China Trade Terms: Because They Matter

Using the right shipping terms is crucial when buying products from China, as columnist Dan Harris explains.

If you purchase product from China, do not use FOB as a shipping term. Use FCA or CIF or even EXW. But eliminate FOB from your vocabulary today. After you do that, get a copy of Incoterms and learn what the above shipping terms mean and use them exactly as specified. Do not edit the terms.

Before you decide this is just a trivial issue, Google “Tianjin port explosion” and ponder who bore the nearly $1 billion in losses from that. Was it the seller or the buyer? Did any insurance company pay for the loss? Or did they escape the obligation to pay because in fact no insurance covered the items sitting in the port waiting for delivery?

Imagine you are a U.S. company that purchases product from China pursuant to a contract manufacturing arrangement. The completed product is packed into a container at the China factory and then gets transported from the factory to the port by truck. The container sits in a processing yard at the port for a week and then is finally loaded onto the ship.

There is a lot that can go wrong in this process. Who gets paid if the container is lost? What happens if the truck carrying the container to the port gets into an accident and the entire shipment is destroyed? What happens if the container is stolen from the port? What happens if there is an explosion at the port and the container is destroyed? What happens if the cargo ship sinks in a storm, as just happened with the El Faro?

Risk of loss is determined by the shipping terms used for the transaction. For international shipments, shipping terms have been carefully developed and are embodied in the Incoterms document written by the International Chamber of Commerce. Incoterms cover virtually all of the important issues relating to the international shipment of goods. Selection of a single term resolves virtually all of the important issues. For this reason, every buyer must decide what term will be used and then must operate in compliance with the selected term.

When our China lawyers discuss this with clients, the clients often are indifferent; they far too often seem to believe that our insisting on precision is just lawyer obsessing with no application to the real world of business. They are wrong. Risk of loss is a fundamental issue for all international trade business. The recent Tianjin explosion and El Faro sinking illustrate why.

The big issue is where risk of loss transfers. And this issue is decided by the choice of shipping terms. In our experience, U.S. buyers frequently make the mistake of choosing Free On Board (FOB) as their shipping term. They make this choice as a pricing term to ensure that the price of the product does not include the price of insurance and freight to ship the product from China to the U.S.

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When they chose FOB, they fail to account for risk of loss because under FOB, risk of loss passes only after the product has been loaded onto the vessel. Since risk of loss transfers when the product is loaded onto the vessel, the buyer purchases insurance that covers the product at that point. But who has the risk of loss from when the product leaves the Chinese factory until it is loaded onto the ship? The answer is that the Chinese factory has the risk of loss.

But Chinese factories virtually never have insurance for the brief period between when the product leaves their factory and when it is loaded on the vessel. This then means that during the period between delivery to the carrier and loading on the vessel, the risk of loss for the product is uninsured. If the buyer is aware that the product is uninsured, then that is a risk that the buyer willingly assumes. But rarely do U.S. buyers realize that they are taking on this considerable risk with product for which they probably have already paid at least half.

The solution to this problem is simple: use the right shipping term. As the drafters of Incoterms clearly state, for modern shipping by sea, the FOB term should never be used. The proper term is Free Carrier (FCA). Under FCA terms, risk of loss passes when the shipment is put into the custody of the carrier. It does not matter where the carrier takes delivery. It may be at the factory or it may be at the port. Since the buyer can be certain where risk of loss passes, the buyer can be certain that it has obtained the appropriate insurance and the issue of insurance is not left to the seller.

A related and even more difficult problem arises when buyers define their own terms that simply make no sense. In this area, the problems arise when buyers confuse risk of loss, transfer of title, and acceptance of product. In a recent case, we reviewed a contract where a U.S. buyer had provided that the shipping term would be FOB, but that risk of loss would transfer only after the product was delivered, inspected, and accepted. FOB means risk of loss transfers when the shipment is loaded on the vessel. It does not mean anything else.

For this reason, the language provided by the buyer simply did not make sense. In fact, there is NO shipping term that provides for transfer of risk of loss under these terms. The buyer confused risk of loss with acceptance of the goods, two entirely unrelated concepts. But, by providing internally incoherent contract language, the buyer did nothing but harm themselves. The only possible result is that insurance for the product would be purchased on entirely random terms. If the shipment is lost, will the insurance company pay? If the insurance company does pay, who will they pay, the factory or the buyer?

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The purpose of a contract is to make business terms more predictable. This failure to use standard terms in the standard way just makes the situation less predictable, all to the detriment of the buyer. There is no reason to do that. Instead, just do the right thing. It’s for your own good.


Dan Harris is a founding member of Harris Moure, an international law firm with lawyers in Seattle, Chicago, Beijing, and Qingdao. He is also a co-editor of the China Law Blog. You can reach him by email at firm@harrismoure.com.