australian export: a guide to law and practice

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Australian Export

A Guide to Law and Practice

Australian Export: A Guide to Law and Practice provides students andbusiness people interested in international trade with a clear andconcise guide to the main procedures and regulatory environmentfor international business transactions.

The book contains details on the steps involved in a direct saleof goods including: international sales law, trade terms, paymentmechanisms, transport, insurance, customs arrangements (includingimporting) and dispute resolution.

It also canvasses the legal and procedural considerations forexporting via an agent or distributor, via licensing and franchisingarrangements or through the establishment of an overseas presence inthe target market. This comprehensive guide to export and importprocedures and regulations also points to the various sources wheremore in-depth information can be found if required.

This book is an essential starting point for understanding therequirements and pitfalls of international business transactions.

Justin Malbon is an Associate Professor and former Dean of Law atGriffith University.

Bernard Bishop is Senior Lecturer in the Department ofInternational Business and Asian Studies at Griffith Business School,Griffith University.

AustralianExport

A Guide to Law and Practice

Justin MalbonandBernard Bishop

Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo

Cambridge University PressThe Edinburgh Building, Cambridge , UK

First published in print format

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© Justin Malbon, Bernard Bishop 2006

2006

Information on this title: www.cambridge.org/9780521613958

This publication is in copyright. Subject to statutory exception and to the provision ofrelevant collective licensing agreements, no reproduction of any part may take placewithout the written permission of Cambridge University Press.

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Cambridge University Press has no responsibility for the persistence or accuracy of sfor external or third-party internet websites referred to in this publication, and does notguarantee that any content on such websites is, or will remain, accurate or appropriate.

Published in the United States of America by Cambridge University Press, New York

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Contents

Figures and Tables page ixPreface xiAbbreviations xiii

Chapter 1: An Introduction to the Export and Importof Goods and Services 1

Chapter 2: Contracts for the International Sale of Goods 43

Chapter 3: Incoterms 76

Chapter 4: Payment 88

Chapter 5: Transport of Exported Goods 109

Chapter 6: Cargo Insurance 128

Chapter 7: Customs 154

Chapter 8: Exporting through an Overseas Representative 184

Chapter 9: Exporting via Licensing and FranchisingArrangements 203

Chapter 10: Exporting via an Overseas Business Presence 233

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C O N T E N T Sviii

Chapter 11: Dispute Settlement 265

Chapter 12: Exporters and the WTO 289

Index 309

Figures and Tables

F I G U RE S

1.1 Flowchart of an export of goods transaction page 12

1.2 Letter of Credit 14

1.3 Proforma Invoice 17

1.4 Commercial Invoice 18

1.5 Packing List 19

1.6 Certificate of Insurance 20

1.7 Certificate of Origin 21

1.8 Bill of Exchange 22

1.9 Request for Export Declaration 23

1.10 Forwarding Instruction 24

1.11 Bill of Lading 25

1.12 Container List 26

1.13 Pre-Receival Advice 27

1.14 Proforma Invoice 28

1.15 Commercial Invoice 29

1.16 Acknowledgement of Order 30

1.17 Packing List 31

1.18 Shippers Letter of Instruction 32

1.19 Air Waybill 33

1.20 Certificate of Origin 34

ix

F I G U R E S A N D TA B L E Sx

1.21 Fax Advice 35

1.22 Advice of Despatch 36

4.1 Letter of credit procedure 93

4.2 Payment against documents 100

12.1 Major structural features of the WTO 291

12.2 Flowchart of dispute resolution procedures in the WTO 307

TA B L E S

6.1 Exclusion provisions in various insurance regimes 146

6.2 ICC and UNCTAD general exclusions 149

6.3 Provisions for loss minimisation 152

11.1 Provisions of the Model Law and selected arbitration rules 276

Preface

W e have writ ten this book for all of those who want to gainan understanding of the procedural matters involved in international businesstransactions and their underlying legal basis. We envisage that the book will be ofuse to students of international business as well as Australian business persons whoare contemplating export or import transactions.

The book commences with an introductory chapter that provides an overviewof the legal and procedural matters involved in the direct export of goods and ser-vices. The following six chapters deal with the important matters of internationalsales law, standard terms for delivery, payment, transport, insurance and customs.Because many exporters utilise either an intermediary or an overseas presence toassist the export side of their business, we have included chapters on the legal andprocedural issues in these cases. The book also contains a chapter on licensing andfranchising transactions to reflect the rapid expansion of Australian businesses intooverseas markets using these methods. The final two chapters deal with disputeresolution in international transactions. The first of these deals with the issuesinvolved in resolving disputes between private parties through litigation and arbi-tration. The final chapter discusses the resolution of disputes at the government togovernment level through the World Trade Organisation from the point of viewof Australian exporters and importers.

The law and practice of international trade are complex. A book of this length isnot able to provide in-depth discussion of all of the law and all relevant procedure.For that reason we have included references in each chapter to authoritative websiteswhere more detailed information can be found. The title of the book reflects ourapproach as a guide to the law and practice. While we have made every effortto ensure that the relevant law and practice are stated correctly and are up todate, those contemplating an international transaction should not rely solely onthe information provided in this book but should seek advice from the variousprofessionals and specialists who can provide assistance in international businessmatters.

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P R E F A C Exii

Finally we would like to thank the many business people who have providedinformation that has assisted us in the preparation of this book. We particularlythank TridentGLOBAL for their assistance with the preparation of the documen-tary case studies in Chapter 1. We also thank Associate Professor Leanne Wisemanfor her comments on the licensing chapter; Robyn White for her assistance withpreparation of the manuscript and Josh Keech for his research assistance for somechapters of the book.

Abbreviations

ACCI Australian Chamber of Commerce and IndustryACEAN accredited client export approval numberACS Australian Customs ServiceAHECC Australia’s Harmonised Export Commodity Classification

SystemAPEC Asia Pacific Economic CooperationAQIS Australian Quarantine and Inspection ServiceASEAN Association of South East Asian NationsASIC Australian Securities and Investment CommissionCFR Cost and FreightCIF Cost, Insurance and FreightCIP Carriage and Insurance Paid ToCISG Convention on the International Sale of GoodsCMI Comite Maritime InternationaleCMR cargo management reengineeringCPT Carriage Paid ToDAF Delivered at FrontierDDP Delivered Duty PaidDDU Delivered Duty UnpaidDEQ Delivered Ex QuayDES Delivered Ex ShipDFAT Department of Foreign Affairs and TradeDSB Dispute Settlement BodyEDN export declaration numberEFIC Export Finance Insurance CorporationEXW ExworksFAS Free Alongside ShipFCA Free CarrierFIATA International Federation of Freight Forwarders Associations

xiii

A B B R E V I A T I O N Sxiv

FOB Free on BoardGATS General Agreement on Trade in ServicesGATT General Agreement on Tariffs and TradeGDP gross domestic productIATA International Federation of Air TransportICA Insurance Contracts Act 1984ICC Institute Cargo ClausesICS integrated cargo systemICSID International Centre for the Settlement of Investment DisputesIPR intellectual property right(s)IT information technologyLCIA London Court of International ArbitrationM&A mergers and acquisitionsMIA Marine Insurance ActML Model Law on International Commercial ArbitrationMSQA meat safety quality assuranceMTO multimodal transport operatorNIE newly industrialising economyNIP non-injurious priceOECD Organization for Economic Cooperation and DevelopmentPCT Patent Co-operation TreatyPRA pre-receival adviceSDR special drawing rightSLI interim receipt – forwarding instructionTCO tariff concession orderTMRO Trade Measures Review OfficerTRIMs Trade Related Investment MeasuresTRIPS Trade Related Aspects of Intellectual Property RightsUCP Uniform Customs and Practices for Documentary CreditsULD unit load deviceUNCITRAL United Nations Commission on International Trade LawUNCTAD United Nations Conference on Trade and DevelopmentUNIDROIT International Institute for the Unification of Private LawUSP unsuppressed selling priceWCO World Customs OrganisationWIPO World Intellectual Property OrganisationWTO World Trade Organisation

11 An Introduction to theExport and Import of Goodsand Services

While Austral ia has traditionally been an exporter ofagricultural and mineral commodities, the past two decades have witnesseda rapid rise in the export of both manufactured goods and services. Accord-ingly, those wishing to enter the field of international business now needto be aware of the various laws and procedures that apply when export-ing commodities, manufactured goods, and services. In 2003–04 exportsof primary products, including minerals, comprised approximately 50 percent of Australia’s exports. Manufactured goods and services accounted forapproximately 25 per cent each. Coal, iron ore, petroleum, wheat, meat,wine, aluminium and gold dominate Australia’s primary product exports.Somewhat surprisingly, motor vehicles play a large role in manufacturedexports. While the major destinations for Australia’s exports are in theAsia–Pacific region, the Middle East and Europe are growing markets formany small and medium exporters of processed foods and some man-ufactured goods. The Department of Foreign Affairs and Trade website(<www.dfat.gov.au>) provides annually updated statistics on the compo-sition of Australia’s exports and imports.

The terms, conditions and procedures for the sale of commodities havedeveloped over several centuries. In many industries there are now standardform contracts, with the parties often only left to negotiate on price, methodof payment, delivery, and the various costs associated with transport, insur-ance and the like. In addition, the export of agricultural commoditiesfrom Australia has had a tradition of being concentrated in the hands ofmarketing boards that purchased from growers and then exported, whileminerals tend to be exported by large-scale mining companies. The knowl-edge of export procedures and law has therefore not been widely knownand understood. However, with the rapid rise in exports of manufactured

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A U S T R A L I A N E X P O R T2

goods and services, many more businesses now need to become familiar withexport procedures. For many, the procedural details involved in exportingmanufactured goods and the many issues that have to be negotiated havepresented something of a steep learning curve.

Trade in services defies the standardised procedures and forms of agree-ment that have developed in relation to the longer-established goods trade.This is because of the various ways in which services can be exported,ranging from an in-country presence to deliver the service in the overseascountry to the service being delivered in the home country of the exporter.These various modes for the export of services are discussed in more detaillater. Exports of services from Australia have been propelled by a greaterwillingness of countries to allow large-scale involvement in their servicesectors by foreign service providers, particularly over the last decade. Amoment’s reflection on service industries in such fields as telecommuni-cations, finance, tourism, education, construction, distribution, transportand engineering immediately highlights the extent to which major playersin those industries are rapidly expanding beyond national boundaries.

This chapter gives an introduction to the practical matters that arisein the export of goods and services. Throughout the chapter, we refer tothe various legal issues that arise and to later chapters of the book wheresuch issues are discussed in more detail. The objectives of this chapter aretherefore to provide an understanding of:� the various ways in which a transaction for the sale of goods can be

initiated;� the importance of agreeing at the outset on the fundamental terms and

conditions of the transaction;� the vital role that documentation plays in international sales of goods

and therefore the need for careful attention to detail; and� the difficulties that arise for service exporters because of the various

modes by which service exports can occur.

H O W A R E T R A N S A C T I O N S F O R T R A D EI N G O O D S A N D S E R V I C E S I N I T I AT E D ?

In very simple terms, an export transaction from Australia occurs either as aresult of the buyer making an initial approach to the exporter or the exporteractively searching out and approaching a potential buyer. Whether or notan exporter is simply prepared to sit back and wait for potential buyers toapproach it, or whether the exporter wishes to actively promote its productin the international marketplace, depends on the nature of the product and

I N T R O D U C T I O N 3

the exporter’s choice of marketing techniques. If an Australian firm wishesto import goods or services, generally it must seek out possible sourcesfor the required items and then make contact with potential suppliers tonegotiate the relevant terms on which the supplier is able to sell it thegoods.

The Internet has revolutionised international marketing. It is now mucheasier for a potential buyer to source products and compare prices and evenquality from the details provided on an exporter’s website. It is also easierfor an exporter to advertise its product much more widely than it couldhave done little more than a decade ago. Before that time exporters andimporters had fewer options available, having to rely to a much greaterextent on printed advertising materials and personal knowledge of theindustry in order to find potential buyers or suppliers.

While the Internet does not supplant traditional marketing techniques,it has provided some new advantages in negotiation for both exporters andimporters. As far as importers are concerned, the abundance of informationon the Internet about competing products and services makes it mucheasier to identify and compare the various global sources of supply. As faras exporters are concerned, those who have mastered the art of designing auser-friendly website and ensuring potential buyers are easily able to findit may well be in a strong position to have the buyer accept the exporter’sterms and conditions for the supply of the goods. If, on the other hand,it is the exporter that has to search out and make contact with the buyer,the buyer may initially consider itself to be in the stronger negotiatingposition concerning the terms and conditions on which the goods aresupplied. Having its terms and conditions accepted is not only a matterof giving the exporter greater control over the transaction, but may alsohave a significant bearing on the profitability of each sale. For example, ifthe exporter is able to insist on an ‘incoterm’ favourable to itself, it willreduce transport costs and raise profitability. Likewise, if the exporter is ableto have its terms of payment accepted it can reduce the risk of the buyerdefaulting.

The foregoing assumes that the exporter and the potential buyer have hadno prior dealing with each other. While all trading relationships betweenunrelated parties have to commence at this point, the vast majority oftransactions are simply repeat business arising from a successful businessrelationship that has developed between the parties over several years. Inthese cases, the parties will have an already established method of dealingand will more than likely know the terms and conditions that the otherexpects. It may even be the case that the parties have become so familiar


with each other that a buyer need only phone the exporter and the goodswill be dispatched on an understanding that the usual terms and conditionsas to payment and delivery will apply.

However, as in any relationship, problems and misunderstandings mayoccur. For example, the buyer may reject the goods either because theexporter has shipped defective goods or because the goods have been dam-aged during transport. Alternatively, delays outside the control of the partiesmay have caused deterioration in the goods or may pose problems for thebuyer because it has on-sold the goods. If the parties have become hap-hazard regarding the terms and conditions on which transactions proceed,then it may require significantly more effort and goodwill to resolve prob-lems than if it is clearly established in each transaction just what terms andconditions will apply. As will be seen in later chapters, resorting to formalmethods of dispute resolution is both costly and usually fatal to the businessrelationship. It is as well to be clear in every transaction, regardless of theextent of the relationship, about what terms and conditions apply.

T E R M S A N D C O N D I T I O N S F O R T H ES A L E O F G O O D S

In most export and import transactions there are a number of fundamentalmatters that the parties usually agree on before the transaction takes place.These are:� a detailed description of the goods to be supplied and quality standards

that are to apply to those goods;� the price and method of payment; and� the means by which the goods will be delivered to the buyer.The need for a full description is essential so that there can be no mis-understanding about what exactly it is that is being sold. Failure to sup-ply goods in accordance with the contract description will give rise to anaction by the buyer. This matter is discussed in more detail in Chapter 2.The description of the goods will usually occur in the communication fromthe buyer to the exporter (often referred to as the purchase order) if thebuyer approaches the seller, or in the exporter’s communication to the buyeroffering to supply the goods if the exporter is initiating the transaction. Theextent to which the agreement should describe the goods depends on thenature of the goods being sold and the degree to which it is necessary todescribe quality standards in detail. For many classes of goods there areelaborate sets of standard terms and conditions established by industrybodies relating to quality that parties refer to in their communications.


In these cases, such terms and conditions are said to be incorporated byreference into the agreement between the parties.

When an export transaction is being negotiated, the price is of courseuppermost in the minds of the parties; but so too is the way in whichthe price will be paid. As we shall see in Chapter 4, the parties have achoice here. The buyer might agree to send the money for the goods to theexporter by telegraphic transfer before the goods have even left the exporter’spremises. Alternatively, the buyer might make arrangements with its bankto open a letter of credit allowing the exporter to collect payment froma bank in the exporter’s country upon presentation of certain documentsrelating to the goods. Yet another option is for the buyer to make paymentto the seller only when the bank in the buyer’s country gives the buyerthe documents needed to collect the goods; these documents would havebeen forwarded by the seller’s bank. This method of payment is referredto as documentary collection. Finally, if the seller and the buyer have alongstanding relationship the seller might permit the buyer to pay for thegoods after the buyer has received them. This is referred to as payment onopen account. As can be seen, it is vital that the parties agree to the methodof payment at the start of the transaction.

The third fundamental matter is delivery of the goods. This raises issuescommon to all international trade in goods and it should come as nosurprise that there has been some standardisation of delivery terms. Thisstandardisation is referred to as the ‘ICC (International Chamber of Com-merce) incoterms’. These were first developed in 1936 and are periodicallyrevised to reflect advances in technology and logistics. When a buyer or aseller uses a particular ‘incoterm’ in its initial communication to refer tothe means by which the goods will be delivered, both parties are assumed toknow what responsibilities fall on each regarding the transport, insurance,export and import clearance and expenses, and the point at which riskpasses. The details of ‘incoterms’ will be discussed more fully in Chapter 3.

In addition to these fundamental matters, many sellers and buyers like toinclude provisions in their agreements to safeguard their positions in casesomething goes wrong during the transaction. These include provisionsthat:� enable the seller to retain title to the goods until paid;� set out the rights and obligations of the parties should an unforeseen

event arise beyond the control of the parties to prevent the performanceof the contract;

� declare what law applies to the contract;� determine the method by which any disputes will be resolved;


� determine the place where any disputes will be heard and the relevantdispute resolution body;

� determine the rate of interest for late payment by the buyer;� determine the amount of damages for late delivery by the seller; and� set out the currency of payment and rate of exchange that is to apply.

There is no one set of terms and conditions that will suit every transactionbetween every buyer and seller. Sometimes buyers and sellers agree on a setof terms and conditions that will apply for the duration of their tradingrelationship, with the seller then simply sending shipments as requested.On the other hand, there are many cases where even among longstandingrelationships all that the parties ever agree on are the three fundamentalmatters of description of the goods or services, payment and delivery. Someorganisations active in international trade matters have developed simpleexport contracts that seek to cover not only these three fundamentals butalso many of the safeguard provisions. One such body is the InternationalChamber of Commerce (<www.iccbooks.com>), which has developed astandard sales contract that could be used in most simple sales of goodsagreements.

While it may seem prudent to include many of the safeguard provisions,the desire of the buyer to obtain the goods and the desire of the seller toreap its profit on the transaction as soon as possible often preclude detailednegotiations about such matters as which law will apply to the contract orwhere any disputes will be heard. Many exporters hold the view that as longas careful attention is paid to documentation, quality assurance and securingpayment, the risks are not great enough to warrant the possible difficultiesand delay involved in negotiating over the finer points of safeguard clauses.In any event, as many also point out, most errors that occur can be sortedout if there is a good relationship between the parties. One of the aims of thisbook is to give the reader an appreciation of the ramifications of adoptingsuch a minimalist approach, thereby enabling the intending exporter tobetter assess the risks of such an approach.

D O C U M E N T S A N D P R O C E D U R E

When an exporter receives an order for goods, it will often contain a descrip-tion of the goods, a proposed price, method and time of delivery, and meansof transport. After receipt of the order, the exporter has to decide if it willaccept the terms and conditions proposed or whether it needs to enter intonegotiations to make the terms and conditions more favourable to it. Thismay be required, for example, if the exporter’s warehouse or production


department is simply not able to fill the order in the time requested. Theexporter may also wish to renegotiate matters such as price, terms of deliveryor payment method. If the parties have had prior dealings or if the standardterms and conditions of the exporter are known to the buyer, the exportermay simply send an acknowledgment of the order, which will constitutean acceptance.

Once the parties have agreed to the conditions of sale, the exporter’s doc-umentation department must prepare a number of documents to completethe transaction. The following sections trace the basic steps that must betaken in a typical export of goods. Some transactions will require additionaldocuments depending on the requirements of the buyer’s bank and importauthorities in the buyer’s country. It is therefore important for exporters tobe aware of the particular documentary requirements that apply to theirproduct in the importer’s country. Many of these steps are discussed inmuch greater detail in the chapters that follow on payment, transport andcustoms. Only an introduction is given here so that the reader can gain anappreciation of the various steps and the order in which they are usuallytaken.

S T E P 1 A R R A N G E T R A N S P O R T A T I O NO F G O O D S

The first step the exporter takes is to book space on a ship to transportthe goods. This can be done either directly or through a broker or freightforwarder. If the goods are to be transported by air this is done either directlythrough the airline, or through an air cargo agent or a freight forwarder. Atthis point the exporter may also request that a container be made availablefor collection on a set date so that the goods can be packed into it.

S T E P 2 T H E P RO F O R M A I N V O I C E

The exporter then prepares what is known as a proforma invoice to sendto the buyer. This is a draft of the formal commercial invoice that will beprepared after the exporter has obtained an export declaration number andfinalised other details of the shipment. It contains basic shipping infor-mation and the description of the goods being shipped. The buyer mayneed the proforma invoice to apply for a letter of credit or to commencearrangements for the clearance of the goods through customs in its owncountry.


S T E P 3 C U S T O M S

After this the exporter has to apply to customs to obtain an export dec-laration number (EDN). If the goods to be exported do not fall into thecategories of goods restricted by the Export Control Act 1982 (Cth) and thevarious Orders made under that Act, the exporter will satisfy initial govern-ment requirements by simply obtaining the EDN. The Australian CustomsService has an online system for exporters to obtain EDNs. Exporters canapply to become registered with the Service; once registered, the exporter isable to obtain an EDN for any transaction upon the completion of a formonline. The system will be discussed in more detail in Chapter 7.

There are quite a number of agricultural exports and other goods that arerestricted under the Export Control Act. These include the export of meat,dairy produce, fish, grains, horticultural produce, wool, skins, hides, liveanimals, pet food, some processed foods, and a range of products designatedas dangerous goods. If the goods fall into one of these restricted categoriesit is necessary to obtain an export permit. For most agricultural exports,the relevant government agency that issues the permit is the AustralianQuarantine and Inspection Service or AQIS (<www.aqis.gov.au>). AQIShas an online system for issuing permits known as EXDOCS. Again, oncean exporter is registered to use the system, all it needs to do to obtain apermit is to fill in a form online and the system will provide it with apermit number and also a sanitary or phytosanitary certificate (if required),which forms part of the export documents. The EXDOCS system alsoissues the exporter with an EDN as the system is linked to the AustralianCustoms Service’s system. Further details regarding the EXDOCS systemand permits that are required but not covered by the system are given inChapter 7.

S T E P 4 P RE P A R A T I O N O F D O C U M E N T SB Y T H E E X P O R T E R

The exporter then prepares the documents that are necessary to finalisearrangements for the transport of the goods and to enable the buyer toclear the goods at the port of arrival. Depending on the method of pay-ment, the seller or buyer may need to produce the documents to theirrespective banks before payment can be made. The standard documentsinclude a commercial invoice, a packing list, an insurance certificate, anda certificate of origin, and if payment is to be made by documentary creditor documentary collection, a bank draft also needs to be prepared. In some


cases a buyer or its bank may require documents in addition to these, suchas a declaration regarding packaging materials, to ensure that the packingmaterials do not breach quarantine regulations in the importing coun-try. Some discussion is needed at this point about each of the importantdocuments that the exporter has to prepare and their relevant purposes.

The commercial invoice is the document that sets out the total price to bepaid by the buyer for the goods, including freight and insurance charges,which are shown separately. The commercial invoice includes a descriptionof the goods, the relevant particulars of the parties, details of the shippingof goods, and the EDN or permit if applicable.

The packing list refers to the commercial invoice and is the documentthat shows how many packages are being sent and what is contained ineach. A copy of the packing list is usually placed on each package in theconsignment. If a container is being sent, a copy of the packing list is alsooften attached inside the container.

In addition, a container list is also prepared stating the number ofcontainers.

Many exporters have a general policy of insurance with a marine insur-ance company that allows the exporter to produce individual insurancedocuments for each shipment over the course of a year, for example. Theinsurance arrangement is then renegotiated.

The certificate of origin declares the goods to be of Australian origin.The exporter prepares this document but it needs to be authenticated byone of a designated number of bodies. The official Chamber of Commercein each state of Australia is able to sign a certificate of origin. There is adetailed list of criteria to determine whether the goods qualify as goods ofAustralian origin, and authenticating bodies might require some evidenceto show that these criteria are satisfied before issuing the document.

As noted, other documents may be required by either the customer orits bank to enable the goods to be cleared by importation authorities or forpayment purposes.

The exporter is required to prepare a number of documents relating tothe transport of the goods. The two most common are the pre-receivaladvice (PRA) and the interim receipt – forwarding instruction (shippersletter of instruction [SLI] in the case of airfreight).

The pre-receival advice is the document the exporter must forward tothe port authority. It sets out the necessary details: vessel number; date ofshipment; booking number with the shipping line; details of the containerand number of the seal placed on the container at the exporter’s premiseswhere the container has been loaded onto the truck that takes it to the wharf;


all details of the shipment including the EDN; and details of shipping dateand the goods being shipped. This is now done electronically. The portauthority confirms to the exporter that the PRA is in order. Without anaccepted PRA the goods will not be permitted to enter the wharf area.

The interim receipt – forwarding instruction or shippers letter of instruction(for airfreight) is the document that the exporter forwards to the shippingcompany or the airline to allow it to prepare the bill of lading in the caseof sea freight or the air waybill in the case of airfreight. The forwardinginstruction contains all of the details regarding the shipment includingport of loading, place of receipt, the name of the vessel or aircraft, and adescription of the goods shipped.

Once all these documents are completed, the container is packed andtransported to the place nominated by the shipping or airline company forloading onto the ship or aircraft.

It is essential that all the documentation prepared by the exporter is con-sistent. Fortunately there are a number of computer programs available toexporters to facilitate the preparation of these documents. These programsenable the exporter to enter all of the necessary information once only andthe program generates the necessary documents.

S T E P 5 D O C U M E N T S I S S U E D B Y B A N K SA N D T R A N S P O R T C O M P A N I E S

The preparation of these documents by the exporter is not the end of thedocumentation trail. As noted earlier, other parties are also involved, par-ticularly transport companies and banks. The shipping or airline companywill prepare a bill of lading or air waybill based on the exporter’s interimreceipt – forwarding instruction or SLI.

The bill of lading or air waybill is the receipt for the goods and is evidenceof the contract of carriage between the exporter and the carrying company.The buyer is often required to produce this to enable it to collect the goods.The details of these transport documents will be discussed more fully inChapter 5. The documents are frequently transmitted to the buyer via thebanking system as explained below.

If the method of payment by the buyer is by way of documentary letterof credit, the buyer’s bank will have issued a letter of credit in favour of theexporter and will have forwarded it to the exporter via the bank with whichthey deal in the exporter’s country. The letter of credit contains the variousrequirements of the buyer’s bank relating to documents and other mattersthat the exporter must satisfy for the exporter to be paid. Letters of credit


will be discussed in more detail in Chapter 4. For the present it needsto be stressed that all documents prepared by the exporter and all datesby which various matters have to be attended to must conform exactly tothe requirements in the letter of credit, otherwise the exporter risks notbeing paid. To collect payment under a letter of credit the exporter alsoneeds to prepare a bill of exchange. This document, commonly called adraft, is a formal demand for the buyer to pay. An example is shown in thesample export documents in this chapter. The same applies if the method ofpayment is by documentary collection. Details of the relevant procedureswill be discussed in Chapter 4.

In addition to transport companies and banks, the exporter may alsoneed to produce an inspection certificate, certifying to the buyer that thegoods have been inspected before the container was sealed and that theycomplied with the description in the contract. Various agencies, such asSGS, perform inspection functions for a fee, if this is needed, and willissue inspection certificates. An inspection certificate might form part ofthe documents required by the buyer’s bank or by importing authorities inthe buyer’s country.

If the terms of delivery require the exporter to deliver the goods to thebuyer within the buyer’s country, it may be necessary for the exporter toprepare a further range of documents to enable the goods to be cleared atthe port of arrival. These documents may include a request for an importlicence and the various forms required by customs authorities in the relevantcountry. Because these will vary from country to country and from productto product, no detailed information can be given here. A useful World ImportRegulations Directory can be purchased from Austrade that provides basicinformation. Most exporters, however, employ an agent who is familiarenough with customs procedures in the country of import to prepare thevarious required documents in the language of the country of import andliaise with the customs authority regarding the entry of the goods.

The flowchart in Figure 1.1 summarises the various steps that mustbe taken for an export transaction from the exporter’s point of view.Following the flowchart are two fictitious transactions for the exportof goods that show what documents would need to be prepared.TridentGLOBAL assisted in preparing the documents. They deliver globaltrade solutions, comprising of a blend of software and consulting servicesthat allow companies to automate and manage the complexity of theirglobal trade, compliance and logistics processes. Their system ensures thatall information in the documents is consistent. The examples given beloware samples only and exporters need to check what exact documents are


exporter receives purchase order

book space on ship/aircraft

prepare and send proforma invoice

to buyer

obtain EDN

prepare documents as required by L/C or as agreed

if no L/C e.g.:

commercial invoicepacking listinsurance certificatecertificate of origin

negotiation of terms and conditions – have buyer sign contract or acknowledge order if standard terms apply

prepare PRA and forwarding

instruction/SLI

bill of lading/air waybill issued and goods sent to

buyer. Buyer notified by fax if airfreight

documents forwarded to buyer (via bank or courier)

exporter is paid and buyer collects goods

Figure 1.1 Flowchart of an export of goods transaction


required for any transaction they are entering into. The examples are ficti-tious transactions; any similarity to actual transactions is unintentional.

The first fictitious transaction (Figs 1.2–1.13) involves the export of carparts to Japan. The goods are to be transported by sea and payment is tobe by letter of credit. The example assumes that the parties have previouslynegotiated the terms and conditions of sale. The example also shows theprocedure the TridentGLOBAL system uses for obtaining an EDN as wellas preparing a PRA.

The second example (Figs 1.14–1.22) involves the export of manchesteritems to Dubai. Since it is assumed that the parties have had prior dealings,only an acknowledgment of order is sent, which means accepting the order.It is also assumed that payment will be made on receipt of the goods. Becausethe shipment is by air, the exporter advises the purchaser by fax when thegoods have been dispatched and sends the documents by courier. Thisexample does not show the procedure for obtaining an EDN as it is similarto that shown in the previous example.

HOLD ORIGINAL FAX COPY 08 82562 9177 AND IEO X80762 ADVICE OF ISSUING BANK’S IRREVOCABLE DOCUMENTARY CREDIT OUR REFERENCE NUMBER: MD2BX863717 GLOBAL TRADE SERVICES LEVEL 3, 92 SOUTH ROAD EDWARDSTOWN SOUTH AUSTRALIA PHONE (08) 8806 2000 FAX (08) 8806 2021 DATE OF ADVICE: 28 March, 2005 DATE OF EXPIRY: 31 May, 2005 Dear sir, We have received an irrevocable documentary credit in your favour details of which follow. ISSUNG BANK: NIPPON BANK PO BOX 2009 TOKYO, JAPAN BENEFICIARY: CAR PARTS AUSTRALIA 369 INDUSTRY STREET LAUNCESTION TASMANIA, 3021 AUSTRALIA DOCUMENTARY CREDIT NUMBER: 999 AMOUNT: AUD 1,005,900.00 DATE OF ISSUE: 25/03/2005 APPLICANT: JAPAN AUTOS PO BOX 98765 TOKYO, JAPAN CREDIT AVAILABLE WITH: AUSTRALIA BANK CORPORATION BY NEGOTIATION AGAINST PRESENTATION OF THE DOCUMENTS DETAILED HEREIN AND OF THE BENEFICIARYS DRAFTS AT: SIGHT DRAWN ON: JPBROWN TREASURY SERVICES, SINGAPORE AUSTRALIA BANK CORPORATION SPECIAL INSTRUCTIONS: ALL OUR CHARGES ARE FOR BENEFICIARY. THE ATTACHED AUTHENTICATED DOCUMENTARY CREDIT/OPERATIVE INSTRUMENT IS BEING ADVISED TO YOU AT THE REQUEST OF THE ISSUING BANK INDICATED

ABOVE AND CONVEYS NO ENGAGEMENT ON OUR BEHALF UNLESS ISSUED BY BRANCHES OF THIS BANK. IN THE EVENT THAT THIS DOCUMENTARY CREDIT/OPERATIVE INSTRUMENT IS ADVISED BY ELECTRONIC MEANS NO HARD COPY WILL BE FORWARDED IN ACKNOWLEDGEMENT. PLEASE CHECK THE CREDIT TERMS CAREFULLY. AUSTRALIA BANK MAY BE ABLE TO GUARANTEE PAYMENT UNDER THIS LETTER OF CREDIT. FOR MORE DETAIL CONTACT YOUR INTERNATIONAL BUSINESS MANAGER.

Figure 1.2 Letter of credit


LOC.ID:SD3 INCOMING SWIFT MSG-700 TEMPLATE-3886677 26/03/2005 {1: f01AUSBNKAU2SAXXX45663904639} {2:07001804021125AUSTBNKPGPMBXXX0089074 FROM: NIPPON BANK MANAGING DIRECTORS OFFICE PO BOX 2009 TOKYO JAPAN {4: 20503251804N} {4: **27 SEQUENCE OF TOTAL :27: 1/1 ** 40 FORM OF DOCUMENTARY CREDIT :40A: IRREVOCABLE **20 DOCUMENTARY CREDIT NUMBER :20: 999 ** 31C DATE OF ISSUE OF THE D/C :31C: 050325 ** 31D DATE AND PLACE OF EXPIRY :31D: 050531 AUSTRALIA **50 APPLICANT :50: JAPAN AUTOS PO BOX 98765 TOKYO JAPAN ** 59 BENEFICIARY :59: /CAR PARTS AUSTRALIA 369 INDUSTRY STREET LAUCESTION TASMANIA 3021 AUSTRALIA ** 32B CURRENCY CODE, AMOUNT :32B: AU 1005900.00 **41 AVAILABLE WITH … BY … :41D: AUSTBNKAU2S BY NEGOTIATION ** 42C DRAFTS AT … :42C: SIGHT ** 42A OR 42D DRAWEE :42A: CHASSING33 JPBROWN TREASURY SERVICES 1005 HIGHLAND DRIVE SINGAPORE ** 43P PARTIAL SHIPMENTS :43P: ALLOWED ** 43T TRANSSHIPMENT :43T: ALLOWED ** 44A LOADING ON BOARD/DISPATCH/TAKING IN CHARGES AT/FROM … :44A: HOBART AUSTRALIA ** 44B FOR TRANSPORTATION TO … :44B: PORT TOKAI JAPAN ** 45 SHIPMENT OF (GOODS) :45A: AUTOMATIVE SPARE PARTS AGAINST APPLICANT ORDER NOS. PM-905412 AS PER BENEFICIARY’S EMAIL DATED 12/03/2005 CIP TOKYO ** 46 DOCUMENTS REQUIRED :46A: DOCUMENTS REQUIRED IN DUPLICATE UNLESS OTHERWISE INDICATED

Figure 1.2 Letter of credit (cont.)


