Thursday, October 15, 2009

FOB 2: Free On Board

Exporters of bulk cargo such as palm oil, oil and gas in resource-rich countries like Malaysia will typically receive purchase orders with a Free On Board (FOB) delivery term. These bulk goods are loaded onto large ships known as bulk carriers or tankers. Bulk carriers and tanker fleets flying the M'sian flag include those owned by the MISC, Tanjung Offshore, Global Carriers and Bumi Armada.

The M'sian legal framework on delivery terms for carriage of goods by sea is rather archaic. There may be valid governmental policy reasons for this laggard posture, namely, the liability risk protection of vessels flying the M'sian flag. The time may have arrived for M'sian policy makers to start examining and balancing the need to protect M'sian-registered vessels against the goal of making M'sian maritime companies more competitive in the international arena.

Furthermore, there are significant risk issues involving the relative liabilities of the shipping carriers, the insurer, the exporters and the overseas importer. Many companies tend to leave these matters in the hands of the lower management, supervisory and clerical staff when quarterly revews are probably necessary. These are tactical management issues to be considered.

This issue is a large one and, I am narrowing the discourse into a series of blog entries. This entry focuses on the FOB delivery term.

FOB: Delivery term
FOB is a standardized goods delivery term commonly used in international trade. The International Chamber of Commerce has standardized the definition of FOB through Incoterms.

The salient features of FOB sales under Incoterms 2000 are that, firstly, the seller merely delivers the goods to the ship. Secondly, the buyer is obliged to nominate the ship, if buyer fails to do so can nominate substitute ship within a reasonable time. And, thirdly, the risk for loss of or damage to goods passes from seller to buyer when goods cross ship’s rail (The Pyrene) or when loaded on board ship which deems delivery of goods by seller to carrier to be good delivery to buyer. Generally, neither party is obliged to arrange insurance.

In deciding on the case of Kwei Tek Chao, Devlin J. noted that an unusual feature of Cost, Insurance and Freight (CIF) sales is that there are 2 parallel “transactions”. First, there is a physical delivery of goods where the goods must either conform to sample or description failing which buyer has right to reject goods after examination. Second, it involves the delivery of shipping documents where the documents must conform strictly to the description in the letter of credit failing which the buyer has the right to reject the documents for non-conformity.

In the case of Ganda Edible Oil the M’sian Federal Court noted that in FOB sales that involve documentary credit payments, these 2 rights of rejection are also available to the FOB buyer.

Delivery of goods
Physical delivery of goods by seller to the ship completes the seller’s obligations with respect to physical goods. Consistent with Devlin J.’s finding in The Pyrene and Incoterms on the FOB seller’s delivery obligations – delivery is completed when goods cross the ship’s rail and loaded on board the ship.
Bills of lading (B/L)
In addition to delivery terms such as FOB, the contract for the carriage of goods is important. This carriage contract is evidenced by issuance of the B/L. The B/L has 3 characteristics as explained by Mustill LJ in The Delfini namely, the acknowledgement of receipt of goods by carrier, a document of title and, a contract of carriage of goods.

Under M’sian law B/Ls are governed by the English Bills of Lading Act 1855 (UKBLA) but the UK has moved since 1992 to a completely revamped Carriage of Goods by Sea Act to govern B/Ls and other carriage of goods contracts.

The UKBLA suffers from several disadvantages. Firstly, it recognizes only the B/L as the only form of carriage contract. Other carriage documents, for example, a mate’s receipt, are not protected by the UKBLA and, therefore, the endorsee can’t sue carrier.

Secondly, it links the right to property with right to sue, where right to property is transferred using different mechanism than B/L the endorsee may lose right to sue carrier. This is one of the judicial propositions from The Delfini.

Thirdly, it does not recognize the rights of part owners of unascertained bulk goods without benefit of transfer of property can’t sue carrier: eg Re Wait, Re London Wines. In such a case the “ascertainment by exhaustion” formula applied by Mustill J. in The Elafi is not available.

