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  • 3.1.1-COTTON MARKETING-STANDARD CONTRACTUAL TERMS

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  • Standard contractual terms

    Chapter 3 - Cotton marketing - Contracts

     
     

    Quality – terms of valuation

    Cotton fibre is produced at many different origins from a variety of seed varieties distributed under varying local controls and planted in different districts farmed and managed under different criteria and controls. The result is the production of a wide range of lint fibre properties influenced not only by these factors but also by climatic conditions throughout the planting, growing and picking cycles.

    Cotton lint is marketed in different ways, and buyers rely on the supplier to meet the precise contractual quality specifications.

    • On description (based on ‘Universal Standards’) is a system of manual classification of grade and colour with reference to the Universal Cotton Grade Standards. Universal Standard boxes are produced by USDA under the Universal Cotton Standards Agreement. Valuation of cotton lint is performed with reference to several different ‘standard’ boxes, created for that purpose by the accredited organization.
    • The role of standard boxes in the international cotton trade is to allow trading partners throughout the world to identify a quality of cotton by a written ‘description’, the quality being evidenced within the standard boxes, lodged and held by authorized bodies or ‘signatories’ which are the major international cotton associations. These standard boxes are available to anyone on application and payment of the appropriate fee.
    • Basis ‘on type’ is the process of selling cotton fibre on the basis of a private ‘type’(sample) which represents the specific named characteristics defined by the seller and is supplied to the potential buyer for approval. This may be an internationally recognized ‘standard’ type quality, and is sometimes traded by name alone if the quality is well recognized; however, it is envisaged that the potential buyer will hold a physical type at the time of contract. The ‘type’ may represent the grade (leaf/trash content and colour) and the staple length of the fibre, or just the grade alone; this will be defined on the seller’s offer. Other characteristics obtained by mechanical testing may be expressed separately. Type samples should always be sealed to ensure that no manipulation of the contained fibre is possible.
    • HVI (high volume instrument testing) or SITC (Standard Instrument Testing) is a fully implemented system that provides results not possible by manual or physical evaluation. The seller will specify in the contract the range of specifications they are content to offer. SITC fibre testing is operated by a majority of spinning mills in the world today, and an increasing percentage of cotton lint production is also being evaluated by SITC.

    The testing authority should be agreed and stated in the contract.

    • Sale on government class means a sale made based on government classification (e.g. USDA) based on grade, colour, staple length, micronaire and other standard measurements made by HVI. It is a practice in the United States to base sale on green card, or initial and obligatory classification of cotton performed by the USDA Classing Board when cotton is ginned. In Central Asia ginning mills issue certificates of quality with major quality characteristics of the fibre. In cases of deviation of quality from contract stipulations, value differences circulars issued by cotton associations can be used to settle differences. The associations produce the value differences estimates for use during arbitration procedures to settle quality disputes between the contract parties.
    • Sale on certification means that at the time of contract the parties will agree the basis of quality and insert a clause in the contract stating that an independent certification of quality will be conducted by a named independent international cotton controller. The certificate issued will form a part of the shipment documentation provided to the buyer. The certificate will identify the actual lot numbers and quantity, and be signed and dated by the appointed company.
    • Preshipment inspection and approval of actual stock lots means that at the time of contract the parties agree the quality basis of the contract. A clause is added that permits the buyer to access the allocated lots of cotton and to inspect and sample prior to shipment. The buyer has the option of delegating a company representative or appointing an international cotton controlling company to attend the seller’s nominated storage location to draw samples and value the fibre against the contracted quality basis. Shipment is not made until approval of the tendered lots has been received from the buyer.