COMMERCIAL INVOICE. FULL SET OF CLEAN ON BOARD NEGOTIABLE MARINE BILLS OF LADING CONSIGNED TO ORDER BLANK ENDORSED MARKED FREIGHT PREPAID. MARINE INSURANCE CERTIFICATE ISSUED IN TRIPICATE AND BLANK ENDORSED . PACKING LIST IN QUADRUPLICATE CERTIFICATE OF ORIGIN ** 47 ADDITIONAL CONDITIONS :47A: DRAFTS DRAWN UNDER THIS DOCUMENTARY CREDIT MUST BEAR DATE OF RELATIVE TRANSPORTATION DOCUMENT, DOCUMENTARY CREADIT NUMBER AND DATE THEREOF. ** 71B CHARGES :71B: ALL OTHER BANK CHARGES EXCEPT ESTABLISHING BANK CHARGES ARE FOR ACCOUNT OF BENEFICIARY. ** 48 PERIOD FOR PRESENTATION :48: DOCUMENTS ARE TO BE REPRESENTED WITHIN 15 DAYS OF INSSUANCE OF TRANSPORTATION DOCUMENTS. ** 49 CONFIRMATION INSTRUCTIONS :49: WITHOUT ** 53 REIMBURSEMENT BANK :53A: CHASSING33 JPBROWN TREASURY SERVICES SINGAPORE 1005 HIGHLAND DRIVE SINGAPORE ** 78 INSTRUCTIONS TO THE PAYING/ACCEPTING/NEGOTIATING BANK :78: PLEASE HONOUR DRAFTS DRAWN UNDER THIS DOCUMENTARY CREDIT AND IN REIMBURSEMENT CLAIM ON OUR PORT MORESBY OFFICE ACCOUNT WITH JBROWN CHASE BANK SINGAPORE DOCUMENTS TO BE FORWARDED BY CONSECUTIVE COURIER TO NIPPON BANK PO BOX 2009 TOKYO JAPAN. WE HEREBY ENGAGE WITH DRAWERS AND BONA FIDE HOLDERS THAT THE DRAFTS DRAWN AND NEGOTIATED IN CONFORMITY WITH THE TERMS OF THIS CREDIT WILL BE DULY HONOURED ON PRESENTATION. NEGOTIATING BANK TO ADVISE ISSUING BANK BY SWIFT ALL DRAWINGS UNDER THIS DOCUMENTARY CREDIT. ** 57 “ADVISE THROUGH” BANK :57D: /NIPPON BANK 19 CONNELL ST HOBART AUSTRALIA BSB 049 011 A/C NO. 057 159 202 ** 72 BANK TO BANK INFORMATION :72: THIS DOCUMENTARY CREDIT IS SUBJECT TO THE ICC UNIFORM CUSTOMS AND PRACTICE FOR DOCUMENTARY CREDITS (UCP 500) AND TO ICC DOCDEX RULES. THIS IS THE OPEARTIVE INSTRUMENT AND NO CONFIRMATION WILL FOLLOW -} {5: {MAC: F4FD8780} {CHK:EBD 899B4E0F3}} *** RECORD 220644300000000000 WRITTEN TO FILE LCOLOC ***

Figure 1.2 Letter of credit (cont.)


Figure 1.3 Proforma invoice


Figure 1.4 Commercial invoice


Figure 1.5 Packing list


Figure 1.6 Certificate of insurance


Figure 1.7 Certificate of origin


Figure 1.8 Bill of exchange


Figure 1.9 Request for export declaration


Figure 1.10 Forwarding instruction


Global Trans Non-Negotiable COPY Ocean or Combined Transport Bill of Lading

(4) B/L No. AUYB42305000027

(1) Shipper/Exporter Car Parts Australia 369 Industry St, Lanceston Tasmania Australia

(5) Reference Nos: STT: AU102000362577 SHIPPER REF: 809453 CONSIGNEE REF:

(2) Consignee Japan Autos PO Box 98765 Tokyo, Japan

(6) GLOBAL TRANS 65 Dourne Road Alexandria, NSW 2015, Australia Tel: (61-2) 9333 5555, Fax: (61-2) 9333 566

(3) Notify Party

(7) For Delivery of Goods apply to:

(8) Vessel/Voyage (see clause 14.1 of the Bill of Lading terms) Ace Dragon 99

(11) Place of Receipt (Applicable only when document used as Combined Transport B/L) HOBART AUSTRALIA

(9) Port of Loading HOBART

(10) Port of Discharge TOKAI

(12) Final Destination (Applicable only when document used as Combined Transport B/L) TOKYO JAPAN

BELOW PARTICULARS FURNISHED BY SHIPPER – CARRIER NOT RESPONSIBLE – FOR MERCHANT’S USE ONLY AND NOT PART OF THE BILL OF LADING CONTRACT

Automotive Spare Parts; JA050 – JapanAuto; PCIU5060709/090909

1600KG 8.54m3

EDN: AAAATX7U9 CONTAINER NO. / SEAL NO. PCIU 5060709 090909 MOVEMENT FCL/FCL SHIPPED ON BOARD 5 APR 2005 Above particulars as declared by shipper, but without responsibility of or representation by the Carrier (see clause8). (16) Carrier’s Receipt (see clauses 1 and 8) Total number of containers or packages received by Carrier:

ONE Container

RECEIVED by the carrier in external apparent good order and condition unless otherwise stated the number of containers, packages or other customary freight units to be transported to such place as agreed, authorized or permitted herein and subject to all the terms and conditions appearing on the front and reverse of this Bill of Lading. The particulars given above as stated by the Merchant and the weight, measure, quantity, marks, conditions, contents and value of the Goods considered unknown by the carrier. In witness whereof the number of original Bills of Lading stated on this side have been signed and where one original Bill of Lading has been surrendered any others shall be void.

(17) Freight and Charges

(18) Prepaid

(19) Collect

(20) Declared Cargo Value (see clause 7.3): $1,000,000 AU

(21) Number of Original Bills of Lading: 3/THREE

(22) Place and Date of issue of B/L: 5 Apr 2005 SYDNEY

CIP INCOTERM 2000, Letter of Credit Req by 25/03/05. Issuing Bank: Nippon Bank, Advising Bank: Australia Bank

Freight prepaid AU$5000 Insurance Prepaid AU$900

(23) Issued as agents for Global Trans as Carrier by:

Figure 1.11 Bill of lading


Figure 1.12 Container list


Figure 1.13 Pre-receival advice (PRA)


Figure 1.14 Proforma invoice


Figure 1.15 Commercial invoice


Figure 1.16 Acknowledgement of order


Figure 1.17 Packing list


Figure 1.18 Shippers letter of instruction


Figure 1.19 Air waybill


Figure 1.20 Certificate of origin


Figure 1.21 Fax advice


Figure 1.22 Advice of despatch


E X P O RT S O F S E R V I C E S

The procedural aspects of exporting services are quite different from theexport of goods. Services do not need to be transported or cleared throughcustoms. In addition, the means of payment is often quite different becausestandard letters of credit were developed especially for international trade ingoods. The following discussion focuses on how services exports can occur.The various terms and conditions and the procedures that are followed inany sale of services is very much a matter for the parties to decide.

The diverse nature of the procedural and regulatory framework that canapply to sales of services across international boundaries becomes apparentif we look at the various modes by which trade in services can occur. Sales ofservices to foreign consumers can occur in one of four ways. First, the serviceprovider might sell its service to foreign customers within its own homecountry. Second, it might export the services directly to the consumer in theoverseas country. Third, it might send its personnel to deliver the servicesto the consumer in the consumer’s country; or fourth, it might set up apermanent establishment in the country of the consumer and deliver theservices through that establishment. Some examples of each type of servicetransaction highlight the complexities that arise in determining relevantlegal and procedural issues.

D E L I V E RY O F S E R V I C E S W I T H I N T H EH O M E C O U N T RY O F T H E S E R V I C EP R O V I D E R

Two common examples of the first mode of international sales of servicesare education and tourism. The education sector in Australia only becamea major player in Australia’s exports from the late 1980s. Within the lastdecade it has risen to be one of the nation’s top export earners and a majorsource of funding for Australia’s public universities.

The sale of the service itself occurs within the country of the serviceprovider when the foreign student enrols at the institution and pays tuitionfees. The nature of the agreement between the institution and the studentis similar to that for domestic students, and accordingly, while the sale isclassified as an export, it nonetheless has overwhelmingly domestic features.Subject to the domestic legislation that governs educational institutions, thematter of the agreement between the institution and the students is largelyone for the institution itself and the terms on which it will provide theservice. Additionally, while all educational institutions tend to follow similar


procedures in providing the service in order to remain competitive, eachinstitution has considerable freedom to determine the procedural mattersin relation to the delivery of the service.

In legal terms, the agreement between the institution and foreign stu-dents is very similar to an agreement between it and domestic students.But the agreements that those institutions enter into with agents in foreigncountries to recruit students on their behalf have more of an internationalflavour. In these agency relationships the agent is often paid a commis-sion based on the number of students that enrol in the institution. Thuswhile the agreement between the institution and the student is similar to adomestic contractual arrangement for providing educational services, theagency agreement by which the students are recruited does have a trulyinternational element.

Tourism is also a major export earner for Australia. Here again, theservices that earn the income are provided mainly within Australia. So inmany cases, whether the tourist is a foreign or a domestic tourist makeslittle difference to the agreement and legal obligations existing betweenthe service provider and the customer. However, there is an internationalelement to agreements in the tourism industry when local tour operatorsor major hotel chains enter into agreements with foreign tour companiesto bring groups of tourists to Australia. The terms of such agreements arelargely a matter for the parties themselves in accordance with usual prac-tices within the industry. There are no internationally recognised rules ofprocedure or international conventions governing these agreements such asexist in the sale of goods other than the international conventions relatedto passenger travel. In a similar way to the education sector, tourism oper-ators might also engage agents in foreign countries who might sell tours toAustralia on behalf of the tour operator. The legal considerations involvedin both types of agency relationships are similar and will be dealt with inChapter 8.

D I R E C T D E L I V E RY O F S E R V I C E S T OT H E O V E R S E A S C O N S U M E R

The second method for exporting services is for the provider of thoseservices to export the services directly without leaving its home country.A useful example is the information technology (IT) industry. A potentialcustomer located in an overseas country might find a particular softwaredesigner in Australia through the Internet or through industry sources.


The customer might ask the designer to develop a specialised program forit and send it by email. The designer will do the work and then email the fileto the customer after suitable arrangements have been made for paymenteither via the Internet or otherwise. In this simple scenario the parties haveconsiderable freedom to agree to any terms they think fit regarding thesupply of the service. But as with the sale of goods, questions of delivery,payment, and description of the services to be provided need to be dealtwith by the parties in their agreement along with other matters.

The simple scenario above is often more complicated in practice becausesuppliers in the IT industry often support their provision of services withsome form of physical backup by way of a computer disk and may alsosupply some computer hardware. In a case where sale of the services iscombined with sale of goods, the Convention on the International Sale ofGoods (Vienna Convention or CISG) might apply to the transaction. Thiswill have implications for the obligations of the parties and the remediesthat both buyer and seller have if one or the other fails to perform itsobligations. This is discussed in more detail in Chapter 2.

A further variation that is common in the IT industry is for the devel-oper of a computer program to enter into agreements with distributorsin overseas countries to market the program to consumers in that country.This often takes the form of a distribution agreement and associated licencefor the use of the intellectual property that belongs to the developer. Thedistributor will pay the developer (exporter) a certain percentage of the saleprice – a royalty – for all copies of the program that are sold. The legalissues associated with exports and intellectual property are discussed inChapter 9.

Another increasingly common example of delivery of services acrossinternational boundaries is telemarketing. Some Australian companies arenow engaging service providers in countries such as the Philippines andIndia to contact potential buyers of a service in Australia. The decreasingcost of international telephone calls, combined with the low cost of labourin developing countries, makes it less costly for some Australian companiesto do their telemarketing to Australian customers from offshore. The issueof such outsourcing is subject to some criticism because the employees ofoverseas companies contracted to do the telemarketing offshore are some-times not paid a wage but merely receive a commission if they make a sale.Such dubious labour practices would not be permitted in telemarketingcompanies operating within Australia. Some go so far as to call the overseastelemarketing companies the ‘new sweatshops’ of Asia.


D E L I V E RY O F S E R V I C E S T H R O U G HM O V E M E N T O F P E R S O N N E L

A third method for the export of services arises where the service providerdelivers the service by physically travelling to the country in which thecustomer is located. The exporter in this instance does not necessarilyhave an established business presence in that country. A useful example isthe construction industry, particularly as it relates to major infrastructureprojects. It is becoming common for governments to search worldwidefor the best designs and construction methods for major infrastructureprojects such as airports, rail systems, ports and the provision of utilitiessuch as power and water, rather than necessarily awarding all aspects of thoseprojects to local companies. Tenders are called internationally for variousparts of the project, including its overall project management. In order toprepare a tender bid and then carry out the work if the tender is successful,it is often necessary for the tendering firm to have personnel stationedwithin the country where the work is to take place in order to supervise thedelivery of the service, but not otherwise to have any permanent businessestablishment there.

International contracts in the construction industry are complex andoften involve overseas tenderers lodging what is known as performanceguarantees that guarantee to the buyer that the contractor will completethe work. Performance guarantees usually enable the beneficiary of theguarantee to call up the guarantee if certain events occur. It is not uncom-mon for disputes to arise out of the construction of infrastructure projects.Such disputes are often referred to arbitrators skilled in the particular field.The intricacies of resolving disputes through arbitration are discussed inmore detail in Chapter 11.

D E L I V E RY O F S E R V I C E S V I A A NI N - C O U N T RY P R E S E N C E

The fourth method by which services can be delivered is through theestablishment of a business presence in the overseas country. This canoccur either through a service provider establishing a new business entityin another country or by the service provider acquiring another serviceprovider in the same industry in the other country. Since the late 1990sthere has been marked growth in international mergers and acquisitions.Each year the United Nations Conference on Trade and Development


(UNCTAD) releases its World Investment Report containing statistics andother information about international investment. A careful examinationof the tables on mergers and acquisitions (M&A) shows that it is com-mon in any year for well over 50 per cent of the value of global mergersand acquisitions to occur in service industries such as telecommunications,finance, retail, information technology services, media and so on.

There are many reasons for the rapid rise in M&A activity in recent years.Perhaps the most plausible one is the need for companies to increase theirmarket share and competitiveness in the hope of raising profits and shareprices. Since it is possible to go only so far with cutting costs internally,firms look to the synergies and economies that occur through a merger oran acquisition in order to further reduce costs.

Closely aligned with the need to increase market share and competitive-ness is what can be called the ‘follow the leader’ explanation for M&As.An observation of the figures shows that M&As tend to concentrate inparticular industries in certain years. One explanation for this is that onceone major player in the industry acquires another player, other firms withinthat industry feel they have to follow suit in order to maintain their owncompetitiveness. This explains peaks of activity in the telecommunicationsand banking and insurance industries as well as in non-service industriessuch as petroleum and automobiles.

Yet it is not always the case that follow-the-leader activity is the result ofsound business decisions. Sometimes acquisitions are made to enhance theprestige, job prospects or remuneration of the CEO, but the significanceof such motives is often hard to determine because other reasons will bealways offered.

Liberalisation can also be advanced as a major reason to explain theincrease in M&As, particularly among the newly industrialising economies(NIEs) in the Asian region. In recent years many NIEs in Europe,Latin America and Asia have moved to allow foreign investment in theireconomies by way of merger and acquisition. This has made opportunitiesfor service providers to move into those economies to establish a businesspresence. Allied to these activities are the large-scale privatisations that haveoccurred in some countries. In Latin America, for example, the large-scalesell-off of telecommunications providers and utilities allowed foreign serviceproviders to enter these industries. Similarly, following the Asian economiccrisis of 1997–98, there has been considerable privatisation and rational-isation in the financial services sector, allowing foreign banks to establisha presence through acquisition. Even in Australia, services account for a


considerable proportion of M&A activity. For example, of the M&As inAustralia in 2000 that exceeded US$1 billion, nearly half, by number andvalue, were for acquisitions in the electric power industry.

The legal issues associated with the establishment of a business presencein another country either by a new business or through merger and acqui-sition are complicated. In Chapter 10 we deal at some length with whatis involved in establishing a business presence by a joint venture, branchor subsidiary. Needless to say, once a service provider has established itspresence in the overseas country, agreements relating to the provision ofservices in that country will largely accord with practices within the indus-try there, as well as having to comply with local legalisation. Thus theprovision of services through the establishment of an overseas presence isthe mirror image of the delivery of services in the home country of theservice provider. In both cases it will be domestic laws and procedures thatgovern the service provider’s contracts with customers.

22 Contracts for theInternational Sale of Goods

Internat ional trade involves the sale of goods andservices. In this chapter we examine the international sale of goods, moreparticularly the contract law that applies to the transactions. Every countryhas its own laws governing contracts. Imagine, then, the legal complexityfacing an international trader selling its goods to an overseas buyer. Does thelaw of the country from which the goods are sold apply to the contract, orthe law of the country where they are bought, or does some other law apply?If the contract law for the international sale of goods was the same in eachcountry, there would be less concern about which country’s law applies.This was imagined in the early twentieth century when the InternationalInstitute for the Unification of Private Law (UNIDROIT) was establishedin 1929 as an auxiliary organ of the League of Nations. UNIDROIT’s firsttask was to draft a uniform law for the international sale of goods.

UNIDROIT’s work was interrupted by the demise of the League and theoutbreak of World War II. Nevertheless, UNIDROIT was re-established in1940 on the basis of a multilateral agreement. It is now based in Rome andexists as an independent intergovernmental organisation whose purposeis to study needs and methods for modernising, harmonising and coordi-nating private international law. UNIDROIT completed its sale of goodsproject in 1964 when it submitted a Convention for the International Saleof Goods and the Convention for a Uniform Law on the Formation ofContracts for the International Sale of Goods to a conference attendedby only 28 nations. The two Conventions did not have much impactbecause only seven European and two other countries became parties to theConventions.

The baton was picked up by the United Nations Commission on Inter-national Trade Law (UNCITRAL), a United Nations body based in a

43


modern highrise UN building on the banks of the Danube River in Vienna.A Secretariat was established to draft a United Nations Convention on Con-tracts for the International Sale of Goods (CISG). The draft Conventionwas amended and adopted by a Diplomatic Conference in 1980 and cameinto force on 1 January 1988. The delegates to the Conference considered a1978 draft accompanied by a Secretariat Commentary on the draft. As theDiplomatic Conference relied heavily on the Commentary for its delib-erations, and largely approved the 1978 draft with minor revisions, theCommentary is the most authoritative explanation of the background andintended meaning of specific provisions of the CISG. An annotated accountof specific provisions of the CISG, which includes the Secretariat Commen-tary, can be found at <www.cisg.law.pace.edu/cisg/text/cisg-toc.html>.

Because the CISG is in effect a model law, it has no legal effect ofitself. It only gains legal effect in some countries if a law is enacted bya country’s parliament that copies the CISG into its own legislation, orin other countries if a country’s government signs up to the CISG. UnderAustralia’s constitutional system, the Federal Government was required firstto have the Convention take effect under international law (which it didon 1 April 1989), and then enact the provisions of the Convention throughparliament. In order to provide constitutional certainty the CISG was givenlegislative effect by similar legislation passed by the Federal and each of theState Parliaments: the Sale of Goods (Vienna Convention) Act 1989. In eachcase the legislation simply attached a copy of the CISG as a schedule tothe Act and stated that the provisions set out in the schedule are the lawof Australia (or the relevant State in which the statute was enacted). Bygiving effect to the CISG in this way, the law in other countries that haveenacted the CISG is the same as in Australia. Article 7 of the CISG inAustralia is the same, for example, as that in the CISG in Germany, justas Articles 25 and 78, for example, are the same. This makes things muchmore convenient, as the law on the international sale of goods is more orless identical in all CISG countries.

The CISG is not completely identical in CISG countries because PartIV allows a member country to exclude or modify the operation of someof its provisions. The Scandinavian states (Denmark, Finland, Norwayand Sweden) declared that they are not bound by Part II, which dealswith the formation of contracts. They also declared that the CISG doesnot apply to inter-Scandinavian trade. This was because they had spenta considerable amount of time developing uniform sale of goods legis-lation before the advent of the CISG, and presumably did not want tosee that effort wasted by fully adopting the CISG. In practical terms this

C O N T R A C T S 45

makes little difference to the operation of the law applying to the inter-national sale of goods as the Scandinavian laws are very similar to theCISG.

Australia declared that the CISG does not apply to its territories atChristmas Island, the Cocos (Keeling) Islands and the Ashmore andCartier Islands, and New Zealand declared that it does not apply to theCook Islands, Niue and Tokelau. PR China, Singapore, St Vincent andGrenadines, and the United States declared they are not bound by Article1(1)(b) CISG, which means they are not bound by laws determining whichlaw applies to the law of the contract. Article 1(1)(b) is discussed in moredetail below. Other countries have made declarations under Article 96,thereby altering the operation of some of the provisions of their CISG law.(See <www.cisg.law.pace.edu/cisg/countries/cntries.html>.)

The CISG applies as the law of 64 countries, including Australia,Canada, China, France, Germany, Italy, New Zealand, Singapore, theRussian Federation and the United States. Countries that have not adoptedthe Convention law include Japan and the UK (for a list of Conventioncountries see <www.cisg.law.pace.edu/cisg/countries/cntries.html>).Given the wide coverage of the Convention, we will explore it in somedetail in this chapter.

This chapter aims to provide an understanding of:� when the CISG applies;� the CISG provisions on contract formation;� obligations of the seller and the buyer with reference to the CISG’s

gap-filling provisions; and� remedies for breach of contract; and damages.

W H I C H C O U N T RY ’ S L AW S A P P LY T OT H E C O N T R A C T ?

There is no ‘international law’ applying to contracts. The law applying toa contract for the international sale of goods (or services, for that matter)is usually the domestic law of a country in which a party to the contracthas its place of business. A contract for the sale of wine from California toJapan, for example, will usually be regulated by the law of either Californiaor Japan. The parties could include a clause in their contract specificallystating that the law of California or the law of Japan or indeed another lawapplies to the contract. This is known as a choice of law clause. The clausecould, for example, say that ‘The law applying to this contract is the law ofJapan and if any dispute arises the parties agree to submit to the jurisdiction


of the courts of Japan’. In the absence of a choice of law clause, decidingwhich law applies to the contract can be extremely complex and can inviteexpensive, time-consuming and largely unproductive disputes about whichcountry’s laws apply to the contract.

If there is no choice of law clause in a contract for the sale of goods, andthe buyer and seller are in different CISG countries and have not excludedthe operation of the CISG, then questions about which country’s lawsapply are less pressing because the law in both countries dealing with thesale of goods is the same. There may, however, be ancillary legal issues notdealt with by the CISG that are at issue, which would again raise questionsabout which law applies to the contract. For example, questions may ariseabout title to the goods, something that is not covered by the CISG. It istherefore advisable to include a choice of law clause in a contract whereverpossible.

If one party to the contract is in a CISG country and the other is not,for example the place of business of the seller is in Australia and the place ofbusiness of the buyer is in Japan, then the CISG will apply to the contract ifthe law applying to the contract is that of Australia; and the CISG will notapply if the law applying to the contract is that of Japan (Article 1 CISG).If both parties to the contract have their place of business in non-CISGcountries, then the Convention will not apply. However, the parties couldagree in their contract that the law applying to the contract is the CISG. TheCISG would then apply to the contract as a result of agreement betweenthe parties, unless the domestic law applying to the contract prevents ormodifies such agreement.

T Y P E S O F C O N T R A C T S T O W H I C H T H EC I S G A P P L I E S

If the CISG is the law applying to the contract under step one, the secondstep in deciding whether the CISG applies to a contract is deciding whetherthe subject matter of the contract is governed by the CISG.

P RE P O N D E R A N T L Y F O R T H E S U P P L YO F G O O D S

The Convention will not apply if the preponderant part of the seller’s obli-gations is the supply of labour or other services, rather than the supply ofgoods (Article 3(2)). It can be difficult deciding whether the Conventionapplies under this article. If a contract is for the sale of major computinghardware and it includes the services of technicians to install and test the


computer system and develop software, the question is whether the contractis preponderantly for the provision of goods or services. Preponderant inthis context means more than half. This leaves open the question, half ofwhat? It could mean either more than half the monetary or financial valueof the contract or half of the quantity of goods supplied. During the draft-ing of the CISG, Britain proposed that the word ‘preponderant’ refer onlyto the measure of the quantity of the goods and services supplied, but thatapproach was rejected. It is therefore possible to measure the value of thecontract either by the quantity of goods being supplied or by their mon-etary value, or by some combination of both. Although this may seem toleave the issue unresolved, adopting too prescriptive a method for decidingpreponderance could lead to unfair outcomes in some circumstances. It istherefore left to tribunals and courts to decide whether a contract is prepon-derantly for the supply of goods in the light of the particular circumstancesof each case.

Generally, the CISG will not apply to franchise agreements, largelybecause most international franchise agreements are not mainly aimed at theinternational supply of goods by the franchiser to the franchisee. Usually,an international franchise arrangement will involve an agreement betweenthe international franchisor (for example Domino’s Pizzas or Burger King)entering into a master franchise agreement with a national master fran-chisee. This arrangement will generally not involve the supply of goodsto the master franchisee. The national master franchisee will then enterinto franchise agreements with a range of smaller franchisees. Franchisingis further discussed in Chapter 9.

O T H E R M A T T E R S N O T C O V E RE D B YT H E C I S G

The CISG does not apply to the sales of goods bought for personal, familyor household use (Article 2). The purchase of books from Amazon.comoutside the United States for personal use, for example, is not regulatedby the CISG even if the purchase involves the international sale of goods.The CISG also does not apply to the sale of goods by auction, or the saleof stocks, shares, investment securities, negotiable instruments or money,ships, vessels, hovercraft or aircraft, or the sale of electricity. Nor does theCISG apply to the seller’s liability for death or personal injury caused byany goods (Article 5). If a carrier is injured because of manufacturing faultsin the goods, the CISG says nothing about the manufacturer’s, buyer’s orseller’s liability under negligence for any injury caused to the carrier.


The CISG itself is not concerned with the validity of a contract otherwisecovered by the Convention (Article 4). The CISG does not, therefore,deal with questions about voiding the contract for illegality. This is notsurprising because matters of illegality are complex, and will usually relateto the domestic law of the parties’ place of business. Illegality is thereforebest dealt with by domestic courts and not international tribunals. Anexample of a matter that can arise is if a contract is for the export of goodswhere the seller did not obtain the correct export licence or fill in the correctcustoms forms. It is possible here that the contract will be rendered voidunder local laws because it is illegal. Deciding whether in fact the contractis illegal can mean deciding whether or not the relevant legislation intendedvoiding sale of goods contracts – a matter best left to a domestic court.

The Convention does not deal with trade usages (Article 4), unless thisis expressly provided for under the Convention. A trade usage is a practiceor way of doing business that has developed in an industry over a periodof time. A number of trade usages regarding the international shipment ofgoods are captured by the International Chamber of Commerce’s incoterms(see Chapter 3).

The statement in Article 4 that the CISG does not deal with trade usagesappears to be contradicted by Article 9, which states that the parties ‘arebound by any usage to which they have agreed and by any practices whichthey have established between themselves’. The conflict is more apparentthan real since Article 4 states that it applies unless another provision inthe Convention expressly provides otherwise. It does seem odd, neverthe-less, that one provision states that trade usages are not dealt with by theConvention, and another proceeds to deal with the question of trade usagesat some length. Article 9(2) is expressed so broadly that it appears to totallyundermine the broad claim of Article 4. Article 9(2) states that:

The parties are considered, unless otherwise agreed, to have impliedly madeapplicable to their contract or its formation a usage of which the parties knewor ought to have known and which in international trade is widely knownto, and regularly observed by, parties to contracts of the type involved in theparticular trade concerned.

The opposing sentiments of Articles 4 and 9 reflect the undercurrentof political tension that existed during the drafting of the Convention. Anumber of socialist and developing countries objected to inserting tradeusages into contracts, claiming they had evolved in developed countriesand would therefore reflect the interests of parties in those countries.


Developed nations, however, were keen to retain trade usages because oneof the purposes of the Convention, as they saw it, was to support andgive effect to industry practices and party intent, rather than impose com-mercially ineffective terms on contracts from the outside. That said, theConvention fails to define what trade usages are, which is problematicsince there are trade usages among national industries as well as interna-tional usages among industries. It is unclear whether national usages apply,and what should be done if a trade usage in one nation conflicts with ausage in another. Applying both Articles 4 and 9 suggests that the mean-ing of trade usages should generally be read narrowly, so that they wouldnormally not encompass a national usage unless it reflects well-acceptedinternational usages.

Article 4 also states that the Convention is not concerned with the effectthat the contract may have on the property in the goods sold. That is, itdoes not deal with the question of who has legal title to the goods. This is inpart dealt with by the incoterms because they set out the parties’ obligationsregarding delivery of the goods. ‘Delivery’ is not always synonymous withtransfer of ownership. Again, the issue of property rights to goods can bea complex one. It is particularly relevant if goods are being transportedby ship, air or land and are damaged in transit. If the seller is at riskregarding the goods when they are damaged, it will usually be requiredto find replacement goods or provide some form of compensation to thebuyer. If the buyer is at risk, usually it will either have to wear the loss orrecover compensation from the carrier.

I N T E R P R E T I N G T H E C I S G

Contract disputes under the CISG are usually dealt with either by a court ina particular country or by an international arbitration tribunal. The partiesto a contract can agree in their contract, or by subsequent agreement, tohave their dispute resolved by an arbitration tribunal. We discuss resolvingdisputes by international arbitration in Chapter 11. Courts and tribunalsare often required not only to decide what the parties did and said inrelation to a contract dispute, but also to decide precisely what the CISGsays about a particular legal point. As an example, a party may terminatea contract if the other party ‘fundamentally breached’ the contract. Article25 says that a fundamental breach occurs ‘if it results in such detrimentto the other party as substantially to deprive him of what he is entitled toexpect under the contract’. This definition raises more questions than itresolves. For instance, what precisely does ‘substantially deprive’ mean in


this context? Does it mean that a party must show that it has been deprivedof 50 per cent or more of the monetary value of the goods it ordered, orare there other ways of deciding whether the party has been substantiallydeprived? What if the buyer is a manufacturer and the goods orderedunder the contract are to be components for machinery manufactured bythe buyer, and the seller failed to deliver 20 per cent of the ordered goods.This would appear not to be a substantial detriment. But what if thiscauses major manufacturing delays leading to the loss of a vital customerand thereby causing substantial loss of potential financial earnings to thebuyer? Would this amount to a fundamental breach under Article 25? Toanswer the question, the interpreter would have to drill down into theintended meaning of ‘substantial detriment’ in Article 25. This is just oneexample of the many questions that an interpreter of the CISG may befaced with. We discuss fundamental breach in more detail at pp. 66–70.

When interpreting the meaning of a particular CISG provision, adecision-maker (that is, a court or international arbitration tribunal) isrequired first to have regard to the plain meaning of the words of the rel-evant CISG Article. If the meaning is unclear, the decision-maker mustattempt to work out what the drafters of the CISG intended the Articleto mean. As we mentioned earlier in this chapter, the CISG was largelydrafted by the UNCITRAL Secretariat, which wrote a commentary on theCISG, thereby providing an explanation of the purpose for most of theprovisions in the Convention.

If after reading the Secretariat’s Commentary on an Article its meaning isstill unclear, leading international commentators’ views about its meaningcan be sought. Leading commentaries include John Honnold’s UniformLaw for International Sales Under the 1980 United Nations Convention, andPeter Schlechtriem’s edited work, the Commentary on the UN Convention onthe International Sale of Goods (Clarendon Press, 1998). The commentatorsdiffer among themselves as to the meaning of some contentious provisions,or say nothing on the point in contention, in which case further assistancecan be gained by reading decisions of courts in various countries regardingthe point. Regard can also be had to any arbitration decisions, althoughthey are often either not available, because the parties to the dispute wantto keep it confidential, or there are only very brief summaries of thedecision.

