest that Mino increase the size of the order to create a container-load, or that he order different products to fill up the container.

Inland transport is made by road, by rail, by barge, by mail, or by a mixture: the choices are familiar.

For the goods to arrive safely, correct packaging and shipping marks are essential. Such matters are often made the subject of a separate clause in the export contract because claims arising from delay or damage can be settled only if it is clear who is responsible for packing and marking.

Transportation poses a third, altogether different kind of problem: docu­mentation. Whatever means of transport is chosen, correct documentation is essential. If payment is made by letter of credit—as is often the case— then the bank must refuse to pay if the shipping documents are in any way incorrect.11
Step 4: Transfer of Risk, Transfer of Ownership, Insurance

At the point of delivery, risk generally passes from the exporter to the buyer. What is the "risk" that passes? First, the risk of loss or damage. If the goods are smashed by a fork-lift, stolen by a stevedore or damaged by a downpour—one side must bear the loss. Similarly if the goods cause harm to a third party—for example, a consignment of corrosives left in the sun explodes and severely burns a passer-by—who pays? Negotiators often decide, for the sake of simplicity, that these risks are transferred at the point of delivery, and this, as we shall see, is the standard arrange­ment under the so-called Incoterms.

Obviously the issues of risk and insurance go hand in hand. A prudent businessman who faces a risk, arranges insurance.

Transfer of ownership (or title as it is often called) can take place at any point between the signature of the contract and final payment for the goods. In international trade, these two points are often widely separate; the parties must decide what they want.12

Step 5: Terms of Trade

All the decisions that Aziz and Mino make about the delivery of their shampoo have been made millions of times before. For this reason, the business community has developed a kind a shorthand for standard deliv­ery situations. Some of these shorthand expressions, FOB (free on board), for example, or CIF (cost, insurance and freight) are familiar to most businesspeople. Others, such as DDU or FCA are less well known. The advantages of using such terms are obvious: if Aziz offers the sham­poo for $20 a canon FOB (Port Verbena), then Mino knows that she will transport the goods to the ship's rail at her own risk and cost. When the goods cross the ship's rail, risk as well as the cost of freight and insur­ance pass to him. He also knows that he is responsible for nominating the ship that will be used. And so on. One term covers a great deal of decision-making.

With patterns of trade, means of transportation, and communications changing so rapidly, usage of terms of trade naturally develops differently in different parts of the world; international trade, however, needs agreed, standardized terminology. These standards are provided by the Inter­national Chamber of Commerce in Paris in its set of 13 Incoterms (International Commercial Terms) issued most recently in 1990.13


11 For more information on these problems, see Section 4 of this chapter and Chapter 2 on payment

12 For detailed information, sec Section 5 below.

13 For detailed information, see Section 6 below


Agreed on Paper
Study the scenario, and then answer the questions.
Verbena Paper makes disposable paper plates, cups and napkins for hot-dog and hamburger stands. John Merrit, the factory manager, is negotiating for raw paper to be delivered to his factory for manufacture into paper products. The supplier is Wendell Paper Industries of Esperanza. Wendell and Verbena Paper have agreed in principle a trial delivery of 40 tons of raw paper.

Which of the following decisions should the two parties make in negotiating the delivery clause? (If the issue raised is not an aspect of delivery as outlined above, the answer is No.)

  1. The quality of the paper. No.

  2. The place of delivery. Yes

  3. The transfer of risk. Yes

  4. What to do if the ship named by buyer does not arrive. Yes

  5. Whether or not to ship goods in a container. Yes

  6. What delays in delivery will be excusable. Yes

  7. When payment is due. No

  8. Who must insure the goods up to what point. Yes

  9. How disputes will be settled. No

  10. An Incoterm. Yes

  11. What means of transport will be used. Yes

  12. The transfer of title. Yes


(I) 2 . TIMING

Naming a delivery date is the first step in negotiating the timing of an export deal. Complex issues concerning coming into force, delay and compensation for delay must also be negotiated. What are the main considerations in drafting provisions about timing and delay?


Because exports are often subject to official approvals, the delivery date in many contracts depends on the receipt of the last approval. If delivery is late, the delay is classified into one of two categories, excusable and non-excusable. Excusable delay often involves a grace period and is nearly always subject to a force majeure provision 14 . Any losses to the buyer caused by non-excusable delay must be compensated. The amount of compensation is usually set in advance in a so-called “liquidated damages” provision.


Getting the delivery date right is a matter of managerial know-how: the exporter must know how long it takes to obtain supplies, manufacture the goods, package them, arrange pre-shipment inspection and transport them to the agreed point of delivery. First time exporters often set delivery dates that are hopelessly optimistic – and pay a heavy penalty for their mistake. The buyer, for his part, must know exactly whenthe goods are needed: too early a date ties up money in unused goods, while delivery too late may mean big losses, especially if the goods are to be resold.

