Client Question:
We sell CPT, leaving the Buyer to insure. As we have no risk, do we need to verify that the Buyer takes out cover?
Answer:
A commercial term privately expresses the desired division of risk between the Seller and the Buyer. It exists only in the contained world of the sales contract, and it only considers the position of the Seller and the Buyer.
In a CPT (Carriage Paid To) agreement, risk passes to the Buyer when the Seller makes the goods available to the first carrier, presumably at the point of supply or some other place in the country of supply. It creates a low-risk contract for the Seller, and correspondingly, it is a high-risk contract for the Buyer.
However, in executing a transaction, the supplier is not just the Seller. They take on many additional roles, roles that are not addressed or regulated by the commercial term.
Even in a commonplace and mundane export (and not every export is commonplace and mundane), the supplier will have multiple parallel functions and responsibilities over and above being the contractual Seller.
While it is clear that a CPT model results in a low-risk contract for the Seller, it is misleading in a practical sense to only consider the commercial term when identifying ‘real-world’ commercial risks.
Risk management requires an alignment of the Seller’s expressed contractual position (their rights) with the everyday risks (the realities) of business.
It is impractical (if not misleading) to see a commercial term as the absolute expression of the Seller’s risk appetite when risk-appetite is more readily and precisely expressed in the payment conditions that the Seller may allow or accept.
For example, if a CPT Seller offered an open account (unsecured credit) then, should something go wrong in transit (e.g. a total loss), although the Seller might have the contractual right to be paid, if the Buyer has no insurance cover the Seller runs the practical risk that the Buyer will not have the money to pay them, assuming they wished to.
In that simple example it follows that if the CPT Seller offers unsecured credit to a foreign entity, they should ask to sight evidence that the Buyer is carrying adequate cargo insurance as a condition of the credit agreement.
Having the right to be paid is not the same as having money in the bank, and you can’t pay your taxes (or salaries) with rights.
(Of course, the South African Seller in a CPT contract is also the Vendor for VAT purposes and the Resident for Exchange Control purposes. In these roles, a default by the Buyer has serious repercussions, and the Seller’s position under the Incoterms Rules is worthless to the Vendor and Resident in controlling their onerous exposure.
To offer unsecured credit must be contemplated as a VAT and Exchange Control risk before it is assessed as a commercial one. Credit insurance solves neither the VAT nor ExCon risk but simply replaces one set of risks with another.)
While there’s more to consider, it is prudent that the CPT Seller does not offer unsecured credit or, if they must, that they ensure the Buyer is carrying adequate cargo insurance in the event of loss or damage.
But even when payment is secured, the execution of the export creates an array of risks for the supplier in their parallel role as the Shipper.
As the party contracting with the carrier in the CPT model, the Shipper has liabilities and risks independent of the Seller’s risks and liabilities.
Perhaps the most extreme example is in seafreight, in the unlikely event of a General Average.
An uninsured named-Consignee has the opportunity to abandon their interest in the cargo and to walk away from a General Average contribution.
But the contracting Shipper does not have the opportunity to so readily abandon responsibility, and selling CPT without knowing if the Buyer has taken out adequate insurance may come back to haunt the Seller in their parallel role as Shipper.
This is an extreme example, but in any form of transport, the Consignee has a period where they might abandon their interest, leaving the Shipper with a cost, risk or obligation that the CPT Seller believes it has excused itself from.
Any protection afforded to the Seller by the commercial term, however, cannot be used by the Shipper to deflect a legitimate claim from the carrier.
But not all of the Shipper’s default risks can be covered by insurance. While CPT might be a low-risk approach for the Seller, it is not a no-risk contract.
Regardless of how remote the possibility of the Buyer abandoning the cargo, the risk that it may happen is amplified by allowing the Buyer unsecured credit, and further, by allowing the possibility that the Buyer has no access to insurance cover.
In short: if the Seller was seeking a one-option model, CIP (Carriage and Insurance paid To) is a better choice, with the Seller forcing insurance into the sale agreement (for the Buyer’s risks). Knowing the Buyer has cover does not eliminate all risks, but it removes several of the hidden risks in trade, provided that payment is secured.
The Seller should accept CPT only when prevented by law from arranging cover, denying them the opportunity to sell CIP.
In that event, ideally the prudent Seller should call to sight the Buyer’s insurance conditions before the supply contract is finalised, but certainly no later than prior to physical release of the cargo into the supply chain.
Insurance aside, the CPT Seller undermines their entire model if they grant unsecured credit. While commercial terms offer no guidance on payment conditions, it would be consistent with the CPT and/or CIP Seller’s apparent risk-appetite that they are prepaid or to at least have the Buyer’s payment obligation bank-secured.
Business is all about money. Payment is not an accidental byproduct of commerce; it is the whole point to commerce.
A commercial term expresses the Seller’s position, but an export comprises of many roles, and risk-management of the Seller’s position is often the least important consideration when managing that range of functions.
It is only my opinion, but allowing a model where there is potentially no cargo insurance is to betray the mandate given to us by the shareholders – protect the company.
Source: Freight Training