With so many different courts and tribunals throughout the worldhaving the capacity to deal with CISG disputes, it is possibile that theywill interpret the CISG’s provisions inconsistently. This creates the risk


of heightened confusion and uncertainty about the meaning of variousprovisions. Article 7 attempts to deal with this risk by requiring courts,tribunals and any other interpreters to have regard to the CISG’s ‘inter-national character and the need to promote uniformity in its applicationand the observance of good faith in international trade’. Arguably, theCISG is developing its own jurisprudence independent of the nationaljurisprudence of individual countries. In support of this proposition, anInternational Chamber of Commerce Tribunal in Arbitral Award 9887 ofAugust 1999 said:

As to the applicable law, the Arbitral Tribunal held that under the new Rulesof Arbitration of the International Chamber of Commerce it was not boundto make use of any national law (including conflict of law rules) and was freeto apply instead recognized international legal standards. It then held CISGapplicable, considering the strong recognition of CISG in the arbitrationpractice ‘as a set of rules reflecting the evolution of international law in thefield of international sale of goods’. Furthermore it pointed out that CISGwould be applicable to the case at hand also under general principles ofinternational private law, since the requirements of Art. 1(1)(a) CISG weremet.

If an international sale of goods matter is to be decided by a domesticcourt, it is more likely that the court will refer to national laws regardingsale of goods disputes rather than consider the CISG jurisprudence as anindependent international jurisprudence that functions without specificreference to national laws. Nevertheless, those courts are equally likely,under Article 7, to have regard to the decisions of courts in other countriesin order to gain a sense of the approach that is being taken internation-ally, so that reasoning can be adopted that is consistent with internationalnorms.

The CISG attempts to maintain a degree of harmony with most contractlaw systems throughout the world, as it also attempts to deal with the spe-cific issues arising under international trade. At the time the Conventionwas drafted international communications tended to be more difficult andexpensive than they are today. Even now, the international export of goodstends to be more complex and to involve more difficult arrangements thanin the internal national transportation of goods. International export andimport is regulated by customs and import regulations, and by differinglaws and practices in the places of export and import. In addition, interna-tional transportation of goods often involves greater distance than national


transportation and consequently more risks and expense. In other words,many things can go wrong under international sales agreements. For thisreason, the CISG attempts to limit the grounds on which parties canterminate contracts, and attempts to compel parties to keep their con-tracts on foot and meet their contractual obligations as far as reasonablypossible. This objective is particularly evident in Part III of the CISG, whichrequires the buyer to notify the seller of the delivery of non-conforminggoods under the contract and give the seller an opportunity to correct thesituation. So if 15 crates of red wine are delivered instead of 20, the buyer(generally speaking) cannot simply terminate the contract for breach. Thebuyer must inform the seller and allow it the opportunity to supply themissing crates, provided the seller bears any additional expenses and lossesdue to the failure to meet the original order.

C O M M O N L A W A N D C I V I L L A WL E G A L S Y S T E M S

As mentioned, the CISG operates as a national law in over 60 countries,and applies in many different legal systems. In terms of commercial law,at least, there are two general legal systems in operation: the common lawsystem and the civil law system. The common law system has its roots in theBritish legal system and the civil law in the continental European legal sys-tem. The civil law system tends to be more systematically set out in writtencodes and statutes than the common law system. The civil law is set out ina hierarchical way, with the nation’s constitution as the primary document,followed by the civil code and the criminal code. Subordinate to the codesare statutes dealing with more specific matters, followed by administrativedirections. As one moves down the hierarchy the laws become less abstractand general and more specific in the way they deal with matters. Courtstend to interpret and apply the law to specific cases brought before them.Previous court decisions tend to be merely of persuasive value in assisting acourt to deal with the matter at hand. Civil law countries include continen-tal European countries and numerous countries in Asia, including Japan,South America and other parts of the world.

The courts in common law countries have tended to play a more centralrole in the development of the law than has been the case in civil lawcountries. This is changing because of the increasing volume of statutes(that is, laws made by parliament) being enacted. The common law systemis in practical terms developing a greater similarity to the civil law system


than at any previous time in its development. Despite that, the common lawsystem is founded on a number of fundamental assumptions and practicesthat differ from the civil law. The courts have a long tradition in whichthey have themselves developed the law in numerous fields, including thelaw of contract, negligence, and the criminal law. The courts did this on acase-by-case basis, referring to earlier decisions to reaffirm legal principlesdeveloped in those cases and further developing the law in subsequentcases. The doctrine of precedent plays a central role here, in which thecentral tenets of a decision made by an authoritative court are binding onless authoritative courts. However, if there is any conflict between a judge-made law and a parliament-made law, the latter prevails. In that sense,parliament, and ultimately the people, is supreme. Common law countriesinclude the United Kingdom, Ireland, the United States, Canada, Australiaand New Zealand.

C A N T H E PA RT I E S T O A C O N T R A C TO P T O U T O F T H E C I S G ?

Assuming the CISG is the law applying to a contract for the internationalsale of goods, it is nevertheless possible for the parties to a contract toexpressly or impliedly opt out of all or some of the provisions of the CISG.Article 6 CISG states: ‘The parties may exclude the application of thisConvention or, subject to article 12, derogate from or vary the effect ofany of its provisions’. Article 12 refers to the operation of the CISG incountries that have made declarations that certain parts of the CISG do notapply.

Generally, parties to international sale of goods arrangements do not getlawyers to draft elaborate contracts. They simply make purchase orders forthe goods, or make phone, fax or email orders. Much is left unsaid aboutwhat happens if the goods sent are damaged, or do not completely satisfythe order. Where these gaps or silences exist, the CISG applies. The CISGtherefore operates as the residual law underlying the contract. It aims to fillthe gaps or the silences of a contract. As mentioned above, the CISG doesnot fill all the gaps – the passing of risk in the goods (which is dealt withby the incoterms), questions of liability for negligence, and other mattersare not covered by the CISG.

An underlying policy of the CISG is that it does not attempt to dictateterms to contract parties, because (under one theory of contract law, atleast) the law believes in party autonomy, or freedom to contract. Under


this theory the parties are free to negotiate their own contract terms withoutthe law interfering. Some legal commentators disagree with this theory,arguing that the law only allows parties to negotiate freely and agree oncontract terms within certain parameters. The law, they say, sets certainstandards of contract behaviour that the parties cannot opt out of. Partiescannot, for example, act in a dishonest, misleading, or unduly exploitativeway.

Arguably, the law also sets other basic standards of behaviour of theparties, including an obligation to contract in good faith. Article 7, forinstance, states that when interpreting the CISG regard is to be had tothe observance of good faith in international trade. This does not explicitlyimpose obligations of good faith on the parties, but it does require that partyobligations be understood within the context of a law, namely the CISG,that aims to ensure that parties meet standards of good faith. The precisemeaning of ‘good faith’ is much debated by lawyers. Generally speaking,it requires that the parties act honestly and reasonably towards each other,not work to undermine the operation of their own contract, and not takeadvantage of the other party by extracting gains from them that are notdue under the contract.

Parties can opt out of the CISG by expressly saying in the contract thatit does not apply, or that parts of it do not apply. Even if a contract makesno mention of the CISG, any provision in a contract that is inconsistentwith the CISG will have the effect of overriding the inconsistent CISGprovisions.

T H E S T R U C T U R E O F T H E C I S G

There are 101 provisions of the CISG, which in essence deal with theformation of international sales contracts; the rights and obligations ofparties to the contracts; and the remedies available to parties for any breachesof the contracts. Part I (Articles 1–13) deals with the general application ofthe CISG. Part II (Articles 14–24) deals with the formation of contracts.Part III (Articles 25–88) deals with the sale of goods contract itself andis divided into five chapters: Chapter I, general provisions; Chapter II,obligations of the seller; Chapter III, obligations of the buyer; Chapter IV,the passing of risk; and Chapter V, obligations common to both buyer andseller. Part IV (Articles 89–101) deals with a number of matters relatingto the implementation of the CISG itself. The CISG can be found at<www.uncitral.org/en-index.htm>. The remainder of this chapter willbroadly follow the structure of the CISG.


PA RT I I : F O R M AT I O N O FT H E C O N T R A C T

A contract is formed when one party makes an offer and the other partyaccepts it. This simple proposition raises numerous questions: does theoffer have to be in writing; what precisely were the terms of the offer; canthe offeror withdraw the offer before it is accepted; how must the offereecommunicate any acceptance to the offeror; and what if the offeree acceptsthe offer with certain conditions applying? These are relatively standardmatters addressed by contract law in most countries, and they are alsoaddressed by the CISG. The CISG is generally consistent with the law inmost countries regarding the formation of contract. It does, however, tendto be more consistent with civil law principles regarding the formation ofcontracts than it is with common law countries, though the bias is relativelyminor. Under the CISG, and in civil law countries, a contract is formedwhen the offerer receives communication of acceptance from the offeree.However, if the offeree posts notice of its acceptance by mail, then underthe common law the contract is formed when the offeree posts the letterof acceptance. Under the civil law and the CISG, acceptance occurs whenthe letter of acceptance is received by the offeror.

In addition, in common law countries a contract does not exist unlessthere is ‘consideration’. This requirement can raise complex legal questions,but in short it is a requirement that something must be provided in returnfor something else. Most commonly, consideration exists if one party sellsgoods in return for the payment of money by the other. Consistent withthe civil law, the CISG does not require consideration, but obviously itrequires some subject matter on which the contract is based.

O FF E R

An offer is a proposal for a contract addressed to one or more people. Peoplein this context can include a company or any form of corporate body. Theoffer must be sufficiently definite and indicate an intention to be bound bythe offer. It will be sufficiently definite if it specifies the goods and the pricepayable for them. Note, however, that under Article 55 CISG, if a contractdoes not expressly or impliedly fix or make provision for determining theprice, the parties are considered, in the absence of any indication to thecontrary, to have impliedly made reference to the price generally chargedat the time of the conclusion of the contract for such goods sold undercomparable circumstances in the trade concerned. The offer must also


expressly or impliedly specify the quantity of goods that are being offeredfor sale or the means for determining the quantity (Article 14).

A product catalogue that sets out the goods for sale by a manufacturer orexporter will normally not be an offer because it is addressed to numerousunspecified people. Article 14(2) emphasises this point by stating that a‘proposal other than one addressed to one or more specific persons is tobe considered merely as an invitation to make offers, unless the contrary isclearly indicated by the person making the proposal’. So a catalogue wouldnormally be an invitation to make offers and not an offer itself, unless therewas a statement in it stating that the exporters will supply the goods atthe prices stated in the catalogue, regardless of who accepts the offer. It isdifficult to imagine any supplier being prepared to bind itself in this way asit may well amount to an invitation to unreliable and financially unstablepurchasers to accept the offer.

An offer becomes effective when it reaches the offeree (Article 15). Inpractice, this requirement is not always as obvious as may first appear. If theofferee hears about the offer from someone other than the offeror, from afriend for example, this does not amount to a communication of the offer.This may mean that the offer can be withdrawn until it reaches the offeree.An offer may be withdrawn if the withdrawal reaches the offeree before orat the same time as the offer (Article 15(2)). Under Article 24 the offerreaches the offeree when ‘it is made orally to him or delivered by any othermeans to him personally, to his place of business or mailing address or,if he does not have a place of business or mailing address, to his habitualresidence’.

The offeror can revoke the offer if the revocation reaches the offereebefore the offeree dispatches an acceptance of the offer (Article16(1)). Butthe offeror can hold the offer open for a fixed time. If this happens, the offercannot be withdrawn before the fixed time expires. An offer also cannot bewithdrawn if it was reasonable for the offeree to rely on the offer as beingirrevocable and the offeree acted in reliance of the offer (Article 16(2)).

A C C E P T A N C E

Article 18 deals with the acceptance of offers. There is no need for accep-tance to be formally made in writing. Any statement or other conductindicating assent to an offer is sufficient. Generally speaking, silence orinactivity does not constitute acceptance. It is, however, possible in somecircumstances that silence will amount to assent. If, for example, an orderfor goods stating the quantity and price is faxed to a supplier (which would


amount to an offer to purchase goods) and the supplier does not replyto the fax but nevertheless dispatches the goods to the purchaser, thiswould amount to an acceptance and the creation of a valid contract despitethe supplier’s silence. The supplier’s activity in meeting the order wouldconstitute acceptance.

There can also be acceptance if there is both silence and inactivity. J. O.Honnold gives examples of when silence and inactivity can and cannotamount to acceptance. In the following example he says there is no contractbecause the seller attempts to force acceptance by the buyer:

On June 1 Seller sent Buyer an offer to sell a specified type and quantity ofgoods at a stated price, and added: ‘This is such an attractive offer that Ishall assume that you accept unless I hear from you by June 15.’ Buyer didnot reply. Seller shipped the goods on June 16.

But in his next example there is a contract because the buyer assumed theduty to respond but failed to do so in time:

On June 1 Buyer delivered the following to Seller: ‘Please rush price quo-tation for the following goods [specifying quantity and quality]. If you donot hear from me within three days after I receive your quotation, consideryour offer as accepted.’ Seller delivered the quotation to Buyer on June 3;Buyer did not respond until June 10, when he objected to the prices thatSeller had quoted.

(J. O. Honnold, Uniform Law for International Sales under the 1980United Nations Convention, 3rd edn, Kluwer Law International,

1999, p. 173)

According to Honnold, these two examples illustrate the point that theprovision regarding silence in Article 18(1) is no barrier to there being acontract in the second example. Article 6 allows parties to ‘derogate fromor vary the effect’ of the Convention’s provisions. The buyer in the secondexample proposed that if the seller sent a quote to the buyer, the buyerwould be bound unless it responded within three days. As the buyer didnot do this, it amounted to acceptance of the offer. The buyer’s objectionabout price came too late.

As mentioned previously, acceptance occurs the moment the indicationof assent reaches the offeror. This departs from the common law ‘postal rule’,which states that acceptance occurs at the moment the offeree dispatchesthe notice of acceptance. Acceptance occurs when the notice of acceptanceis orally made to the offeror or written notice of acceptance arrives at their


place of business or mailing address or, if they do not have a place of businessor mailing address, to their habitual residence. So, for example, in a casewhere an offer is made by Fred, an employee in Zan Incorporated, and thenotice of acceptance arrives in the mail room at noon, if Fred withdraws theoffer at 1 p.m. and the notice of acceptance arrives on his desk at 2 p.m.,a contract is formed. The purported withdrawal of the offer occurred afterthe acceptance because acceptance occurred when the notice arrived at theplace of business, regardless of when it arrived on Fred’s desk. The situationwould be different if Fred stated in his offer that acceptance occurred whenit arrived on his desk.

Under Article 22, a withdrawal of an offer is effective if it reachesthe offeror before or at the same time as the acceptance reaches theofferor. Other points of interest regarding acceptance include the factthat:� The offeror may state that the offer is open for a specified period, in

which case acceptance must be made within that time.� If no time for acceptance is specified, it must be made within a reasonable

time after the offer was made. In working out what is a reasonable time,the way in which the offer was made (such as by letter, fax or email) canbe taken into account. An offer made by rapid means of communication,for example by email, suggests that a reasonable time is a relatively shorttime after the offer was made.

� A verbal offer must be accepted immediately, unless the circumstancesindicate otherwise.

� If the parties have developed a practice, or there is an industry usage,in which certain acts constitute acceptance (for example simply sendinggoods off in response to an order), then this practice will constitute anacceptance, provided it is done within a reasonable time after the offeris made.

C O U N T E R - O FF E R S

If one party makes an offer but the other responds with a purported accep-tance that varies the terms of the original offer, this may amount to arejection of the original offer and the making of a counter-offer (Article19). If, for example, Amy Inc. offers to sell 10 tonnes of high-grade steel for$250 000 and Steelers Ltd responds by stating that it will accept the offer at$200 000, this will amount to a rejection of the original offer and the mak-ing of a counter-offer. If Amy Inc. accepts the counter-offer, a contract isformed.


The variation of the original will amount to a counter-offer if it variesthe originally offered price, payment terms, quality and quantity of thegoods, place and time of delivery, or the extent of one party’s liability tothe other or the settlement of disputes (Article 19(3)).

PA RT I I I : T H E S A L E O FG O O D S C O N T R A C T

Part III CISG deals with the rights, obligations and remedies of the partiesto a contract for the international sale of goods. It deals with the terms ofthe contract and the consequences of any breach of those terms. A centralconcept in the CISG regarding rights and remedies for breach of contractis the harmed party’s right to remedies for any loss suffered as a result of a‘lack of conformity’ with the contract. If the lack of conformity amounts toa fundamental breach of the contract, the harmed party can terminate thecontract, as long as notice is first given to the breaching party. The harmedparty can also seek damages for any loss suffered from the breach. We dealwith fundamental breach at pp. 66–70. If the lack of conformity amountsto a non-fundamental breach, the buyer cannot terminate the contract, butit can seek damages for any loss suffered.

The distinction between mere non-conformity and fundamental breachcan be illustrated this way; if the buyer orders 50 cases of oranges but theseller delivers only 40 cases, the buyer cannot terminate the contract andreturn the 40 cases as this is a mere non-conformity and not a fundamentalbreach. If, however, the buyer is a wholesaler and needs the oranges to arriveby 1 June in order to meet the demands of the supermarkets and fruiterersthat it supplies, and the buyer states in the contract that the oranges mustbe delivered by that date and that time is of the essence, and the orangesare delivered by the seller on 30 June, this may amount to a fundamentalbreach. The buyer may on 7 June, for example, inform the seller that thecontract has been fundamentally breached and is terminated, and thenproceed to make an alternative purchase of oranges. The seller would beliable to pay damages for any losses suffered by the buyer as a result ofthe breach of contract. Damages is a legal term which effectively meanspayment of compensation by one party to an amount of money equal tothe value of the loss suffered by the other party. The methods for calculatingthe value of that loss are set out in Articles 74–77 of the CISG.

The CISG attempts to keep contracts on foot as much as is reasonablypossible because the probabilities of errors occurring in international tradeare high compared to domestic trade. The CISG provides a number of


mechanisms to enable the parties to correct any non-fundamental breaches,as long as the breaching party wears the additional expense of undertakingthe corrective measures.

Deciding whether there is a lack of conformity requires first decidingwhat the terms of the contract are, and second whether those terms havebeen complied with or not. If there is non-compliance with the contractterms, this amounts to non-conformity.

The terms of the contract are any express terms agreed between theparties in writing or verbally. Note, however, that some countries that haveadopted the CISG have excluded the CISG provisions that allow verbalcontracts. Often the written components of contracts between the partiesamount to little more than a faxed or emailed sales order. Much about theterms of the agreement between the parties is left unsaid. The CISG playsthe useful role of supplying ‘gap-filling’ provisions to the agreement. Thatis, unless the contract says otherwise, the CISG effectively adds a numberof additional terms to the contract, which we discuss next.

G A P - F I L L I N G T E R M S O FT H E C O N T R A C T

The gap-filling provisions of the CISG apply to an international sale ofgoods contract unless the contract expressly or impliedly states otherwise.

G A P - F I L L I N G O B L I G A T I O N S O NT H E S E L L E R

The seller is required to deliver the goods to the buyer, hand over anydocuments relating to them, and transfer the property in the goods to thebuyer, unless the contract says otherwise (Article 30). If the contract doesnot specify the place the goods are to be delivered to, then the seller must:� hand the goods over to the first carrier for transporting the goods to the

buyer; or� take the components to the place for manufacture if the buyer and seller

are aware that the goods are components for manufacturing products;or

� take the goods to the seller’s place of business.The seller must also deliver the goods on the day fixed or determinable fromthe contract, or if this is not the case, make delivery within a reasonabletime.


The CISG requires that the seller must deliver goods that are of thequantity, quality and description required by the contract and that arecontained or packaged in the manner required by the contract (Article 35).The goods are assumed not to conform with the contract (except if theparties have agreed otherwise) unless they:� are fit for the purposes for which goods of the same description would

ordinarily be used;� are fit for any particular purpose expressly or impliedly made known to

the seller at the time of the conclusion of the contract, except where thecircumstances show that the buyer did not rely, or that it was unreason-able for it to rely, on the seller’s skill and judgement;

� possess the qualities of goods which the seller has held out to the buyeras a sample or model; and

� are contained or packaged in the manner usual for such goods or, if thereis no such manner, in a manner adequate to preserve and protect thegoods (Article 35).The seller is required to deliver goods that are free from third party

rights (Article 41). That is, the seller must ensure that it owns the goodsit is selling or that it has the right to sell the goods, and that they do not,for example, belong to someone else. Article 42 deals with the delivery ofgoods that may have intellectual property rights associated with them. Theseller must deliver goods free of third party intellectual property rights.That is, for example, if clothing is delivered with a brand name like ‘Gap’,the seller must ensure they have permission (for example a licence) tocarry the brand name on the clothes. Under Article 43, if the buyer findsout that there is a third party claim against the goods (and the seller wasnot already aware of the nature of the claims), it must inform the seller ofthe nature of the claims being made, or lose the right to claim a breach ofthe seller’s obligations under Articles 41 and 42.

G A P - F I L L I N G O B L I G A T I O N S O NT H E B U Y E R

The buyer must pay the price for the goods and take delivery of them asrequired by the contract and the CISG (Article 53). Under common law,or the civil law for that matter, if the parties have not agreed on price thereis a risk that no contract exists because the agreed terms are too uncertain.That is, if an order is made for goods, but price is not mentioned, thereis a risk that no valid contract exists. Article 55 deals with this problem


by deeming that the parties have agreed on a price that the goods wouldnormally be sold at under comparable trading conditions.

Articles 56–59 insert other gap-filling terms into a contract that relateto the calculation of price and the time and place for making payment. Asan example, the buyer is not bound to pay the price until it has had anopportunity to examine the goods, unless the procedures for delivery orpayment agreed on by the parties are inconsistent with the buyer havingsuch an opportunity. Of course, the parties can expressly or impliedlyexclude these gap-filling terms.

W H E N D O E S T H E R I S K I N T H E G O O D SP A S S F RO M S E L L E R T O B U Y E R ?

The seller is liable, under Article 36, for any lack of conformity with thecontract at the time that the risk in the goods passes to the buyer. Generally,at any time during the course of the contract, either the buyer or the sellercarries the risk in the goods. If the goods are damaged, stolen or lost, thequestion is, who is at risk regarding the goods? That is, who wears the lossif the goods are damaged or lost? The incoterms are standard terms thatcan be incorporated by reference into contracts that deal with the passingof risk. If a sales contract, for example, states that the goods are to be soldfree on board (FOB), the risk in the goods passes from the seller to thebuyer once the goods pass over the ship’s rail at the port of embarkation.

If the contract does not include an incoterm, and the parties are otherwisesilent on the question of passing of risk, then if the contract for sale involvesthe carriage of goods, the risk passes from the seller to the buyer when theseller hands the goods to the first carrier (Article 67). If the goods are soldwhile they are in transit, the risk passes when the contract is concluded(Article 68); otherwise the risk passes to the buyer when it takes over thegoods (Article 69).

T I T L E T O T H E G O O D S

The CISG does not deal directly with the question of who has title to thegoods. ‘Title’ to the goods is another way of saying the legal right or legalliability in relation to the goods. It is an apparently simple term that masksa plethora of complex legal issues. We tend to think of title as synonymouswith ownership, which to some extent it is. But it is a concept that is quitecomplex. You may ‘own’ your car, but your entitlement to use the car will


be governed by the law, including the requirement that you hold a validdriver’s licence. If you allow someone else to drive your car, you may eitherbe giving him or her a licence (that is, a permission) to drive the car, oryou might be leasing the car to him or her. Whether you are liable for anydamage or loss to the car will depend on the agreed terms of the licenceor lease. The lease may even prevent you using your own car during theperiod of the lease, because you have agreed to give the lessee exclusive useof the car during the period of the lease. In addition, you may sell the carduring the period of the lease, so that while the car is being used by oneparty, ownership in the car is transferred. If you take the car to a garage forrepairs, you will have (either expressly or impliedly) granted certain rightsto the garage to interfere with your car (for the purpose of repairing it) andto use the car for test drives. If you have borrowed money to purchase thecar under hire purchase or leasehold, then the lender will invariably secureits interest in the loan by holding some form of title over the car. Usuallythe lender will require that the loan be repaid before the car is sold or thelender will require that its consent be given before any sale takes place.

A range of differing rights also attaches to goods being exported. Theseller may initially hold title to the goods, while certain rights to possessionof the goods are granted to the parties transporting the goods. Title to thegoods may change at any time during transport, either through agreementusing the incoterms or by simply selling the goods while in transit. If thegoods are damaged or lost in transit, often the question is who carries therisk in the goods; this is crucial in deciding who is liable for the loss andthe extent of that liability.

The seller’s goods may be subject to a mortgage or other kind of securityheld by a lender, or the carrier of the goods might hold some kind ofsecurity over the goods until payment is received from the seller for theirtransport. Article 41 requires the seller to deliver goods to the buyer free ofany right or claim of a third party. So if a third party right (other than anintellectual property right) is attached to the goods when they are deliveredto the buyer, the buyer can sue the seller for damages for any losses it suffersas a result of the seller breaching Article 41.

Intellectual property rights may attach to the goods. These can includetrademarks to any brand names shown on the goods; patent rights to anyinvention or process contained in the goods; and design rights to the waythe goods are designed. The seller must have the permission (licence) of theholder of the intellectual property rights associated with the goods, which isgenerally granted on payment of a licence fee or royalty payment. Article 42


requires the seller to deliver goods that are free of third party intellectualproperty rights, which at the time of sale the seller knew about or ought tohave known about.

Under Article 43, the buyer loses its rights under Articles 41 and 42 ifit does not give notice to the seller of the third party claims. However, theseller is not let off the hook if it knew about the third party’s right or claim.

C O R R E C T I V E M E C H A N I S M S F O RK E E P I N G C O N T R A C T S I N O P E R AT I O N

The CISG goes to some lengths to allow the parties to take steps to keeptheir contract alive, even if there have been shortcomings by one or bothof the parties in meeting their obligations under the contract. The reasonis to encourage parties to maintain their contractual relationship, even iferrors have occurred in performance. The corrective mechanisms cannot beused if there has been a fundamental breach of the contract for the obviousreason that if a party is substantially deprived of what it could reasonablyexpect under the contract, there is little point in allowing the other partyto attempt to resuscitate what is in effect a dead contract.

The corrective measures, for the most part, can only be exercised if theydo not cause unreasonable loss or delay to the harmed party. In addition,exercising corrective measures will not remove the harmed party’s right tosue for damages for any loss it has suffered as a result of any defectiveperformance of the contract by the breaching party.

W H A T C O R RE C T I V E M E A S U RE S C A N T H EB U Y E R T A K E ?

The CISG requires the buyer to take action to examine the goods as soon aspracticable, which is usually soon after they reach their place of destination(Article 38). After making the required inspection, the buyer must notifythe seller of any lack of conformity with the contract, otherwise the buyerloses the right to claim remedies under the CISG for the lack of conformity(Article 39).

The buyer can require the seller to do what it agreed to do under thecontract (Article 46). In other words, if the seller has delivered only someof the goods, the buyer can require it to provide the balance of the goodsrequired under the contract. Other available corrective measures allow� the buyer to reduce the price payable for the goods proportionate to

their actual value as against the contract price (Article 50);


� if the goods require repair, the buyer to require the seller to make theappropriate repairs (Article 46);

� if the goods delivered exceed the quantity requested, the buyer to choosewhether or not to take the goods, but the buyer must of course pay forthe excess quantity of goods (Article 52); and

� if the goods delivered arrive before the agreed date, the buyer to choosewhether or not to take the goods (Article 52).If the seller has not been able to perform the contract on time, the buyer

can extend the time for performance, in which case the buyer cannot takeany legal action against the seller until after the extended period (Article 47).The buyer can claim damages, however, for any loss suffered as a result ofthe delayed performance. If the seller does not deliver within the extendedtime, the buyer can avoid the contract under Article 49.

W H A T C O R RE C T I V E M E A S U RE S C A N T H ES E L L E R T A K E ?

Under the CISG, the seller can:� require the buyer to pay the price for the goods, take delivery of them

or perform its other contractual obligations (Article 62);� fix an additional time for the buyer to perform its obligations (Article

63); and� if the buyer is required under the contract to specify the form, measure-

ment or other features of the goods, but fails to do so by the agreeddate or within a reasonable time, the seller can either make the specifi-cations itself according to what it believes are the buyer’s requirements,or inform the buyer of the requirements the seller will meet and give thebuyer a chance to respond. If the buyer does not respond, the seller’sspecifications will apply (Article 65).The CISG also provides a number of other means by which the seller can

take active steps to remedy any non-conformity with the contract. Theseinclude enabling the seller to� deliver any missing parts, replace goods, or make up any deficiency

in the quantity of goods delivered, so long as the replacement goodsare delivered before the delivery date and the process of correcting thedeficiency does not cause the buyer any unreasonable inconvenience orexpense (Article 37);

� remedy any shortcomings at its own expense, even after the agreed deliv-ery date, provided there is no unreasonable inconvenience or expensecaused to the buyer (Article 48);


� ask the buyer whether it will accept the remedial performance by theseller, and if the buyer does not respond within a reasonable time, Article48 allows the seller to proceed with performance of the contract.The seller cannot rely on the buyer’s failure to inspect goods and notify

the seller of any deficiencies if the seller knew about the deficiencies orcould not have been unaware of them (Article 40).

B R E A C H O F C O N T R A C T

The distinction between fundamental breach and non-fundamental non-conformity is significant as it affects the remedies the harmed party canseek. Fundamental breach is so serious that, in effect, there is no point ingoing on with the contract, and it can be terminated by the harmed party.If the breach is non-fundamental, the contract remains operative and theharmed party cannot terminate the contract, but it can seek damages forany loss suffered.

F U N D A M E N T A L B RE A C H

Article 25 defines a fundamental breach as one that results in such detrimentto the other party as substantially to deprive it of what it is entitled toexpect under the contract, unless the party in breach did not foresee, anda reasonable person of the same kind in the same circumstances wouldnot have foreseen, such a result. If there is a fundamental breach, thenthe harmed party may choose to take the drastic step of terminating thecontract (Articles 49, 51 and 64). However, termination of the contractis only effective if notice of termination is given to the breaching party(Article 26).

The CISG refers to termination of the contract as ‘avoidance’ of thecontract. To reduce confusion, we will use the CISG terminology for theremainder of this chapter and refer to avoidance rather than termination.

The CISG appears at first view to provide different grounds for avoid-ing contracts than does the common law. The common law differentiatesbetween contract terms that are ‘conditions’ and terms that are ‘warranties’.A condition, at common law, is a term that goes to the heart of the contract;a warranty, on the other hand, is a term that does not affect the main purposeof the contract. Under the common law, if one party breaches a condition,the other can avoid the contract and seek damages. A breach of a warrantydoes not permit the other party to avoid the contract; it only permits theharmed party to seek damages.


Despite appearances, the entitlement to terminate under the commonlaw for breach of condition and the entitlement to avoid the contract underArticle 25 CISG for substantially depriving the other party of what they areentitled to expect are not approaches that are worlds apart. That statementmight not seem obvious at first, but we will explain what we mean by this.

The common law provides four grounds for avoiding a contract. First,if the contract expressly states that it may be avoided if certain eventsoccur (for example, the goods must be delivered by 1 May, and if not theother party can avoid the contract). This ground for avoidance also existsunder the CISG because, like the common law, it is based on the partyautonomy theory (see Article 6). That is, there is a large measure of freedomfor the parties to include in a contract any terms they negotiate. Second,if there is a breach of a condition under common law, the contract can beavoided. Third, the common law also allows avoidance if the other partyexpressly or impliedly refuses to perform its obligations under the contract.There is some debate among common law commentators as to whether thisallows avoidance if there is a refusal to perform a warranty, or whether thisonly refers to avoidance for anticipatory breach of contract. The preferredview is that it only applies to anticipatory breach. Again, the CISG is notdramatically out of alignment with the common law as the CISG also dealswith anticipatory breach, which we discuss in the next section.

Finally, and somewhat confusingly, the common law allows contractavoidance even if there is not a breach of a condition. This propositionarises from the case of Hong Kong Fir Shipping Co Ltd v Kawasaki KisenKaisha Ltd [1962] 2 Queens Bench 26. In that case ship-owners breached acharter party contract by delivering an unseaworthy vessel. The court foundthat this failure did not amount to a breach of a condition, but despitethat found that the ship’s charterers could nevertheless avoid the contract.The judges in the English Court of Appeal differed among themselveson why it was possible to avoid a contract when the term breached wasnot a condition. Some commentators have argued that the court createdan intermediate category between a condition and a warranty called an‘innominate term’. A breach of an innominate term allows the other partyto avoid if the breach is sufficiently serious. One of the judges in HongKong Fir, Lord Justice Diplock, said that the charterers could avoid if thebreach deprived the charterers of substantially the whole benefit that it wasintended they should obtain from performance of the contract. His test iseffectively mirrored in CISG Article 25.

The four grounds for avoidance under the common law are not sodifferent from the grounds available under the CISG. Under both regimes


the parties can avoid if they specifically provide for doing so in the contract;for anticipatory breach; and for substantially depriving the other party ofa benefit it could reasonably expect under the contract. There are nuanceddifferences between the two regimes, but they are matters of degree ratherthan substance. Avoidance is marginally more available under the commonlaw than the CISG, which is consistent with the CISG’s policy aim ofkeeping contracts on foot as much as reasonably possible.

As mentioned, a party can avoid a contract by notifying the other partyif the other party fundamentally breaches the contract. The requirementto give notice of avoidance has the practical effect of notifying the otherparty that there is no point in attempting to take any further steps to keepthe contract alive. As an example, if the seller is facing delays in deliveringthe goods to the buyer, it might first notify the buyer of the delays andask for a time extension, and the buyer might at first acquiesce to therequest. But if the seller, who is still hoping to meet the extended deadline,finds that there are other unexpected events delaying delivery, the buyermight reach the conclusion that further delays will cause it substantial lossesand so may decide to notify the seller that the contract is at an end (thatis, provide notice of avoidance) and proceed to purchase the goods fromanother source. The buyer would also be entitled to sue the seller for anylosses suffered as a result of the time delays and any additional cost incurredfrom purchasing the substitute goods. Alternatively, the buyer can requestthe seller to provide substitute goods (Article 46). This request might bemade if the seller’s stock of the goods has been damaged, lost or sold outand the seller is able to obtain substitute goods from an alternative supplierat a better price than the buyer could itself obtain for those substitutegoods.