    Growth and quality

    Growth and quality: the growth and origin of the cotton, or the agreed optional growths of the cotton, should be expressed in the contract. ‘Quality’ of cotton fibre can include the following identification of fibre valuations:

    • Crop production year
    • Seed variety of the cotton
    • Obtained by either manual/physical classification or by mechanical testing:
      • Grade (leaf and colour)
      • Length (staple)
       
    • Obtained by mechanical testing/SITC testing:
      • Colour grade
      • Leaf/trash content
      • Length (staple)
      • Micronaire (fineness)
      • Strength
      • Maturity
      • Uniformity
      • Moisture
      • Elongation
      • Short fibre index
      • Count strength product
       

    If sales are made ‘on type’ or ‘description’ (based on the Universal standard boxes), unless otherwise stated, this would imply a physical valuation of the type sample. In the case of contracts mentioning, for example, strength (g/tex) or uniformity this would imply valuation by mechanical means. In this instance the contract may stipulate that certificates are to be supplied to evidence the mechanical testing/SITC results. It is prudent to stipulate which authority is to conduct tests and, in the case of certification, to certify the results. Alternatively, the tests may be conducted by the seller or under the seller’s control or by an appointed third party without certification.

    Whichever valuation method is used the buyer will, unless the contract stipulates certification is ‘final’, have recourse to claim on any lots which do not meet the contracted specifications and fall outside any permitted tolerance.

    Quantity

    Cotton is usually sold in lots, which vary in size from origin to origin. Contracts can be expressed in bales, by the number of ‘standard’ or ‘high cube’ containers FCL (20 or 40 foot), or by weight. All contracts are recognized contracts for weight and are based on the net weight of the shipment, so if for example ‘500 bales’ are contracted and an average bale weight is stated as ‘200 kilos’, the contract would be for 100 tons, allowing for any agreed weight tolerance. Weight tolerance gives the shipper much-needed flexibility within individual shipments. Normally the standard practice is to apply a tolerance of 3%–5% to cotton contracts.

    Price and terms

    Pricing can be ‘fixed’ or based ‘on call’, both expressed in a nominated currency depending on the parties’ agreement and market tradition. Generally cotton prices are expressed in United States cents per pound or United States dollars per ton and sold in units of weight expressed in ‘imperial’ pounds, metric kilos or metric tons.

    • Fixed priced contracts: are contracts where the price has been agreed at the time of contract and will not vary without the express agreement of the parties.
    • ‘On call’ contracts: are commonly known as a ‘basis contracts’. The basis is agreed between the parties at the time of contract with reference to a nominated New York Cotton Futures trading month. The basis could for example be expressed as ‘200 United States cent points/pound off October New York’.

    The mechanism for price fixing in an ‘on call’ contract is stipulated in the contract and expressed as either ‘buyer’s call’ or ‘seller’s call’. In the case of ‘buyer’s call’ the seller will fix the final price of the contract, or portion thereof, on the New York cotton futures month when he or she receives the buyer’s instructions to fix. This must be prior to the first notice day of the future contract month and before the invoice is issued. If the buyer does not issue a fixation order and the parties have not agreed any extension to the fixation period the seller can fix the price.

    Weight basis

    There is an inherent natural moisture gain or loss in cotton bales depending on the atmospheric conditions in which the bales are stored and shipped. Most cotton is sold on the basis of ‘certified landed weight’ with each shipment requiring a weight adjustment or reconciliation upon arrival and discharge at the port of destination or mill premises, depending on the agreement or market tradition.

    The standard formality for shipment is for the shipper to declare the ‘gross’ weight of the shipment. This is the weight of the cotton and the wrapping and wires that hold the bale in place. The ‘tare’ weight is declared on the invoice. This is the weight of the wrapping and the straps or wires. Most contracts use ‘actual tare’ in their reconciliation: the ‘tare’ is weighed and valued at the final destination and is then stated in the ‘landing report’ or weight reconciliation. The ‘net’ weight is found by deducting the ‘tare’ weight from the ‘gross’ weight and is the basis for invoicing the shipment.

    The basis for weighment is often dictated by the available facilities at the origin. Most cotton is still weighed ‘bale by bale’. Certain locations, however, origin or destination, provide only ‘weighbridge’ facilities: the empty vehicle, trailer and/or container passes, prior to loading the cotton bales, over a ‘weighbridge’ scale and the weight is recorded. Once the cotton bales have been loaded on to the trailer or into the container the vehicle again passes over the weighbridge to ascertain the total gross weight of the cotton bales. This is calculated by deducting the weight of the empty vehicle, trailer and/or container (the ‘tare’) from the overall reported weight at the weighbridge. The bale tare weight is then deducted from the total gross weight, and the resulting figure is the net weight of the cotton fibre for that container/trailer load.