As far as the contract is concerned, the delivery date triggers many contract events: at this time, the exporter fulfills his primary duties under the contract; payment normally becomes due: risk, and often title, pass to the buyer: delay—as well as any compensation to be paid by the exporter—is reckoned from the planned date of delivery. What should the exporter know about this key date?
Naming the Date

The simplest way to fix delivery is to use a straightforward calendar date: 13th August 1995, for example. Export contracts are not always so simple, however. For example, let's say Aziz and Mino meet in Verbena in December and agree that Aziz will sell shampoo to Mino. Already it is clear to them both that a certain amount of government red-tape is unavoidable: an export license, a foreign exchange permit, and a certificate of origin are necessary. Because shampoo is a health-care product, special certification is necessary in the buyer's country. How long will it take to obtain the necessary documentation? Because nobody is sure, the parties often plan for the contract to come into existence in two steps: step one is on signature (the signature date): step two is when all the preconditions for the sale have been met (the date of coming into force).

The date of coming into force is not usually a calendar date, but the date on which the last precondition is met. Common preconditions are:
♦ Receipt of import and/or export approval;

♦ Receipt of foreign exchange approval from a central bank;

♦ Issuance of a letter of credit or bank guarantee;

♦ Making of a down-payment by the buyer;

♦ Issuance of an insurance policy:

♦ Issuance of a certificate of origin;

♦ Delivery by the buyer of plans, drawings or other documentation.

Negotiators often agree a cut-off date: if the contract has not come into force within a certain time, for example three months from signature, then it becomes null and void.


14 The terms "grace period" and "force majeure" are explained in the following pages

A cut-off date is common in fixed-price contracts: a long delay can make the price unrealistic. A typical wording:

Coming Into Force

This agreement shall come into force after execution by both parties on the date of the last necessary approval by the competent authorities in the country of the Seller and the Buyer.

If the contract has not come into force within ninety days of execution, it shall become null and void.

How does the date of coming into force affect the delivery date? The delivery date is normally fixed for a certain number of days after the contract has come into force. Let's return to our example: the central bank in Mino's country, Esperanza, often takes months to allocate foreign exchange for imports. Let's say it takes Aziz four weeks to schedule production, manufacture and ship an order. (Let's also assume that Aziz cannot supply Mino's shampoo from stock because he wants a special color.) Naturally Aziz is reluctant to begin manufacturing Mino's sham­poo until his order is definite. Accordingly she fixes the date of delivery four weeks (her manufacturing period) after the date of coming into force. That way. she knows exactly where she stands. So Aziz' contract reads:

The date of delivery shall be twenty eight days after the date of coming force of the contract.

Timing and "Time is of the Essence" Clauses

How important is strict adherence to the agreed deliver) date.' Sometimes, punctuality is essential. If you order a birthday cake to be delivered on your birthda;. —28th June—and the cake arrives on the 29th. it is too late. You no longer want the cake, and you can legitimately refuse to accept it. In a contract requiring absolute punctuality, lawyers sa\ that "time is of the essence of the contract"—if the time is not kept, the buyer has the right to send back the goods and refuse payment.

Is time normally "of the essence" in commercial life? Most legal systems say "No." Late delivery is a nuisance, but it is rarely fatal to the buyer's purposes. This is so, even if the contract contains a clause such as:

Time is and shall be of the essence of this contract.

Despite this clear wording, a judge may decide that time is not of the essence and that the buyer cannot terminate the contract. But late delivery still has expensive results for the exporter, as we shall see in a moment.

One other point is worth making on the precise meaning of delivery dates. Let's say a contract comes into force on 25th November: delivery is fixed thirty days after coming into force—Christmas Day in many places! Must the exporter deliver on a public holiday? Normally not. Delivery takes place, under most legal systems, on the next working day after the agreed time. The parties can change this if they wish, but few contracts do so.

In some contracts the exporter has the further duty to notify the buyer that delivery has taken place. The exact form of this notification varies from contract to contract, depending in part on the place of delivery, on the method of payment, and on the needs of the buyer.

Excused Delay and the Grace Period

Aziz and Graham, a customer in Nonamia, have done business together for some years. In their regular contracts is this clause15 on late delivery:

For each week of late delivery the Seller shall pay the Buyer 0.1% cf the contract price.

