Essential elements of the sales contract
The sales contract Learning objectives This chapter outlines the importance of the sales contract. It emphasises the need for the buyer and seller to agree upon specific data elements that will enable the shipment of the goods, or provision of services or performance, and the creation and presentation of the appropriate documents. It will also provide for an agreement on how the seller will be paid for those goods, services or performance. By the end of this chapter, you should be able to: ◆◆ outline the parties to a sales contract; ◆◆ analyse the relationship between the sales contract and the payment to be made thereunder; ◆◆ explain the use of Incoterms 2010 in domestic and international trade; and ◆◆ identify the need to apply the correct Incoterm to a transaction.
5: The sales contract
The most basic agreement in international trade is the sales contract concluded between a seller and a buyer. This is often referred to as a ‘sales agreement’, an ‘export contract’ or a ‘foreign sales agreement’. For the
purpose of this study text, we will use the term ‘sales contract’.
All other agreements and procedures commonly used in international trade result from the performance of this contract. For example, two essential components of a sales contract are the seller’s agreement to provide the
goods to a buyer and the buyer’s agreement to pay the specified price in return. In the context of a cross-border transaction, the first of these usually involves the conclusion of a contract with a carrier to transport the goods from the country in which the seller is located to that of the buyer. The buyer’s agreement makes it necessary for it to arrange payment through the banking system.
The payment mechanisms commonly used in cross-border trade transactions were briefly examined in Chapter 3. Other procedures related to sales and payment can be subject to government requirements, such as customs procedures and exchange control regulations.
A documentary credit, as a chosen method of settlement, is an undertaking separate from the sale or other contract on which it may be based. This essential characteristic and its consequences will be covered in further
detail throughout this study text, but in commercial (rather than legal) terms documentary credits are issued to facilitate performance of the buyer’s payment obligation to a seller.
This chapter explores the relationship between the seller and buyer. It identifies the key decisions that both parties need to make in a sales contract, and it concludes with the assumption that the parties choose a
documentary credit as the method of settlement.
5.2 Sales contracts
Many sales contracts are made between a seller and a buyer located in the same country. In these circumstances, the laws of that country will govern the contract’s execution and any disputes that might arise.
For a cross-border transaction, the situation is different. There is no general system of international commercial law that covers such contracts.
This means that the execution of a sales contract is likely to be governed by provisions that will differ from one country to another, reflecting the different commercial laws in each.
This situation provides significant scope for uncertainty in the event of a dispute between a seller and a buyer. Resolving such disputes can be time-consuming and costly, especially if they are to be resolved in court or via
arbitration. In extreme cases, sales contracts can be deemed null and void, with a consequent loss for both parties.
This potential for confusion makes it vital that a seller and buyer reach an agreement over the precise content of the sales contract.
Banks play no role in the negotiation of the sales contract, which is signed only by the seller and buyer.
5.2.1 The content of a sales contract
The key element of any sales contract (see sample Figure 5.1) is the agreement of a buyer to pay a seller an agreed price for a specified quantity of goods. In many countries, this simple agreement is sufficient to constitute an import–export contract. In other words, the contract does not need to be a lengthy or formal document to be legally enforceable. Contracts also do not need to be formally notarised. An agreement can equally be reached in a telephone conversation, or via an email or fax message.
Figure 5.1 Sample sales contract CONTRACT FOR SALE OF GOODS THIS AGREEMENT IS MADE ON THE (Date) BETWEEN “The Seller” (Name and address of the Business offering the service) AND “The Buyer” (Name and address of the client) CONCERNING “The Goods” (Description of Goods) IT IS HEREBY AGREED AS FOLLOWS 1. The Sale and Contract Price 1.1. The Seller agrees to sell the Goods to the Buyer 1.2. The Buyer agrees to pay the sum of £ for the Goods (“the Purchase Price”) 1.3. The Purchase Price is: (delete as applicable) • Inclusive of tax • Exclusive of tax • Not subject to tax 1.4. The Purchase Price shall be paid: (delete as applicable) • In Full in advance • By (Specify details of payment terms and method e.g., sight or XX days after shipment, open account, documentary credit, documentary collection etc.) 2. Delivery of Goods 2.1. The Goods shall be delivered by the seller or collected by the buyer according to the following terms: (Specify details of collection/delivery terms and dates) 3. Property Rights and Assumption of Risk .......... 4. The Condition of the Goods and Warranties .......... 5. Force Majeure ………. 6. Whole Agreement, Governing Law, Severability and Miscellaneous Provisions ………. IN WITNESS OF WHICH the Buyer and the Seller have signed their names below: On behalf of the Buyer On behalf of the Seller (Sign) (Sign) (Print Name) (Print Name) (Position if signing on behalf of a company) (position if signing on behalf of a company) (date) (date)
In practice, a sales contract will contain more detail than only the quantity of goods and the sale price. It will usually also cover related items such as the time period for delivery, the method of payment and the manner in
which the goods are to be delivered, usually by reference to a trade term (or an ICC Incoterm – see section 5.3). Some contracts will also specify which country’s law will apply and which court or arbitration system has
jurisdiction to hear any claims in the event of a dispute.
