CIF and FOB Contracts

Critically assess the rules on risk in relation to CIF and FOB contracts

CIF and FOB contracts – Goods in transit are a target for opportunists and thieves. Fire can break out almost anywhere. More rarely, road and rail accidents occur. Goods carried across water are subject to the predictable risks of loss or damage during the course of loading and of discharging, by sinking, stranding, by the ingress of water, by contamination by other goods, sweating and damage through shifting, etc. Perishable goods suffer if delayed. Some cargoes, especially bulk cargoes, suffer a measure of inevitable loss due (for example) to natural shrinkage or to the difficulties of accurately measuring or assessing their true weight on loading and discharge. Cargoes carried by air tend to suffer less damage but as non-perishable air cargo is often of high value, air cargoes are a magnet for thieves. International carriage can involve partial carriage by sea, road and rail with transhipment and consolidation for the purposes of making up full loads. Each operation increases the risk of goods going astray or becoming damaged . So how do sellers and buyers protect themselves? Who bears the risk? This assignment will critically assess the passing of risk in relation to CIF and FOB contracts and conclude that neither option is preferable and that either type of contract brings with it its own difficulties.

It is difficult to define a FOB contract because there are many different variants: Devlin J explains the FOB contract as a “flexible instrument. ” The main obligations of the parties to an FOB contract were described judicially in Wimble, Sons and Co v Rosenberg. The seller must put on board ship goods which conform to the contract an must pay all charges in connection with loading. The seller is not obliged to book shipping space in advance; the buyer must nominate the ship to carry the goods and notify the seller of the nomination in time to allow the seller to deliver the goods on board. The costs of carriage are for the buyer’s account .

However, the parties may, and frequently do, modify their obligations under any FOB contract. In particular, the relationship between seller, and buyer and carrier may vary according to the nature of the arrangements made. In Pyrene and Co Ltd v Scindia Steam Navigaion Co Ltd , Devlin J recognised three situations:

(a) B designates a ship on which S is required to load the goods. There is no prior contractual arrangement between B and the carrier. S delivers the goods to the ship and puts them on boar in return for a bill of lading, either in his own name or showing B as consignor. In either case, S forwards the bill of lading to B and, according To Devlin J, S makes the contract of carriage and is a party to it. Devlin J describes this as a classic FOB contract.

(b) S may undertake additional duties. Under this type of FOB contract, S undertakes to arrange the carriage, and possibly insurance. S places the goods on board ship and receives a bill of lading in his own name, which he forwards to B in return for payment. S is clearly a party to the contract of carriage in this case, and the contract is very similar to a CIF contract ; however, the contract price excludes carriage costs so that if they increase, B must pay extra.

(c) Alternatively, B may take the contract of carriage in advance. In this case S puts the goods on board ship in exchange for a mate’s receipt, which he forwards to S who uses it to obtain a bill of lading.

Passing of risk does not follow when passing of property occurs in a FOB contract, and it is the passing of risk that we are concerned with here. The general rule in s20 of the Sale of Goods Act 1979 applied to FOB contracts and risk prima facie passes with property so that risk normally passes to the buyer when the goods are put across the ship’s rail. Thus in Pyrene & Co Ltd v Scindia Steam Navigation Co Ltd the tender was at the sellers risk when it was dropped during loading prior to crossing the ship’s rail.

Even in circumstances where property does not pass to the buyer on loading, risk normally will pass. This will apply even where goods shipped for the buyer form an unascertained part of a larger bulk; once the goods are shipped, the seller has fulfilled his obligation to deliver the goods and nothing remains tot be done by him under the contract. The buyer has an insurable interest in the goods from the time of shipment . If the contract varies the sellers duties, it may therefore vary the point at which risk passes; for instance, if the contract is for the goods to be delivered “free on board stowed”, the sellers duties are not complete until the goods are safely stowed, so that risk may not pass until this point.

Risk of loss may also remain with the seller by virtue of he provisions of s32 of the Sale of Goods Act. Section 32 (3) provides that:

“where goods are sent by the seller to the buyer by a route involving sea transit under circumstances in which it is usual to insure, the seller must give to the buyer such notice as will enable the buyer to insure them during the sea transit”

If the seller fails to supply such information, the goods are at his risk during the sea transit. It has been argued that s32(3) can have no application to FOB sales because the contract requires the seller to deliver the goods “free on board” and delivery to a carrier is normally deemed to be delivery to he buyer.

As Bradgate suggests Section 32 (2) may be more important. This section applies where the seller makes a contract of carriage on behalf of the buyer – .i.e. in cases of, to coin Devlin’s description, “classic FOB” contracts and where the seller takes on additional duties – and requires him to make “such contract as is reasonable having regard to the nature of the goods and the circumstances of the case.” If the seller fails to do so, and the goods are lost or damaged during transit, the buyer may either decline to treat delivery to the carrier as delivery to himself or claim damages from the seller. What is reasonable will depend on the circumstances of the cases.