At present, Aziz and Graham are negotiating delivery of 400 cartons of hair conditioner. Graham wants delivery on 20th May. Aziz doubts that she can achieve this date and offers 20th June. Aziz won't give an earlier date because she risks paying the agreed "penalty" if she is late. Graham is reluctant to accept the later date; he wants the earliest delivery possible. As skillful negotiators, Aziz and Graham decide to fix the earlier date as the delivery date, but to waive the payment of a penalty for a month— creating a one-month grace period.

15 There is a full explanation of such "penalty" clauses below.

Their contract now reads:

If delivery is not effected within one month of the agreed delivery date, then the Seller shall pay the Buyer 0.1% of the contract price.

The effect of a one-month grace period is not at all the same as a delivery date set for one month later: the exporter has an early, good-faith target to meet, and the buyer can exert considerable moral pressure before the mechanism of the "penalty" takes over. And there are clear advantages to both sides if early delivery is possible: the buyer gets the goods—and the exporter receives payment—up to a month earlier than planned. These advantages are achieved—unusually—without additional risks.

Excused Delay and Force Majeure

Good faith is essential in business life—but it does not always assure success. If disaster strikes in the form of a hurricane or an earthquake, the exporter may be unable to deliver on time, or at all. Such natural disasters are sometimes called "acts of God" and, by long tradition, acts of God excuse performance of a contract. In recent times, lawyers have argued that other unavoidable events should also excuse performance: war, for example, fire, or new government regulations. Most recently, some contracts have added strikes, lockouts and labor unrest to the list. Taken together, all such unavoidable circumstances are called force majeure (a French expression meaning a superior power). The principle behind force majeure is clear: if the exporter shows absolute good faith but simply cannot deliver the goods, then his duties under the contract can be suspended or perhaps terminated altogether. A typical contract wording:

If either party is prevented from, or delayed in, performing any duty under this contract by an event beyond his reasonable control, then this event shall be deemed force majeure, and this party shall not be consider in default and no remedy, be it under this contract or otherwise, shall be available to the other party.

Force majeure events include, but are not limited to: war (whether war is declared or not), riots, insurrections, acts of sabotage, or strikes, or other labor unrest; newly introduced laws or Government regulations; delay due to Government action or inaction; fire, explosion, or other unavoidable accidents; flood, storm, earthquake, or other abnormal natural event.

The force majeure clause, like other contract provisions, is negotiable; the parties can decide what excuses and what does not excuse performance. In monsoon countries, for example, contracts often include the statement:

Force majeure events do not include monsoon rains

Any problems the two sides foresee can be mentioned in the contract as excusing, or not excusing, performance.

If a force majeure condition continues for months, life becomes difficult for both sides, so contracts often regulate the force majeure period, in particular the right of one (or both) parties to terminate the contract.

If either party is prevented from, or delayed in, per­forming any duty under this Contract, then this party shall immediately notify the other party of the event, of the duty affected,and of the expected duration of the event.

If any force majeure event prevents or delays perform­ance of any duty under this Contract for more than sixty days, then either party may on due notification to the other party terminate this Contract.

The diagram below shows three possible outcomes of force majeure:

Two outcomes here are satisfactory: resumption of delivery, and orderly termination of the contract. But the situation is unclear and risky for both sides if they failed to regulate their rights in the event of force majeure.

We must now make some difficult, but important, legal distinctions and see how different legal systems cope with the problem of giving the buyer some remedy for any unexcused delay he suffers.

First, the generally accepted principle: if one party to a contract causes harm or loss to the other, then the law will find a way to redress this harm or loss. When an exporter delivers late, this normally causes some loss or damage to the buyer; maybe the buyer cannot use a piece of equipment as soon as expected or must keep one of his own customers waiting. The law provides two remedies for such damage.

  • The court may order the exporter to fulfill his obligayions: this means issuing a decree of specific performance requiring the exporter to make a delivery as agreed or

  • The court may require the exporter to pay the buyer compensatory damages- a sum of money that will fully and adequately compensate the buyer for any measurable loss.

In addition, the court may allow the buyer to cancel the contract- though this does nothing to enforce his rights.

Which choice is the court likely to make? In the Introduction we saw that no contract is complete in itself—every contract is subject to some national law. National laws fall into two main families16: those that derive from the English common law and those that derive from the Roman civil law. One difference between these families is their choice of remedy: common-law countries (England, the United States, most of the British Commonwealth and ex-Commonwealth) prefer to award damages, while civil-law countries (most other countries) usually enforce performance.
The concept of enforced performance presents no problems: the judge simply orders the party in default to perform as promised. Damages are a more complex issue. Damages are sums of money paid to compensate an injured party for some kind of "damage." In setting a figure for compen­satory damages for late delivery, the courts usually ask three questions, looking for the answer "Yes" in each case:

♦ Did the loss provably follow from the breach?

