Introduction to Free on Board (FOB)

FOB has its origins in the days of sailing ships.

In the Incoterms® 2020 rules, as in previous versions, FOB requires the seller to place the goods on board the vessel nominated by the buyer. From that point on risk of loss or damage to the goods transfers to the buyer. “On board” is no longer defined as placing the goods “across the ship’s rail” and, in fact, is not defined any further as it will be a matter for the contract to specify depending on the nature of the goods. 

The buyer is responsible for the costs of transport from the named port of shipment, the duties, tariffs and taxes for import customs and any additional transportation costs to the final destination. The seller must cover the costs of transporting the goods to the named port, loading the goods on board the named vessel, and clearing the goods for export (including any fees or charges).

Since it is the buyer who contracts for carriage, the “shipper” on the bill of lading should be the buyer, not the seller.

The seller will most likely require at least a mate’s receipt or some other form of evidence of export (such as a copy of the bill of lading) for their VAT/GST purposes.

Often, where a letter of credit is involved, the seller is shown on the bill of lading as the “shipper”, in which case the seller would be wise to inform themselves of the additional liabilities they might be taking on under the terms and conditions of the bill of lading.

Free on Board (FOB) Incoterms 2020 rule – introduction, history, and uses

“Free on Board” has been in use since the sailing ship days. It was, of course, included in the first version of Incoterms® in 1936 and has remained identical in concept throughout the later versions.

The requirement is that the buyer must contract for the vessel or space on the vessel, and the seller must load the goods onto that vessel. 

Interestingly, the delivery requirement was that the seller must simply deliver the goods on board, but the cost split was that the seller bears all costs and risks until the goods have “passed over the ship’s rail”. For decades this wording caused confusion and lawyers’ fees.

How do the costs and risks get split at the point while the goods are suspended above the ship’s rail? The 2010 version finally aligned the cost and risks matter with delivery, eliminating mention of the ship’s rail.

An interesting provision that has been in the Incoterms® rules ever since the 1990 version has been that the seller must arrange for shipment at the buyer’s cost and risk on the “usual terms” if it is so agreed in the contract. Sellers, however, should be wary of doing this. It will depend on the customary procedures in the relevant countries as to whether this is practical and desirable or could have unfortunate legal consequences for the seller.

The contract should lay out very specifically what is required of the seller and limit their liability if they are to be declared as the shipper or consignor. This provision seems a little at odds with how FOB is supposed to work. Whether it has a place now in the world of sea transport is a good question.

Use of FOB

FOB is not appropriate for container shipments under the Incoterms® 2020 rules. This is because, in container shipments, the cargo is given to the carrier at a place some distance from the port, such as a container yard or even the seller’s premises. As such, the seller does not load them “on board” the vessel and another term (like FCA) would be preferable in this situation.

It must also be pointed out that the peculiarly North American concept of “FOB shipping point, freight prepaid”, “FOB destination”, and “FOB destination, freight prepaid” have no place in international trade or domestic trade anywhere else.

As the Incoterms® 2010 and now 2020 rules are very much intended to apply to both international and domestic trade, it is hoped that all manner of strange local rules will die out. 

Free on Board (FOB) podcast

Free on Board (FOB) seller and buyer obligations

Using Free on Board for container shipments

Unfortunately, sellers and buyers commonly treat FOB as merely a price point – the seller doesn’t pay the freight, and the buyer does.

Freight forwarders treat it as a way that they know the seller pays local charges in the export country, freight is marked as “collect” on the transport document and paid by the buyer. Often, their instruction forms to be completed and signed by the seller will only show three or four options, and FOB always features whether the goods are being transported by container or by air.

The simple fact is that in the vast majority of transactions handled by freight forwarders – i.e., LCL (less than container load), FCL (full container load), or air – FOB should not be an option.

Clarifications to FOB use over the years

Incoterms® 1990, in its preface for FOB, stated, “When the ship’s rail serves no practical purpose, such as in the case of roll-on/roll-off or container traffic, the FCA term is more appropriate to use.”

In the Incoterms® 2000 rules, FOB had a one-paragraph preface that included, “If the parties do not intend to deliver the goods across the ship’s rail, the FCA term should be used.”

Then, the 2010 version strengthened this concept by splitting FAS, FOB, CFR, and CIF off into their own section as “Rules for Sea or Inland Waterway Transport” and included an even stronger explanation: “FOB may not be appropriate where goods are handed over to the carrier before they are on board the vessel, for example, goods in containers, which are typically delivered at a terminal. In such situations, the FCA rule should be used.”