In the alternative, risk may pass to the buyer prior to shipment. In Cunningham v Munro it was suggested that if the goods deteriorate because of the buyer’s delay in giving the seller shipping instructions, or because the buyer induces the seller to deliver goods to the port before the goods can be loaded the buyer would be liable for such deterioration; he would be entitled to reject the goods for non-compliance with the implied conditions as to quality in the Sale of Goods Act, but would be liable to the seller in damages for the deterioration.

The CIF contract is a cost, insurance and freight contract. As Lord Wright observed in 1940: “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. ” Under a CIF contract the seller is required to arrange the carriage of the goods and their insurance in transit, and the cost of those arrangements is included in the contract price. The seller obtains a bill of lading ad a policy of insurance and forwards them to the buyer, together with an invoice for the price, and the buyer pays on receipt of the documents. In Diamond Alkali Export Corp’n. v. Fl. Bourgeois , McCardie J. trenchantly stated that only an on board bill of lading constituted good tender under a CIF contract. He observed that only such a document fell within the mercantile custom proved in Lickbarrow v. Mason and underpinning the judicial acceptance of a bill of lading as a document of title at common law. His words should not be taken to mean, however, that other mercantile customs, if duly proved in litigation, would not receive similar judicial recognition . This was not the means employed in other decisions (not as such dealing with CIF seller’s documentary obligations) to justify the conclusion that a received for shipment bill of lading was a document of title at common law .

The CIF has many advantages. The buyer has the advantage of knowing from the date of the contract the exact price he must pay to obtain the goods; the contract price includes freight and insurance. More importantly, the use of documents to perform the contract and represent the goods allows the parties to deal with the goods afloat. Thus the buyer may resell the goods before they arrive. The use of documents facilitates the involvement of financial institutions: the documents can be transferred direct to the buyer’s bank as security for the advance of the price: the bank will be willing to take up and hold documents where it would not be prepared to take possession of the goods themselves and normally, where the payment is to be by the bankers’ documentary credit, this is what happens. This, in turn, allows the seller to be assured of payment and to receive the goods. Indeed, he is assured of payment even if the goods are damages or never arrive at al for he is entitled to be paid on presentation of the documents ; the buyer is generally protected against such losses by the bill of lading, giving a contractual right against the carrier, and the policy of insurance, covering most accidental losses.

It is important to consider at this juncture the effect that the Vienna Convention on Contracts For the International Sale of goods have had on risk in FOB contracts . Article 67(1) of the Convention states that:

“If the contract of sale involves carriage of goods and the seller is not bound to hand them over at a particular place, the risk passes to the buyer when the goods are handed over to the first carrier for transmission to the buyer in accordance with the contract of sale. If the seller is bound to hand the goods over to a carrier at a particular place, the risk does not pass to the buyer until the goods are handed over to the carrier at that place….”

In the case of a contract of sale f.o.b. a named port of shipment, the second sentence appears the appropriate comparison, producing a result consistent with the common law. It is suggested that this is the case even if the seller chooses to have the goods delivered to the named port of shipment by an independent carrier; see the commentary on Article 67 by Barry Nicholas . Under Article 67(2):

“Nevertheless, the risk does not pass to the buyer until the goods are clearly identified to the contract, whether by markings on the goods, by shipping documents, by notice given to the buyer or otherwise.” This might prevent the passing of risk in an unascertained part of a specific bulk in circumstances in which risk might pass at common law.

CIF contracts are an exception to the general rule in s20 of the Sale of Goods Act which links the passing of risk to the passing of property. Whereas property under a CIF contract passes at the time the buyer pays and takes up the documents, the goods are deemed to be at the buyer’s risk from the time of shipment. Where the seller ships goods for the buyer, risk passes at the time of shipment ; where the contract is made after shipment, risk passes at the time of the contract but retrospectively, so that the goods are deemed to have been at the buyer’s risk since the time of shipment . This might seem hard on the buyer, but in fact imposes little hardship. The buyer takes the benefit of the contract of carriage and policy of insurance and is therefore able to claim, either under the contract or the policy, in respect of most damage or loss from the time of shipment. Moreover, the rule “is or damaged while at sea. ” However, the buyer is expose to risks not covered by the contract of carriage or insurance.

In the case of Manbre Saccharine Co v Corn Products Co McCardie J defined the six stages at which loss or damage may occur during a CIF transaction:

1. Loss/deterioration after the buyer has paid the price is clearly for the buyer’s account. The goods are the buyer’s property and at his risk.

2. Loss/deterioration after tender of documents is also for the buyer’s account unless the buyer is entitled to reject the documents and throw the loss back to the seller.

3. If the goods are lost or deteriorate after the goods have been appropriated to the contract, the seller may still tender the documents; once goods have been appropriated to the contract the seller is not entitled to tender any others.

4. If the goods are lost after shipment but before they have been appropriated to any particular contract, can the seller appropriate them to contract and require the buyer to pay? There are judicial dicta which suggest that he can appropriate or the lost cargo; the buyer is, after all, protected by the policy of insurance and contract of carriage against most losses.

5. Goods are lost after the contract is made but before shipment. Here the position is clear; the seller cannot ship any goods and so cannot fulfil his contract using the “lost” goods.