    • Gross landing weight: can also be expressed as ‘certified landed weights’ and is usually conducted under supervision of an independent international weighing organization appointed by the seller. All cotton must be weighed under the supervision of the seller’s representative. Under ICA Rules there are specific time limits for weighing: for example, in the case of weighbridge weights 14 days (two weeks) from the date of arrival of the cotton, or 42 days (6 weeks) for bale weights. The parties should establish the point of delivery for weighing and will cover the cost of their own representatives.
    • Gross shipping weights final: are established under the control of the shipper’s and buyer’s nominated representatives and are usually final. It is normal practice for these to be established by an independent weighing organization or an organization agreed between the parties to perform the task at a named location. The time period for this task can be agreed separately by the parties. However, under ICA Rules it is to be conducted within 42 days (6 weeks) before shipment. It is important to ensure that weighing is conducted within the time allowed or that the time period is extended, or shipped weights are declared final with mutual consent of the parties.

    Payment

    There are various payment terms adopted by the raw cotton trade. Most trade is conducted under letter of credit (L/C) transactions. It is essential to be precise in the detail and mechanism for payment: for example, in the case of L/C transactions the payment clause should clearly specify the payment date or period, e.g. ‘at sight’ (on presentation of documents).

    Letter of credit (L/C): may take several different forms, but unless otherwise stated they are all ‘irrevocable’ and cannot be cancelled. An L/C constitutes a definite undertaking by the issuing bank to pay provided the stipulated documents comply with the terms and conditions stated when presented to the ‘nominated bank’ or ‘issuing bank’. A ‘confirmed L/C’ is recommended to ensure payment, subject to the presentation of a compliant set of shipping documents. This requires confirmation to be added by the exporter’s (seller’s) bank or another nominated bank at the request of the ‘issuing bank’. It then provides a definite undertaking of the ‘confirming bank’ to pay, provided of course that all terms and conditions have been complied with.

    L/C payment terms can be ‘at sight’ or at a deferred date or period after presentation. This must be as agreed at the time of contract or contract amendment, as it obviously constitutes a cost consideration for interest.

    The irrevocable confirmed L/C is therefore an undertaking by the ‘opening bank’ (buyer’s bank) to reimburse the ‘beneficiary’(the seller or other nominated party) upon presentation of a set of shipping documents fully in compliance with the specific list of documents in the L/C and containing the precise wording and clauses stipulated. Such documentation will normally include a set of invoices, original full set of bills of lading, weight/packing list, phytosanitary and/or fumigation certificate, and certificate of origin, along with other documents such as quality, inspection and shipping company certificates (the latter document may be called upon to stipulate the age of the carrying vessel).

    A valid and workable L/C should be opened by the buyer and advised to the seller in advance of the contracted shipment or delivery period. The contract should specify in the appropriate section the latest date the L/C should be advised in order to allow the seller (shipper) the appropriate amount of time to prepare and effect shipment in accordance with the contract terms.

    The list of documents specified under L/C payment terms can be extensive. It is often based on the historical practice of the importing country or banking system within that country and bears little relationship to the documents actually required to effect import formalities. It is therefore important for sellers to check all requirements under an L/C to ensure they can meet all the documentary demands within the timeframe permitted for presentation and negotiation. This is normally 21 days from the date of shipment (in the case of carriage by vessel, the date of the bill of lading).

    Once the validity for shipment or negotiation has lapsed there is no security for payment, and the result may be an unpaid consignment lying indefinitely at a foreign port. If terms cannot be met the seller can only rely on an approach and the goodwill of the buyer to instruct their bankers to extend or amend the specific terms and conditions or to accept the discrepancies as advised.

    The security provided by a letter of credit is only as good as its acceptability to the seller and the financial and commercial standing of the opening bank. Every care must be taken by sellers to ensure that they can comply with the L/C terms with reference, and they should seek guidance from their bankers and also the advising or negotiating bank.

