Comparing FOB and CIF Contracts in International Sales: An Analysis of Their Characteristics and Seller-Friendly Qualities

Introduction

Amongst the contracts that are commonly used in international sales, Free on Board (FOB) contract is considered to be popular for exporters, as it offers flexibility and other advantages to the exporters. FOB is governed by rules that are set under the Incoterms.

International Commercial Terms (Incoterms) are published by the International Chamber of Commerce. These terms facilitate the conduct of global trade and contain rules that are to be followed in domestic as well as international trade (Hosking, 2016, p. 12). The Incoterms 2010 explains both the (Cost, Insurance, Freight) CIF as well as FOB (Free on Board) contracts. Both CIF as well as FOB are rules for sea and inland waterways only. An important aspect of these incoterms is to describe the point when the risk shifts from the seller to the buyer. In FOB contract, the risk transfers to the buyer when the goods are loaded on to the carrier. In CIF contract, the risk passes to the buyer only when the documents are received by him. This means that the risk may pass to the buyer even before the goods are boarded on the vessel, if the documents are received before (Klotz, 2008, p. 62). For economics dissertation help, understanding Incoterms is critical.

CIF and FOB are two kinds of contracts that are entered into by parties to an international transaction of sale of goods. Both contracts are popular with the contracting parties in international sale of goods transactions, however, each has certain peculiar characteristics, which make it attractive to the parties. FOB contracts are more friendly to the sellers and CIF contracts are preferred by buyers (August, 2000, p. 602). This essay critically analyses the two kinds of contracts in order to understand how FOB contracts may have qualities that make them particularly attractive for sellers.

F.O.B contracts

In Pyrene and Co Ltd v Scindia Navigation Co Ltd, [1954] 2 QB 402, Lord Devlin recognised three types of FOB contracts: (a) the strict or classic FOB contract; (b) an FOB with additional duties (this would be a classic FOB but with extra duties); and (c) the modern FOB contract (Bradgate & White, 2007, p. 250). The classic FOB contract would require the buyer to nominate a ship and the seller is under a duty to place the goods on board when the ship arrives. The seller enters into a contract of carriage with the carrier on behalf of the buyer. In the second kind, that is FOB with additional duties, the same rules apply, as the ones mentioned before, however, here the seller may take additional duties upon himself, such as nominating the ship. The modern FOB, sees the buyer contracting with the carriage carrier by himself or through his agent, who then send the Bill of Lading to the buyer (Bradgate & White, 2007, p. 250).

It is said that the contract involving FOB terms has endured far longer than any other kind of contract that is comparable in international trade (Lorenzon, et al., 2012, p. 249). The first reported case with the mention of FOB contract was Wakkerbarth v Masson, (1812) 3 Camp 270. The mercantile conditions of that age (early 19th century) led to the evolution of the FOB contract, when merchants had to charter ship to call on different ports to pick up merchandise that would have been selected on the basis of previously inspected sample. (Lorenzon, et al., 2012, p. 250).

FOB contracts are considered to be more flexible in nature, as compared to the CIF contracts. FOB contracts can be tailored as per the needs of the parties, and they are not as such rigid from a conceptual point of view. Thus, in an FOB contract, parties may vary the incidents without changing the nature if the contract as an FOB contract (Bradgate & White, 2007, p. 249).

In FOB contracts, the buyer nominates the ship that is to effect the carriage of goods. It is presumed that the buyer would do so, unless it is otherwise agreed to before between the buyer and the seller. In other words, the duty to nominate a ship is presumptive in nature (Cargill UK Ltd v Continental UK Ltd_ and Richco International v Bunge, [1989] 1 Lloyd's Rep. 193). As FOB contracts are flexible in nature, this can be done by the parties to the contract. The rationale behind the rule of nominating the ship is to enable the seller to effect delivery on board the carrier chosen by the buyer himself. An important point here is that the buyer must give a notice of nomination to the seller within a reasonable period (Bremer Handelgresselshaft v J.H. Rayner & Co., [1978] 2 Lloyd's Rep. 73). On buyer’s failure to do so, the seller can terminate the contract. Again, this depends on the nature of the contract and the buyer and seller may contract differently. However, in absence of such a contract, the presumptions are as discussed here.

C.I.F. contracts

In CIF contract, the seller for international sale of goods, must contract and pay for the cost, freight and insurance of the goods to be brought to the chosen port of destination (Hosking, 2016, p. 12). In contrast to FOB in terms of point of origin, the CIF contracts were first reported in cases in Tregelles v Sewell, (1862) 7 H& N 574. At that time, CIF were seen as beneficial to both buyers as well as sellers, in situations which demanded the delivery of goods and the payment by buyer, even when the buyer was not physically present (Lorenzon, et al., 2012, p. 250).