Now, in the 2020 version’s Explanatory Notes for Users, the matter is even more clearly explained: “This rule is to be used only for sea or inland waterway transport where the parties intend to deliver the goods by placing the goods on board a vessel. Thus, the FOB rule is not appropriate where goods are handed over to the carrier before they are on board the vessel, for example, where goods are handed over to a carrier at a container terminal. Where this is the case, parties should consider using the FCA rule rather than the FOB rule.”

In container shipments, the seller does not put the goods “on board” the vessel

Why are the roles so set against using FOB for container shipments? Everybody does it. Why don’t the rules accommodate just it?

The answer is that the delivery point in the FOB Incoterms® 2020 rule is when the goods are delivered on board the vessel by the seller, and this is almost always impossible for the seller to do when the goods are containerised.

When the seller sells goods that will be shipped as a full container load (FCL), it either packs the container provided by the buyer’s carrier at its premises or delivers the goods to a facility nominated by the buyer’s carrier where they will be packed into the container. From there, the container may well be moved to a terminal or container yard (CY) contracted by the shipping line in the port, awaiting the arrival of the vessel to be loaded.

If the goods are less than a container load (LCL), they will be picked up from the seller by the buyer’s carrier or delivered by the seller to a container freight station (CFS) nominated by the buyer’s carrier where they will be consolidated with other goods into a container, which then moves as just described.

The seller has no direct control of, or knowledge of, what is happening to the goods once they leave the seller’s possession and are in the possession and control of the buyer’s carrier.

The seller certainly cannot deliver the goods on board the vessel.

Free on Board (FOB): advantages and disadvantages

Advantages for the seller

What are the advantages for the seller to use the FOB Incoterms® 2020 rule?

The most obvious is that when the goods have been delivered on board the buyer’s vessel, the seller has not only physically done what it has to do, but it might seem that it also has no further costs, risk of loss or damage to the goods, or responsibilities.

Well, that is not quite correct.

The seller must still (at its own cost) provide the buyer with proof that the goods have been delivered on board, whether that be a mate’s receipt, some other form of receipt, or a transport document such as a bill of lading. The seller must also assist the buyer with any information or documents the buyer will need for its import clearance formalities (at the buyer’s request, risk, and cost).

The most usual such document is the certificate of origin, but in practice, it is unusual for the seller to charge the buyer with the relatively insignificant cost of this.

Possible risks for the seller

Despite the seller not having any risk of loss or damage after delivery, a prudent seller would look at the agreed payment arrangements, which are outside the coverage of Incoterms® 2020.

What would happen if the buyer refused payment because it knew that the vessel had sunk? Or the market for that commodity has had a sudden downturn? What would happen if the buyer simply went bankrupt during the voyage?

Clearly, the seller would still have the risk of loss or damage to the goods, so the seller might like to investigate a contingency policy for marine cover.

From the buyer’s perspective

The benefit to the buyer is that it has control of the goods on the vessel it has arranged, and it has control of the costs as well.

The buyer has the risk of loss or damage to the goods from the point where they are delivered on board, and depending on the nature of the goods and their packaging, if any, it would be wise to detail in the contract precisely what this means.

For example, with bulk product poured into the holds, it would likely include the word “trimmed” to indicate that the load is evenly poured throughout the hold and relatively level at the top to distribute the weight correctly. For drums of product, it might include an agreement that dunnage, often scrap material, be provided to prevent the drums from moving and sliding and that they be lashed to hold them in place – what part does the seller have to play in these?

Free on Board (FOB) diagram 2024

Diagram: FOB – The seller must carry out all export formalities and the buyer must carry out import formalities. Source: ICC

Free on Board and letters of credit

Banks, in their letter of credit (LC) applications, are just as much at fault as forwarders for misleading their clients.

Their LC application forms almost invariably state three or four three-letter terms marked as “Incoterms”, and again, FOB features prominently, making buyers feel obliged to tick the FOB box even though their goods are containerised or by air.

Where does that leave the seller and buyer when they have agreed with each other to use the correct rule of FCA, but their bank insists on stating FOB because that is what is on their form and “we have always done it this way” or “this is our standard procedure”?

Banks cope very well with a true FOB Incoterms® 2020 transaction because it fits the way their application forms were designed decades ago, it fits very well with the way the LC rules – UCP600 – were written, and it fits very well with the SWIFT message standards for transmitting an LC in their MT700 format.

Nice and neat, a port of loading, a port of discharge, a latest onboard date, a requirement for a “full set of clean on board bills of lading marked freight collect….”

FOB Video – What are Incoterms® 2020 and why are they important?