    • Cash against presentation of documents to a nominated bank: provides an alternative payment mechanism but is not secure. It offers no payment guarantees and is normally used only between contractual parties with a long, regular and fairly secure relationship. Documents are dispatched by the exporter to his or her local bank, with instruction to be forwarded to the buyer’s nominated bank for payment. Upon receipt of the documents at the buyer’s bank, documents are presented to and accepted by the buyer who will authorize his or her bank to reimburse the value of the presentation, less a deduction of the bank’s collecting charges. The documents remain in banking channels and there should be no concern of a loss of control of the documents, or the goods they represent, but there is no guarantee of or timing for payment.
    • Cash against presentation of documents on arrival of vessel: is a similar payment term, with the exception that the due date for payment is the date the vessel arrives at the contracted port of destination or discharge. It is necessary under this payment method to ensure that a ‘latest date for payment’ is expressed in days commencing from date of bill of lading. Under ICA Rules this is stipulated as 49 days (7 weeks). This timing should be further stipulated in the contract and bank instruction letter to address the potential, for example, of an insured event and total cargo loss of the shipment or of the goods not arriving for any other reason.

    Whatever method of payment is agreed, it is essential for exporters to have access to the financial status of their trading partner and to conduct any financial investigations necessary in advance of contract and shipment.

    Prudence is essential in all transactions. It is the relationship between the parties that matters and that will eventually assist in addressing any documentary issues or difficulties arising from shipments. Mutual understanding of the trade and some flexibility is always required to resolve payment or documentary issues and releases. Delays in the release of the shipment due to non-payment can result in sizable costs being applied to the containers at the port of discharge, and should be avoided wherever possible.

    Shipment

    Shipment refers to the loading of the cotton on to a conveyance for delivery to the buyer or a carrier who will provide a bill of lading or combined transport document as a receipt. In the case of ‘on board’ bills of lading the captain or the captain’s agent will sign the bill of lading when the goods are loaded on the vessel.

    Most cotton today is shipped in 40 foot FCL (full container loads) under ‘shipper’s load, stow and count’, meaning that the shipper takes responsibility for the contents of the containers, the majority of which are loaded or stuffed in the container yard. The container yard is where the containers are stored, collected or delivered, full or empty, and where loading and stuffing of containers is conducted by the shipper. It is the point where a shipping line or ‘water carrier’ accepts custody and control of containers for onward shipment.

    Date of shipment: in the case of shipment by vessel this is the ‘on board’ date shown on the ocean bill of lading or the date the cotton is ‘received’ under a combined transport document.

    Spot: goods are stored at a named fixed location or warehouse at the port or other named location for immediate delivery.

    Prompt: in the case of tender or shipment, this is defined under ICA Rules as 14 days. It is prudent to avoid such expressions and ensure that specific dates or months are expressed in the contract to avoid ambiguity.

    Shipment advice: the seller must provide the buyer with full details of the shipment as soon as these are available following shipment. This should include the name of the vessel, voyage number, bill of lading or combined transport document number and ‘received’ or ‘on board’ date, along with other information contained on the transport document (for example weight/number of bales and container/seal numbers). Under ICA Rules this must be done promptly. Otherwise the buyer has the option within 14 days of any deadline set out in the contract of closing the contract in accordance with the Rules. If the seller provides the invoice or shipment details after any deadline and the buyer intends to close out the contract he or she must inform the seller within three days. If there is no limit in the contract and the seller does not provide the invoice or details within 21 days of the date of the bill of lading, the above will apply.

    Shipment delays: should be advised as soon as known to the buyer. Failure to inform can create problems, and potentially defaults. All delays should be documented wherever possible especially when the fault lies outside the control of the exporter. Claims of force majeure are evident at times but a notice for this or any delay in shipment can initially just extend the period allowed for shipment and not address the immediate difficulty facing the parties. Amicable solution is the best option and may include renegotiation of the shipment/delivery period, with any resulting agreement by the parties being duly documented.