If the seller has delivered the goods but the delivery is so late that itamounts to a fundamental breach, the buyer must declare the contractavoided within a reasonable time after it has become aware that deliveryhas been made. If the goods delivered are so deficient, or for some otherreason the delivery amounts to a fundamental breach, the buyer mustdeclare the contract avoided within a reasonable time after it has becomeaware that delivery has been made and knew or ought to have known ofthe fundamental breach of contract (Article 49).

The seller may declare the contract avoided if:� the buyer’s lack of performance amounts to a fundamental breach;� the buyer does not perform within the additional time fixed by the seller

under Article 63; or� the buyer declares that it will not perform within the extended period.


If the buyer has paid for the goods, the seller loses the right to avoid thecontract, unless� if there is late performance by the buyer, the seller avoids before it is

aware that performance has been rendered; or� in any other case, after the seller knew or ought to have known of the

breach; or� after any additional period of time fixed by the seller under Article 63,

or after the buyer declared that it will not perform its obligations withinthe additional period.The seller must notify the buyer within a reasonable time after any

late performance; otherwise notice must be given within a reasonable timeafter becoming aware, or after the seller ought to have become aware, ofthe fundamental breach (Article 64).

Once the contract is avoided, the parties are relieved from their obli-gations under the contract, other than the obligation to pay damages andmeet any other obligations as a result of the breach. Also, if the parties havepart-performed their contractual obligations, they are entitled to be paidfor that part of their performance (Article 81).

As mentioned, the buyer is required to inspect the goods when theyare delivered under Article 38 and if it finds, for example, that the failureto deliver the correct goods substantially deprives it of what it is enti-tled to expect under the contract, the buyer can give notice of avoidanceof the contract to the seller. But if the buyer cannot return the wronglydelivered goods to the seller, or cannot return them in substantially thesame condition in which they were received, the buyer loses the right toavoid under Article 82. The goods need not be returned in the identicalcondition in which they were delivered, but must be in ‘substantially’the same condition. However, the buyer can still avoid the contract ifthere is a fundamental breach and the buyer cannot return the goodsbecause:� the reason the buyer cannot make restitution of the goods has nothing

to do with the buyer’s act or omission; or� the goods perished or deteriorated as a result of the buyer inspecting

them; or� the goods or part of the goods have been sold in the normal course

of business or have been consumed or transformed by the buyer inthe course of normal use before the buyer discovered or ought to havediscovered the lack of conformity.As an example of the operation of the last exception; in a German

Supreme Court case (BGH, 25 June 1997) the seller delivered stainless


steel wire under the contract. It was only after the wire had been consumedduring the buyer’s manufacturing process that the defect in the wire wasdiscovered. The defect could not have been reasonably discovered beforethe manufacturing process. The court held that in these circumstances thebuyer did not lose the right to avoid the contract.

The buyer does, however, have to account back to the seller for all benefitsor profits it made from the sale or consumption of the goods (Article 84).

A N T I C I P A T O R Y B RE A C H

A party may wish to suspend or avoid a contract because the other party hasbecome insolvent; because it becomes obvious the buyer cannot pay for, orthe seller cannot deliver, the goods; or because there are other grounds forbelieving the contract will not be performed. Here the party is seeking tosuspend or avoid the contract for anticipatory breach, which is dealt withby Articles 71, 72 and 73.

When debating these Articles at the CISG Diplomatic Conference, del-egates from developing countries expressed concern about the wordingin the draft Convention they were considering, which allowed a party toavoid the contract if it had ‘good grounds to conclude that the other partywill not perform a substantial part of his obligations’. They argued thatthe draft wording allowed a party to avoid a contract simply because theythought the other party might not pay, or might become insolvent, with-out any hard evidence to support that conclusion. The developing nationssought to limit anticipatory breach to circumstances where the other partyhad become bankrupt. Developed nations, on the other hand, argued thatthe mere probability of non-performance should suffice. After consider-able debate the delegates reached a compromise allowing suspension of thecontract under Article 71 if it becomes apparent that the other party willnot perform; and allowing declaration of avoidance under Article 72 ifit is clear that one of the parties will commit a fundamental breach. Thedistinction between circumstances being apparent under Article 71, andcircumstances being clear under Article 72, is probably illusory in practice.In both cases the party intending to suspend or avoid the contract needsto exercise some caution before proceeding, and should ask itself whethera reasonable person in its shoes would form the view that the other partywill not perform.

Under Articles 71, 72 and 73 the party proposing to suspend or avoid thecontract must first notify the other party of this intention. If the other party


responds by claiming they will perform, the first party must decide whetherthey should proceed to suspend or avoid based on whether a reasonableperson in their position would find the other party’s claims to be sufficientlyplausible. If the suspending or avoiding party acts pre-emptively, it risksbeing sued for damages by the other party for any losses it suffers as a resultof the suspension or avoidance of the contract.

If a party intends suspending a contract, it may do so under Article 71if it becomes apparent that the other party will not perform a substantialpart of its obligations as a result of:� a serious deficiency in its ability to perform or in its creditworthiness; or� its conduct in preparing to perform or in performing the contract.

The party suspending performance must immediately notify the otherparty and must continue performance if the other party gives adequateassurance of its performance. As mentioned, Article 71 requires the partyproposing to suspend to exercise some careful judgement, based on thecircumstantial facts, before sending off the notice of intention to suspend.As suggested, what will often be crucial is the response from the other party.If it is persuasive in putting its case that it can perform, then obviously sus-pension should be withheld. If the response is unpersuasive, then obviouslythe contract can be suspended.

A party can avoid the contract under Article 72 after giving reasonablenotice to the other party, and allowing them to provide adequate assurancethat they will perform the contract. As mentioned, notice of avoidance canonly be given if it is clear that the other party will not perform.

Article 73 deals with instalment contracts in which a party has ‘goodgrounds’ for concluding that future instalments will not be made. If so,the party can declare the contract avoided, as long as reasonable notice isgiven.

I M P O S S I B I L I T Y

Sometimes unexpected events can make it impossible for one or both partiesto perform the contract; at common law this is often referred to as a forcemajeure. Disputes can arise between the parties if one party claims it cannotperform because of a force majeure but the other claims that the event wasnot unexpected, beyond the other party’s control, or of such magnitudethat it makes it impossible for it to meet its contractual obligations. Forthat reason it is advisable that the parties agree in writing in their contractabout what events constitute a force majeure and what their obligations and


liabilities are if one occurs. Generally, a contract will provide that if a forcemajeure occurs, the party that is prevented from performing its obligationsby the event is relieved of any liability for not performing those obligations.

The Australian national law firm Mallesons Stephen Jaques recommendsthat parties should include a comprehensive force majeure clause in theircontract along the following lines:

An Event of Force Majeure is an event or circumstance which is beyondthe control and without the fault or negligence of the party affected andwhich by the exercise of reasonable diligence the party affected was unableto prevent provided that event or circumstance is limited to the following:� riot, war, invasion, act of foreign enemies, hostilities (whether war be

declared or not), acts of terrorism, civil war, rebellion, revolution, insur-rection of military or usurped power, requisition or compulsory acquisi-tion by any governmental or competent authority;

� ionising radiation or contamination, radioactivity from any nuclear fuelor from any nuclear waste from the combustion of nuclear fuel, radioac-tive toxic explosive or other hazardous properties of any explosive assem-bly or nuclear component;

� pressure waves caused by aircraft or other aerial devices travelling at sonicor supersonic speeds;

� earthquakes, flood, fire or other physical natural disaster, but excludingweather conditions regardless of severity; and

� strikes at national level or industrial disputes at a national level, or strikeor industrial disputes by labour not employed by the affected party, itssubcontractors or its suppliers and which affect an essential portion ofthe goods but excluding any industrial dispute which is specific to theperformance of the delivery of the goods or this Contract.

In the absence of the parties including a force majeure clause in theircontract, Article 79 of the CISG becomes relevant. Article 79(1) states thata party

is not liable for a failure to perform any of his obligations if he proves thatthe failure was due to an impediment beyond his control and that he couldnot reasonably be expected to have taken the impediment into account atthe time of the conclusion of the contract or to have avoided or overcome itor its consequences.

Exemption from liability only lasts for as long as the impediment exists.Article 79(2) deals with circumstances in which failure to perform is theresult of the conduct of a third party; and Article 79 requires the party that


cannot perform to notify the other party of the impediment and the effecton its ability to perform.

Article 79 has been criticised for being vague and for not providing anadequate system of remedies. The Article may inhibit a party from claimingdamages for non-performance because of impossibility, but it does not ruleout other remedies, such as restitution. In any event, the criticism that theArticle is vague is probably a bit unfair as no legal system has been able todeal with force majeure with any real certainty. This is because these eventsat one level can be said to be unexpected, but at another level can be saidto be capable of being anticipated. The chances of you randomly takingthe jack of hearts the first time from a shuffled pack of cards, for example,is improbable (one in 52), but one that you could take into account beforeyou randomly select a card. So the difficult question is, what impendingevents can you reasonably take into account when you conclude a contract?

As another example, if the contract is for the delivery of specialisedmachine components that are only manufactured by the seller and its fac-tory accidentally burns down, making it impossible for the seller to meetthe delivery requirements, is this an impediment under Article 79? At firstthis may appear to be an impediment beyond the seller’s control and one itcould not reasonably have anticipated or overcome. But what if the sellerhad received repeated warnings from safety inspectors that the factory wasa fire hazard and that certain fire prevention measures needed to be taken,but the seller ignored the warnings? This may change the outcome underArticle 79 so that the seller cannot be exempted from paying damagesfor failure to perform the contract. But what if the fire resulted from astorm of unusual and unexpected intensity and may have occurred evenif the measures mentioned by safety inspectors had been put in place?This example serves to illustrate how difficult it can be in practice decidingwhether or not a party is entitled to be relieved of liability for damages underArticle 79.

D A M A G E S

If a party has suffered a loss as a result of the other party’s breach of thecontract, it may be entitled to monetary recompense, known as damages.The amount of the damages the injured party is entitled to is a sum equal tothe loss, including a loss of profit, suffered as a result of the breach (Article74). This reasonably straightforward statement hides a myriad complexquestions, which themselves derive from the inherent complexity of causeand effect. If, for example, I agreed to sell you 24 crates of Henschke


Lenswood Giles Pinot Noir 2002 for $3000 and I only deliver 12 crates,then how much have you lost? At a minimum you would not have to pay$1500, which is the price for the goods that were not delivered. If you werea wine distributor, then presumably you would have made a profit fromselling the 12 crates, had they been delivered. That loss of profit could beadded to the calculation of damages. But what if after the agreement to sellthe wine was entered into, the wine won a highly prestigious internationalwine prize and the publicity surrounding a Hollywood star who says it’shis most valued wine leads to a huge increase in the value of the wine? Thenotional loss of profit would skyrocket, far exceeding the original purchaseprice for the 24 crates of wine. Should the seller be liable for such losses?

Calculating damages essentially comes down to questions of foresee-ability. Under Article 74, the damages must not exceed the loss which theparty in breach foresaw or ought to have foreseen at the time of the con-clusion of the contract, taking into account the facts and matters that areknown or ought to have been known at the time by the breaching partyas a possible consequence of the breach of contract. The word ‘possible’ inthis context should not be read too broadly. Anything, as is often said, ispossible! However, in this context the word should not be taken to includehighly unlikely or improbable events. Neither should Article 74 be readtoo narrowly. It allows for both consequential as well as direct losses. Italso allows the calculation of damages to include the injured party’s lossof expectancy and any losses suffered from relying on the harming party’spromises under the contract. In addition, it allows for calculations of theamount of money required to restore the injured party to the financialposition they would have been in had the breach of contract not occurred(in other words, restitutionary claims). The overriding proviso in makingthese calculations is that the amount of damages should not include lossesthat are too remote a causal connection to the breaching conduct by theharming party.

Taking our example, then, if I did not know and could not have beenreasonably expected to have known when I entered into the contract that thewine would win an international prize and gain the unsolicited endorsementof a Hollywood star leading to a huge surge in the wine’s value, then thedamages would not include the loss of profit attributable to those events.

Generally, damages will be based on the price for replacement goodsor the expected resale value of the goods. If after the contract is avoidedthe buyer purchases replacement goods, the buyer can claim the differencebetween the contract amount and the amount paid for the replacementgoods (Article 75). Similarly, if the contract is avoided and the seller sells


the goods that have not been delivered to the buyer (because of the buyer’sbreach), the seller can claim the difference between the contract price andthe lower resale price (Article 75). These claims can be made in additionto any other losses suffered as a result of the breach. If replacement goodsare not purchased or the goods resold by the seller at a lower price, thebenchmark for assessing the losses can be the current market price for thegoods at the time of the breach (Article 76).

The injured party must, however, take all reasonable measures to mit-igate the losses, including any loss of profit that might be suffered. If, forexample, the seller delivered apples instead of oranges and there is no pointin returning the apples because they would deteriorate, the buyer wouldneed to make reasonable attempts to sell the apples in order to reduce theamount of damages payable by the seller. If it is not appropriate to on-sellthe goods to mitigate the loss, the party in possession of the goods musttake reasonable steps to preserve them (Articles 85–88).

The injured party is entitled to claim interest, though the CISG doesnot state how the interest is to be calculated. The learned commentaries onthe CISG offer advice on how these calculations can be made.

33 Incoterms

In a contract for the sale of goods, perhaps the mostsignificant obligation on the vendor is to deliver the goods that are thesubject of the sale. In return, the buyer has the obligation to pay the pricethat has been agreed. International sales of goods pose special problems forthe vendor in fulfilling its delivery obligations. These include problems thatmight arise regarding the transport of the goods; clearing goods throughcustoms in both the exporting and importing countries; the associated costs;and the point at which the risk of loss or damage to the goods passes fromseller to buyer with consequent implications for insurance. A moment’sreflection reveals that these various subparts of the delivery obligations canbe combined in numerous ways, thereby making the drafting of a deliveryclause in an international contract of sale a rather complex task which, ifnot performed well, could lead to many misunderstandings and potentialdisputes.

In order to introduce some standardisation into delivery obligations ininternational sales, the International Chamber of Commerce devised whatis known as the ‘incoterms’ in 1936. The incoterms have been revisedseveral times since then to reflect changes in international trade practice.The revisions tend to occur every ten years or so. The most recent versionof incoterms was released in 2000. This version of the incoterms contains13 different sets of delivery obligations. Most international contracts forthe sale of goods select one or other of these terms to define the parties’obligations regarding delivery. The term that is selected will depend ona range of factors including the nature of the goods, the practice in theparticular industry and the bargaining power of each. Whichever term isselected needs to be stated in the contract clearly. For example, if the term

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FCA is selected, the correct way to show this as the delivery obligationin the contract is to state that the terms of delivery will be FCA at thenamed place (Incoterms 2000). As will be noted below, while there are 13official incoterms in the 2000 version, there are many more unofficial tradeterms. Thus if the parties to an international sale intend one of the officialincoterms to apply, they need to ensure that the words ‘incoterms 2000’are used.

In legal terms, a statement in the agreement between the buyer and theseller that the terms of delivery will be, for example, FCA at the named place(Incoterms 2000) has the effect of incorporating all of the sub-elementsof the FCA incoterm into the agreement between buyer and seller. This isknown as incorporation by reference. Such a practice is clearly sanctioned bythe CISG in Article 9, which allows parties to bind themselves by referenceto practices that are widely used in the international trading communityfor similar types of sales. The titles of the 13 incoterms are listed below. Itcan immediately be seen that they fall into four groups: E terms, F terms, Cterms and D terms. The significance of this division will become apparentin the discussion that follows.

� EXW (Exworks)� FCA (Free Carrier)� FAS (Free Alongside Ship)� FOB (Free On Board)� CFR (Cost and Freight)� CIF (Cost, Insurance and Freight)� CPT (Carriage Paid To)� CIP (Carriage and Insurance Paid To)� DAF (Delivered at Frontier)� DES (Delivered Ex Ship)� DEQ (Delivered Ex Quay)� DDU (Delivered Duty Unpaid)� DDP (Delivered Duty Paid)

In this chapter the reader should gain an understanding of:� the range of obligations regarding delivery that each of the incoterms

seeks to address;� how these obligations are shared differently between seller and buyer for

each of the 13 different incoterms; and� when it is appropriate to use each incoterm.


T H E R A N G E O F O B L I G AT I O N SA D D R E S S E D B Y T H E I N C O T E R M S

Each of the 13 different incoterms in the Incoterms 2000 edition con-tains ten different obligations for the buyer and ten different obligationsfor the seller for each incoterm. Thus each of the 13 terms has ten sub-parts that apply to the seller and ten that apply to the buyer. In orderto facilitate comparison between the 13 different incoterms, the ten sub-parts under each deal with the same subject matter. In order to give thereader an appreciation of the various obligations that the incoterms areseeking to allocate between the parties, we now discuss what each of theseten subparts addresses. We then turn to the substance of each of the 13incoterms.

P RO V I S I O N O F T H E G O O D S I NC O N F O R M I T Y W I T H T H E C O N T R A C TA N D P A Y M E N T O F T H E P R I C E

In each of the 13 incoterms the first obligation of the seller is to delivergoods in conformity with the contract and the first obligation of the buyeris to pay the price as agreed in the contract of sale.

L I C E N C E S , A U T H O R I T I E SA N D F O R M A L I T I E S

This subpart of each incoterm is used to allocate the responsibility forobtaining the various government approvals between the parties. For mostof the 13 incoterms it will be seen that the responsibility for fulfilling exportformalities lies with the seller but the responsibility for obtaining importlicences lies with the buyer.

C O N T R A C T S O F C A R R I A G EA N D I N S U R A N C E

The obligation to arrange the contract of carriage and insurance differsmarkedly among the 13 incoterms, as will be noted below. Generally speak-ing, this obligation falls on the buyer in the case of the E terms and theF terms in the list above, but on the seller in the case of the C and D


terms. It needs to be noted that for the most part the obligation to arrangethe contracts of carriage follows the obligation to pay for the carriage.

D E L I V E R Y A N D T A K I N G D E L I V E R Y

This obligation sets out in detail what the seller must do to discharge itsobligations regarding delivery. In other words, it sets out where the goodshave to be delivered to, whether this be to a carrier, alongside a ship, oreven to the buyer’s premises. For the buyer, this obligation sets out whatthe buyer must do to fulfil its obligations regarding accepting delivery ofthe goods.

TR A N S F E R O F R I S K S

This subpart of each incoterm defines the point at which the risk of loss ordamage to the goods passes from the seller to the buyer. For the most partthe transfer of risk occurs at the point of delivery. As such, it has impor-tant implications for insurance and the legal remedies available under thecontract of sale and its governing law. It needs to be pointed out herethat the point at which transfer of risk in the goods occurs is not nec-essarily the same point at which transfer of ownership occurs. While theincoterms deal with transfer of risk, they do not deal with transfer ofownership. The CISG is also silent on this matter. Thus the parties needto consider whether a clause setting out the point at which ownership istransferred needs to be included in the contract. This might be advisablein order to give the seller the right to resell the goods should any defaultoccur on the part of the buyer through, for example, failing to acceptdelivery.

D I V I S I O N O F C O S T S

This subpart of each incoterm is closely related to the obligation to arrangethe contract of carriage and insurance. As will be discussed in more detailbelow, the costs of carriage tend to fall on the seller in the C and D termsbut on the buyer for the E and F terms. The cost of insurance is morevariable, as will be noted.


N O T I C E

This subpart provides that the seller has to give notice to the buyer whentheir delivery obligations have been or will be completed so that the buyercan arrange to accept delivery. Likewise if it is the buyer’s obligation toarrange transport, then the buyer must notify the seller of the arrangementsthat have been made. As noted above, the buyer will normally only beresponsible for arranging transport under the E and F terms.

P RO O F O F D E L I V E R Y

The seller has the obligation to provide proof of delivery to the buyer. Thiswill often be necessary to enable the buyer to collect the goods. It alsoconstitutes the evidence that the seller has fulfilled its obligation to deliverthe goods. Usually the proof that delivery has occurred will be the formaltransport document that the carrier issues. This subpart of each incotermspecifically allows for documentary proof of delivery in electronic form ifthat has been agreed between the parties.

C H E C K I N G P A C K A G I N G A N D I N S P E C T I O N

This subpart divides responsibilities between the seller and the buyer inrelation to packaging the goods and inspecting the goods. Thus the sellerhas the obligation to adequately pack the goods as well as pay for anychecking of the goods that needs to be completed by the carrier. The buyeris responsible for inspecting the goods. This division of responsibilities isuniform across the entire 13 incoterms.

O T H E R O B L I G A T I O N S

The other obligations in each incoterm make it incumbent on the sellerto assist the buyer in obtaining all documents that can only be issued inthe country of export but that are nonetheless necessary to ensure that thegoods can leave the country of export or enter the buyer’s country. Thissubpart refers only to those extra documents that the buyer needs. Theseller still has to provide the basic documents to prove delivery as notedabove. However, if extra documents are required to enable the goods tomeet import requirements in the buyer’s country, then the buyer has to pay


any costs associated with these documents. An example here might be acertificate of origin that is required by importing authorities in the buyer’scountry but can only be issued in the seller’s country.

T H E I N C O T E R M S ( 2 0 0 0 )

As noted above, the incoterms can be divided into four groups. The E termsare those most favourable to the seller because the buyer is responsible forcollecting the goods from the seller’s premises and all transport and otherarrangements thereafter. At the other end are the D terms that are the mostfavourable to the buyer. Under the D terms the seller will be responsiblefor getting the goods onto the wharf in the buyer’s country and, dependingon the D term that is used, may even be responsible for import clearance,customs duty, and delivery to the buyer’s premises. The F and C termsare ‘middle-ground’ terms. The F terms are slightly more favourable tothe seller because once the goods are handed over to the carrier the buyerbears all costs from then on. The C terms are more favourable to the buyerbecause the seller has to pay the main transport costs. What follows is adiscussion of each of the 13 incoterms and some pointers about when eachmight be appropriate when exporting goods from Australia

‘ E ’ T E R M S

Incoterms 2000 contains only one E term: Exworks. If the parties haveagreed that this term will apply to their delivery obligations, then the sellersimply has to place the goods at the disposal of the buyer at the namedplace of delivery. Thereafter, the buyer bears all risks and costs. If usingthis incoterm, the parties should specify the place where the buyer is tocollect the goods. The incoterm also provides that the seller has to give thebuyer sufficient notice as to when and where the goods will be available forcollection. The notice provision is therefore particularly important becauseonce the notified date arrives then the goods will be deemed to be at thedisposal of the buyer and the buyer will therefore bear the risk of loss ordamage to the goods from that day forward. If using this incoterm, it is alsouseful to specify whether the seller has to assist the buyer with loading ofthe goods and if so to specify that this be done as agent for the buyer, so asnot to affect the provisions in the incoterm regarding the transfer of risk.

This incoterm is most likely to be used where there is a seller’s marketfor the goods or when the goods have been tailor-made for the buyer. It is


understandable that in ordinary international sales of goods from Australia,buyers would be reluctant to agree to this incoterm given the high transportcosts that apply because of Australia’s geographic distance from most majoroverseas markets and the possible variations that might occur in those costsbetween the date of contract and the date when the goods are actually readyto be collected by the buyer.

In addition, while the seller is obliged to assist the buyer to obtain cus-toms clearance for the export of the goods, the buyer takes a significant riskthat clearances might not be issued in time for the transport arrangementsthat have been made. As Chapter 7 shows, there are serious logistical dif-ficulties for an overseas buyer attempting to apply for customs clearance.For that reason the buyer relies heavily on the seller’s obligations to renderassistance in this regard. If the goods being sold are restricted goods underthe Export Control Act 1982, it seems even more unlikely that a buyerwould be prepared to rely on the seller obtaining the necessary permits.Again, Chapter 7 shows that it would be almost impossible for a buyer toobtain those permits itself. Thus the Exworks term is unlikely to be usedin ordinary sales of goods unless the buyer has agents or a presence in theexporter’s country to attend to these logistical and procedural matters.

‘ F ’ T E R M S

Incoterms 2000 has three F terms. Of these, only one is appropriate formultimodal or air transport: FCA. The reason here is that the other twoincoterms (FAS and FOB) specify the point of delivery as either alongsidethe ship (FAS) or on board the ship (FOB). Thus if the goods are deliveredto a carrier at some point inland from the port, the FCA incoterm shouldbe used. Because most international sales of goods from Australia (otherthan commodities) are now transported using containers that are deliveredto a container depot and from there to a ship or are delivered to an aircarrier’s depot, the following discussion will place most emphasis on theFCA incoterm.

The incoterm FCA (Free Carrier) places the onus on the buyer to nom-inate a carrier to whom the seller must deliver the goods and a place atwhich the delivery should occur. ‘Carrier’ is defined widely enough toinclude freight forwarders who enter into contracts of carriage but actuallysubcontract the various parts of the carriage to other transport operators.Carrier could also mean an airline or a multimodal transport operator.The details of each of these types of carriers are discussed more fully inChapter 5. The incoterm places responsibility on the seller to arrange


for customs clearance of the goods and any export licence that may berequired.

If using this incoterm it is important for the buyer to give precise instruc-tions to the seller about the time, place and name of the carrier because thishas implications for the division of risk and costs. If the named place is theseller’s premises, then delivery will be complete when the goods are loadedonto the carrier’s vehicle, with the seller bearing all risks and costs up tothat point. If, however, the buyer requires the seller to deliver the goods toa depot operated by the carrier, then delivery will only be complete oncethe goods arrive at the carrier’s depot. Thus the seller will be responsible forloading the goods at its premises, arranging for transport to the depot, andcovering any insurance for the journey. Should the buyer fail to nominate aplace for delivery to the carrier, the seller has the right to select such place asis convenient. While it is the buyer who bears responsibility for arrangingand paying for the transport costs after delivery to the carrier, it is oftenmore practical for the seller to negotiate with the carrier. The incotermprovides that the buyer can make such a request of the seller but that ifthis occurs the seller arranges the contract of carriage at the buyer’s risk andexpense. It is therefore implied that the seller would do so as agent of thebuyer.

Under the incoterm FOB (Free on Board), it is the responsibility of theseller to get the goods on board the ship and bear all costs and risks ofdoing so. The buyer bears the responsibility for arranging the contract ofcarriage and insurance and notifying the seller of the time and place fordelivery. The seller bears the costs of arranging for customs clearances andany export permits. Now that most goods are transported in containersand via multimodal transport operators, it is arguable that this incotermmay only be appropriate in cases where commodities are being transportedin bulk carriers or where the buyer has chartered a vessel to transport thegoods. The risk is said to pass when the goods cross the ship’s rail. However,what is meant by ‘ship’s rail’ will depend on the practices that occur at theport of loading. Thus in the case of loading of minerals onto a bulk carrierby means of a conveyor belt, the goods might not have technically passedthe ship’s rail until the point at which they exit the conveyor to pour intothe hold of the ship. The buyer will also bear responsibility for the costs ofany delay (such as storage charges) that occurs because the ship nominatedby the buyer has failed to arrive on time or because the buyer has failedto give the seller adequate notice to enable the seller to effect delivery atthe time stipulated. This is particularly important in the case of charteroperations.


The term FAS (Free Alongside Ship) stipulates that the division of riskand cost occurs when the goods are placed alongside the ship at the namedport of shipment at or within the time specified. As is the case with FOB,the buyer arranges the contract of carriage and insurance and is respon-sible for any costs arising because of delay or failure to notify in time.As is also the case with FOB, the seller agrees to arrange clearance forexport.

‘ C ’ T E R M S

Incoterms 2000 contains four C terms: CPT (Carriage Paid To the namedport of destination); CIP (Carriage and Insurance Paid To the namedport of destination); CFR (Cost and Freight Paid To the named portof destination; and CIF (Cost, Insurance and Freight paid to the namedport of destination). The feature that distinguishes the C terms from theF terms is that under the C terms the seller agrees to pay for transportand, depending on the C term chosen, the cost of insurance. Because ofAustralia’s distance from most major export markets, the decision to use Cterms rather than F terms has significant cost implications for the exporterunless the cost of freight and insurance can be built into the price for thegoods. If these costs can be built into the price, use of the C terms mighteven be advantageous for an exporter because they may be able to obtaindiscounts in freight rates if they regularly use a particular shipping line toa particular destination. At the same time, willingness to use the C termsoffers the buyer the convenience of not having to arrange or pay for freightand/or insurance.

The terms CPT and CIP are perhaps the most useful because they envis-age the use of multimodal or air transport. The older terms of CFR andCIF only apply to sea transport and like their corresponding F terms (FOBand FAS) are more appropriately used for bulk shipments or charter oper-ations. The terms CPT and CIP are identical except for the obligationto arrange and pay for insurance. Thus they will be dealt with togetherin the following discussion. Likewise, the terms CFR and CIF are iden-tical except for the insurance obligation and they will also be dealt withtogether.

Under the CPT and CIP terms the seller is obligated to arrange thecarriage of the goods, deliver the goods to the carrier and pay all freightand other costs incurred in the actual carriage of the goods to the pointnominated. The seller is also responsible for the costs of delivery to thecarrier including loading costs, any cost of checking the goods by the carrier,


packaging, and customs formalities in the country of export. The buyer isresponsible for import clearances and costs. If using this term, it is importantfor the buyer and seller to agree on the point to which carriage should bepaid, particularly if the goods have to pass through a transit point. It is alsoadvisable for the parties to agree whether the seller is to be responsible forunloading costs because the wording of this incoterm appears to leave itopen to the buyer and seller to agree on unloading costs. While the sellerhas to pay the costs of carriage, the risk in the goods passes when the goodshave been delivered to the carrier. In this sense the passing of risk occurs atthe same point as in the FCA term. The seller is required to give sufficientnotice to the buyer that the goods have been delivered to enable the buyerto receive delivery.

As noted, the difference between the CPT and CIP terms is that underthe latter the seller is responsible for arranging and paying for insurance aswell as the contract of carriage. The insurance arrangements must be suchas to allow the buyer to claim directly from the insurer if loss or damage tothe goods occurs. However, the insurance need only be on the minimumterms as set out in the Institute Cargo Clauses unless the buyer specificallyrequests, and agrees to pay for, additional coverage for events such as war,strikes, riots and other civil disturbances. Further discussion of the InstituteCargo Clauses can be found in Chapter 6. The insurance cover must befor 110 per cent of the value of the goods and must cover the goods untilthey are taken over by the buyer at the named point of destination. As inthe case of CPT, it is equally as important for the buyer and seller to agreeon responsibility for unloading expenses as well as agreeing on the deliverypoint.

The remaining two C terms (CFR and CIF) can only be used for trans-port by sea and, as indicated above, are more appropriate for bulk carriageand charter operations. The costs that the seller must bear and the obli-gations regarding notice are the same as those in the other two C terms.However, in CFR and CIF transactions the obligation of the seller is todeliver the goods on board the ship and the point of transfer of risk withCFR and CIF occurs when the goods cross the ship’s rail. The commentsmade above in the discussion of the F terms concerning the difficultieswith this point of risk transfer are equally applicable here and will not berepeated.

The main difference between CFR and CIF is in the seller’s obligationsregarding insurance, and here again the seller’s obligations under CIF aresimilar to those canvassed above in relation to CIP. For reasons mentionedabove it is also important to stipulate a named port of destination when


using these two terms. It is also necessary to agree on the issue of unloadingcosts and, for charter operations, to ensure that the obligations for payingthese align with the charter contract.

‘ D ’ TE R M S

All the D terms differ slightly from each other on the point at which deliverymust be made to the buyer, and so each will be discussed in turn. But acommon feature of all of them is the obligation of the seller to bear allrisks of loss or damage to the goods up to the point at which delivery hasoccurred in accordance with the D term that is chosen. The seller shouldcarefully consider its insurance costs and options if a D incoterm is chosen.

The term DES (Delivered Ex Ship) obliges the seller to attend to andpay for all the transport arrangements, clearances in the country of export,any transit arrangements and all packaging and associated expenses, and tonotify the buyer of the estimated arrival time of the vessel that is transportingthe goods. Risk passes when the goods are delivered at the named pointof destination. The incoterm envisages delivery to be complete when thegoods are placed in a deliverable state on board the ship at the named portof destination. The buyer has to make arrangements to unload the goodsand clear them through customs in the buyer’s country.

DES is most often used for charter operations where the seller chartersthe ship and bears all expense until the ship is ready to be unloaded. If thisterm is used it is essential to be sure that the contract between buyer andseller is drawn up with the charter contract entered into between the sellerand the charter company in mind. As will be made clear in Chapter 5,costs associated with delays in unloading can be very expensive for a sellerwho has chartered a vessel and therefore the contract between the buyerand the seller needs to be clear about the division of costs regarding anysuch delays. Under the DES incoterm, it is arguable that if the buyer isunable to unload the vessel because of port delays then the goods havenot been delivered and so the seller will have to bear the costs of delay(demurrage costs).

The term DEQ (Delivered Ex Quay) is similar to DES except that theseller has to pay for unloading expenses and the goods will not be consideredto have been delivered until they are actually unloaded at the port of arrival.Once unloaded, it is the responsibility of the buyer to arrange for customsclearance as well as the payment of any duties and charges associated withthis. The seller has to give notice to the buyer of the estimated time of arrival


of the vessel to allow the buyer to arrange for collection and completion ofany applicable customs formalities.

