CDCS Master Series – Article 2
International trade does not start with a Letter of Credit. It starts much earlier — with a sales contract quietly signed between a buyer and a seller, often without any banker present. Yet, this single document determines almost everything that follows: the choice of Incoterms®, shipment obligations, insurance responsibility, document requirements, risk transfer, and ultimately whether an LC will function smoothly or collapse into disputes.
For CDCS candidates and trade professionals, misunderstanding the sales contract and Incoterms® is one of the most common and costly weaknesses. This article unpacks these foundations in a clear, newspaper-style narrative — practical, exam-focused, and rooted in real trade scenarios.
What Is a Sales Contract in International Trade?
A sales contract is a legally binding agreement between a seller (exporter) and a buyer (importer) that defines the terms under which goods are sold and delivered.
In international trade, a sales contract typically covers:
- Description of goods
- Quantity and quality specifications
- Price and currency
- Delivery terms (Incoterms®)
- Shipment period and place of delivery
- Payment terms (LC, collection, open account, advance)
- Insurance requirements
- Governing law and dispute resolution
CDCS insight: Banks are not parties to the sales contract, yet the LC is drafted based entirely on it. Any ambiguity in the contract often resurfaces later as documentary discrepancies.
Why Bankers Must Understand the Sales Contract
Many junior bankers believe sales contracts are “commercial matters” outside banking. This assumption is dangerous.
A poorly drafted contract can cause:
- Conflicting Incoterms® and LC clauses
- Impossible document requirements
- Insurance gaps
- Disputes over shipment responsibility
- Refusal of documents by banks
In CDCS exams, questions frequently test whether you can identify mismatches between:
- Sales contract vs LC
- Incoterms® vs transport document
- Risk transfer vs insurance coverage
Introduction to Incoterms® 2020
Incoterms® (International Commercial Terms) are standardized trade terms published by the International Chamber of Commerce (ICC). They define:
- Who delivers the goods
- Where delivery takes place
- When risk transfers from seller to buyer
- Who pays which costs
The current version is Incoterms® 2020, effective from 1 January 2020.
Critical exam rule: Incoterms® apply only if expressly incorporated into the sales contract.
Correct usage:
FOB Chittagong Port, Incoterms® 2020
Incorrect usage:
FOB Chittagong
Structure of Incoterms® 2020
Incoterms® 2020 consists of 11 rules, divided into two categories:
A. Rules for Any Mode of Transport (7)
- EXW – Ex Works
- FCA – Free Carrier
- CPT – Carriage Paid To
- CIP – Carriage and Insurance Paid To
- DAP – Delivered at Place
- DPU – Delivered at Place Unloaded
- DDP – Delivered Duty Paid
B. Rules for Sea and Inland Waterway Transport (4)
- FAS – Free Alongside Ship
- FOB – Free on Board
- CFR – Cost and Freight
- CIF – Cost, Insurance and Freight
CDCS favourite: Knowing which rules are NOT suitable for container trade (FOB, CFR, CIF) is a frequent exam trap.
Risk vs Cost vs Control – The Core Logic of Incoterms®
A common misconception is that Incoterms® determine ownership. They do not.
Instead, Incoterms® allocate:
- Risk (who bears loss or damage)
- Cost (who pays for freight, insurance, handling)
- Control (who arranges carriage)
Example: FOB vs CIF
Under FOB:
- Risk transfers when goods are loaded on board
- Buyer arranges freight and insurance
Under CIF:
- Risk transfers at the same point as FOB
- Seller pays freight and minimum insurance
This distinction is essential for understanding insurance documents in LCs.
Incoterms® and Letters of Credit: Where Problems Begin
Many documentary discrepancies arise not from poor documentation but from wrong Incoterms® selection.
Common mismatches:
- FOB term used for containerized cargo → wrong transport document
- CIF used but insurance policy does not match CIF requirements
- DDP used without clarity on import customs responsibility
Banker’s reality: Banks examine documents, not contracts — but inconsistencies still cause refusal.
Focus on High-Risk Incoterms® (Exam Perspective)
EXW – Ex Works
- Maximum obligation on buyer
- Seller has minimal responsibility
- Problematic for exporters using LCs
FCA – Free Carrier (Preferred Alternative)
- Suitable for container trade
- Flexible delivery locations
- Increasingly recommended by ICC
DDP – Delivered Duty Paid
- Maximum obligation on seller
- Includes customs duties and taxes
- High legal and compliance risk
CDCS exam tip: Questions often ask which term places maximum obligation on the seller — the answer is DDP.
Incoterms® 2020 vs Previous Versions
Key updates in Incoterms® 2020 include:
- Replacement of DAT with DPU
- Higher insurance requirement for CIP (Institute Cargo Clauses A)
- Enhanced FCA option for onboard bill of lading
- Clearer security-related obligations
CDCS does not test memorization — it tests application.
Real-World Example (Bangladesh Context)
A Bangladeshi garment exporter signs a contract:
CIF Hamburg, Incoterms® 2020
The LC requires:
- Insurance policy for 110% of invoice value
- Covering “all risks”
Exporter submits an insurance policy with limited coverage.
Result: Documents rejected — not because of LC error, but because CIF imposes minimum insurance responsibility on the seller.
Common Mistakes by Trade Professionals
- Using FOB for container shipments
- Ignoring Incoterms® year
- Assuming Incoterms® determine payment method
- Confusing risk transfer with title transfer
Avoiding these mistakes alone can significantly improve CDCS performance.
CDCS Quick Revision Checklist
Before moving to the next topic, ensure you can:
- Explain the purpose of a sales contract
- Identify the structure of Incoterms® 2020
- Match Incoterms® with transport modes
- Distinguish risk, cost, and control
- Identify high-risk terms
Case Study: How a Poorly Drafted Sales Contract Triggers LC Failure
Consider an importer in Bangladesh purchasing capital machinery from Germany. The sales contract states:
Delivery term: CIF Chittagong
However, the contract does not specify the Incoterms® version. The LC later issued requires:
- Multimodal transport document
- Insurance covering warehouse-to-warehouse risks
The exporter ships the goods in containers and presents a bill of lading showing a container terminal, not the port rail. Insurance coverage is limited to basic marine risks.
Outcome:
- Bank refuses documents
- Shipment is delayed
- Demurrage costs arise
- Buyer and seller dispute responsibility
Root cause: Ambiguous sales contract and incorrect Incoterms® usage — not banking error.
This type of scenario is frequently reflected in CDCS case-based questions.
Incoterms® and Transport Documents: A Critical Link
Incoterms® directly influence the type of transport document required under an LC.
Examples:
- FOB, CFR, CIF → Bill of Lading
- FCA, CPT, CIP → Multimodal or combined transport document
- D-terms → Proof of delivery may be outside banking scope
Exam insight: Choosing the wrong Incoterm often leads to requesting an impossible document — a classic CDCS trick question.