The CIF contract gives protection to both buyer and seller. The seller undertakes the charges for shipping and insurance and tenders shipping documents to the buyer. These allow the seller to get contractual rights as against the carrier and the insurer. At the same time, the buyer is required to pay for the goods as against the tender of documents. This also means that the buyer cannot demand to see and examine the goods before payment. This gives protection to the seller. Therefore, there is a balance for both the seller and buyer. Courts have tried to create a balance for the buyers in situations where the goods do not exist on the date of contract by holding that the buyer is not liable to pay for such goods on receipt of documents (Couturier v Hastie, (1856) HLC 673).

The interesting feature of the CIF contract is that the buyer pays when the shipping documents are tendered to him and not when he receives the goods. Thus, at times it has been said that a CIF contract is a contract for sale of documents and not a contract for sale of goods, as observed by Scrutton J in Arhnold Karberg & Co v Blythe, Green, Jourdain & Co, [1915] 2 KB 379. This is not a point on which there is a lot of conseus though. For instance, the Court of Appeal has held that a CIF contract is a sale of goods to be performed by the delivery of the documents (Bridge, 1998, p. 122). Again, in Hindley & Co Ltd v East Indian Produce Co Ltd, [1973] 2 Lloyd’s Rep 515, a cost and freight contract (which is similar to a CIF contract) was held to be a contract for sale of goods to be performed by the delivery of documents.

One of the most important documents in the CIF contract is the bill of lading, and it is the evidence of contract of carriage, as well as the receipt of the goods issued by the carrier and document of title (Bridge, 1998, p. 234). With the bill of lading passing to the buyer, the property in the goods also passes to the buyer. Therefore, the risk here passes to the buyer. The buyer has the right of action against the carrier or the insurer should such a situation arise where goods are lost, damaged in transit or not delivered. The constructive delivery passes to the buyer on the passage of the bill of lading (Biddell Bros v E Clemens Horst Co, [1991] 2 Lloyd’s Rep. 92). Buyers do have remedies in breach of contract if the goods do not conform to the decription or quality that is agreed upon (Weiler v Schilizz, (1856) 17 CB 619) (Bridge, 1998, p. 280).

Another common feature in the CIF contract is the use of letter of credit, which are used when the transactions are made with the help of banks in the export as well as import nations. These are promises made by banks to guarantee payment on sales contract provided that the seller submits appropriate documents (Morrissey & Graves, 2008, p. 36). The issuing bank works on behalf of the buyer, and it is required to pay the promised price of goods and the documents are to be submitted to the issuing bank (Morrissey & Graves, 2008, p. 39). The protection to the buyer is that documents must be strictly complied with and the bank is under a duty to ensure that the documents are in compliance (Equitable Trust of New York v Dawson Partners Ltd. (1927) 27 L.I L. Rep. 49) If there is a fraud on part of the seller, and the issuing bank is aware of it, then the bank can be restrained from paying the credit (Discount Records v Barclays Bank, [1975] 1 Lloyd's Rep. 44; Standard Chartered Bank v. Pakistan National Shipping Corporation, [2002] UKHL 43). This is part of the protection for the buyer. Despite these advantages of the CIF contract, some countries do not recognize CIF contracts at all. Colombia, Algeria, Pakistan and Iran do not allow imports on CIF terms (Carr & Stone, 2013, p. 8). Therefore, CIF is not a common feature that is found in use among all countries. A disadvantage to the seller under CIF contract is that as the cost of the insurance and freight is borne by the seller, the fluctuations in the currency exchange are also to be borne by the seller (Ryder, et al., 2012, p. 184). The buyer pays the contractual price to the seller at the time of tender of documents by the seller.

Both CIF and FOB contracts are popular in international sale of goods contracts and each offers its unique advantages to the buyers and sellers. The seller has the advantage of getting paid against delivery of documents, thereby eliminating the chance of not getting paid when the goods reach their destination (Baskind, et al., 2013, p. 531). Even though the documents must conform to the decided terms, the seller has the opportunity to make corrections in the documents if found to be non-conforming as long as the seller gives the documents within the decided time period (Ryder, et al., 2012). As soon as the documents are accepted and the goods shipped, the risk in the goods passes to the buyer (Baskind, et al., 2013, p. 531).