6. The goods are lost after shipment, but before the contract of sale: can the seller make a contract to sell lost goods? A contract to sell specific goods would be void in such a case, by virtue of s6 of the Sale of Goods Act and a contract for unascertained goods from a designated source, as where the seller contracts to sell part of the cargo of a named vessel already lost, would be void for mistake at common law in such circumstances. Alternatively, the seller might be held impliedly to warrant the existence of the goods at the time of the contract; and if he seller knows of the loss he may be held to have fraudulently misrepresented his belief in that the goods exist. If the goods exist at the time the contract is made but have already deteriorated, the position is equally unclear.

Again it is useful to consider the application of the Vienna Convention to risk in CIF contracts. Under the Convention Article 67(1) provides:

“If the contract of sale involves carriage of the goods and the seller is not bound to hand them over at a particular place, the risk passes to the buyer when the goods are handed over to the first carrier for transmission to the buyer in accordance with the contract of sale. If the seller is bound to hand the goods over to a carrier at a particular place, the risk does not pass to the buyer until the goods are handed over to the carrier at that place. The fact that the seller is authorised to retain documents controlling the disposition of the goods does not affect the passage of risk.”

Where the contract of sale contemplates land carriage by an independent carrier prior to sea carriage by a sea carrier the Convention contemplates the passage of risk prior to shipment.

Article 67(2) states:

“Nevertheless, the risk does not pass to the buyer until the goods are clearly identified to the contract, whether by markings on the goods, by shipping documents, by notice given to the buyer or otherwise.” This provision appears to preclude the appropriation of lost or damaged goods so as to pass the risk of loss or damage at sea prior to appropriation.

Article 68 provides:

“The risk in respect of goods sold in transit passes to the buyer from the time of the conclusion of the contract. However, if the circumstances so indicate, the risk is assumed by the buyer from the time the goods were handed over to the carrier who issued the documents embodying the contract of carriage. Nevertheless, if at the time of the conclusion of the contract of sale the seller knew or ought to have known that the goods had been lost or damaged and did not disclose this to the buyer, the loss or damage is at the risk of the seller.”

The first sentence of this article, unlike the common law, contemplates the passage of risk at a time when the goods are at sea despite the difficulty of ascertaining the precise moment at which goods were damaged in the course of a long sea voyage. The second sentence contemplates circumstances in which the risk in respect of goods sold in transit may pass retrospectively as from the time the goods were handed over to a carrier. Presumably in such a case there is no requirement of prior identification of the goods to the contract. It may be that the seller is required to cover the goods by transit insurance is a circumstance sufficient to bring a case within the second sentence. In any event the operation of the second sentence is qualified in a case where, at the time of the conclusion of the contract of sale, the seller knew or ought to have known that the goods had been lost or damaged and did not disclose this to the buyer .

In conclusion the following comparisons can be made between the two types of contracts. The first is that under a FOB contract the buyer bears the risk of fluctuations in freight rates and insurance premiums and secondly that a CIF contract will always be an export contract. The most salient point must be that since the seller makes the arrangements for carriage and insurance the Sale of Goods can not apply to CIF contracts, and it has been demonstrated this can produce a degree of uncertainty in these contracts, however to conclude in relation to risk neither method is preferable, and it can be said that each type of contract bears with it its own risk.

Bibliography

Cases

Comptoir D’Achat et de Vente du Borenbond Belge SA v Luis DeRiddler Limitada [1949] AC 293
Cunningham v Munro (1922) 28 Com Cas 42
Diamond Alkali Export Corp’n. v. Fl. Bourgeois [1921] 3 K.B. 443
Ishag v. Allied Bank International [1981] 1 Lloyd’s Rep. 92
Inglis v Stock (1885) 10 App Cas 263
Johnson v Taylor Bros [1920] AC 144
Lickbarrow v. Mason (1787) 2 T.R. 63
Manbre Saccharine Co v Corn Products Co [1919] 1 KB 198
Pyrene and Co Ltd v Scindia Navigation Co Ltd [1954] 2 QB 402
Re Olympia Oil & Cake Co and Produce Brokers Ltd [1915] 1 KB 233
Ross T Smyth & Co Ltd v T D Bailey, Son and Co [1940] 3 ALL ER 60 HL
The Marlborough Hill [1921] 1 A.C. 44
Wimble, Sons and Co v Rosenberg [1913] 1 KB 279

Journal Articles

Bridge M, (1993) “The Carriage of Goods By Sea Act 1992”, Journal of Business Law July 379-383
Dance M, (2002) “Loss Damage and Expense to Cargo – Avoiding and Reducing The Risks”, Due Diligence and Risk Management 3.3(7)
Feltham J, (1991) “CIF and FOB Contracts and The Vienna Convention on Contracts For the International Sale of Goods”, Journal of Business Law September 413-425

Books

Bradgate R, (2003) “Commercial Law”, Third Edition, Butterworths Lexis Nexis
Dobson P, (2003) “Commercial Law”, Third Edition, Cavendish Publishing
Goode, (2004) “Commercial Law”, Third Edition, Butterworths Lexis Nexis
Worthington S, (2003) “Commercial Law and Commercial Practice”, Hart