Rather than use a sales contract, a seller will often send the buyer a proforma invoice (see Figure 5.2), containing the details of the goods and their unit prices, before the transaction is concluded. Similarly, a buyer may send
the seller a purchase order (see Figure 5.3) confirming its commitment to purchase certain goods at an agreed price and on specified terms.
5.2.2 Contract terms and conditions
Sales contracts are usually agreed between a seller and buyer acting in their normal course of business, rather than between private individuals.Moreover, many sellers and buyers have their own standard conditions of
sale and purchase. These set out the terms on which they normally conduct business and will typically be included by reference in a sales contract.
Problems can arise, however, because there are likely to be some differences between the standard terms of the seller and those of the buyer. The two parties may well exchange these standard terms during pre-contract
negotiations. If the differences are not resolved at this stage, problems can arise later if there is a dispute. This is because it can be difficult to establish which set of conditions, if either, will apply to the transaction.
In extreme cases, the dispute will be taken to a court or tribunal, where a judge or arbitrator might decide that no contract was ever concluded because the seller and buyer did not agree on the applicable conditions. In practice, however, a judge or arbitrator is likely to try to seek a resolution by determining one or other set of conditions applies, or even that both sets of conditions apply to the extent that they do not conflict.
5.2.3 The law governing contracts
In most cases, sales contracts are governed, at least in part, by the laws of the country in which one of the parties involved is located. The seller and buyer may themselves agree which law is to apply by including a specific provision in the sales contract.
If there is no such agreement or provision, then in the event of a dispute a judge or arbitrator may first have to determine the governing law. In these circumstances, a judge or arbitrator will often decide to apply the law of
the country most connected with the contract, which may be the country to which the goods are being delivered. The use of trade terms (Incoterms –see section 5.3) determines the point at which delivery is deemed to have
occurred, for example a seller fulfils its delivery obligation when the goods are loaded on board a ship at the named port of loading under both CIF (‘cost, insurance and freight’) and FOB (‘free on board’) Incoterms.
There have been a number of attempts to introduce an international law for export sales. The latest is the United Nations Convention on Contracts for the International Sale of Goods (CISG), signed on 11 April 1980 in Vienna
and which came into force as a multilateral treaty on 1 January 1988, after being ratified by 11 countries. The CISG provides a standardised set of legal rules for import–export transactions. As of July 2015, 83 countries
had ratified the Convention.
5.2.4 A checklist for an effective sales agreement
In addition to determining the quantity of goods and any unit price, a seller and buyer should agree the following points to minimise the risk of dispute and thereby establish the appropriate Incoterm.
- The terms of delivery of the goods
- The point at which the risk in respect of the goods passes from seller to buyer
- Who should clear goods through customs and where
- Who arranges for insurance for the carriage of goods and up to what point
- What precise risks to the goods need to be covered and specifically shown as covered on the insurance document
- What commercial documents are needed and what should be shown on them
- Whether any other documents (such as inspection certificates) are needed and who is to issue them
5.2.5 The sales contract and the method of settlement
Having agreed that the method of settlement is to be a documentary credit, it is important that the sales contract be as specific as possible in describing the payment terms and the type of documentary credit that is required.
For example, a sales contract that merely indicates
◆◆ settlement by irrevocable documentary credit,
◆◆ settlement by documentary credit,
◆◆ documentary credit payable at sight, or
◆◆ documentary credit payable 60 days after the date of shipment and such like may not achieve the expectations of the seller.
As will be noted in Chapters 6 and 7, there are a number of different forms of the documentary credit, each of which can offer an element of benefit to a seller or buyer.
For a seller that is looking to sell its goods on a ‘sight’ basis with the expectation of full payment, less normal bank charges, once a complying presentation is made to a nominated bank, it is not sufficient to state in
the sales contract ‘payment by documentary credit at sight’. The buyer, as applicant of the documentary credit, may arrange for the issuance of a documentary credit that is available by negotiation, on a sight basis (and
therefore meet the condition of the sales contract for a sight documentary credit), but the outcome will be that if the seller (as beneficiary) requires immediate settlement, it will receive the proceeds for a complying
presentation less interest for the period between the nominated bank effecting settlement and the issuing bank providing the nominated bank with reimbursement.
A seller requiring immediate settlement, without deduction for interest, should indicate ‘documentary credit available with [name of its preferred bank] by payment’.
These types of issue will be covered in Chapters 6 and 7.
