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Manufacturer’s Corner: Are Your Shipping Terms Exposing You to Unexpected Risk?

Today we continue our review of your terms and conditions to make sure they are appropriate for you.  Manufacturers are often surprised to learn that their shipping terms can be a significant source of risk.  Let’s explore that risk – and learn how to guard against it – by beginning with the basics.

As you would imagine, if something goes awry during shipping or delivery, and the product you send gets damaged, someone has to bear that loss.  The question is whether that someone is you or your buyer.[1]

Rather than go through the myriad shipping terms that might be used to shift risk of loss, and the corresponding points at which risk of loss might pass, let’s look at what you should consider including in your terms and conditions to ensure that your buyer assumes the risk of loss sooner rather than later.  The Uniform Commercial Code’s provisions on risk of loss can be annoyingly convoluted in the abstract, so this focus will assist in giving a clear introduction to the issues you should be looking for.

The first thing you can do to protect your expectations is to specify in your terms and conditions when risk of loss will pass.  Generally speaking, you want this to be as soon as the product leaves your control.  So consider specifying that risk of loss passes as soon as you tender the product to the shipping company that will deliver it.  There will be instances when this may not be what you want to do, but it is a good starting point.

Second, you can specify shipping terms that have the effect of passing risk of loss to your buyer at a similarly early time.  For instance, if you are a manufacturer in Dallas, you could specify that shipment will be made FOB Dallas or FAS Dallas.[2]  Specifying that delivery will be made CIF or C&F has a similar effect, even when those terms go on to designate the buyer’s location as the place of delivery.[3]

If you don’t take one of these steps, risk of loss generally will not pass to your buyer until the product is tendered to your buyer at the destination point, or when your buyer actually receives the product.[4]  It should be clear that if you are going to keep the risk of loss during shipment, you need to price your product accordingly or purchase appropriate insurance.

The foregoing recitation of general rules is subject to an important caveat: it assumes that there has not been a breach of the sales contract.  If you fail to tender conforming goods, for instance, risk of loss remains with you until your buyer accepts them or you cure the non-conformity.  Conversely, if your buyer repudiates the contract, risk of loss passes to the buyer at the time of repudiation (assuming it had not already passed) and remains with the buyer for a reasonable period of time, at least to the extent that your insurance is insufficient to cover any loss that may occur.

Remember also that it may not be enough to look at your terms and conditions to determine when risk of loss passes.  Where your buyer sent a purchase order, you sent an invoice, and your buyer sent a confirmation, you may discover that the terms and conditions in your buyer’s documents conflict with yours.  You then need to determine which will control.  Terms of shipment are a particularly easy source of conflict to overlook, because the conflicting terms may lead to the same outcome assuming all goes as planned.  For example, say that your terms call for shipment FOB Dallas with delivery ultimately to be made at your buyer’s warehouse in New York, whereas your buyer’s terms simply call for shipment FOB New York.  Under either set of terms, your carrier will deliver the product to the New York warehouse, but only under your terms will the risk of loss pass to your buyer upon tender of the product to the carrier in Dallas.

From a big picture perspective, this article should highlight to you the importance of understanding all of your terms and conditions, and making sure that they are appropriate for your business and the pricing decisions you have made.  It should also highlight to you the importance of reviewing the competing terms and conditions set out by your buyer.  But, more specifically, you should now have the basic tools you need to evaluate how your terms can affect whether you or your buyer bears the risk of loss if something goes wrong during shipping, and the knowledge to take appropriate measures to hedge that risk through price adjustments or insurance.

[1] This article focuses on risk of loss between you and your buyer, as set out in Article 2 of the UCC.  Article 7 of the UCC sets out the general rules on liability for carriers, warehousemen, and the like.  Those rules are also important, but beyond the scope of this article.

[2] This article focuses on risk of loss, but that is not the only thing affected by use of the shipping terms discussed here.  If you use FOB or FAS terms, for example, it is your burden to deliver the product to the carrier at your risk and expense.

[3] Again, however, using these terms will impose additional requirements on you – in this case, with respect to what you are required to obtain from your carrier, and whether or not you are required to purchase insurance on the goods.  Be sure you understand all the implications of using these mercantile symbols before you select one for purposes of passing risk of loss.

[4] Another possibility, if you use an “ex ship” term, is that risk of loss will pass when the product is properly unloaded from the ship.