The term DDU (Delivered Duty Unpaid) obliges the seller to deliver thegoods to a place named by the buyer within the buyer’s country and to bearthe risk of loss or damage to the goods up to that point. The seller also hasto make all the necessary transport arrangements as well as obtaining exportclearances and clearances for transit through any third country. The buyeris responsible for unloading the goods at the named point. The provisionsof this term oblige the buyer to obtain the necessary import licences andto arrange any custom formalities that apply.

The term DDP (Delivered Duty Paid) extends the delivery obligations ofthe seller a little further than DDU and is the most onerous of all deliveryterms for the seller. It requires the seller not only to deliver the goods(unloaded) to the place named by the buyer but also to arrange for anyimport licences and customs clearance procedures. The buyer is obligatedto assist with this. Where either DDP or DDU is used, the seller has togive the buyer notice to allow it to take such measures as are necessary totake delivery of the goods.

Discussion of the term DAF (Delivered at Frontier) has been left until lastbecause it is unusual for Australian exporters to use this term. It requiresthe seller to bear all risks until the goods arrive at an inland boundarybetween countries. Thus it is more applicable for sales between parties fromadjacent countries where rail transport is used, such as between countriesin the European Union or within North or South America. However, it ispossible that an Australian exporter who has storage facilities at Rotterdam,for example, may agree to supply goods to a German customer and agreethat the point of delivery will be the frontier between Holland and Germany.In this case the Australian exporter will be responsible for all the costs andformalities of clearing the goods for import into Holland and the transportright through until the border point with Germany. At this point thebuyer would bear the costs of transport. There would be minimal clearanceprocedures for the buyer to undertake because Holland and Germany areboth members of the EU.

44 Payment

In every internat ional bus ines s transact ionthe issue of payment is uppermost in the mind of the exporter. This chapterintroduces the main means by which payment is effected in internationaltransactions. While the emphasis is on payment for the export of goods,payment for services is also discussed.

At the outset, it is necessary to distinguish between payment and price.Payment refers to the process by which the exporter will receive the money.Price refers to the amount the exporter will receive. The calculation of theprice that the exporter should charge for the goods usually includes the costof production and other overheads as well as any costs of the export transac-tion that the exporter has to bear. The costs specific to export could includefreight charges, insurance, inspection costs, and other administrative over-heads associated with the transaction and, depending on the incoterm thatis chosen, might even extend to import duties, unloading expenses, andinternal transport and storage charges in the country of destination. Mostfirms have detailed costing procedures in place. A discussion of the variousalternatives is beyond the scope of this book.

Likewise, there is an ever increasing array of financial arrangements thatexporters have at their disposal to obtain the working capital necessary tofinance the production of the goods or services. These range from sim-ple bank overdrafts to more complex financial instruments provided byprivate financial institutions through to government-sponsored initiativessuch as those provided by the Export Market Development Grants Schemeadministered by Austrade. Again, a description of the various financialinstruments available, along with their advantages and disadvantages, can-not be adequately covered in this book and are more appropriately dealtwith in works on international financial management. The question of

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financing production costs is therefore only referred to in this chapter tothe extent to which it is relevant to the main discussion on methods ofpayment.

On the other hand, the question of the ways in which the exporterreceives payment is of central concern to the obligations that each partyhas to meet under the agreement for the sale of goods or services. Thischapter will therefore canvass the four main ways by which payment iseffected in international transactions along with the risks inherent in usingeach method. There are four methods of payment: payment in advance ofdelivery; letters of credit; payment in exchange for documents; and paymenton open account. It is appropriate to include in the chapter some discussionof how the risks of each can be minimised. The objectives of the chaptertherefore include:� gaining an understanding of the processes involved in each of the four

main methods of payment;� understanding the risks associated with each method; and� understanding how these risks can be minimised.

P R E PAY M E N T

P RO C E D U RE

Prepayment occurs when the exporter obtains the agreement of the buyerto pay for the goods before the buyer has taken delivery of them and beforethe buyer has obtained the documents that entitle it to take delivery. Thisfrequently occurs before the goods leave the exporter’s premises. Often, allthat the buyer has is a proforma copy of the invoice (see Chapter 1) andperhaps a proforma of the transport document. The most common meansby which prepayment occurs is through the buyer transferring funds to theexporter’s bank account via telegraphic transfer.

The main advantage of prepayment for the exporter is that it will receivepayment while it still has control over the goods. Buyers are understandablyreluctant to agree to such a method of payment because they risk thepossibility that they will not receive the goods or that the goods they receivewill not conform to the description in the contract of sale (see Chapter 2).While the buyer has the right to sue the seller if the goods are not deliveredor if the seller delivers non-conforming goods, enforcing this right can bedifficult. These difficulties are discussed later in Chapter 11 on disputeresolution. For these reasons, if buyers are prepared to agree to prepaymentthey may well want some discount in the price.


An interesting case that illustrates some of the dangers with prepaymentsis Fu Kong Inc v Hua Yun Da Group Ltd [2004] 3 Hong Kong Law Reports &Digest 87. In that case the plaintiff, a US-based company, agreed to buya shipment of cashmere sweaters from a mainland Chinese company. TheChinese company had difficulty with obtaining the necessary export quotas,so the US company agreed to advance $300 000 to the Chinese companyvia a Hong Kong company specifically to enable the Chinese company topurchase the export quotas. When the main contract fell through, the UScompany wanted the $300 000 returned from the Hong Kong company.The Hong Kong company claimed it had already given the money in cashto the mainland China company, having carried most of it in a suitcasefrom Hong Kong to Beijing. The court was not prepared to accept theevidence of the Hong Kong company and held that the money it receivedwas held in trust for the specific purpose of forwarding it to the Chinesecompany to purchase export quotas. Because the export quotas were notpurchased, the Hong Kong company had to refund the money to the UScompany.

Because of the obvious difficulties, prepayment usually only occursif the exporter has a very willing buyer and if there is little competitionin the marketplace for the product or service. However, some exporterstake the view that if the buyer is a serious customer it will be preparedto pay an amount up front, having earlier established the integrity of theexporter and the quality of the product. Alternatively, all providers withinan industry might have a common position regarding prepayment. A usefulexample here is the provision of educational services. Overseas students atAustralian and most overseas tertiary institutions are required to pay theirtuition fees for each semester or term within a very short time after thebeginning of the semester. Thus they are required to prepay for the servicesthey are about to receive.

R I S K S F O R T H E E X P O R T E R

Prepayment for goods and services, including for information technol-ogy, may be made over the Internet. The most common way of doingthis involves the exporter requiring the buyer to provide their credit carddetails. While there seems to be no risk in this procedure, instances offraud continue to grow. For example, the credit card issuer (bank or otherfinancial institution) may well be able to verify that the card is a valid creditcard but may not be willing to provide the exporter with an assurance thatthe name and address shown on the credit card is the same as the one to

P A Y M E N T 91

which the exporter is sending the goods. Problems arise if the true owner ofthe card is unaware that its credit card number has been stolen. When thetrue owner receives the bill it will refuse to pay it, which may lead to thefinancial institution refusing to pay the exporter. Although most financialinstitutions take every precaution against fraud, exporters need to be awarethat prepayment for goods or services is not without its risks and may wantto consider the insurance option.

L E T T E R S O F C R E D I T

The next most secure means of payment for the exporter is by letter of credit.The letter of credit remains the chief means of payment in internationalsales. The prime advantage for the exporter is that it enables the exporterto be paid for the goods as soon as they are shipped from the exporter’scountry. It provides payment to the exporter at a similar time as occursunder prepayment but, as we shall see, because of the strict requirementsapplying to letters of credit transactions, it can be slightly less secure forthe exporter.

P RO C E D U RE

The buyer (the applicant) is the party that initiates the payment processby approaching a bank in its country to issue a letter of credit for theinvoice amount in favour of the exporter (the beneficiary). The buyer’sbank usually has arrangements in place to ensure that the buyer’s accounthas the necessary funds to support the letter of credit. In order to issuethe letter of credit, it is normal practice for the exporter to have sent thebuyer a proforma invoice (see example in Chapter 1). This documentaims to provide the buyer’s bank with the necessary details to issue theletter of credit. An example of a letter of credit is shown in Figure 1.2 inChapter 1.

The buyer’s bank (the issuing bank) states in the letter of credit the nameof a bank in the exporter’s country from which the exporter can collectpayment under the terms of the letter of credit. This bank is referred toas the advising bank or sometimes as the nominated bank. The letter ofcredit is then forwarded to the advising bank in the exporter’s countryto advise the exporter that the letter of credit has been issued. There is aninternational electronic system known as the SWIFT system that banks useto securely transmit the details of the letter of credit electronically betweenthemselves as well as to ensure that the letter of credit is genuine.


Once the advising bank receives the letter of credit, it is forwarded tothe exporter. As will be noted later, the letter of credit sets out a numberof conditions on which it has been issued along with a range of documentsthat the exporter must present to the advising bank before it can collectthe proceeds. Provided that the exporter meets these conditions and sendsthese documents to the advising bank, the bank will pay the exporter andseek reimbursement from the buyer’s bank. To collect payment the exportermust make out a draft or bill of exchange to accompany the documentsthat it presents to the advising bank. The draft sets out the amount that isto be paid and is usually addressed to the buyer’s bank or, in the case of aconfirmed letter of credit, to the advising bank.

The exporter must ensure the draft is properly addressed, and that all therequired details are complete and correct. In the case of Durham Fancy GoodsLtd v Michael Jackson (Fancy Goods) Ltd (1968) 2 Queens Bench 839, thecourt would not accept that a draft addressed to M. Jackson (Fancy Goods)Ltd was sufficient when it should have been properly addressed to MichaelJackson (Fancy Goods) Ltd. The draft can require payment by the bankimmediately (at sight) or within a set period, such as 60 days if this iswhat the exporter and the buyer have previously agreed. On receiving thedraft, the advising bank sends the documents to the buyer’s bank. Afterbeing notified of the arrival of the documents, the buyer collects themfrom the bank. The buyer will need these documents to collect the goods.Of particular significance is the bill of lading, which the buyer needs forcollecting the goods from the shipping company.

The following flowchart sets out the steps in a simple letter of credittransaction. An exporter should check its own bank’s letter of credit pro-cedures, as these can vary slightly from transaction to transaction.

R I S K F O R T H E E X P O R T E R

There is a standard set of international rules governing letters of creditknown as the Uniform Customs and Practices for Documentary Credits(UCP). The UCP were first developed and adopted by the InternationalChamber of Commerce in 1929 and have been revised several times sincethen. These rules are incorporated by reference into the agreement betweenthe buyer and the bank that issues the letter of credit. It is also incorporatedby reference in the agreements between the banks themselves and betweenthe exporter and its bank. Some discussion of the more important ruleswill make it clear why letters of credit can pose some payment risks for theexporter.

P A Y M E N T 93

buyer approachestheir bank

(issuing bank)

buyer’s bank issuesletter of credit

letter of credit forwardedto advisory bank inexporter’s country

advisory banknotifies exporter of

letter of credit

exporter presents documentsfor payment to advisory bank

after shipment

advisory bank seeksreimbursement from issuing

bank

Figure 4.1 Letter of credit procedure

The most fundamental risk is the issuing bank refusing to honour thecredit. Even though the advising bank pays the exporter upon presentationof the required documents, this is usually done on the assumption that theadvising bank can recover the money from the exporter if for some reasonthe issuing bank does not reimburse the advising bank. Although the UCP500 (Article 9) requires the issuing bank to pay when the beneficiary meetsthe terms of the letter of credit, it is difficult to enforce the obligations ofthe issuing bank because of its location in the country of the buyer.

To protect themselves against these difficulties, exporters generally seekto have their letters of credit issued as both confirmed and irrevocable.Having the letter of credit issued as irrevocable means that the issuing bankcannot legally revoke its obligations. On the other hand, a revocable letterof credit can be revoked by the issuing bank at any time (Article 8 UCP) andtherefore poses considerable risk for the exporter. If the credit is revoked,the issuing bank is not liable to the exporter for any loss or damage it hassuffered (Cape Asbestos Co Ltd v Lloyds Bank Ltd [1921] Weekly Notes 274).It is now usual practice for letters of credit to be irrevocable, with the UCPspecifically providing that letters of credit will be irrevocable unless clearlystated to be revocable.


The exporter can also attempt to have its own bank confirm the letterof credit, if the letter of credit allows for this, or try to have the advisingbank confirm the letter of credit. Having the letter of credit confirmedmeans that the confirming bank bears the obligation to pay the exporterregardless of whether the receiving bank receives reimbursement from theissuing bank. The advantage for the exporter of having the letter of creditconfirmed is that the advising bank is obliged to pay when the exportermeets the terms of the letter of credit (Article 9(b) UCP).

The second risk to the exporter arises from the exporter being unable tomeet the terms of the letter of credit. Many of the provisions of the UCP dealin detail with requirements regarding the presentation of the documents tothe bank by the beneficiary. These requirements must be met for the bankto accept them. For example, Article 23 sets out the requirements a bill oflading must meet to be acceptable. Articles 30–33 deal with other transportdocuments. Articles 34–36 deal with insurance documents and Article 37with commercial invoices. The exporter needs to ensure that it producesthe documents required by the letter of credit, as well as ensuring that thedocuments meet the requirements set out in the relevant UCP provisions.The UCP states that banks are under no obligation to accept documentsthat do not conform to the requirements.

In Southland Rubber Co Ltd v Bank of China (1997) Hong Kong lawReports & Digest 1300, the beneficiary of an irrevocable unconfirmed letterof credit presented a bill of lading and other documents to the negotiatingbank (advising bank) for payment under a letter of credit. The negotiatingbank refused to accept the bill of lading under Article 23(a)(i) UCP 500,alleging that the bill on its face neither indicated the name of the carriernor bore the signature of the shipmaster or shipmaster’s agent; its letterheadonly showed the printed name of the ship as PT Kemah Nusasemesta, notstating clearly who was the carrier. The beneficiary sued the bank for breachof UCP 500 on the grounds that the letterhead was sufficient to indicatethe name of the carrier. Justice Pang of the High Court of Hong Kongfound in favour of the bank, observing that under Article 13(a) of the UCP500 the obligation on the bank was not a fact-finding one and was onlyto ensure that the documents complied strictly with the letter of credit. Tocomply, the document had to show the name of the carrier and be signedby the master of the ship or his agent.

In 2003 the International Chamber of Commerce issued an addendumto the UCP 500 to cater for the increasing degree to which the standarddocuments of international trade (invoices, bills of lading, insurance cer-tificates, etc.) are being produced only in electronic format. The addendum

P A Y M E N T 95

to UCP 500 sets out the requirements that must be met for banks to pay onelectronic documents. While there seems to be an inevitable trend towardsreplacing the paper trail with an electronic one, the large range of docu-ments that may be required by letters of credit makes this a difficult task.As will be noted in Chapter 5, a system known as the Bolero System hasbeen developed to allow for entirely paperless transactions. However, at thepresent time, the costs of joining the Bolero network are prohibitive formost small and medium exporters.

If the exporter becomes aware that it is not able to obtain a particulardocument required by the letter of credit, it is possible for it to request anamendment to the letter of credit, but this can only occur with the agree-ment of the issuing bank. Alternatively, the exporter has to risk sending thedocuments (via the banks) hoping that the buyer will accept the defectivedocuments. In such circumstances a buyer might accept documents withminor errors but might use this as a negotiating tactic to try to get somereduction in price. It is therefore useful to check the documentary require-ments of letters carefully before documents are prepared rather than leavingthis until immediately before they are to be presented. Letters of credit alsoinclude an expiry date, and exporters must ensure the relevant documentsare submitted before this date.

Once the exporter presents the documents, the advising bank will exam-ine them to ensure that they meet the requirements of the UCP and theterms of the letter of credit. If the bank does not accept the documentstendered by the exporter, it must advise the exporter within seven days(Article 13 UCP). In Seaconsur Far East Ltd. v Bank Markazi JanhouviIslami Iran (1993) 1 Lloyd’s Reports 236, the plaintiff, an arms dealer, con-tracted to sell arms to the Iranian government with payment under a letterof credit issued by Bank Markazi, with the advising bank being Bank Melliof London. After Seaconsur had made its first shipment it presented itsdocuments to Bank Melli. The bank refused to pay because the documentsdid not conform to the requirements of the letter of credit. Several daysafter this the plaintiffs had a meeting with the bank to discuss the issue.But no formal notification of rejection appeared to have been issued tothe plaintiff. The court held that the bank had therefore not complied andpermission was given by the court to the plaintiff to commence proceedingsagainst the issuing bank (located in Iran).

The exporter can request the issuing bank to waive any non-complianceof the documents with the letter of credit, but it is under no obligation todo so. The issuing bank also has seven days to decide whether or not to pro-vide a waiver. Consequently, an exporter who produces non-conforming


documents can encounter a fairly lengthy waiting period to discoverwhether or not it is going to be paid.

A L T E R N A T I V E T Y P E S O F L E T T E R SO F C RE D I T

The standard letter of credit has evolved to cater for variations to the usualscenario of payment by the advising bank direct to the exporter uponproduction of the documents. The UCP contains provisions that apply tothe issue of all the following types of letters of credit other than back-to-backcredit.

R E V O L V I N G C R E D I T

The first variation of the standard letter of credit has been developed tocover situations where there is a long-term contract between exporter andbuyer. For example, let us assume that the exporter has a long-term contractwith the buyer over, say, a period of a year and will deliver the goods inseveral shipments but wants to be paid for each shipment as it leaves.Rather than issue a separate letter of credit for each shipment, the buyercan ask its bank to issue a revolving letter of credit that allows for regulardrawings of a set amount to cover each shipment, with the total amount ofall drawings not to exceed an agreed specified sum (most credit cards heldby individuals operate as revolving credit). Banks may be willing to enterinto this arrangement more readily than what was traditionally regarded asa revolving letter of credit, which simply restored the amount of the creditto its original amount each time a drawing was made. Understandably, thisposed serious risks for the bank because if the credit was reinstated to thefull amount each time a drawing was made the total amount drawn overthe lifetime of the credit could be extensive, and if the bank had agreed tosuch an unrestricted revolving credit it had to honour each drawing. Forthis reason traditional revolving credits are often issued as revocable credits.

R E D C L A U S E C R E D I T

The red clause credit also operates to facilitate long-term contracts byallowing the exporter (beneficiary) of the letter of credit to draw on thecredit to pay suppliers for goods that it needs to fulfil its contract with thebuyer. This type of letter of credit is not often used now because exportershave many other ways of getting the necessary working capital to financeinternational sales.

P A Y M E N T 97

Two further types of letters of credit have evolved to cater for situationswhere the beneficiary is merely a trader who needs to obtain the goodsfrom a third party, such as a manufacturer or supplier, to fulfil the terms ofa contract with a buyer.

TR A N S F E R A B L E C R E D I T

The first is a transferable credit. Here the trader requests its customer toarrange for the issue of a transferable credit in the trader’s favour. Thetrader then requests the advising bank to transfer the credit to the supplier.The advising bank sends the credit to the supplier’s bank and the supplier’sbank then advises the supplier that the credit has been opened. When itcomes time to collect on the credit, the supplier exchanges the documentsspecified in the letter of credit for payment and those documents are inturn transmitted to the trader’s advising bank. The trader exchanges theinvoice it has made out to the original customer who opened the letter ofcredit for the invoice of the supplier in return for payment. The trader’sbank (the original advising bank) then sends the trader’s invoice and theother documents to the customer’s bank for forwarding to the customer.

The transferable letter of credit allows the trader to invoice its customerfor a higher amount than the invoice that the supplier presents to its bank.The trader’s profit is therefore the difference between the two invoicedamounts. If the trader does not want the customer to know the identity ofthe supplier, the original letter of credit must allow for the presentation ofdocuments that do not identify the supplier. While this protects the trader,as middleman, from being cut out of future transactions by the supplier,some issuing banks might be reluctant to issue transferable credits becauseof the risks of having a number of parties involved.

B A C K - T O - B A C K C R E D I T

A back-to-back credit is similar to a transferable credit except that in theback-to-back arrangement the trader approaches the advising bank andoffers the letter of credit as security to the bank for the issue of a furtherletter of credit in favour of the supplier. The buyer may not know of theback-to-back arrangement because the credit issued to the supplier is acompletely separate transaction to the main letter of credit. Back-to-backarrangements entail a degree of risk for the banks and for the originalbeneficiary. If the supplier does not perform then the bank will call upthe security it has obtained from the trader. A bank is therefore generally


reluctant to issue a back-to-back credit unless it is confident that the traderis financially sound. Even then it is exposed to some risk because the tradermay become insolvent, leaving the bank exposed.

S T A N D B Y L E T T E R O F C R E D I T

Situations sometimes arise where it is not the exporter that wants securityfor payment but the buyer, who needs some security to ensure that theexporter actually fulfils its bargain. This typically arises in construction orother contracts where the exporter has to supply a combination of goodsand services and the buyer wants to ensure that the project gets completed.Large-scale infrastructure projects are a good example. In these cases thebuyer might ask the exporter for a standby letter of credit. This is akinto a guarantee by the exporter that it will fulfil its obligations. Under thestandby letter of credit, the buyer is entitled to demand that the issuingbank pays the amount for which the credit has been issued if the exporterdefaults on its arrangement. The bank is obliged to pay when the buyerdemands payment without any examination of the facts relating to thedefault. Of course, standby letters of credit are very risky for the exporterand therefore tend not to be used. Rather, exporters engaged in long-termcontracts where the buyer wants some security for its obligation tend touse either demand guarantees or surety arrangements that are issued foronly a small percentage of the overall contract price, say 10 per cent. Suchguarantees can also require specific forms of evidence to be produced toprove default by the exporter. The International Chamber of Commercehas issued a set of rules (the International Standby Practices) to govern theissuance of demand guarantees by banks to try to standardise the practice.

PAY M E N T A G A I N S T D O C U M E N T S

Payment against documents is a frequently used mechanism when theparties are each prepared to bear some risks and wish to avoid the higherbank fees charged for letters of credit. But this type of payment also requirescareful attention to documentary matters.

P RO C E D U RE

If the contract between the exporter and the buyer is to provide for paymentagainst documents, it is essential that the documents supplied to the buyerby the exporter be specified in detail. As in the case of letters of credit, thedocuments include the bill of lading or air waybill, the commercial invoice,

P A Y M E N T 99

packing list, insurance document, certificate of origin, and inspection orother certification regarding the quality of the goods if required. The con-tract should also specify the bank that is to act as the exporter’s bank and thebank that is to act for the importer. As is the case with letters of credit,there is a standard code of practice applying to documentary collections –the International Chamber of Commerce Uniform Rules for Collections.

The procedure that is followed in a payment against documents trans-action begins with the exporter shipping the goods to the importer. Theexporter then presents the agreed documents to its bank (the remittingbank), which are usually accompanied by:� a collection order detailing the various documents that are attached; and� a draft (bill of exchange) addressed to the buyer requiring the buyer to

pay.The draft will either require the buyer to pay ‘at sight’ or within a giventime (typically 30, 60 or even 90 days) after collecting the documents. Thefollowing steps are then taken (see Fig. 4.2):1. The remitting bank sends the documents to the bank in the buyer’s

country (the collecting or presenting bank).2. The collecting bank advises the buyer that the documents are available

for collection.3. The buyer examines the documents and, provided they conform with

the documents that have been agreed to in the contract between buyerand exporter, the bank accepts the draft and either pays the buyer thespecified amount of the contract price in exchange for handing thedocuments over to the buyer or agrees to pay within the set time.

4. The collecting bank remits the funds to the exporter’s bank.A variation of this procedure is that the exporter arranges with its bank

to transfer the bill of lading and draft to the buyer’s bank in exchange forthe contract amount that is sent direct to the exporter’s bank. If an exporteris able to make these arrangements with its bank, the bank usually protectsitself with the right to recover any funds it may have paid out to the exporterif for some reason the buyer refuses to pay as agreed.

The procedure for payment by documentary collection is illustrated inthe following diagram.


The main risk for the exporter in a documentary collection using a sightbill is that the buyer will refuse to accept the bill of exchange (draft) uponpresentation by the collecting bank. As has been detailed in Chapter 2, it isalways useful to include a retention of title clause in the agreement between


contract between exporters andbuyers specifies documents to

be provided

exportersendsgoods

exporter presentsdocuments to its

bank

exporter’s banksends documents to

buyer’s bank

buyer’s bank gives documentsto buyer in exchanges for

payment

buyer’s bank remits fundsto exporter’s bank

Figure 4.2 Payment against documents

buyer and seller to make it clear that the exporter still has title to the goodsand can therefore dispose of them should the buyer default. Nonetheless,disposal of goods in such a situation could result in a significant loss for theexporter because it may have to incur storage and other charges related tothe goods; the problem is compounded in the case of perishable goods thatneed to be disposed of quickly. If the exporter wants the collecting bank totake proceedings for dishonouring the bill of exchange, the procedure thebank should follow if the buyer refuses to accept or honour the bill mustbe set out in the collection instructions (Article 24 of the Uniform Rulesfor Collections). These proceedings can be lengthy, making quick actionagainst a defaulting buyer difficult.

The exporter is in a worse situation if the bill is a term bill. Article 7of the Uniform Rules for Collections states that documents are releasedto the buyer under a term bill upon acceptance of the bill by the buyer.Acceptance does not always mean that the buyer will pay up within thetime required. This can result in the exporter losing control of the goodsand not being paid.

P A Y M E N T 101

A further risk to the exporter results from possible errors in the docu-ments. As noted earlier, the remitting bank will take collection instructionsfrom the exporter and forward them to the collecting bank along with thedocuments. Neither the collecting bank nor the remitting bank is requiredto verify the content or authenticity of the documents. Thus the exporterhas no assurance that the buyer will accept the documents. Buyers who havesecured a better deal have been known to try to get themselves out of theoriginal deal by rejecting the documents on the basis of non-conformity. InBerger & Co. Inc. v Gill and Dufus (1984) 1 Appeal Cases 382, the respon-dents (buyers) rejected a shipment of ‘argentine bolita beans’ because theappellant (seller) had not provided a certificate of quality to confirm thatthe shipment accorded with the quality of a sample that had been sup-plied earlier. The contract provided that payment was to be on the basisof cash against documents and the terms of the contract were ordinaryCIF terms. The House of Lords held that when the terms are simplystated as ordinary CIF terms, a certificate of quality is not one of theusual shipping documents that a seller is required to tender to the buyerin order to receive payment, and the buyer’s rejection of the documentswas a breach of contract for which the seller was entitled to terminate thecontract.

The Uniform Rules for Collections severely limit any bank liability fordelay (Article 14). Delay in transmission of the documents is particularlyserious for perishable goods because the goods may arrive and begin to de-teriorate well before the documents arrive, resulting in the buyer refusingto accept the bill when it is eventually presented. For this reason standarddocumentary collection is not suitable as a means of payment for airfreightof perishable goods.

The Uniform Rules for Collections also provide that remitting banksassume no liability if the instructions are not carried out. Thus if a collectingbank fails to follow the instructions of the remitting bank by failing to collectfees and charges, for example, the remitting bank will have no responsibility.The exporter will only have recourse against the collecting bank if it hasacted in breach of its obligations to act in good faith and exercise reasonablecare (Article 9).

PAY M E N T O N O P E N A C C O U N T

If the exporter agrees to payment on open account, the buyer does notpay until it has received the goods, or within an agreed time (30, 60 orsometimes 90 days) after receipt of the goods. Under this method, aftershipment of the goods the exporter sends the documentation direct to the


buyer, or to a party nominated by the buyer, to allow the buyer to clear thegoods through customs and collect the goods from the carrier. The buyerpays the exporter by telegraphic transfer or bank draft (see Figs. 1.14 to1.20 in Chapter 1).

This method of payment is quite common in international trade, butexporters generally do not use it until after a relationship of trust has beendeveloped with the buyer. It is common for exporters to use differentpayment methods for different classes of customers. For example, first-time customers might be required to either prepay or pay by letter ofcredit. When the exporter is confident of such customers’ credit standing,the customer might be upgraded to payment on open account. A furtherreason for the widespread use of payment on open account is that manyexport transactions occur between related parties. For example, the sellermay partly or wholly own the buyer or the buyer might be a distributor forthe seller’s goods. In the case of a distributorship relationship, the partiesare likely to have established sufficient trust to allow payment via openaccount. In addition, the distributor might try to negotiate this method ofpayment because the terms it will get from its customers might also be 30,60 or 90 days and it is therefore advantageous for the distributor to alignpayment of the sales it makes with its obligations to pay the exporter.


Payment on open account incurs the greatest risk for the exporter. Risk canarise in a number of ways. First, the buyer might simply refuse to pay for thegoods. More likely, the buyer might try to negotiate some discount fromthe exporter because of some alleged non-conformity of the goods with thecontract description. Second, the goods might fail to clear customs in thebuyer’s country. While the buyer would usually be responsible for suchclearance, it would understandably be reluctant to pay if the goods are heldup in customs. If the exporter has not been careful in checking the relevantimport regulations for the buyer’s country, it can even find that the goodsare prohibited imports. In that case, the buyer will often not be obliged topay at all as the entire contract may be void because of illegality. Finally,exports to countries that have a high degree of political risk can sometimesgo astray at the port of arrival. In that case, the importer is unlikely topay for goods it has not received. While many of these scenarios mightstill allow the exporter to have a valid cause of action against the buyer,recovering the costs of the goods from the buyer in a foreign jurisdiction isfraught with difficulty.

P A Y M E N T 103

The following section reviews various ways exporters can minimise theirrisk of non-payment not only in open account transactions but also whenthe other methods of payment discussed above have been used.

R I S K M A N A G E M E N T

The foregoing has detailed the risks with the various methods of payment.There are a number of alternatives that exporters can use to try to minimisethese risks. These include credit risk assessment, insurance, hedging againstforeign exchange movements and factoring.

C RE D I T R I S K A S S E S S M E N T

Most businesses have procedures for assessing the credit risk of potentialcustomers before entering into dealings with them. These procedures helpavoid possible future non-payment problems.

In international transactions, assessing credit risks becomes more dif-ficult and expensive than in the case of domestic sales. There are variouscredit risk assessment agencies that provide credit assessments of variouscompanies throughout the world, but most exporters tend to rely on theservices offered by their own bank. Most of the major banks have rela-tionships with banks in other countries from which assessments of thecredit ratings of potential customers can be obtained. Many exporters alsosupplement and test the information they receive by visits to the coun-tries where their major customers are located, thereby obtaining some in-depth knowledge of the industry and the reputation of the various playersin it.

As has been noted above, exporters also need to be able to check thecredit risk of the banks that potential customers might use. Again, majorbanks offer services to customers to assess the risk of the various banks,particularly regarding letters of credit transactions. Banks usually have alist of recommended banks throughout the world and exporters shouldattempt to have potential customers only use banks that their own bankapproves. This is particularly the case for countries where the financialsystem is still in a relatively underdeveloped state.

I N S U R A N C E

Credit insurance is another means by which exporters can seek to protectthemselves from loss arising from non-payment. If letters of credit are used


as the payment mechanism, the need for credit insurance is less necessary ifa reputable overseas bank is involved. The exporter should therefore checkthe fees and charges for letters of credit as against the premium rates forcredit insurance. In Australia, bank fees on a letter of credit transaction ofA$1 million may be as low as A$500. Insuring the same amount may beconsiderably more costly depending on the risk that the insurer assigns tothe customer and the country in which the customer is located. However,an advantage of credit insurance is that banks may be more willing to acceptit as a form of security to advance working capital to fund the productionof the goods for export rather than the use of other devices such as redclause credits. Regardless of whether the letter of credit or credit insuranceis used, exporters should factor the costs of the letter of credit or insuranceinto their pricing structure.

As is the case with all insurance, exporters need to be fully aware ofthe terms and conditions of the insurance to judge whether or not thismeans of protection should be used. In particular, they should be awareof their obligations under the policy, which events give rise to a liabilityof the insurance company to pay, and when and how much the insurancecompany will pay.

Insurance companies always require full disclosure by the person seekingto be insured. In the case of export credit insurance this may extend todisclosing the details of every contract of sale for which the exporter desirescover. In addition, exporters may need to provide evidence to the insurancecompany of the creditworthiness of all prospective customers, or rely on theinsurance company itself to establish this at the exporter’s cost. This is inaddition to the payment of the insurance premium. Insurance companiesalso require prompt disclosure of any circumstances that may give rise to aclaim. For export credit insurance it is also often a condition that exportersshould refrain from dealing with customers who have previously defaultedon payment.

Exporters should also read policies carefully to be aware of the events thatgive rise to the insurance company’s liability to pay. Typically, insolvencyof the buyer, failure of the buyer to pay and failure of the buyer to acceptthe goods will be circumstances that require the insurance company to paywhen a claim is made. However, a range of other circumstances may ormay not be covered, depending on the policy. These include non-paymentas a result of war, political instability, terrorism, industrial action, failure ofthe exporter to obtain relevant export or import licences, or the exporter’scorrupt activity. If an exporter wants coverage for more contingencies, then,if such an option is available, it may increase the amount of the premium.

P A Y M E N T 105

Premium rates may also vary depending on the country where the buyer islocated.

Finally, the insurance company’s liability to pay usually only occurs whenthe exporter is said to have suffered a ‘loss’. The policy will always specifythe point at which this occurs. For example, the point in time when abuyer can be said to have defaulted on payment may be some time afterthe due date for payment. Policies may also state that the exporter hassuffered no loss if the buyer has any justification for disputing its liabilityto pay. For the exporter to establish that the buyer has no justification mayrequire expensive court action or arbitral proceedings, to be taken by eitherthe exporter or the insurance company. The cost of these proceedings willoften be borne by the insurance company, but only up to the percentageof the loss that they are required to pay. Policies also provide a means ofcalculating how much the insured is likely to recover. This is not alwaysthe full amount owing by a defaulting buyer. For example, exporters arerequired to mitigate their loss by selling the goods if the basis of the claimis rejection of the goods by the buyer. Further, some policies will limitthe liability of the insurance company to a specified percentage of theloss. In other words, the total loss to the exporter is not always coveredin full.