5.3 The use of Incoterms in trade
One of the challenges in any sales contract is to ensure that both parties understand their responsibilities. These include the payment of carriage, insurance, loading and unloading costs, import and export taxes, and any
other associated costs. Each of these will be the responsibility of either the seller or buyer. The buyer needs to understand these responsibilities to be able to calculate the full purchase price; the seller, to provide an accurate
sales price. The chance of dispute is minimised when the parties share the same understanding of their respective responsibilities.
One of the best ways in which to minimise the chance of a dispute, in both domestic and international trade, is to use ‘Incoterms’. The ICC first published its Incoterms in 1936, and over time they have become the accepted international standard for trade terms referred to in sales contracts.
The current version of Incoterms, Incoterms 2010, came into effect on 1 January 2011. The full version is provided in ICC Publication No. 715.Incoterms 2010 have been designed to reflect changes in commercial
practices that have occurred since the last revision in 2000. These include reference to electronic alternatives to paper documentation, cargo insurance clauses, and also the establishment of two new Incoterms: DAT
(‘delivered at terminal’) and DAP (‘delivered at place’).
5.3.1 The scope of Incoterms
Incoterms deal solely with the rights and responsibilities of parties involved in the delivery of goods sold under a contract of sale. They do not extend to other contracts, such as insurance, carriage and payment, although the
Incoterm that is used may have implications for such contracts.
For example, the Incoterm CFR (‘cost and freight’) implies that carriage will be effected on a port-to-port basis. This means that either a bill of lading, a charter party bill of lading or a non-negotiable sea waybill should be
requested. Under a documentary credit, the type of transport document called for should comply with the stated Incoterm.
5.3.2 Incoterm categories
There are 11 Incoterms, which are for use in domestic and international transactions. Each one sets out the obligations of the seller and buyer under the sales contract, and indicates the point at which responsibility
is transferred from seller to buyer. The seller’s obligations escalate from EXW (‘ex works’ – the minimum) to DDP (‘delivered duty paid’ – the maximum). Any obligation that does not appear in a particular Incoterm is the responsibility of the buyer unless the sales contract states otherwise.
The 11 Incoterms are divided into two groups: seven that are suitable for any mode or modes of transport; the remaining four applying to sea or inland waterway transport only. When incorporating an Incoterm into a
sales contract, the seller and buyer should take care to ensure that the term selected is appropriate to the agreed point of delivery and the mode of transportation to be used.
The 11 Incoterms are grouped as follows:
◆◆ Group 1: Rules for any mode or modes of transport
– EXW (‘ex works’)
– FCA (‘free carrier’)
– CPT (‘carriage paid to’)
– CIP (‘carriage and insurance paid to’)
– DAT (‘delivered at terminal’)
– DAP (‘delivered at place’)
– DDP (‘delivered duty paid’)
Group 2: Rules for sea or inland waterway transport only
– FAS (‘free alongside ship’)
– FOB (‘free on board’)
– CFR (‘cost and freight’)
– CIF (‘cost, insurance and freight’)
5.3.3 Applying the appropriate Incoterm, and the applicable transport and insurance
Figures 5.4–5.14 indicate some of the main aspects of each Incoterm listed in section 5.3.2. The Incoterms are set out in a logical order under each grouping, starting with the term that imposes the least obligation on a
seller and ending with that which imposes the most.
Sellers and buyers are advised to review the full content of ICC Publication No. 715 once an Incoterm has been identified, so that they understand its full implication and the obligations that it imposes.
Irrespective of the chosen Incoterm, the buyer pays for the goods according to the terms of settlement agreed in the sales contract, proforma invoice or purchase order.
126.96.36.199 Group 1: Incoterms for use with any mode or modes of transport
These Incoterms may be used irrespective of the mode of transport selected and may be used where more than one mode of transport is used.
5.3.4 Understanding rights and responsibilities when using Incoterms
Figures 5.4–5.14 illustrate how the rights and responsibilities of the seller and buyer vary depending on the Incoterm used. Understanding the limits of each party’s responsibilities is crucial when negotiating the precise terms of a sales contract, especially when payment is due under a documentary credit.
Sellers agree to payment under a documentary credit because a bank gives an undertaking that payment will be made, as long as the documents presented conform to its requirements. This undertaking is independent of
the buyer’s ability to pay. Following contract negotiations, the seller should scrutinise the terms of a documentary credit to make sure, among other aspects, that it conforms to the Incoterm quoted in the sales contract. For example, a documentary credit should not indicate the need for presentation of an air waybill if the Incoterm is designed for sea shipment. Similarly, if the seller is not responsible for insuring the goods, the documentary credit should not indicate a requirement for the seller to procure an insurance document.
Any conflict between the Incoterm, the documentary credit and the sales contract can result in delays in the issuance of, advising of, or payment under a documentary credit. Any delays will have a financial cost – including, as a minimum, the impact of the delay on cash flow. In extreme cases, if the terms of the documentary credit cannot be complied with because of such conflict, a bank will not be in a position to honour or negotiate.