    The shipment month or period should be clearly stipulated, for example ‘August 2008’ or, for a spread shipment position, ‘August/September/October 2008’. In the case it would be necessary to specify the quantities for each position should be specified. It may also be agreed to provide ‘option months’, for example ‘August/first half September at seller’s option’ or ‘September/October at buyer’s option’ or ‘ latest 15 August 2008’. Whichever expression is used, it is important to ensure that L/Cs are received and cotton lots are positioned for shipment to meet the shipment period.

    Shipping companies often utilize a series of hub ports that serve as routing or transshipment stations where the containers are discharged from one vessel and reloaded onto the vessel serving the final port of destination. If the contract specifies a latest date of arrival or the duration of the voyage, it is important to ensure that the shipping schedule will fit with the buyer’s requested arrival timing. Delays in shipment or arrival are a constant problem to buyers, who are increasing dependent on ‘just in time’ arrivals to meet their production scheduling.

    Freight – shipments by vessel

    FOB (free on board) contracts: the buyers arrange the booking and payment of freight and must advise the seller or shipper before the commencement of the shipment month or period. The buyer should tell the seller the details of the freight booking in sufficient time for the positioning and loading of containers. The information should include the name and address of the shipping company and coordinates of the local representative office at the port of loading, name of the vessel, voyage number, and estimated time of arrival at, and sailing from, the contracted load port. FAS means ‘free alongside ship’.

    CF or CIF (cost including freight) contracts: the seller or shipper will arrange suitable freight and will book, pay the freight costs, and arrange all logistics at the port of loading or other nominated point of loading for the positioning of containers for loading and transport to the port for shipment. If the parties agree, the current cost of freight at the time of sale can be expressed in the contract. Any variation in this cost of freight from the date of contract to the date of shipment can then be directed for settlement to either the seller or the buyer. However, most CF or CIF contracts are based on ‘freight final’ terms, which means that the seller or shipper absorbs the risk and any variation in the rate of freight. Under this condition there is no recourse to the buyer.

    Insurance

    The responsibility to insure and the undertaking of risks are defined in the express terms of the contract. Under ICA Rules, whichever party is responsible for insurance must cover 110% of the invoice value of the shipment and must include:

    • ‘Marine cargo insurance’ and ‘transit insurance’ in line with the Institute Cargo Clauses (A) or Institute Commodity Trades Clauses (A);
    • ‘‘War Risks Insurance’ in line with the Institute War Clauses (Cargo) or the Institute War Clauses (Commodity Trades);
    • ‘‘Strikes, riots and civil commotions insurance’ in line with the Institute Strikes, Clauses (Cargo) or Institute Strikes Clauses (Commodity Trades);

    Unless otherwise agreed between the parties, sellers are responsible for ‘country damage’ (see below). Policy documents or insurance certificates should be produced as part of the shipment documentation providing cover for marine cargo insurance, transit insurance and country damage.

    ‘Country damage’ is generally recognized to be damage to or deterioration of the cotton fibre in the country of origin that has occurred prior to loading containers or the vessel. It is caused by excessive moisture absorption or by dust or dirt (sand) contamination from the exterior of the bale, and is caused primarily by unsatisfactory storage or transit conditions. All care should therefore be taken when handling cotton bales and storage logistics at origin locations.

    Special clauses

    Special clauses are a ‘free type’ area in the contract that permits the parties to state any specific terms or conditions that apply to the contract. For example, this may include a statement containing an option that the sellers may apply to switch the origin of all or part of the contract, or may specify a latest date for an L/C to be advised.

    Reverse side of the contract ‘conditions’

    Most sellers have established in their contracts a standard listing of terms and conditions that apply to every sale they conclude. The buyer must of course agree to these conditions. In a majority of cases a pre-existing relationship exists between buyer and seller so the standard contract form and layout is a recognized document. This section may reinforce certain terms or conditions and attach additional conditions, such as a section on ‘carrying charges’ (storage, insurance and interest costs that may apply in the event of a delay in shipment caused by the buyer’s late opening of an L/C).