While insurance for non-payment is a vital consideration for exporters,the requirements of the policy and its costs need to be balanced againstthe possible risks. But for open account transactions where the exporteris exposed to serious risks, there may be few alternatives available for therisk-averse exporter.

F A C T O R I N G

Factoring is a particularly useful technique for exporters who want to coverrisks of non-payment. It is not widely used by Australian exporters, andthere are very few factoring firms in Australia that deal with internationaldebt. In an international factoring transaction the exporter assigns its over-seas debts to the factor, which arranges to collect the debts for a fee. Thefactoring firm takes charge of all of the exporter’s documents relating tothe transaction and handles the presentation to banks as necessary to makesure the factor gets paid. Typically, the factoring firm is prepared to pay80 per cent of the amount of the transaction to the exporter upon receiptof the exporter’s documents, and once the factor receives the proceeds fromthe buyer it pays the remaining 20 per cent to the exporter less its fee. It isalso usual for the exporter to pay interest to the factor on the 80 per cent


that has been advanced until the time that the factor receives the purchasemoney.

Often the factoring company will have a relationship with a factoringcompany in the buyer’s country. This enables it to provide credit checks onpotential buyers as well as to assist in collecting the debts from the buyer ifit defaults on payment. Factor Chain International is an organisation thatmany factoring firms belong to in order to assist with credit assessments.

There are considerable advantages for some exporters in factoring. Fac-toring avoids the administrative burdens of letters of credit and also avoidsthe costs and administrative overheads associated with credit insurance.It is particularly useful for smaller exporters as it not only saves the timeand expense associated with other means of payment protection but alsoprovides access to the funds immediately the debt arises, giving exportersa source of finance. The costs of factoring may therefore be less than othermeans of payment, particularly when taking into account the administra-tive costs involved with the other means of payment. For smaller exporterswho are only able to negotiate open account payments, factoring mayrepresent a useful way of managing the financial side of their exportoperation.

M A N A G I N G F O RE I G N E X C H A N G E R I S K

Difficulties can arise for exporters if they are to receive the proceeds of theirsale in currencies other than their home currency because the latter maychange in value in relation to the currency in which they are being paid. Forexample, an exporter may have contracted to sell goods to a US buyer forUS$60 000 at a time when the exchange rate was 60 cents US for A$1. Theexporter would therefore expect to receive A$100 000. But the terms ofthe contract might provide for payment in 90 days. By that time theexchange rate might be 80 cents US for A$1. The exporter will thereforeonly receive A$75 000 when the US dollars are converted to Australiandollars at the time of payment. Of course if the Australian dollar depreci-ated against the US dollar to 50 cents US for every A$1, then the exporterwould receive A$120 000 and would be better off.

Exporters may therefore wish to protect their position against foreignexchange movements. There are a number of ways to do this. In order togain a full understanding of the various alternatives available it is advisableto consult books on international financial management or discuss thiswith the international operations departments of various banks. However,a brief overview of some of the better-known alternatives is provided here.

P A Y M E N T 107

These include forward exchange contracts, money market hedging, and thepurchase of currency options. The main aim of these hedging devices is toincrease certainty for the exporter and to reduce risk.

A forward exchange contract allows the exporter to agree with a bank toconvert foreign currency proceeds to Australian dollars at a set rate at thetime the exporter receives the funds. The forward exchange contract remainsthe most popular method that exporters use to protect their position whenreceiving payment in currency other than A$. Banks are able to quoteexporters’ forward exchange rates, generally on a 1, 3, 6 or 12-month basis.Thus at the time that the exporter is setting the price it may wish to examinethe forward rate of exchange that will apply at the time it is to be paid andcalculate how much it will need to receive in foreign currency at that timeand at that rate to make the profit on the sale that it anticipates. For example,an exporter might calculate that it needs to receive A$100 000. It mightdiscover that the forward exchange rate for 90 days is 80 cents US to A$1,while at present it is only 60 cents US for A$1. Therefore, to guaranteethat it will receive A$100 000 at the time for payment, it needs to set thecontract price at US$80 000 and take out a forward exchange contract tosell US$ in 90 days at 80 cents US to the Australian dollar. Of course, ifthe Australian dollar did not in fact appreciate by as much as the forwardexchange contract, the exporter would have been better off not takingout the forward exchange contract. For example, if the Australian dollaronly appreciated to 70 cents US to A$1, the exporter would have receivedapproximately A$114 285 if it had not done anything to protect its positionand simply have converted the US$ proceeds when they arrived. On theother hand, if the Australian dollar had appreciated even further than therate achieved in the forward foreign exchange contract (say 90 cents USfor A$1), the exporter will be better off than if it had not done anything toprotect its position.

A further alternative is for the exporter to take out a US$80 000 loan atthe time of entering into the contract, convert that loan into A$ immediatelyand then repay that loan in 90 days in US$ from the proceeds of thesale in US dollars; there will of course be interest charged on the loan.Even though the exporter may have converted the borrowed money intoAustralian dollars and invested those funds for the 90 days, the interestit receives is unlikely to be as much as the interest that it has had to pay.The difference, along with any bank fees, will be the cost for protecting itsposition. This alternative is not used as often as forward exchange contractsbecause the interest differentials tend to be greater than the fees chargedfor a forward exchange contract.


A more flexible but often more expensive alternative is for the exporterto purchase what are known as currency options. Purchase of a simplecurrency option means that the exporter enters into an arrangement withits bank to have the option of purchasing Australian dollars at a specifiedexchange rate at a specified time in the future. For example, the exporterwho wants its A$100 000 price at a specified certain rate of exchange mightfind that it can purchase a 90-day currency option at the rate of 80 centsUS to the A$, thus guaranteeing that its US$80 000 contract will in facttranslate to A$100 000 when payment falls due. If, when the time forpurchase falls due, the actual exchange rate is lower than 80 cents US tothe A$1 (say 70 cents US to the A$1), this would result in the exporterreceiving more A$ than it would have received had it exercised the optionto convert at the 80 cent rate. If this scenario occurred the exporter wouldnot exercise its option. If, however, the A$ appreciates to say 90 cents USto the A$1, then the exporter will exercise its option to convert at the 80cent rate because not exercising its option and simply converting at the90 cent US rate would mean it would receive less than the A$100 000 itwants from the sale. However, options attract a considerable fee, often inthe order of around 2 per cent. Thus exporters need to build this into theirpricing structure.

As can be seen from this very simple example, the options arrangementcovers the exporter for both appreciation and depreciation of their homecurrency. The simple option arrangement referred to above is often calleda ‘vanilla’ option because of its simplicity. Banks now have many moresophisticated versions of options and larger exporters are well advised tocheck with their bank about the possibilities that now exist. Nonetheless,before entering into any of these strategies for protecting their sale proceedsagainst foreign exchange movements, exporters need to weigh up the costsagainst the risks.

55 Transport of ExportedGoods

Most exports of goods from Australia require theservices of either a seagoing transport operator or an airline for the carriageof goods to the country of destination. Even if goods are ordered overthe Internet by an overseas buyer, the Australian exporter must arrange totransport the goods to the buyer by sea or air transport or by the postalservice, which in turn uses sea or air transport. The contract between theexporter and the transport operator is a separate contract to the mainsales contract. But the sales contract will often contain incoterms or otherclauses naming the party to the contract who is responsible for arrangingand paying for the transportation of the goods. The reader is referred toChapter 3 for a detailed discussion of incoterms.

This chapter reviews some of the important aspects of sea and air trans-port. In each case the discussion follows the logistics of arranging trans-port, the important aspects of the contract of carriage and the liability ofthe carrier. At the outset it needs to be emphasised that the law relatingto transport of goods is complex. In a chapter of this length we can onlygive an introduction. Those wishing to acquire a more detailed knowledgeof the intricacies of international transport law should consult specialistworks on transport law.

Two preliminary questions arise before an exporter or an importer entersinto a contract of carriage with a transport operator. These are whether thecarriage should be by sea or by air and whether the exporter should arrangethe transport itself or use the services of a freight forwarder.

In many situations the choice between sea and air transport will bedecided by the nature of the goods. Most commodities exported orimported to or from Australia, such as beef, wool, grain, minerals andmany manufactured goods, are transported by sea. On the other hand,

109


air transport tends to be used where goods are by their nature valuable(gemstones), perishable (seafood, fresh fruit and vegetables) or are sophis-ticated and high-value products (specialised medical equipment) or areurgently required to avoid costly delays to production (spare parts). Butthere are many situations where it is not immediately obvious whethergoods should be transported by sea or air. In these cases it is often necessaryto make a careful comparison of the costs to determine the most appro-priate method of transportation. While the pure freight costs are muchgreater for air than for sea transport, when insurance costs, packaging,storage costs and the cost of waiting for payment (if goods are sold onopen account) are taken into account, airfreight may be the less expensiveoption.

The next question follows closely from this. Should the exporter arrangeits own transport or hire a freight forwarder to undertake this on its behalf?Again it is necessary to weigh up the forwarder’s fees against the savingsand other advantages that the exporter will derive.

Freight forwarders have specialised knowledge of the available shippinglines and airlines and the freight rates that apply. Freight rates for sea trans-port are set either by shipping conferences, which are a consortium ofindividual shipping lines, or by individual lines themselves if they are notmembers of a shipping conference. Rates vary considerably depending onthe value of the commodity that is being exported or, in the case of containershipments, on the size and number of containers that are being shipped.Due to their expert knowledge, freight forwarders are able to offer exporterscomparisons in freight rates between alternative carriers and means of car-riage. Freight rates are not a simple charge per item but comprise a numberof different charges including the charge for the transport of the containeritself, the costs associated with the use of the container, any container ter-minal handling charge, the port authority’s charges and a possible surchargeto allow for currency fluctuations (currency adjustment factor) and, moresignificantly, fluctuations in the price of fuel (bunker adjustment factor).Freight rates for air transport are as complicated and are discussed later inthis chapter.

In the case where less than a full container load is being shipped,freight forwarders are able to do what is known as consolidation andcombine the shipments of a number of exporters into a single container,thereby saving on freight rates. The specific knowledge they have of thevarious charges avoids the need for the exporter to have a member ofstaff acquire this knowledge. While large exporting companies have their

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own shipping clerk whose specific task is to arrange shipment and thenecessary documentation, many smaller exporters find that the costs offreight forwarders are considerably less than maintaining such an opera-tion in-house.

Freight forwarders offer other advantages. They may be able to adviseexporters on the most appropriate, and at the same time least expensive,form of packaging for the means of transport chosen. And they may be in abetter position than the exporter to determine whether sea or air transportis more cost-effective. In line with current international business trendsand in order to service the needs of their increasingly globalised clients,the freight-forwarding industry is itself becoming global. Thus the samecompany may be able to arrange for the transport of the goods from theexporter’s premises through to the buyer’s premises, as well as prepare allshipping documentation as well as the documents required to comply withcustoms regulations in both the exporting and importing country. Largerfreight-forwarding agents can often act as customs brokers to facilitate thecompletion of import and export requirements on behalf of their clients.Many freight-forwarding companies also have their own storage facilities,which allows exporters to deliver goods to freight forwarders’ depots withthe forwarders making all the arrangements to get the goods on board theship or aircraft, or to handle all arrangements for the delivery of the goodsfrom door to door.

This chapter will discuss:� the logistics of sea transport;� contracts for the sea carriage of goods;� the liability of the carrier in a carriage of goods by sea;� the logistics of air transport;� contracts for the carriage of goods by air; and� liability of air carriers.

S E A T R A N S P O RT

L O G I S T I C S

Containerised shipping has become the dominant mode for the sea trans-port of goods other than those that are shipped in bulk. The followingdiscussion will deal at some length with the standard procedures used byexporters in shipping their goods by container, followed by some discussionof the procedures followed when goods are shipped in bulk via a charter


operation. The flowchart in Chapter 1 shows the steps described in thischapter.

An exporter wanting to send a container load of goods overseas needsto make arrangements with an appropriate shipping company (or freightforwarder) to book the container on the ship. Shipping lines either advertisetheir routes and dates of sailing directly or they use the services of bookingagents to handle cargo reservations on their behalf. Most shipping com-panies now deal with booking requests electronically via email. They arealso able to arrange for the dispatch of a suitable container to the exporter’spremises. While the size of containers has been standardised to facilitateloading and storage, there are specialised containers for the transport ofgoods such as those requiring refrigeration.

Once the exporter receives the container, it is its responsibility to ensurethat it is properly packed. After packing and any required inspection, thecontainer is sealed. The transport of the container from the exporter’spremises to the wharf or the shipping company’s container terminal willbe done either by a carrying company arranged by the exporter or bythe shipping company if the arrangements for transport include collectionfrom the exporter’s premises. A pre-receival advice will have already beenarranged by the exporter to ensure that the goods can enter the port areaand to allow the shipping company to arrange its cargo ready for loadingon board.

As between the exporter and the buyer, the responsibility and risk asso-ciated with the transport leg from the exporter’s premises to the containerterminal or the wharf area depends on the terms of delivery (incoterms)agreed between the exporter and the buyer. In the case of F, C and D terms,however, the exporter will be responsible for this leg of the journey andwill therefore need appropriate insurance, at least up to this point. Oncethe goods are delivered to the shipping company, the contract of carriagebetween it and either the exporter or importer (whoever has entered intothe transportation contract) will in part decide the respective obligations ofeach of these parties. The shipping company’s liability is discussed in moredetail below.

The exporter must also furnish the shipping company with a forwardinginstruction that provides the details necessary for the shipping company toprepare the bill of lading. If the goods fall within the categories of dangerousgoods, as listed in the International Maritime Dangerous Goods Code, theexporter needs to have lodged a dangerous goods declaration with the Aus-tralian Maritime Safety Authority at least 48 hours before shipment andalso advise the shipping company. Once the shipping company receives


the forwarding instruction it returns a copy of it to the exporter. Thisacts as an interim receipt for the goods. In practice it is the exporter whothen prepares the draft bill of lading, taking into account any informa-tion provided in the interim receipt. The draft bill of lading is forwardedto the shipping company for signature. Once the bill of lading is signed,it is available for collection by the exporter upon payment of the freightcharge. If the terms of payment are by documentary collection or docu-mentary credit, the exporter is able to present the bill of lading togetherwith other documents to its bank to receive payment. It is usual practice forthe bill of lading to be a ‘shipped’ bill. This means that it is issued after thegoods have been loaded on board. It is less common to obtain a ‘receivedfor shipment’ bill, indicating that the carrier has taken charge of thegoods.

The Internet is now being increasingly used by exporters, transport com-panies and banks in place of the traditional paper-based system. It is nowquite common for transport documents (such as forwarding instructions,commercial invoices, packing lists, pre-receival advices and sea waybills)to be produced and processed in electronic form. The Bolero Project is anambitious attempt to convert every aspect of export documentation into anelectronic system that can be used worldwide. Its objective is to convert allthe usual documents used in international business transactions into a stan-dardised format so that those subscribing to the system can use standardisedforms to create documents that can then be accessed over the Internet bythe various relevant parties. The Project aims to have many of the transportdocuments discussed above online as well as booking requests, bookingconfirmation, bills of lading, forwarding instructions and interim receipts.Commercial documents such as purchase orders, commercial invoices andpacking lists can also be created online, as can letters of credit. For thoseusing the system, it allows most documents to be created and forwardedelectronically. A number of major shipping lines as well as most of theworld’s major banks are members of the Bolero Project. The transmissionof messages in the system occurs via the SWIFT system, which, as notedin Chapter 4, is the network used for the secure electronic transmission ofletters of credit. Belonging to the Bolero network is reasonably expensiveat this point and so its use is far from universal.

A large proportion of goods shipped from Australia are agricultural andmineral commodities that are shipped in bulk. While ordinary oceangoingliners have facilities for the transport of bulk cargo, it is quite commonfor commodities to be shipped under charter party arrangements. If anexporter wishes to charter a vessel there are essentially three choices. First,


it is possible simply to hire the ship for a single voyage, with the ship-ownerand the ship’s crew taking responsibility for the conduct of the ship duringthe voyage. This is known as a voyage charter party. Second, the exportercan hire the ship for a set length of time; again, the ship-owner and thecrew take responsibility for the ship during the time it is chartered. Thecharterer may or may not sub-charter the vessel to other parties who alsowish to send cargo to the same destination as the charterer. This is knownas a time charter. The third possibility is for the charterer to hire the wholeship and provide its own crew. This is known as a ‘bareboat’ or ‘demise’charter.

Exporters who wish to charter a vessel usually do so through brokerswho handle ship charters. The exporter contacts a broker, who knowswhich vessels are available for charter. The terms of the charter are thennegotiated between the vessel’s owner and the charterer. As will be notedbelow, the contract of carriage is contained in the charter agreement. Thisalso includes the costs and responsibilities for storage prior to loading,loading costs, port charges and unloading expenses. Bills of lading mayalso be issued for charter voyages.

C O N T R A C T S O F C A R R I A G E

The standard C and D trade incoterms frequently oblige the seller to arrangetransport. Thus in many international sales transactions exporters need toenter into agreements with carriers to transport the goods. The terms ofthe standard contracts of carriage are usually contained in either an ‘oceanbill of lading’ or a ‘charter party agreement’. This section discusses eachof these documents. During the discussion that follows a ‘bill of lading’ isassumed to be an ocean bill of lading unless otherwise stated. This meansthat the bill of lading refers only to the carriage of goods that occurs byship.

B I L L O F L A D I N G

A bill of lading is a document that is issued by the carrier to the exporter. Asnoted above, it is prepared from the information provided by the exporterto the carrier in the forwarding instruction. The bill of lading serves threemajor purposes. First, it is evidence of the contract of carriage between theexporter and the carrier. In almost all cases it contains the terms on whichthe carrier will carry the goods. But it cannot strictly be said to be the actual


contract between the parties because it is issued only after the goods havebeen received. Since the agreement between exporter and carrier is enteredinto before the goods are delivered to the carrier, the bill of lading, as adocument prepared after the event, can only be evidence of that contractrather than the contract itself.

The bill of lading also entitles the holder of it to collect the goods. Again,strictly speaking, the bill of lading is not a document of title to the goodsbut only a document that indicates that the person who holds it is primafacie entitled to obtain delivery of the goods. Collection of the goods bythe holder of the bill of lading is facilitated by the fact that the bill oflading is a negotiable instrument. This means it can be endorsed by theoriginal holder (the exporter) in favour of the exporter’s bank to enable, forexample, the exporter to receive payment under a letter of credit. It can thenbe endorsed by the bank in favour of the buyer, who may then endorse itin favour of a person to whom it has on-sold the goods. That person, beingthe legal holder of the bill, can then present it to the shipping company toobtain delivery. By releasing the goods to the legal holder of the bill, theshipping company fulfils its obligations for delivery to the correct person.In most jurisdictions the legal holder of the bill of lading is also entitled tosue the carrier for any damage that has resulted to the goods arising out ofthe carriage.

The bill of lading is also said to act as a receipt for the goods. Althoughthe exporter obtains an interim receipt from the carrier on delivery of thegoods, it is the bill of lading that formally sets out the goods receivedand the condition of the goods at the time of delivery to the shippingcompany. Should any dispute arise about when any damage to the goodsoccurred, a clean bill of lading (one that shows that the goods were receivedin good order and condition) provides evidence that the damage musthave occurred after the goods were shipped. For this same reason, shippingcompanies are careful to note any damage to the goods, their packagingor, in the case of container shipment, to the container itself at the timethey are delivered. In such a case the bill of lading is said to be ‘claused’ bysetting out the particulars of the insufficiency of the packaging or damageto the goods. In the case of container shipments, the exporter is responsiblefor adequately packaging the goods inside the container. The shippingcompany will generally not be responsible unless the container itself hasbeen mishandled.

In addition to containing the terms and conditions of the contract ofcarriage, the bill of lading document must comply with a number of legalformalities. For Australian exporters the minimum information that a bill


of lading must contain is set out in Article 3 of the Hague Visby Rules (asamended), which are contained in Schedule 1A to the Carriage of GoodsBy Sea Act of 1991(as amended) (Cth). Article 3 of the Hague Visby Rulesrequires a bill of lading to contain the markings on the goods that identifythem as being the ones referred to in the bill of lading, the number ofpackages or quantity and weight, and the apparent order and condition ofthe goods. In the case of bills issued for containerised goods, these require-ments are met by the bill of lading stating the number of the containerand the number of the seal placed on the container, as well as a descriptionof what is in the container. Bills of lading also show the gross weight ofthe container, whether the goods covered by the bill of lading are a fullcontainer load (FCL) or part of a consolidated shipment (a light containerload or LCL) as well as details of the consignor, consignees, port and date ofshipment. The bill of lading will also specify whether it is issued at the timethe goods have been received for shipment (a received for shipment bill) orhas been issued after the goods have been loaded on board (a shipped bill).Shipped bills of lading are more common than received for shipment bills.

The terms and conditions of shipment are printed on the back of thebill of lading. Because bills of lading are pre-printed forms prepared byshipping companies it is not surprising to find that many of the terms andconditions are for the benefit of the shipping company. Standard bills oflading often contain a number of clauses that give the shipping companygreat freedom in dealing with the goods. For example, there are conditionsthat allow the ship to take any route to the destination; to undertake anydiversion that may be necessary with the shipper to pay compensation forsuch diversion; to load and unload the goods in any manner required byport authorities; and to subcontract any part of the carriage to others, withtheir servants and agents enjoying the same immunity against liability asthe carrier enjoys. This latter clause is often referred to as a ‘Himalaya’clause. The bill of lading also provides that delivery of the goods to theholder of the bill of lading will discharge the shipping company from anyliability regarding their obligations to deliver the goods.

Bills of lading also seek to impose obligations on the exporter. For exam-ple, the exporter is taken to have inspected and to be satisfied with thecontainer provided by the shipping company and to have agreed thatthe container that has been delivered is suitable for the transportationof the goods. In addition, the shipping company’s statement about thecondition of the goods only refers to the condition of the container. It isthe exporter who is responsible for the packaging of the goods inside thecontainer. Unless there is an express agreement to the contrary, the exporter


is also expected to accept that the goods may be transported above or belowdeck and to contribute by way of general average to any loss that mightoccur if that part of the cargo is jettisoned in an emergency. The conceptof general average is discussed in more detail in the following chapter oninsurance.

All shipments from Australian ports are governed by the minimum stan-dards set out in the Hague Visby Rules as amended by the Carriage of Goodsby Sea Regulations 1998, and accordingly all bills of lading issued in Australiaalso state that they are issued subject to them. Attempts by the carrier tolimit its liability in the bill of lading must therefore be consistent with itsability to do so under these rules. The obligations imposed on a carrier bythe rules are discussed below.

In many export transactions it will not be necessary for the exporter toreceive a negotiable bill of lading from the carrier. For example, there maybe no need for the importer to have the option of selling the goods whilethey are in transit since the payment mechanism adopted by the partiesmight not require negotiation in favour of third parties. For these reasonsthe sea waybill has become a common alternative to the bill of lading. Theconditions of carriage are similar to those in a bill of lading. The carriage isgoverned by the Hague Visby Rules (as amended) and the sea waybill actsas a receipt for the goods. However, it is neither a document representingtitle to the goods nor a negotiable instrument. Upon arrival the buyer cancollect the goods by presenting suitable identification to show that thebuyer is the named consignee on the sea waybill.

M U L T I M O D A L C O N T R A C T S O F C A R R I A G E

It is now common for the one transport company or freight forwarder tohandle the transport of goods from the exporter’s premises right throughto delivery to the buyer, which usually involves several different modes oftransport. As noted earlier, firms engaged in the business of internationalcarriage of goods are becoming increasingly globalised. Shipping compa-nies are acquiring or establishing land transport companies, while freight-forwarding companies have expanded their business operations across inter-national boundaries.

Two standard documents have been developed to give evidence of theterms of the contract of carriage by multimodal transport. The first ofthese is known as the ‘FIATA Multimodal Transport Bill of Lading’. Thistype of bill of lading is often referred to as a ‘house bill of lading’ and isissued directly by freight forwarders and may be in either negotiable or


non-negotiable form. Many of the terms and conditions of this documentare similar to the ordinary ocean bill of lading as discussed above. But, thistype of bill of lading imposes liability for loss of the goods or damage causedby delay. The liability of freight forwarders contracting as multimodalcarriers is discussed in more detail below.

The second type of multimodal transport document is a ‘combinedtransport bill of lading’ (or ‘through bill of lading’). This document iscommonly used when the carrier operates the different modes of transportfor the carriage of the goods, or subcontracts the land portion of the carriageto another carrier. For example, the carrier may own shipping lines as wellas trucking services or may subcontract the land carriage to a local transportcompany. The terms of the combined transport bill of lading are very similarto the terms of the ordinary ocean bill of lading discussed above. The liabilityof the carrier is discussed in more detail below. Combined transport billsof lading are less common in Australia than house bills of lading.

G E N E R A L C O N D I T I O N S O F C H A R T E R

If the transport of the goods occurs under a charter operation, the conditionsof carriage will be governed primarily by the contract between the ship-owner and the charterer. But an additional complication arises here. It isoften the case in charter party arrangements that either the charterer, orthose on whose behalf the charterer is carrying goods in the ship, will alsoneed bills of lading to cater for the sale of the goods while in transit orfor obtaining payment. The ship-owner issues the bills of lading (‘charterparty bills of lading’) to the people who are shipping the goods when thecharter is a voyage or a time charter, but in the case of a bareboat charterthe charterer itself issues the bills of lading.

In order to avoid conflict between the charter party agreement and thebills of lading, the terms and conditions set out in the standard charterparty bills of lading are very short, and simply incorporate the terms ofthe charter party. Additionally, because charter party agreements are notautomatically governed by the Hague Visby Rules, charter party bills oflading usually specify that the bill of lading itself is governed by those rules.Further, the charter party bill of lading must contain standard details suchas the description of the goods, details of the consignor and consignee,container number, seal numbers, and so on.

The charter party agreement itself requires the owner to be responsiblefor making the ship seaworthy and properly manning, staffing and equip-ping the ship. Under a time or voyage charter the ship-owner is allowed


to select the route of the voyage, to deviate from that route as necessary,and to follow the directions of port authorities. There are also provisionsthat set out what the rights and obligations of the parties are if loadingor unloading is prevented by strike action or if civil unrest or the risk ofterrorism makes it unsafe for the ship to sail. The standard charter partyagreement specifies that the charterer is responsible for loading and unload-ing, but allows the charterer to cancel if the ship is not ready for loadingat the appointed time. It also contains provisions that specify a set numberof days for both loading and unloading. If the charterer is unable to loador unload within the time stipulated (other than in circumstances set outin the agreement) then it is obliged to pay demurrage to the ship-ownerat a rate specified in the agreement. The standard charter party agreementalso contains an important term requiring the charterer to indemnify theowner for any action that may be taken against the owner under the billsof lading that the owner may have to issue.

L I A B I L I T Y F O R S E A C A R R I A G EO F G O O D S

As noted above, all goods shipped from Australia are subject to the pro-visions of the Carriage of Goods by Sea Act and Regulations. The Act andregulations have adopted the Hague Visby Rules but with some variations.All bills of lading issued for carriage of goods by sea from Australia aresubject to these rules and are required to state the same within the bill. Anexamination of the liability for carriage of goods by sea therefore requiressome discussion of the relevant provision of both the Carriage of Goods bySea Act and the amended Hague Visby Rules that are incorporated into theAct as Schedule 1A. The discussion here will focus on when a sea carrier isliable, the amount for which it is liable, and the necessary steps that haveto be taken by a party to give notice to the carrier. Importers need to beaware that the Hague Visby Rules as set out in the Carriage of Goods by SeaAct do not necessarily apply to shipments from ports outside Australia toports within Australia, and so contracts of carriage governed by laws otherthan Australia’s might result in variations to the liability of the shippingcompany.

T H E L I M I T A T I O N O F C A R R I E R L I A B I L I T Y

Article 1 of the Hague Visby Rules provides that the period of ‘carriage’begins when the goods are delivered to the carrier at the port limits. The


carriage ends when the goods are placed at the disposal of the buyer atthe port of destination. Article 1 also provides that the contract of carriageincludes consignment notes, sea waybills and bills of lading that are issuedelectronically.

Article 3 of the rules imposes obligations on the carrier to make theship seaworthy; to properly man, equip and supply the ship and to makeall parts of the ship where goods are carried fit and safe for the carriageand preservation of the goods. Further, the carrier is obliged to ‘properlyand carefully load, handle stow keep care for and discharge the goodscarried’. The carrier is not permitted to exclude liability for loss or damagearising from failure to carry out these obligations (Article 3(8)). However,Article 4 of the Hague Visby Rules allows the carrier to escape liability in awide range of circumstances. First, it will not be liable for loss or damage ifthis results from unseaworthiness of the vessel unless that unseaworthinessresults from the carrier failing to exercise due diligence in carrying out itsprimary obligations as set out above. Article 4 goes further by specifyingthat if loss or damage occurred as a result of a wide range of events, thecarrier will not be liable. Accordingly, if, for example, the loss or damageoccurred because of fire, storms and other perils of the sea, terrorism, war,piracy, strikes, inadequacy of packaging arrangements, or even from thenegligence of the crew in failing to properly navigate the ship, the carrierwill not be liable – provided of course that they can show they have fulfilledtheir primary obligations under Article 3.

In Shipping Company of India Limited v Gamlen Chemical Company(1980) 147 Commonwealth Law Reports 142, a number of drums ofcleaning solvent stowed in a ship’s hold broke free as the ship encounteredbad weather when crossing the Great Australian Bight. The drums weredamaged, resulting in the loss of their contents. The carrier argued that thedamage was caused by the bad weather and thus relied on the ‘perils of thesea’ defence. The cargo-owner argued that the loss of its cargo arose fromthe negligence of the ship’s crew in failing to stow the goods adequately. Thecourt held that the goods were not stowed properly to accommodate thetype of weather that might be expected in the Great Australian Bight andaccordingly the staff of the shipping company were negligent. The shippingcompany therefore failed in its duty to properly stow the goods.

However, if the carrier can prove that it took all reasonable steps tomake sure that the ship was seaworthy and that it was properly manned,staffed and equipped and that it was fit and safe for the carriage of thegoods, it will escape liability. In Great China Metal Industrial Co Limited vMalaysian International Shipping Corporation (1998) Commonwealth Law


Reports 65, a quantity of aluminium body stock in coils was damaged asthe ship crossed the Great Australian Bight in a journey from Sydney toTaiwan. Bad weather had been predicted for the journey but turned outto be much worse than predicted. The shipping company claimed that itwas not liable because the damage occurred due to perils of the sea. Thecargo-owner claimed, among other things, that the peril of the sea defencewas not available because the shipping company knew about the dangersbefore setting sail. The High Court held that the cargo-owner could notsucceed because it had not established that the vessel was unseaworthy. Thecourt said that the shipping company had complied with its obligationsto properly man, staff and equip the ship. The court was of the view thatit did not need to consider whether the perils of the sea defence appliedbecause the shipping company had fulfilled its obligations to properly man,staff and equip the ship. In his decision, Kirby J suggested that the costs ofbig oceangoing liners always staying in port just because of some predictedbad weather would far outweigh the savings to the few cargo-owners whosuffer loss because of bad weather. This case shows that it is the cargo-ownerwho has first to establish that the ship is unseaworthy and only then is itnecessary for the ship-owner to show that one of the defences applies.

Article 4A of the rules now imposes liability on the ship-owner for anydelay in delivery of the goods unless it can show that the delay was excusableand that it took all measures necessary to avoid the delay. There is a list ofcircumstances that amount to ‘excusable delay’.

There are a number of other provisions of the rules that require comment.Article 5 states that the rules do not apply to charter party agreements butdo apply to bills of lading issued under charter party agreements. Article 6states that the rules only apply to ordinary commercial shipments and thatif there is a ‘special’ cargo for which no bills of lading have been issued, thecarrier and the shipper are free to enter into whatever contractual termsthey please. The carrier’s exemption from liability is also stated to extendto its servants and agents. Thus the Himalaya clauses used by shippers aregiven formal legal validity by the Hague Visby Rules.

Even if the carrier is liable for loss or damage to the goods, the rulesprovide limitations of the amount of liability. The amounts for whichthe carrier will be liable are specified, but are not expressed in terms ofa specified currency such as US dollars but in terms of ‘Special DrawingRights’ or SDRs. SDRs serve as an international currency. Every majorcurrency has a value in terms of SDRs. For the past decade the Australiandollar has been worth approximately 0.5 SDRs, or in other words everySDR is worth A$2. The amount of the carrier’s liability is expressed in


the rules as being limited to either 666.67 SDRs per package or 2 SDRsper kilogram, whichever is higher. The rules obviously cause difficulties forgoods transported in containers. They state that the container itself willbe deemed to be the package unless the shipper specifies the details of thepackages that are inside the container. The shipper therefore has to choosewhether to set this out specifically in the bill of lading or to rely on theweight provisions. An alternative is for the shipper to declare the value ofthe goods to the carrier. Here the carrier will be liable for the value of thedeclared goods. Needless to say, if the value is declared this may well increasefreight rates. Finally, the carrier cannot limit its liability to the amounts setout in the rules if intentional or reckless loss or damage is caused to thegoods by the carrier or its servants and agents.