There are other conveniences for the seller in the CIF contract in the context. International sale of goods contracts are contracted between parties based in different jurisdictions. This necessitates the transfer of the goods from one jurisdiction to another. If the seller sends these goods to the buyer without any payment made to him, then the seller may be at a risk. These risks include, rejection of the goods by the buyer and the responsibility of bringing the goods back. In a CIF contract, the buyer has to pay the seller against the tender of the documents, the seller’s rights are protected as against unjustified rejection and abandoning of goods at a latter point.

The advantages of CIF contracts in contracts of international sale of goods are manifest and manifold. The buyer knows the price that is to be paid through the shipping documents and cargo is facilitated to remain afloat by the buyer paying that price against shipping documents that enables him to get property and contractual rights as against the carrier of the goods and the insurer, despite not actually having entered into a contract with either. The seller pays the cost of insurance and freight and shipping, but bears no risk if the goods are lost or damaged in transit. At the same time, the seller receives a payment for the goods even before the goods are actually delivered to the buyer (Lorenzon, et al., 2012, p. 53).

CIF contracts have been in use in international sale of goods for a long time. It is a popular form of contracting in international sale of goods, where the peculiar nature of the contract protects both the rights and interests of the buyer as well as the seller in a contract that involves the transfer of goods from one jurisdiction to another. This allows for the popularity of the CIF contracts and Lord Wright also observed that "It is a type of contract which is more widely and more frequently in use than any other contract used for the purposes of sea-borne commerce."

The FOB contract comes with its own set of advantages. First, it is the responsibility of the buyer to fix the carrier and inform the seller about the nomination of the carrier. Secondly, the seller is under no responsibility to pay for the freight and insurance of the goods as the goods are Free on Board.

Conclusion

The risk transference differs in CIF and FOB contracts. In CIF contract, the risk passes to the buyer at the time of tender and receipt of documents. In other words, the seller is not responsible or liable for any loss of the goods during carriage. If there is a loss, the buyer may recover damages from the carrier or the insurer, as the case may be. In FOB contract, the risk passes to the buyer when the goods are loaded on the carrier. Here the benefits under the CIF as well as FOB in terms of passage of risk remains the same.

The peculiar limitation of CIF contract with respect to the seller is that he has to pay for the insurance and freight. This becomes a problem in international transactions due to fluctuating exchange rates, which the seller has to bear. The buyer will just pay the contractual price at the time of the tender of documents. Another disadvantage is that CIF contract is not available in all jurisdictions and there are countries which do not allow its traders to make CIF contracts.

The biggest advantage of FOB contract is the flexibility it allows to the exporters. The classic FOB contract requires the buyer to nominate a ship and the seller is under a duty to place the goods on board when the ship arrives. However, while keeping this description intact, FOB contracts may be tailored as per the needs of the parties, and they are not as such rigid from a conceptual point of view. Thus, in an FOB contract, parties may vary the incidents without changing the nature of the contract.

Continue your journey with our comprehensive guide to Evolution of Multinational Corporations.

Bibliography

• August, R., 2000. International Business Law: Text, Cases, and Readings. New York: Prentiss Hall.
• Baskind, E., Osborne, G. & Roach, L., 2013. Commercial Law. Oxford: Oxford University Press.
• Bradgate, R. & White, F., 2007. Commercial Law. Oxford: Oxford University Press.
• Bridge, M. G., 1998. The Sale of Goods. Oxford: Oxford University Press.
• Carr, I. & Stone, P., 2013. International Trade Law. Oxon: Routledge.
• Hosking, R., 2016. What is a reasonable contract of carriage for CIF/CIP purposes: Section 32(2) of Sale of Goods Act 1979. In: International Trade and Carriage of Goods. Oxon: CRC Press, pp. 3-14.
• Klotz, J. M., 2008. International Sales Agreements: An Annotated Drafting and Negotiating Guide. Alphen aan den Rijn: Kluwer Law International.
• Lorenzon, F. et al., 2012. C.I.F. and F.O.B. Contracts. London: Sweet & Maxwell.
• Morrissey, J. F. & Graves, J. M., 2008. International Sales Law and Arbitration: Problems, Cases and Commentary. Aalphen aan den Rijn: Kluwer Law International.
• Ryder, N., Griffiths, M. & Singh, L., 2012. Commercial Law: Principles and Policy. Cambridge: Cambridge University Press.

Take a deeper dive into Enforcement of Investor-State Arbitral Awards: ICSID v New York Convention with our additional resources.