Delivery of documents
In FOB sales where documentary credit is used, as noted in Ganda Edible Oil, the right of the seller to demand payment arises when the shipping documents are delivered, even when goods are still at sea and, even when the goods have been lost at sea: Manbre Saccharine. The rationale may be that the buyer has recourse to insurance. But there must be actual delivery of goods on board a ship. If there were never any physical goods, seller has no right to claim payment: Hindley & Co v East India Produce.

Passing of risk
Although statutes on the sale of goods presumes that risk passes with property, which applies to “simple FOB” sales, for example FOB Incoterms that doesn’t involve documentary credit, under the “strict/classic FOB” and “FOB with additional services” the risk and property may pass at different times. However, in all FOB sales, risk passes when the goods cross the ship’s rail on The Pyrene principle. This gives the FOB buyer recourse to insurance for damage to or, loss of goods provided the FOB buyer takes up insurance coverage.

Passing of property
Legal scholars like Atiyah have noted that modern FOB sales are very similar to CIF sales in that documentary credit is widely used which requires the seller to retain title to goods. Thus retention of title by the FOB seller, as noted by Atiyah, is a function of securing payment by the buyer.

The general rule is that property passes in FOB sales when shipping documents are delivered and paid for by the buyer: The Aliakmon. Part payment is not good enough to transfer property in goods: Mitsui & Co v Flota Mercante. But since the seller arranges the carriage of goods, the B/L is issued in seller’s name, the seller has to indorse the B/L in favour of the buyer. This assumes that the goods are ascertainable.

First, where goods are unascertained, there must be an unconditional appropriation of the goods to enable property to pass from the seller to the buyer. Such issues often arise when the seller gets into financial or insolvency problems. One example is Carlos Federspiel where bicycles assembled and marked with buyer’s identification but remained at seller’s premises, the property couldn’t pass because FOB sales require goods to be delivered to ship. The appropriation was still conditional in that the seller could still change his mind. In contrast, in Hendy Lennox, the assembly of generators at seller’s premises in a Ex-Works sale with markings in favour of buyer was regarded as unconditional appropriation because all that was left was for buyer to arrange to collect the goods.

Second, the problem is made worse in bulk goods sales with several sub-buyers such as Re Wait and Re London Wines where part ownership of bulk goods are unappropriated & unascertained. Even if ascertained by the statutory sale of goods formulas, the sub-buyers can’t exercise independent rights of suit or obtain greater property rights. In UK the law reform in 1995 created a statutory formula to enable part owners of bulk goods to be given the statutory rights of “owners in common” of bulk goods. The legal anomaly still applies to M’sia.

Third, in international trade, sale of goods statutes operate to reserve title to property with seller. This was shown in the M’sian judicial decision in Shanti Kant where B/Ls made “to order” of timber logs could not pass to Indian buyer with a dubious claim. This allows the seller to ensure that payment is received before property in the goods is passed.

Fourth, in The Delfini, the buyer and seller had contractually agreed that property in the goods would pass upon delivery to the ship & that indemnities provided by the buyer would allow delivery of the goods. This is a situation similar to a “simple FOB” sale. Thus a sub-buyer on CIF terms could not claim against the carrier because it had no privity of contract in relation to the carrier. The B/L issued by the carrier was regarded by the English court of appeal, including Mustill LJ, as being a mere receipt for the goods. Since the goods had been delivered, the B/L could not be regarded as a document of title. In any case, property had passed to the buyer who could pass title to the sub-buyer independent of the B/L.

The Delfini was one of the cases that led to the repeal of the UKBLA in favour of the Carriage of Goods by Sea Act in 1992 that corrected the injustice in cases like The Delfini. M’sia remains under the UKBLA regime with all its defects.

Law reform proposition
There is a need for M’sia to consider adopting the statutory formula in the UK Sale of Goods Act and substitute UKBLA and Malaysian Carriage of Goods by Sea Act (which adopted The Hague Rules) with statutes for carriage of goods governing transport documents similar to the UK Carriage of Goods by Sea Act (which adopted The Hague-Visby Rules).

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