The amended rules provide that the carrier’s liability for delay is limitedto the lesser of the actual amount of the loss or two and a half times the seafreight for the goods or the total sea freight for all goods shipped on thatparticular voyage. However, if the shipper can also establish that the carrieris liable under Article 4, then it can resort to the calculation of damages fordelay in terms of SDRs as set out above. This might be important for anexporter in circumstances where perishable products are sent in bulk.

The rules also include provisions about giving notice of any loss ordamage. They require the person who is entitled to delivery to give noticein writing to the carrier of any loss or damage at the time the goods aredelivered or, if the loss or damage is not apparent at that time, within threedays. Any legal action against the carrier must be commenced within a year.

M U L T I M O D A L T R A N S P O R T

Although there is a United Nations Convention on multimodal transport,only a few countries have adopted it as part of their law. Australia has notas yet ratified the Convention. The liability of the multimodal transportoperator (MTO) to the exporter therefore depends on the contract that hasbeen entered into.

Two possibilities exist regarding liability of the MTO. First, the operatormay contract as principal with the exporter, in which case it agrees to ensurethat the goods are delivered to the buyer. In this case the MTO enters intoseparate contracts with each of the carriers required to transport the goods,for example a carrier for the road portion and a carrier for the sea portion.Thus the exporter can take legal action against the MTO if there is lossor damage to the goods regardless of where the loss or damage occurs. Asnoted above, the terms of the contract are generally evidenced by a FIATA


bill of lading if the MTO is a freight forwarder or by a combined transportbill of lading if the operator is the owner of the various means of carriage,or subcontracts the land portion of the carriage. It is common in Australiafor freight forwarders to enter into contracts as principal with shippers;they will therefore be liable to the shipper for any loss or damage occurringduring any portion of the transport. The freight forwarder will have to seekreimbursement under the contracts it has arranged with the various partiesundertaking each leg of the carriage of the goods.

The second possibility is for the MTO to contract with the exporter onlyas an agent for the various carriers who will physically transport the goods.In this case the exporter will have to pursue the various carriers individuallyshould there be loss or damage to the goods, and will have to rely on thelaws governing the carriage.

While there is no generally accepted convention on multimodal trans-port, the International Chamber of Commerce in conjunction withUNCTAD has a set of rules that MTOs can incorporate into their contractswith exporters. Because the rules provide that the MTOs themselves assumeliability to the shipper, it would seem that if the contract incorporates therules then the MTO is likely to be contracting as principal.

The rules contain largely similar provisions to the Hague Visby Rules(as amended). They state that MTOs are liable for loss, damage or delayfrom the time the MTO accepts the goods until the time they are delivered.Damages for delay are specifically recoverable if the shipper has indicatedthe time within which delivery must be completed. The rules also make theMTO liable unless it can prove that the loss, damage or delay occurred otherthan through the fault or neglect of itself and those acting on its behalf.Further, the rules seem to suggest that not only is the MTO responsible forits own acts and those of its servants and agents but also that it is responsiblefor the actions of ‘such other persons whose services are made use of for theperformance of the contract of carriage’.

The MTO rules contain similar provisions to the Hague Visby Rulesin that they limit the amount of liability to 666 units of account perpackage or two units of account per kilogram. However, because of thenature of multimodal transport there is also a provision that states that ifthe damage occurs during a part of transportation that was not coveredby conventions that impose this limitation on amount of liability, thenthe relevant national laws or other conventions that apply at that stage oftransportation will govern the amount of the MTO’s liability. One of thedifficulties with this provision is establishing at what stage of transportationthe damage actually occurred.


The MTO rules also contain similar provisions about notice to thosecontained in the Hague Visby Rules. However, the three-day period fornotice is extended to six days, while the limitation period in which actionmust be commenced is reduced from 12 to nine months.

A I R T R A N S P O RT

L O G I S T I C S

Exporters wanting to transport goods by air can do so either by making adirect booking on an airline or have an air cargo agent handle the bookingfor them. Air cargo agents are those who are approved by the InternationalFederation of Air Transport (IATA) to handle air cargo on behalf of airlines.Some freight forwarders also have this accreditation, allowing them tohandle both sea and air freight. Most exporters use the services of freightforwarders for air transport of goods because freight forwarders will bebetter able to negotiate competitive freight rates. As well as this, airlinecompanies will offer no assistance in completing the air waybill. Usuallyairlines advise exporters to engage a freight forwarder so that these aspectsare taken care of correctly.

Most passenger aircraft also carry freight. There are also specialised aircargo carriers and airlines that operate not only an air cargo operationbut also the on-the-ground collection and delivery of freight. These lat-ter services are operated by what are known as integrators because of theintegration of both the air and land portion of the transport of goods.

Either the exporter or the air cargo agent that has been retained willarrange for the transport of the goods from the exporter’s premises to theair cargo terminal. At that point the cargo is arranged ready for transport.Air cargo is either loaded onto the aircraft on pallets, in special aircraftcontainers (known as unit load devices or ULDs) in the aircraft cargoholds, or into specialised chilled or freezer compartments for the transportof perishable goods. The costs of the airfreight are calculated by weight.Generally speaking, rates per kilogram decrease with the weight of theshipment.

C O N T R A C T O F C A R R I A G E

If goods are transported by air, the primary document of carriage is theair waybill. This document is a non-negotiable instrument that serves as areceipt for the goods as well as evidence of the contract of carriage. Other


steps that must be taken when goods are sent by air include obtainingan export declaration number from customs, any export permit requiredunder quarantine or other laws, and a dangerous goods declaration if thegoods fall into any of the categories of dangerous goods.

Air waybills are completed either by the exporter or by the cargo agentor freight forwarder. Airlines have standard air waybill forms, often bearingthe logo of the airline. Completion of the air waybill is a specialised andcomplicated task that has significant ramifications for the exporter, as willbe seen below.

The air waybill contains the usual particulars for documents of carriage,including a number allocated to the exporter for the air waybill, the name ofthe exporter, consignee, carrier, cargo agent, airport of departure and routeto be followed (illustrated in Chapter 1). Perhaps the most complicated partof completing an air waybill relates to the cargo itself and the freight rateallocated to the cargo. Separate entries must be completed for all items thathave a different class of freight. For each group of items within a given class,the number of pieces, weight of the items in that class, the applicable chargerate and nature and quantity of the goods must be specified. Specialisedknowledge is required of the various freight rates applicable to variousclasses of goods for the completion of this part of the air waybill.

The conditions printed on an air waybill constitute the contract of car-riage, and these are accepted by the exporter when either it or its agentsigns the air waybill. These conditions follow the provisions of the WarsawConvention (as amended) (see below) quite closely in relation to the mini-mum information that is to be contained in an air waybill and the numberof copies that are required, as well as the liability of the carrier. This isdiscussed in more detail below. The standard conditions in air waybillsalso mirror the rights of the carrier as contained in the Convention withregard to flexibility in the carriage of the goods. For example, the condi-tions provide that if the carrier undertakes to use ‘reasonable despatch’ intransporting the goods, it retains the right to use any other aircraft or othermeans of transport it deems necessary as well as to deviate from the agreedroute.

L I A B I L I T Y O F T H E C A R R I E R

The liability of air carriers is complicated by the international legal regimegoverning air transport. The first international convention negotiated inrelation to air transport is known as the Warsaw Convention. It cameinto force in 1929 and was adopted by many countries into their own


laws. In 1955 a new convention was entered into which is known as theWarsaw Convention as altered by the Hague Protocol. Not all countrieshave adopted the amended Warsaw Convention into their laws. In 1976a further amendment was made by what is known as the Four MontrealProtocols. Protocol number 4 applies to air transport of goods. Australia hasadopted the Montreal Protocol but it will not come into force until enoughother countries have also adopted it. There is some reluctance here becausethe Montreal Protocol imposes a higher level of liability on airlines for loss,damage or delay than does the original or amended Warsaw Convention.There is also the Guadalajara Convention, which deals with the situationwhere the contracting carriers do not themselves carry the goods.

The conventions adopt a lowest common denominator approach indetermining which of them governs the air transport of any particulargoods. Thus, while Australia has adopted the Warsaw Convention asamended by the Hague Protocol, if the country to which the goods arebeing sent has only adopted the original 1929 Warsaw Convention, it willbe the original Convention that applies to the carriage of the goods. Like-wise, if the country has adopted none of the conventions then the carriagewill not be governed by any international legal regime and the parties willhave to fall back on the terms and conditions in the air waybill. For thisreason the carrier’s air waybills tend to reflect the standard provisions of theWarsaw Convention. The carrier’s liability to be discussed here reflects theamended Warsaw Convention.

Under the Warsaw Convention (as amended by the Hague and MontrealProtocols), the exporter is responsible for the accuracy of the informationcontained in the air waybill relating to the goods, and must indemnify thecarrier for any damage that arises due to any misstatement. The exporter’sstatements in the air waybill are therefore prima facie evidence of what iscontained in the consignment. The carrier, on the other hand, is liable forany loss or damage to the goods, including any damage resulting from delaywhile the goods are under its control or that of its servants and agents. Thecarrier can only escape liability if it is able to show that it and its servantsand agents took all necessary measures to avoid the loss or damage and thatit was impossible for them to avoid it. The carrier cannot contract out ofits liability under the Convention.

If loss or damage occurs, the Warsaw Convention as amended by theHague Protocol limits the carrier’s liability to about $1 per kilogram (asopposed to the 17SDR per kilogram of cargo under the Montreal Protocol)unless a higher value has been declared by the exporter and accepted by theairline with the commensurate increase in freight rates. For the purposes of


calculating the amount of liability, the weight is the weight of the variouspackages. Notice of any loss or damage must be given to the carrier within14 days of delivery and it must be given in writing. Written notice ofdamages for delay must be given within 21 days. Any court action must becommenced within two years.

Discussion of the case of Siemens Ltd v Schenker International (Australia)[2004] 205 Australian Law Reports 232 provides a good illustration ofmany of the issues relating to air transport as well as the liability of freightforwarders. In this case, Siemens sent a consignment of telecommunicationequipment from Germany to its Australian office in Melbourne. It engagedSchenker to act as the freight forwarders to handle all the transport. Theair waybill issued by Schenker contained the following clause:

Except as otherwise provided in carriers tariffs or conditions of carriage,in carriage to which the Warsaw convention does not apply, the carrier’sliability shall not exceed USD $20 or the equivalent per kg of goods lostdamaged or delayed unless a higher value is declared by the shipper and asupplementary charge made.

The telecommunication equipment was damaged because of the neg-ligence of one of Schenker’s truck drivers on his way from Tullamarineairport to the Schenker depot. The incident occurred outside the bound-aries of Tullamarine airport. The question was whether Schenker could relyon the above-mentioned clause to limit its liability. If so, it would be liableto Siemens to the extent of $74 000; if it could not, it would be liable for$1.7 million.

Siemens argued that the clause limiting liability could only be relied on ifthe Warsaw Convention did not apply to any part of the ‘carriage’ includingthe air portion. Schenker, on the other hand, argued that the clause limitedits liability because it covered damage that occurred during that part ofthe journey not covered by the Warsaw Convention. Not surprisingly, theHigh Court did not give a unanimous decision. The majority, however,decided in favour of Schenker. The implications are that when a freightforwarder issues an air waybill excluding liability, such exclusion is likely tobe effective for periods of carriage outside the periods of carriage coveredby the Convention.

66 Cargo Insurance

An exporter or importer of goods is wise to insuregoods while they are in transit. Insurance can be taken out for any lossor damage to cargo during transit by air, sea or land. Insurance law andpractice relating to transport by sea differ in a number of ways from thatconcerned with air and land transport; these differences are explored in thischapter.

A brief history of insurance is also given, along with an outline of theessential concepts of insurance law, which will help to make sense of whatmay at first appear to be some peculiarities that relate to insurance con-tracts and insurance industry practices. Standard insurance clauses will beexamined, particularly those offered by the Institute Cargo Clauses and theUNCTAD model clauses on marine hull and cargo insurance.

In this chapter the reader should gain an appreciation of:� the essentials of a cargo insurance contract and the relevant law;� the standard ICC and UNCTAD insurance contract terms; and� insurance claims.

A B R I E F H I S T O RY O F C A R G OI N S U R A N C E L AW

Insurance policies for marine cargo have been available since medieval timeswhen sole operators in Lombardy in northern Italy offered them. Marineinsurance continued its development during the medieval period in Italiancities such as Genoa, Venice and Florence. The term ‘policy’ in the insur-ance sense derives from the Italian word polizza, which means promiseor undertaking. The industry gained more economies of scale in lateseventeenth-century Italy with the establishment of insurance companies.Merchants from Lombardy brought insurance practices to England during

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the Middle Ages. The English were later to dominate the insurance industryafter the formation of a society of underwriters in 1779, which agreed on astandard form of Lloyds policies. Extraordinarily, much of the wording ofthose early policies remains in the schedules to the Marine Insurance Act,although they are seldom used in practice these days.

The name Lloyds, as in Lloyds policies and Lloyds of London, dates backto Edward Lloyd who established a coffee house in Tower Street, London,that became a meeting place for men of commerce in the late seventeenthcentury. The establishment gained a reputation for providing trustworthyshipping news and as a place for obtaining marine insurance. Wealthybusinessmen who attended the coffee house shared in risks by signing theirnames on a policy that stated the amount they agreed to cover. Becauseeach signature was added under the previous, the signatories were knownas ‘underwriters’.

Around 1690, Lloyd moved his premises from Tower Street to the cor-ner of Abchurch Lane and Lombard Street. He died in 1713, but businesscontinued at his establishment, with a more formal Society of Insurers grad-ually evolving there. In 1774 ‘subscribers to Lloyd’s’ elected a committeeand moved to new premises at the Royal Exchange at Cornhill. In 1986,Lloyds moved into the large, modern purpose-built premises where it ispresently housed. Although the Society of Lloyds was incorporated underthe Lloyds Act 1871, it is not an insurance company. Rather, it is a societyformed of both individuals and companies. The members underwrite spec-ified risks as syndicates on whose behalf professional underwriters acceptrisks. The capital to support payment of potential claims is provided byinvestment institutions, individual investors and insurance companies.

Lloyds is not the only player in the cargo insurance market. Numerousinsurance companies and entities throughout the world compete for busi-ness. A large shipment of cargo will invariably be covered by an insurancepolicy involving a number of co-insurers, so as to spread their risk. Insur-ance brokers often represent exporters, and negotiate the most competitivepremiums and contract terms for their clients. The Marine Insurance Act1909 (Cth) places certain obligations and liabilities on brokers, in additionto the rights and obligations found under Agency Law, as we will find laterin this chapter.

T H E I N S U R A N C E P O L I C Y

An insurance policy provides evidence of the terms of the insurance agree-ment between the insurer and the insured. The trade practice with marine


cargo insurance requires the party that has the obligation to insure thegoods to arrange the insurance for the party that will become the insured.This means that the party arranging the insurance is not necessarily theparty that can claim under the policy if the cargo is lost or damaged. If thecontract for the sale of the cargo, or the letter of credit for the sale, incorpo-rates by reference contract terms specified in the incoterms, it is fairly easyto work out whether a party is required to arrange insurance for the otherparty. If the CIF (Cost, Insurance and Freight) incoterm is incorporatedinto a contract for the sale of goods, the seller will be required to arrangeinsurance on behalf of the buyer. The CIF incoterm requires that the sellermust insure the cargo for no less than 110 per cent of its CIF value. Theinsurance must cover the whole voyage to the final destination, and theseller must provide the buyer with the shipping documents, which usuallyinclude the bill of lading and the packing list as well as the insurance policy.

A variant of the CIF incoterm is the C&I incoterm, which excludes thecost of ocean freight from the price of the cargo, which means the buyermust pay separately for the carriage of the cargo. The seller, however, is stillrequired to arrange the insurance for the carriage of the goods by sea.

If the FOB (Free on Board) incoterm is incorporated, the seller does nothave an obligation to arrange the insurance but is simply required to loadthe cargo onto the ship from the port of export, after which the risk of thegoods being lost or damaged transfers to the buyer. It is therefore prudentfor the buyer to arrange to have the cargo insured during its carriage by sea.FOB terms are generally inadvisable these days, particularly if the cargo isbeing transported in containers. FOB terms tend to assume the cargo existsas discrete items that are loaded onto ships rather than items of cargo loadedinto containers, often with other cargo that is not related to the contractedcargo, which is then loaded onto ships.

T H E E S S E N T I A L S O F A C A R G OI N S U R A N C E C O N T R A C T

Cargo can be carried by sea, land and air. In Australia at least, the legisla-tion dealing with the carriage of goods by sea is the Marine Insurance Act(Cth) (MIA), while the law dealing with carriage by air and land is generalinsurance law, which is governed by the Insurance Contracts Act 1984 (Cth)(ICA). The reasons for sea carriage having its own legal regime is probablydue more to history than logic. The Australian Marine Insurance Act hasbeen in place since 1910, and has had only a few minor amendments. Atthe time of its enactment it largely copied the British Marine Insurance


Act. The Australian Act has six preliminary sections, some of which mirrorprovisions found at the end of the British Act, so that the Australian sec-tions are six numbers higher than the equivalent British numbers. That is,section 16 of the Australian Act mirrors section 10 of the original BritishAct, and so on.

The MIA is based on the freedom of contract theory. That is, muchof the Act sets out the underlying law that applies to a marine insurancecontract and effectively inserts contract terms into the insurance agreement.However, the parties are free to exclude or vary many of the MIA terms.The MIA therefore largely acts as a gap-filler, which means that the contractterms in the Act will apply if the terms of the contract between the partiesare silent on a particular issue.

Because the parties are free to negotiate their own terms, this usuallymeans in practice that the insurer has the upper hand in negotiating theterms of the marine insurance contract. This may lead to contracts thathave unduly wide exclusion clauses or contain other unfair terms. As aconsequence, the exporter needs to check the track record of the insurerit is dealing with to ensure it has a reputation for fair dealing or, as is theusual practice in the industry, the exporter should hire an insurance brokerwith an established reputation. If an insured party believes that it is beingunfairly denied a claim, it may nevertheless take legal action against theinsurer to compel the insurer to pay up on the claim.

The law treats each policy of insurance and co-insurance as a separatecontract of insurance. Generally, the law of the place where the insurerhas its place of business is the law governing the insurance contract, unlessthe insurance contract specifies the law applying to the contract, in whichcase the specified law will usually apply. Under the MIA each policy istreated as a different contract, which means that if a co-insurance policyfor marine cargo is entered into with an Australian insurance company, theMIA will often apply to that policy. It is therefore far from unusual fora shipment of marine cargo to be covered by multiple insurance policies,each governed by a different legal system, making any legal challenge some-what complex. The Comite Maritime Internationale (CMI) is presentlyworking on a proposal to harmonise marine insurance law throughoutthe world. The CMI is a non-government organisation formed in 1897,and has a membership of distinguished lawyers concerned with maritimelaw and related commercial practices. If the CMI eventually succeeds withits harmonisation ambitions, it would greatly reduce the compliance andother costs involved in the existing fragmented systems throughout theworld.


The carriage of cargo by air and land is dealt with by general insurancelaw. In Australia, the principal legislation applying is the Insurance ContractsAct 1984 (ICA). This is more modern legislation than the MIA and containsmore consumer protection provisions than the MIA. Often cargo is carriedby more than one form of transport, and the insurance relating to the cargowill usually cover the various modes of transport. Uncertainty can arise asto whether the insurance contract is governed by the ICA or the MIA. TheMIA will apply if the dominant activity is sea transport, in other words themarine component of the insurance cover must be more important thanthe non-marine component. Sometimes a number of different policies areprovided in relation to the transit of the same cargo. In such a case, theICA might apply to the policy that does not predominantly cover carriageby sea, and the MIA to the policy that predominantly covers carriage bysea.

Some of the more significant differences between marine insurance andnon-marine insurance are:� In marine insurance law the amount recoverable by the insured is based

on the values of the insured items when the risk commences, rather thanat the time of loss (as is the case under general insurance law).

� In marine insurance law the broker is liable to the insurer for paymentof the premium.

� The insured is not required to disclose the fact that it has been previouslyrefused insurance cover, whereas this must be disclosed to the insurerunder general insurance law.

T H E I N S U R A N C E C O N T R A C T

Insurance is essentially a contract in which the insurer agrees to reimbursethe insured for specified future losses. Under a valid insurance contract,one party (usually the insurer) makes an offer of insurance that is acceptedby the other party (usually the insured). Before the contract is entered into,an insurer will usually require a potential insured to fill in a proposal formrequiring the potential insured to supply certain details about themselves.The law treats the completed proposal form as an offer by the potentialinsured to enter into a contract with the insurer. If an insurance policy isissued, the law takes this to be an acceptance of the offer, and at that pointan insurance contract is formed.

The insurance policy sets out in writing the terms that form the basis ofthe insurance contract. The contract is usually not restricted to the termsset out in the policy; other terms will be implied or imposed by law.


Insurers will often provide ‘cover notes’ if requested by a potential insuredbefore any insurance contract is entered into. A cover note is usually a verbalagreement in which the insurer agrees to provide interim insurance coverwhile the insurance contract is being arranged.

E S S E N T I A L C O N C E P T S

Although an insurance contract is at its heart simply a contract, it doeshave certain peculiarities that distinguish it from other forms of contract.Generally, insurance law requires that:� the insured have an insurable interest in the subject matter of the contract

at the time of entering into the contract and at the time the loss isincurred;

� the parties have a duty of disclosure; that is, the parties must be up frontand honest with each other; and

� the parties have a duty to deal with each other on the basis of utmostgood faith. This is related to the duty of disclosure but extends beyondthat duty and is an obligation that applies beyond the time when thecontract was formed.These basic concepts apply in many countries, although there will be

local variations of the law. Both the Marine Insurance Act and the InsuranceContracts Act, for instance, elaborate on and make some variations to thesebasic concepts. The basic concepts and the statutory variations will beexplained in this chapter.

T H E I N S U R A B L E I N T E RE S T RE Q U I RE M E N T

The law has tended to take a strict view that a claimant under an insurancepolicy must have had a legal or equitable interest in the subject matterof the insurance at the time of entering into the insurance contract andat the time of loss. The idea behind these requirements is to distanceinsurance contracts from gambling arrangements, and to discourage theinsured from insuring something it neither owned nor had an interest in.Prior to reforms brought in Britain in the mid-eighteenth century, partiesthat had no financial stake in the loss of a ship or its cargo would ‘insure’the ship and its cargo. So if a ship was lost at sea, they would recover onthe insurance regardless of the fact that they had lost nothing. This form ofinsurance was indistinguishable from betting. The disconnection betweensuffering a loss and recovering on the insurance policy encouraged over-insurance, which meant that ship-owners could gain more remuneration


from a sunk ship than from one that continued to ply the seas. There waslittle incentive to maintain seaworthy vessels, which led to unsafe ships andunnecessary loss of life.

In response to the reforms, the law moved over time from one extreme tothe other, tending to become overly strict and technical in its requirementthat the insured have an insurable interest in the insured property. Thisled to insurance companies accepting premiums but then refusing to payclaims on the ground that the insured had no insurable interest. The case ofMacaura v Northern Assurance Co Ltd [1925] Appeal Cases 619 offers oneillustration of the law’s strictness. In that case, the insured owned timber,which he sold to a company of which he was the sole shareholder. Heinsured the timber in his own name, and not the company’s. The timberwas destroyed by fire. The court found that the insured could not claimunder the policy because he had no insurable interest in the timber. Hedid not own the timber, the company did. And although he was the soleshareholder and he clearly suffered financial loss as a result of the fire, thatdid not give him a sufficiently direct interest in the timber itself, just as ashareholder of a company does not have a direct interest in the assets ofthe company. A shareholder of an airline company, for example, cannotinsure the company’s aircraft and make a claim if an aircraft is damagedmerely because they are a shareholder. Although at a more abstract levelthe reasoning in Macaura was fair, it failed to take adequate account of theparticular circumstances of the insured, and allow for the fact that he wasnot simply a shareholder in a listed company but the sole shareholder of asmall company and therefore suffered a direct financial loss.

US law adopts a different approach by requiring only that the insuredshow it has a lawful economic interest in the preservation of the propertyfrom loss or damage. This approach is followed in the Australian InsuranceContracts Act, where the insured must at least have suffered a monetary oreconomic loss relating to the subject matter of the insurance contract. So,in relation to goods insured by an Australian insurer that are predominantlycarried by air or land and are therefore not covered by a marine insurancepolicy, the insured only needs to establish that it has suffered a monetaryor economic loss in relation to the insured cargo to establish an insurableinterest.

Marine cargo insured by an Australian insurer is governed by the MIA,which is based on the old insurance law. Here, the insured must have a legalor equitable interest in the insured property, which means that the insurercan raise legal technicalities to deny a claim. The MIA does, however, makea number of exceptions to the old law. Unlike the old law, the insured is


not required to have had an insurable interest in the insured property at thetime the insurance contract was entered into, but must have an insurableinterest in the property at the time of the loss. One reason for this exception,as has been mentioned, is that it is a common practice in the marine cargoindustry for the seller to arrange the insurance on behalf of the buyer. Underthe CIF incoterm, for example, the seller is required to arrange insurancefor the buyer, and the risk in the cargo shifts to the buyer once the goodscross the ship’s rail at the port of export. So the seller is in effect required toarrange insurance on behalf of the buyer to cover any loss during transit.As an additional complication, the buyer can on-sell the goods while theyare in transit. Under the MIA, the second purchaser would be able to claimunder the original insurance policy if the goods were lost or damaged intransit after the sale took place.

The way the MIA establishes the requirement for the insured to have aninsurable interest in the goods is a little complex. It begins by stating that aperson has an insurable interest if it has an interest in a ‘marine adventure’.Under the Act, a person includes a company. Section 11 states that a personhas an insurable interest if they have a legal or equitable relation to theadventure or any insurable property at risk from the adventure. Generallyspeaking, a person will have a legal interest in the goods if they have legaltitle to the goods. They will have an equitable interest if, for example, theyhave a mortgage or lease over the goods, or a partial or future interest inthem. The mortgagor and the mortgagee of cargo can insure the cargo ontheir own behalf and on behalf of another interested person.

Rather confusingly, section 11 proceeds to elaborate on what constitutesan insurable interest by stating that a person has an insurable interest ifthey might gain a benefit from the safety or due arrival of the property,or suffer from the loss, damage, late arrival or detention of the property.So the elaboration the Act provides on the meaning of a legal or equitableinterest appears to extend beyond a merely legal or equitable interest tocover monetary or economic loss.

Problems can arise if goods are sold in transit. The insured can assign(that is, transfer) its insurable interest to the buyer of the goods duringtransit, unless it is expressly forbidden by the policy. The point at issue canbe illustrated this way. Say A is the exporter of goods, which it sells to Bunder a contract containing a CIF clause. A therefore arranges insuranceon behalf of B. Unbeknownst to A and B, during transit the goods aredamaged. B then sells the goods to C while the goods are still in transit, butat the time none of them are aware the goods are damaged. When the goodsarrive, C inspects them, finds they are damaged and seeks to claim under


the insurance policy arranged by A. The question arises as to whether Chad an insurable interest in the goods. The problem here is that at the timeof the loss C had no legal title to the goods, nor did it have any mortgageor other equitable interest in the goods. On that basis it would appear thatC has no insurable interest. However, since section 11 states that a partyhas an insurable interest if it might gain a benefit from the safety or duearrival of the property, it would appear that C could claim, even though ithas no legal or equitable interest. The law is therefore rather uncertain onthis point.

There are legal cases that take a narrow view on this question and othersthat take a more generous view. A more generous view is taken in a casecalled The Moonacre (1992) 2 Lloyd’s Reports 501 in which the insured’syacht was totally destroyed by fire. The claimant’s boat was registered inthe name of a Gibraltar company for tax purposes. The court said that theessential question was whether the connection between the insured andthe loss was close enough to differentiate it from a wagering or gamblingcontract. As the insured was the sole user of the yacht, the court concludedthat he had a real (and insurable) interest in it. A narrower view is takenin NSW Leather Co Pty Ltd v Vanguard Insurance Co Ltd (1991) 25 NSWLaw Reports 699, where the insured purchased leather from a supplier inBrazil. The goods were consigned by the sellers to a forwarding agent at RioGrande, which is hundreds of kilometres inland, where they were packedinto 11 shipping containers which were closed and sealed. It was discoveredafter the containers had arrived in Sydney that they had been broken intoand resealed before they had been loaded onto the ship in Brazil. Boththe sellers and the buyers had been unaware of the thefts until after thecontainers had arrived in Sydney. The buyer claimed under the insurancepolicy, but the insurer denied the claim on the ground that the buyer hadno insurable interest in the goods at the time of the theft.

The NSW Court of Appeal agreed that as the goods had been sentFOB, the insured was not ‘at risk’ in relation to the goods at the time of thetheft, and on that basis would not be able to claim on the insurance policy.However, the policy contained a ‘lost or not lost’ clause. Under that clausethe insurer agrees to insure goods if the loss occurs before the insurancecontract is entered into, provided the insured was unaware of the loss at thetime of taking out the insurance. But the court affirmed that the insuredmust have an interest in the goods at the time of loss. The court foundthat the parties had in fact intended under the contract for the sale of thegoods that the property in the goods would transfer to the buyer at thetime they left the seller’s place of business. The buyer was therefore found


to have had a legal interest in the goods before the thefts occurred, andso could recover because of the lost and not lost clause and the fact thatthey had entered into a contract for the sale of the leather before the lossoccurred.

The insured must not only have an interest in the goods to claim underan insurance policy, they must also suffer a relevant loss in relation to thegoods. In the words of the MIA, the insured must have an interest in a‘marine adventure’. A marine adventure occurs if� a ship, goods or movables is exposed to a maritime peril;� earnings are adversely affected by exposing the insured property to a

maritime peril;� liability to a third party is incurred by the owner or person interested in

or responsible for insured property as a result of a maritime peril.A maritime peril relates to an incident at sea. According to section 9 of the

MIA, it includes ‘fire, war perils, pirates, rovers, thieves, captures, seizures,restraints, and detainments of princes and peoples, jettisons, barratry andany other perils either of the like kind or which may be designated by the[insurance] policy’. The language of the section reminds us that the MIAhas survived since the early twentieth century with barely any amendments,as it quaintly singles out princes for special mention. The uncommon term‘barratry’ means an unlawful practice committed by a ship’s master or crewthat harms its owner or charterer.

Although the maritime peril must relate to an incident at sea, it is notconfined to incidents that happen at sea. A marine insurance contract maycover some land risks or losses on inland waters that are incidental to a seavoyage, but the sea voyage must be the primary risk being insured. TheHigh Court of Australia made the rather curious finding in the case of Gibbsv Mercantile Mutual Insurance (2003) 214 Commonwealth Law Reports604 that the ‘sea’ included the mouth of the Swan River in Perth. In thatcase a woman was injured by Gibbs, who ran a paraflying business. Duringthe course of his business he rode his boat too close to an island in themouth of the river, causing the woman to be slammed against trees, leavingher with severe injuries. Gibbs had third party insurance. The question waswhether it was marine insurance or general insurance. The court foundit to be marine insurance, which meant the policy had a more restrictiveoperation for the insured.

The ICA usually regulates insurance contracts for cargo transported byair or land that are governed by Australian law. Under the Act the insuredis not required to have an insurable interest in the cargo or in any liabilityin relation to the cargo in the way the law understood that requirement


before the ICA was enacted. The insured need only suffer a pecuniary oreconomic loss as a result of the cargo being damaged or destroyed to beable to claim (provided the insurance itself allows for the claim).

D U T Y O F D I S C L O S U RE

Invariably, the insured has better access to information about the subjectmatter of a proposed insurance policy than the insurer. That is, the insuredwill have an advantage regarding essential information on which the insurercan make assessments about whether it is worth insuring the risk and theappropriate premium to charge for the risk. Because of this informationadvantage, the law places a duty on a potential insured to reveal all materialinformation to the insured before entering into an insurance contract. Ifthe insured fails to do this and makes a claim, the insurer may deny theclaim because the insured did not reveal the material information.

Although this is a sound proposition, it has been abused in practice.There have been many instances of insurers attempting (and often succeed-ing with the support of the law) to deny claims on the basis of relativelytrivial and technical failures by the insured to disclose ‘material’ informa-tion to the insurer. The practice of refusal of claims became so notoriousthat it led to reforms in the mid-1980s, leading to the introduction of theInsurance Contracts Act. As mentioned, this Act generally applies (amongother things) to the carriage of cargo by land and air, but not to marinecargo.

Under the old law before the introduction of the Insurance Contracts Act(and the law is still largely the same regarding this point under the MarineInsurance Act), the potential insured was required, before entering into theinsurance contract, to disclose all ‘material’ facts to the proposed insurer.These are facts that would have reasonably affected the mind of a prudentunderwriter in deciding whether it would accept the insurance, and if so atwhat premium and on what terms. This requirement requires the potentialinsured not only to answer the questions set out in an insurance proposalform, but also to reveal material information that has not been specificallyrequested by the proposed insurer. The difficulty for the potential insuredis knowing what would affect the mind of a prudent underwriter. In oneEnglish case in 1922 the court held that the claimant could not claim forlosses suffered as a result of a burglary because he had failed to mentionthat he was a Romanian national on the proposal form, even though he hadbeen living in England for 22 years, since the age of 12. A 1978 English caseheld that the claimant could not claim under a fire insurance policy because


he had not disclosed a robbery conviction, even though there appeared tobe no connection between the prior conviction and the fire.