♦ Was the loss reasonably close to the breach in the chain of events?

♦ Was the loss "mitigated"—in other words, did the buyer take reasonable steps to keep the loss as small as possible?

Let's look at a scenario to see the practical effect of these questions::

Scenario: Aziz has agreed to deliver a consignment of shampoo to Mino on 30th May. By 30th July, she has still not delivered. This delay causes problems for Mino: he has a contract to deliver the shampoo to a chain store in Esperanza in early June. The chain store writes angrily to Mino demanding some explanation. Mino does not reply. In mid-July the chain store writes to Mino again saying that his failure to deliver the shampoo is the latest in a long chain of failures, and that they want no more dealings with him. The loss of this customer costs Mino $300,000 a year. Mino consults a lawyer about claiming damages from Aziz. The lawyer explains that to claim damages from Aziz, Mino will have to show that the loss of the $300,000 was due to Aziz' failure to deliver (which it was in small part), that the loss of the customer was closely and immediately connected with Aziz' failure to deliver (which is arguable), and that he did everything in his power to mitigate the loss (which he did not). It is not likely that a court would order Aziz to pay a large sum in compensatory damages.

Court proceedings to claim compensatory damages, especially internation­ally, are expensive, the results are uncertain, and law suits destroy the working relationship between the parties. Accordingly most international contracts specify the consequences of typical breaches such as late deliv­ery. The two sides simply negotiate a "lump-sum" that the exporter will pay if delivery is late. This sum is sometimes called liquidated damages and sometimes penalty. What is the difference between these terms?

(For further information on the families of law, see Chapter 4, Section 2.)
Liquidated Damages

Normally the exporter and the buyer agree a fair figure, a lump sum to be paid per day (week or month) of late delivery. This "best guess" is called liquidated damages. If delivery is sixty days late, the exporter pays sixty-days damages—no questions asked. That is the principle behind such clauses: payment of liquidated damages avoids expensive discussion. Two what-if questions arise about lump sums, however: first, what if the buyer's losses are much lower than anticipated? Nothing changes: the exporter must still pay. And what if the buyer's losses are much higher? Again, in principle, nothing changes: the exporter pays the agreed sum, and the matter is settled.

Sometimes courts raise or lower obviously unjust figures. For example, the Chinese Foreign Economic Contract Law empowers a court or arbitral agency to reduce or increase in an appropriate amount the amount of liquidated damages...if it is substantially more or less than the resulting loss; French law allows a change if the figure is "manifestly excessive or ridiculously low."

Damages are paid to compensate one pany for a loss—a real loss in the case of compensatory damages, a pre-esgmated loss in the case of liquidated damages. There is. in practiced, a third possibility: sometimes a buyer tries to force the exporter to deliver punctually by imposing an agreed penalty. A penalty clause simply says: "Deliver on time, or you will be punished." Sometimes the figure fixed for the penalty is very high. The distinction is clear: the purpose of a penalty is not to compensate but to punish, or, more correctly, to use the threat of punishment to achieve acceptable performance.

This distinction between a penalty and a provision for payment of liquidated damages is important in common-law thinking; Most common-law countries classify lump-sum clauses include of three types according to the motive behind them. How does this work? In reviewing a late delivery clause, the judge asks if it is (a) a fair pre-estimate (liquidated damages); (b) an attempt to terrorize (a penalty); or (c) an attempt by the exporter to fix a compensation figure so low that, in effect, it relieves him of responsibility for late delivery (the quasi-indemnity). If it is a penalty,

the common-law judge simply refuses to enforce it. If it is a liquidated damages provision, the common-law judge (like his civil-law counterpart) enforces the clause. If it is a quasi-indemnicy, the common-law judge uses some discretion: a seller who uses his power over the buyer (perhaps he is a monopoly supplier) to fix an outrageously low figure is behaving immorally—or "unconscionably" as lawyers express it. The courts will not enforce a clause they consider to be "unconscionable." The three motives in summary form:

Liquidated Damages


Quasi -Indemnity

MOTIVE: To compensate the buyer fairly for any delay in delivery

MOTIVE: To terrorize the exporter into punctual delivery

MOTIVE: To relieve the exporter of liability for deiay in delivery

Enforceable everywhere but subject to increase or decrease in some legal systems

Not enforceable in English law or other common law systems

Enforceable everywhere but open to challenge as


To be practical: how do you know, as an exporter, if a clause in your contract with your customer is an enforceable liquidated damages provi­sion or an unenforceable penalty? Let's see how an English (or common-law) judge might proceed in a specific case. First the clause:

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