TR A N S P O R T O F C A R G O B Y A I R A N D L A N D

As already mentioned, insurance for cargo transported by air and land byan insurance policy governed by Australian law is usually subject to theInsurance Contracts Act. The Act has reformed the law regarding disclosure.Before entering, extending, renewing or varying an insurance contract, theinsured is only required to disclose information that� the insured knows to be relevant for the insurer to decide whether to

accept the risk, and if so on what terms; or� a reasonable person in the circumstances could be expected to know is

a relevant matter.It is common knowledge that the insured is not required to disclose

information that diminishes the risk for the insurer, or else is informationthat the insurer knows or ought to know in the ordinary course of itsbusiness. In addition, the insured is not required to reveal information thatmay increase the insurer’s risk if the insurer waives the requirement for thatinformation to be revealed. If the insured fails to answer a question onan insurance proposal form, or gives an obviously incomplete or irrelevantanswer, and the insurer proceeds to provide insurance cover, the insurer isdeemed to have waived the requirement to have that information provided.

The insured is only required to reveal information actually known to it,and will not be found to have failed the duty of disclosure if it did not revealinformation that it ought to have known about in the ordinary course ofits business. The courts have interpreted this duty to include informationknown by an insured’s agent. In Lindsay v CIC Insurance Ltd (1989) 16NSW Law Reports 673, the insured’s managing agent knew the insuredpremises was being used as a brothel. The failure to mention this in theinsurance proposal amounted to a breach of the duty, even though theinsured was apparently unaware of the use of the premises. However, if aninsured landlord is unaware the tenants had flammable material stored inthe premises, the duty is not breached (CIC Insurance Ltd v Midaz Pty Ltd(1998) 10 ANZ Insurance Cases 74,182 [61–394]). It is not enough thatthe insured merely suspected or believed that a certain material fact existed;to amount to a breach, it must actually know of the fact and fail to mention iton the proposal or renewal form. Any material information about criminalor dishonest conduct must be mentioned, even if no conviction is recordedagainst the offender.


A co-insured will not be able to claim if the other co-insured failed tomention a material fact. In Advance (NSW) Insurance Agencies Pty Ltd vMatthews (1989) 166 Commonwealth Law Reports 606, a married couplewere co-insured for a contents policy for their business, which was damagedby fire. The husband had failed to mention that he had previously beeninvolved in litigation against an insurance company over a claim involvinga fire. His wife was not a party to the non-disclosure, but was found by thecourt to be disentitled to make a claim under the policy.

The insurer cannot refuse a claim if there is a failure to disclose informa-tion, but only if the insurer would have provided the insurance on the sameterms had it been told that information before the insurance contract wasentered into or renewed. If the insured innocently fails to provide materialinformation, or the insurer elects not to avoid the contract, the insurer canreduce its liability to pay on the claim to an amount it would have paidhad it been given the material information.

TR A N S P O R T O F C A R G O B Y S E A

Insurance for the carriage of cargo by sea is governed by the Marine Insur-ance Act, which sets very high requirements on the insured to discloseinformation to the insurer. If the information is not disclosed, the insurercan terminate the contract and refuse to pay up on a claim. The insuredis required to disclose information, even if in some circumstances it isunaware of the information at the time it entered the insurance contract.For example, the insured is required to disclose information it ought tohave known of in the ordinary course of business even if it is unaware ofthe information.

The MIA, in contrast with the ICA, takes the perspective of the insurer,not the insured, in setting the disclosure requirements. The insured needsto make judgements about what information an insurer would require. Theinsured must disclose every material circumstance that would influence thejudgement of a prudent insurer in fixing the premium or deciding whetherit will take the risk. The insurer is entitled to terminate the contract if theinformation is not disclosed, even if the non-disclosure or misrepresentationhas nothing to do with the losses sustained.

The courts have not arrived at an agreed position on what informationis material and must be disclosed by the insured. The approach likely to betaken by a court is that taken in the English case of Pan Atlantic InsuranceCo Ltd v Pine Top Insurance Co Ltd [1995] 1 Appeal Cases 501, which wasfollowed by the Supreme Court of Victoria in Akedian Co Ltd v RoyalInsurance Australia Ltd, Sun Alliance Australia Ltd [1999] 1 Victorian


Reports 80. In Pan Atlantic the court adopted a two-stage test: first, anassessment needs to be taken of the impact of non-disclosure on the mindof a hypothetical prudent insurer. If the insured fails to disclose informa-tion it should have disclosed using this test, the second question to be askedis whether, taking the facts of the particular case under dispute, the non-disclosure did in fact induce the insurer to issue the policy. If the answer isyes, the insurer is not required to pay up on the claim; if the answer is no,the insurer cannot terminate the contract on the ground of non-disclosure.

Although Pan Atlantic has clarified a number of issues, uncertaintiesremain. It is not altogether clear what ‘inducing’ the insurer means. Mustit have been decisive in causing the insurer to agree to enter the insurancecontract, or merely a factor in causing the insurer to enter the contract?The law is not clear on this point. There are also remaining problems aboutwho carries the burden of proving what the insurer would have done if theinformation that was not disclosed to the insurer had in fact been disclosed.Again, the law is uncertain on this point.

D U T Y O F U T M O S T G O O D F A I T H

The duty of utmost good faith is a fundamental obligation on both partiesunder insurance law. To some extent this obligation overlaps with theduty of disclosure in that utmost good faith requires that both partiesconduct their contractual relationship fairly, decently and reasonably. Thefailure to disclose material information is considered to be a breach of theduty of utmost good faith because, generally speaking, the insured hasan information advantage over the insurer in relation to details about theinsured’s particular circumstances, and the insurer is dependent on theinsured disclosing that information.

The duty of utmost good faith extends beyond information disclosureto include any matters arising under and in relation to the contract, andso includes conduct taking place during the course of the contract. Delaysby the insurer in paying on a claim while it unreasonably awaited a policereport leading to the insured suffering liquidity problems has, for example,been found to be a breach of utmost good faith.

Section 26 of the Marine Insurance Act requires that the insured or theiragent must, during negotiations for the insurance contract, only makematerial representations to the insurer that are true. Material representationsare those that would influence the judgement of a prudent insurer in fixingthe premium or deciding whether to take the risk. Section 26(5) states thata representation about a matter of expectation or belief is true if it is made ingood faith. It was argued for the insurer in Economides v Commercial Union


Assurance PLC [1997] 3 Weekly Law Reports 1066 that the representationscould only be made in good faith if they were made on objectively reasonablegrounds. The court disagreed with that argument, however, and said thatgood faith contains an element of subjectivity. In other words, as long as theinsured believes the representations to be true, they can be acting in goodfaith, even if the basis for believing those representations is not objectivelyreasonable.

The duty of good faith arguably favours the insurer under the MIA, atleast, because if there is a breach of the duty it allows the contract to beterminated. If the insurer breaches the duty, the insured has its premiumreturned; if the insured breaches it, it cannot recover on its claim. Theamounts of money at stake are vastly disproportionate. The situation isdifferent under the ICA, where if there is a breach of the duty of utmost goodfaith, the parties are not limited to the remedy of simply terminating thecontract. The parties can seek damages (that is, monetary compensation)for breach of contract, or can seek specific performance, which could allowa court to positively require the insurer or the insured to carry out itscontractual obligations. Under the MIA, the remedy for breach of the dutyof utmost good faith is the right to terminate the contract. As mentioned,this remedy usually advantages the insurer.

WA R R A N T I E S

General contract law distinguishes between contract terms that go to theheart of the contract, which are called ‘conditions’, and less important terms,which are called ‘warranties’. If for example we have an agreement in whichyou are to supply me with a car at an agreed price and you fail to deliverthe car, that would be a breach of condition. A breach of a condition canallow me to terminate the contract and ask for any deposit to be returned.If, however, you supply the car, but it did not include the car radio asagreed in the contract, it could amount to a breach of a warranty, thoughnot a breach of a condition. I would not be entitled to terminate the con-tract and return the car, but I could sue you for the value of the car radio.

Matters are somewhat more confused with marine insurance. For varioushistorical reasons, a ‘warranty’ under a marine insurance contract is usuallytreated as if it were a condition. The main distinction from a generalcontract law breach of condition is that a breach of an insurance warrantydoes not allow the insurer to terminate the contract from the time of itscommencement; rather, the insurer is discharged from liability from thedate of the breach of warranty. The insurer is discharged from liability evenif the breach of warranty bears no relationship to the cause of the loss for


which a claim is being made. Nor does it matter that the breach is trivial. Sounder a marine insurance policy the insured is required to comply strictlywith a warranty.

Despite a breach of a warranty, the insurer can decide to waive its rightsand pay up on the claim. In practice, paying up on marine insurance claimsbecomes somewhat discretionary because the insurer can invariably findthat there has been some minor technical breach by the insured. Conse-quently, the insurer’s track record for paying up on claims, the insurer–clientrelationship, or the broker–insurer relationship, become crucial consider-ations for a potential insured when deciding to take out a policy. Alter-natively, before entering the contract a potential insured could instructits lawyer to identify the warranty clauses and negotiate the addition of aclause that states that a breach of those warranties does not in itself allowthe insurer to be discharged from its obligation to pay up on a claim. Theparties can negotiate either to remove some or all of the proposed warrantyclauses, or to remove the insurer’s right to be discharged from its obligationsif there is a breach that did not contribute to the loss.

There are a number of provisions in the Marine Insurance Act that effec-tively insert terms known as implied warranties into the insurance contract.Section 44 implies a warranty that the insured subject matter is well or ingood safety on a particular day. Section 45 implies a warranty that the shipis seaworthy, but section 46 states that there is no implied warranty that thegoods are seaworthy. Section 45 therefore applies in relation to insurancefor the hull of the ship, but section 46 makes it clear that this does notapply to insurance for the cargo.

Section 47 implies a warranty that the insured adventure is a lawful oneand, to the extent that the insured can control the matter, is carried out ina lawful manner. This warranty might be breached if the seller contracts tosell the cargo in breach of government regulations by selling to the enemyor in breach of economic sanctions. There might also be a breach if thecargo is seized because of a breach of customs regulations.

The parties to the contract can exclude or modify the MIA warrantiesby express agreement. The insurer can negotiate to include additional war-ranties in the insurance policy. These may provide for the particular typeof cargo that is being insured. For example, the warranty may require thatthe cargo be packed or stowed in a particular way or be stored at a specifiedtemperature during transit.

An insurance contract for cargo transported by air or land that is cov-ered by the Insurance Contracts Act is more favourable to the insured thaninsurance under the Marine Insurance Act. Under section 54 of the ICA,the insurer cannot refuse to pay a claim solely because of a breach of the


insurance contract. So a breach of a warranty by the insured does not initself allow the insurer to refuse to pay up on a claim. Section 54 does,however, allow the insurer to reduce payment for a claim by an amountthat fairly represents the extent to which the insurer’s interests were preju-diced as a result of an act by the insured. In other words, the insurer canonly refuse to pay a claim to the extent that the loss relates to the actions ofthe insured. The insurer may also refuse to pay for the insured’s loss undersection 54 if the insured’s act could reasonably be regarded as being capableof causing or contributing to the loss.

VA L U E D A N D U N VA L U E D P O L I C I E S

Under general insurance law, the insured cannot claim more than it haslost. An exception to the rule in relation to marine insurance is the ‘valuedpolicy’. Here, if there is a total loss of goods, the amount of the indemnityis a fixed amount specified in the policy. A valued policy therefore specifiesthe value of the insured cargo (section 33 MIA), whereas the unvaluedpolicy merely states the maximum limit of the insured amount, leaving itsvalue to be calculated after the loss (section 34 MIA). Generally, under avalued policy, the insured can recover the prime cost of the cargo, plus theshipping and insurance charges and a notional profit of 10–15 per cent ofthe value of the cargo.

The unvalued policy will not include a notional amount for lost profits.The insured will need to prove the value of the goods that have sufferedany loss by producing sales invoices, the contract, vouchers and so on. Aloss adjuster will examine these items to make an assessment of the loss forthe insurer. The premium payable for a valued policy is invariably higherthan an unvalued policy.

It is possible for an exporter to insure multiple shipments using an opencover policy. This allows the insured to declare the value of each shipmentwhen it is made. The insurer will issue a certificate of insurance based onthe declaration for each shipment.

I C C A N D U N C TA D S TA N D A R DI N S U R A N C E C O N T R A C T T E R M S

Standard clauses have been developed for marine policies that can be incor-porated by reference into an insurance policy. One set of standard termscommonly incorporated into contracts by Lloyds insurers and insurers thatare members of the Institute of London Underwriters (which together


constitute the greater proportion of the UK marine insurance market) areknown as the Institute Cargo Clauses (ICC clauses). Insurers in other mar-kets, including the Australian, also widely use the clauses. ICC clauses forair cargo are also available. Another source of standard marine insuranceclauses that can be incorporated into insurance contracts by reference arethe UNCTAD model clauses on marine hull and cargo insurance.

The most commonly used ICC clauses are the A Clauses or All Risksclauses. These cover all risks of loss of or damage to the insured cargo. TheC Clauses or Minimum Cover clauses cover damage to the insured cargofrom the ship stranding, grounding, sinking or capsizing; the overturningor derailment of land conveyance; the collision of the ship with anothership or craft; the contact of ship, craft or conveyance with anything otherthan ship or craft (excludes water but not ice); the discharge of cargo atport of distress; fire or explosion; earthquake, volcanic eruption or lightning;general average sacrifice; and jettison. The B Clauses or Intermediate Coverclauses cover the same events as the C clauses together with total loss ofcargo overboard during loading and discharge; washing overboard of deckcargo; seawater entering ship, craft, hold, conveyance, container, lift van orplace of storage; and river or lake water entering same.

The A Clauses are sometimes referred to as Full Cover, the B Clauses asWith Particular Average and the C Clauses as Free of Particular Average.The terms of the ICC clauses are set out at <www.jus.uio.no/lm/private.international.commercial.law/insurance#Cargo>.

As you will see from the ICC clauses, there are extensive exclusionsfrom cover. Section 61 of the MIA provides gap-filling provisions regardingexclusions for the wilful misconduct of the insured, ordinary leakage ofthe goods, and rats and vermin. These provisions apply unless excluded oroverridden by terms in the insurance contract. Table 6.1 sets out the clausesor sections that set out the relevant exclusions.

W I L F U L M I S C O N D U C T O F T H E I N S U RE D

The insurer is liable for the insured loss proximately caused by the insuredevent, even if the loss was partly attributable to the misconduct or negligenceof the ship’s master or crew. But the insurer is not liable for the wilfulmisconduct of the insured (section 61(2)(a) MIA). It is fairly unusual forthe insured to wilfully damage its own cargo, although it is less uncommonfor an insured to scuttle its own vessel so as to claim on the insurance policy.

Clause 3.2 of the UNCTAD model clauses is more detailed than theICC clause on this exclusion. It excludes loss resulting from the personal


Table 6.1. Exclusion provisions in various insurance regimes

CLAUSE ICC MIAICC (Air)clauses UNCTAD

Wilful misconduct of insured 4.1 61(2)(a) 2.1 3.2Ordinary leakage 4.3 61(2)(c) 2.2 3.3Insufficient or unsuitable

packing4.3 2.3 3.5

Inherent vice or nature ofgoods

4.4 2.4 3.7

Delay 4.5 2.6 3.8Charterer’s insolvency 4.6 2.7 3.9Weapons of war 4.7 2.8 3.1.3Rats or vermin 61(2)(c)

act or omission of the insured, done with the intent to cause the loss orrecklessly causing the loss with the knowledge that the loss would probablyresult.

O RD I N A R Y L E A K A G E

The insured cannot claim, under this exemption, for the ‘ordinary leakage,ordinary loss in weight or volume, ordinary wear and tear of the sub-ject matter insured’. In practice this tends to be a fairly uncontroversialexclusion.

I N S U FF I C I E N T O R U N S U I T A B L E P A C K I N G

The insurer is not liable for any loss, damage or expense caused by insuffi-ciency or unsuitability of the packing or preparation of the insured cargo.If loss, damage or expense is incurred in relation to the cargo as a resultof the cargo being stowed in a container or lift van, the insurer will notbe liable if the loss etc. occurred before the insurance was attached to thecargo.

I N H E RE N T V I C E O R N A T U RE O F G O O D S

The insured cannot claim under this exclusion for the natural tendencyof goods to deteriorate through natural decay; for example, fruit rotting,meat putrefying, leather sweating and wine souring. Difficulties arise when


a voyage takes longer than expected, allowing, for example, a cargo of fruitto rot, or seawater to leak into the cargo, thereby acting as a catalyst to thedeterioration of fabrics or leather. The essential question to be asked in thesecircumstances is, what would be the natural course of events regarding thecargo if the contemplated voyage had taken place without the interventionof an unexpected and disrupting event? To use technical language, thequestion is what is the proximate cause, or the real or dominant cause ofthe loss? If the dominant cause of the loss resulted from the inherent natureof the goods, the insured cannot claim. If on the other hand the dominantcause of the loss was an unexpected external accident, then the insured canrecover under an insurance claim.

D E L A Y

The insured cannot recover from loss caused by delays arising during transit.Mere delay is not in itself a ground for the insurer to deny the claim. Thedelay must be the chief cause of the loss. For example, if the goods weredamaged because of the negligent handling of them by the crew, and theship happened also to be significantly delayed in arriving at port, thenthe chief cause of the loss would be the negligent handling and not thedelay; the insurer could not refuse to pay up on the basis of the delay. If,however, a cargo of apples rotted because of the delay, the insurer couldrefuse to pay on the claim because the loss was caused by the delay.

C H A R T E RE R ’ S I N S O L V E N C Y

Under the ICC clauses, if a ship’s charterer becomes insolvent and thevoyage on which the cargo is being carried cannot be continued, causingthe insured to have to pay additional expenses for substitute voyages, theinsured cannot claim for the additional expenses or other resulting losses.The UNCTAD clauses offer two alternative clauses regarding insolvency.Alternative A mirrors the ICC clauses, while Alternative B provides anextensive elaboration of the circumstances in which the exclusion applies.

Under Alternative B, the insured cannot claim if loss is caused by insol-vency and the insured failed to take all necessary and prudent measuresto establish the financial reliability of the owners, managers, charterers oroperators of the vessel. This clause places the onus on the insured to take allnecessary measures to establish the financial reliability of the ship’s opera-tors. Alternative B also provides for the situation typically arising under aCIF incoterm, in which the seller arranges the cargo transit insurance for


the buyer and the buyer takes the risk of damage or loss of the cargo dur-ing transit. Here, Alternative B provides that the buyer/insured cannot beprevented from claiming if there is insolvency, as long as the buyer/insuredbought the insured cargo in good faith without notice of the insolvency orfinancial default of the ship’s operators or the failures of the seller to checktheir financial reliability.

WE A P O N S O F W A R

The weapons of war exclusion is fairly straightforward, and is found in mostif not all forms of transit insurance. It excludes loss, damage or expense aris-ing from the use of any weapon of war employing atomic or nuclear fissionor fusion or other like reaction or radioactive force or matter. UNCTADdoes not, however, have a similar exclusion clause. Clause 3.11 UNCTADoffers an additional exclusion that only applies if the parties expressly agreeto have the term included in the policy. It excludes losses and so on arisingdirectly or indirectly or in connection with nuclear, radioactive or similarmaterial or from the use of or accidents in nuclear installations or reactors.

R A T S O R V E R M I N

Damage to insured cargo by rats and vermin is covered by the ICC AClauses but not by the B or C Clauses or the Air Clauses, unless specificadditional cover is taken to cover these events. Section 61(2)(c) of theMarine Insurance Act also excludes loss caused by rats or vermin. However,since section 61(2)(c) is a gap-filling provision, if the insured has takenout insurance that incorporates the A Clauses, or has taken out additionalcover to insure against rats and vermin, these insurance terms will overridesection 61(2)(c).

G E N E R A L E X C L U S I O N S

General exclusions also appear in the ICC clauses and the UNCTAD modelclauses on marine hull and cargo insurance. The general exclusions dealwith unseaworthiness, war and strikes.

U N S E A W O R T H I N E S S

The unseaworthiness exclusion applies if at the start of the voyage the vesselwas unseaworthy or unfit to go to sea and the insured or its employees


Table 6.2. ICC and UNCTAD general exclusions

Event ICC UNCTAD

Unseaworthiness Clause 5 Clause 3.6.1.1War Clause 6 Clause 3.1Strikes Clause 7 Clause 3.1.7

were aware of the unseaworthiness or unfitness. If the policy covers thecargo being transported by mixed forms of conveyance, namely land or airconveyance as well as conveyance by sea, the exclusion also applies if anyof those other forms of transport are unfit.

WA R R I S K

The war risk exclusion deals with losses to the cargo resulting from:� war, civil war, revolution, rebellion, insurrection, or resulting civil strife,

or a hostile act regarding a belligerent power;� capture, seizure, arrest, restraint or detainment (except by piracy) and

the consequences of those actions or any attempt to undertake those;and

� derelict mines, torpedoes, bombs or other derelict weapons of war.Clause 3.1 of the UNCTAD clauses is more elaborate than the ICC

clauses regarding war risk. In addition to the excluded events mentionedin the ICC clauses, clause 3.1 UNCTAD mentions losses stemming fromsabotage or terrorism committed from a political motive; detonation ofan explosive caused by any person acting maliciously or from a politicalmotive; and confiscation, requisition, or other similar measures taken orattempted by any government or other similar organisation assuming orwielding power.

The reason for the greater elaboration in the UNCTAD clauses is thatdeciding whether a state of war exists is notoriously difficult. A war mayexist, for the purposes of this exemption, even if there is no formal decla-ration of war or severing of diplomatic relations. Insurance law in this areadoes not require the importing of international law definitions of ‘war’ intomarine insurance contracts. Doing so would amount to importing into thecontract obscure and uncertain technicalities of international law ratherthan the common sense of business people.

Deciding whether a ‘civil war’ exists, in policies that specifically exemptlosses arising from them, can be even more difficult. In Spinney’s (1948)


Ltd v Royal Insurance [1980] 1 Lloyd’s Reports 406, a three-part test wasproposed: first, there must be a conflict between opposing ‘sides’; second,the objective of the combatants must be to seize power, or force changes inthe way power is exercised; and third, it must substantially impact on publicorder and the life of the populace. Random, indiscriminate and pointlessviolence is not enough.

There must, of course, be a proximate relationship between theevents mentioned in the war exclusion and the loss suffered (see sec-tion 61(1) MIA). The insurer bears the onus of proving that the exclu-sion applies, which is often difficult (and expensive) to establish. Expertwitnesses, including political scientists and various academics, are oftenrequired.

S T R I K E S , R I O T S A N D C I V I LC O M M O T I O N S

The strikes, riots and civil commotions exclusion is rather broad. It excludesthe insurer’s liability for losses caused by or resulting from strikers, locked-out workmen, or persons taking part in labour disturbances, riots orcivil commotions; strikes, lock-outs, labour disturbances, riots or civilcommotions; or terrorists or any persons acting from a political motive.

A D D I T I O N A L C O V E R

With the payment of an extra premium, most insurers will provide addi-tional insurance cover to provide for losses due to war and strikes. TheICC clauses provide for additional cover for war. This covers war, civilwar, revolution, insurrection, or civil strife arising from those events, andany hostile act by or against a belligerent power. It also covers any relatedcapture, seizure, arrest, restraint or detainment. Losses arising from derelictmines, torpedoes, bombs or other derelict weapons of war are also covered.

The Strikes Additional Cover provides for losses caused by strikers,locked-out workmen, or people taking part in labour disturbances, riotsor civil commotions. It also covers losses caused by a terrorist or a personacting from a political motive.

Gaps can exist between the clauses that exclude liability and the clausesproviding additional cover. For example, the ICC’s strikes exclusions arebroader than the events insured under the strikes additional cover. Civilstrife and insurrection are excluded events that are not covered by the StrikesAdditional Cover clause.


The parties to cargo insurance contracts are generally quite sophisticated.Unlike consumer contracts for, say, household or car insurance, it is not amatter of an insurance company simply offering an insurance policy on atake-it-or-leave-it basis. Both parties will often negotiate particular clausesin a proposed policy, and tailor the policy to the particular circumstancesapplying to the cargo. The exporter might, for example, negotiate throughits broker for the inclusion of additional insurance cover for losses thatmight occur through delays because of the market price sensitivity of thegoods, or cover losses peculiar to the cargo, be it meat, wine, coal or oil.There may be a range of other risks that are unique either to the productbeing transported or the circumstances in which they are being transported.An exporter would be well advised to raise these particular risks with itsbroker so that negotiations can be made on its behalf to attain the optimumlevel of insurance cover.

I N S U R A N C E C L A I M S

When making a claim under an insurance policy, the insured has an obliga-tion to minimise the losses to be paid for under a claim, and an obligationto cooperate with any legal proceedings taken by the insurer in the nameof the insured.

O B L I G A T I O N T O M I N I M I S E L O S S A N DC O O P E R A T E W I T H L E G A L P RO C E E D I N G S

An insured has a general obligation to minimise the losses being suffered,so as to minimise the amount of the claim payable by the insurer. Section84(4) MIA imposes a duty on the insured and its agents to ‘take suchmeasures as may be reasonable for the purpose of averting or minimizinga loss’. The law imposes this obligation and the parties cannot contractout of it. The duty is reiterated by the ICC clauses. Clause 16 states thatthe insured and its servants and agents have the obligation to take suchmeasures as may be reasonable for the purpose of averting or minimisingsuch loss.

In addition to an obligation to minimise losses, the insured has anobligation to cooperate with legal proceedings taken by the insurer againsta third party that caused the loss. If, for example, the losses were caused tothe insured by the negligence of a third party, the insurer might pay up onthe claim and then seek to take legal action against the third party as a resultof its negligence. In taking the legal action, the insurer will, in a sense, step


Table 6.3. Provisions for loss minimisation

Obligation MIA ICC Air Clauses

Minimise loss Section 84 Clause 16 Clause 13Avoid delay Clause 18 Clause 15Cooperate with proceedings Section 85

into the shoes of the insured and use the name and require the cooperationof the insured in pursuing the legal action. This process of stepping intothe insured’s shoes is called ‘subrogation’. Section 85 MIA states that if theinsurer pays for a total loss, it becomes entitled to take over the interest ofthe insured and is thereby subrogated to all the rights and remedies of theinsured from the time when the loss occurred.

The UNCTAD model clauses on marine hull and cargo insurance offertwo alternatives regarding subrogation: clause 10.5.2 states, under Alter-native A, that

each insurer agrees to be subject to the jurisdiction of the courts applicable tothe leading insurer for all disputes under this insurance. The leading insureris authorized by his co-insurers to accept and conduct legal proceedings ontheir behalf.

This clause is useful where there are multiple insurers for the cargo. Theclause identifies the leading insurer as the party that can undertake any legalaction against a third party. Alternative B provides for no subrogation clause,which means that the general law needs to be relied on for subrogationrights.

The assumption underlying subrogation is that the insurer can recoverfrom a third party that causes loss to the insured goods. Problems arise ifthe insured did not have legal title to the insured goods at the time of loss,which means that even if the insurer did step into the shoes of the insured,it would not be able to claim against the third party. The third party wouldsimply argue that the insured/insurer had no right to sue because they hadno title to the goods. Only the party with title can sue. The insurer willtherefore tend to require the insured to prove who held title to the goodsat the time of loss, before they pay out on a claim. In practice this can bemore difficult and inconvenient than first appears. It invariably requiressearching through shipping documents, sales contract and banking recordsto satisfy the insurer as to which of the various parties to the sale contracthad title to the goods at the time the loss occurred. Exporters are well


advised to keep a good record-keeping system to minimise the time andfrustration involved in meeting the insurer’s requests.

If the insurer has subrogation rights, the insured must not do anythingthat would prejudice those rights, otherwise the insured may be liable torepay the insurer any amounts the insurer would be entitled to if its rightshad not been adversely affected. The insured must also have proper regardfor the insurer’s interests when conducting any litigation. The insured willbe liable to pay damages to the insurer for any misconduct or abandonmentof rights caused by any legal proceedings or compromise by the insured.Often the insurance contract will include terms that prohibit the insurerfrom negotiating, paying, settling, admitting to or repudiating any claimwithout the insurer’s prior consent.

In the case of non-marine insurance, the Insurance Contracts Act usuallyapplies. Insurers will generally negotiate to include subrogation rights inits insurance contracts. The ICA does, however, place some limitations onthe insurer’s rights of subrogation. These limitations generally do not affectcontracts in which the insured is a commercial operation. Under section65 ICA, restrictions are placed on rights of subrogation against uninsuredparties whom the insured would not be expected to sue, for example familymembers or others with whom the insured is in a personal relationship. TheAct also restricts the right of subrogation against an employee of the insuredunless the employee’s conduct is serious or involves wilful misconduct.

77 Customs

One of the endur ing characteristics of the nation-state is that national governments insist on the right to maintain some formof restriction over the movement of goods, people and money into and outof their territory. In this chapter we are concerned with the restrictionsthat are imposed on the movement of goods. Usually a customs author-ity or department undertakes the administration of whatever restrictionsapply. In Australia, the Constitution of 1901 gave sole authority to theCommonwealth Parliament to legislate on customs matters. Since thattime, there has been an Australian Customs Service to implement the lawsthat have been passed on the movement of goods into and out of the coun-try. As will be seen, while the Customs Service has been the main playercontrolling imports and exports, it is not the only one. Being a majoragricultural exporter, Australia also has several agencies dealing with theimport and export of agricultural products. The most significant of theseis the Australian Quarantine Inspection Service.

While national governments are the major players in determining theconditions on which goods enter and leave their territories, there hasbeen considerable willingness on the part of nations to adopt uniformapproaches to customs regulation and procedures. This willingness comesabout because it is recognised that international trade is beneficial andthat if there were no common approach to the adoption of laws and cus-toms procedures the flow of trade would be significantly impeded. Thusthere has been cooperation at the international level to obtain some uni-formity. There are two major sources of international influence on domes-tic customs laws and procedure. The first of these is the World TradeOrganisation (WTO). The second is the World Customs Organisation(WCO).

154

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The World Trade Organisation has the aim of reducing the formal ratesof duty that individual nation-states apply to the various classes of goodsthat enter their territories as well as attempting to reduce non-tariff barriersand adopting common standards in relation to import procedures. Some150 countries of the world are members of the WTO. Membership meansthat every country has to offer the same conditions for the entry of goodsto traders from every other member country. While there are some impor-tant exceptions to this basic principle (such as free-trade agreements), itsoperation over the years has meant that countries tend to impose the samerates of duty on goods entering their territory regardless of the origin ofsuch goods from WTO member countries.

Under the WTO system and its predecessor the GATT (General Agree-ment on Tariffs and Trade), there have been considerable reductions in therates of duty on manufactured goods and a reduction in some non-tariff bar-riers such as quotas and other quantitative restrictions. In recent years therehas also been increasing agreement among member countries concerningthe adoption of common standards that should apply in determining thequality of goods. An example here is the phytosanitary agreement relatingto standards for agricultural products. In order for the WTO system toachieve its aims, nation-states must implement customs laws that are con-sistent with the agreements they have entered into. While Chapter 12 willdeal with the WTO system in more detail, it is important to recognise atthis point that it does impose some constraints on the types of customslaws that countries can adopt.

The World Customs Organisation is an association of the customsauthorities of 168 countries. One of its major functions is to achieveuniformity in the procedural aspects of customs matters. It has achievedconsiderable success in three areas. The first of these is the adoptionby most countries of the world of a uniform system for classifyinggoods. This system, known as the Harmonised Commodity ClassificationSystem, gives every known product a number. The WCO website has asubscription facility that allows subscribers to search for any given prod-uct to determine its classification number. The search result will give boththe product classification number and a detailed description so that thesearcher can be sure that their own product actually meets the descrip-tion for products given that classification number. The WCO updates itsclassification system every three or four years to keep up with new prod-ucts and changes to products. Most countries adopt the WCO system intotheir own laws, with the result that customs authorities around the worldknow what product to expect when they see a given product classification


number shown on export or import documentation. Australia has adoptedthe WCO classification system in the Customs Tariff Act. It is known asthe AHECC (Australia’s Harmonised Export Commodity ClassificationSystem).

A second area where the World Customs Organisation has made signifi-cant progress is in ensuring uniformity in the way in which goods are valuedfor duty purposes. When goods are imported, countries apply a rate (as apercentage of their value) of import duty to many categories of goods. Therate for various products is set out in each country’s laws. The rate mustaccord with the commitments that the country has made in its agreementwith the WTO. However, in order to apply a percentage rate of importduty, it is necessary to know the value of the goods. Since any number ofmethods can be adopted for valuing goods (cost price, market value, valueof substitute goods for example), the WTO adopted a hierarchy of methodsthat should be used when goods are valued for duty purposes. The WCOhas developed detailed procedures that exporters, importers and customsofficials can use for the valuation of goods for duty. The issue of valuationwill be discussed in more detail later.

A third area where there has been some success is the development of stan-dards that member countries should strive to adopt in the administration oftheir customs system with the aim of facilitating the efficient flow of goodsand thereby promoting international trade. A convention on the Harmon-isation and Simplification of Customs Procedures exists but is not yet inforce because not enough countries have ratified it. The convention estab-lishes standards that countries can adopt in relation to risk managementsystems for monitoring compliance, making customs laws and proceduresreadily available, developing automated customs procedures, allowing pay-ment of duties by electronic funds transfer, and implementing an appealsprocess for disputes regarding duty assessments. Australia has ratified thisconvention and, as will be noted below, has already implemented many ofits provisions.

The WCO has also been working to adopt detailed procedures to deter-mine the origin of goods in line with the basic rules of origin set out in theWTO agreement. As will be seen later, rules of origin are becoming a majorissue because, with the recent proliferation of preferential trade arrange-ments, it is becoming more important to know the source of importedgoods for duty purposes.

Thus while the WTO sets out the basic principles of agreement betweenmember countries on matters such as rates of duty, valuation of goods andrules of origin, the WCO devises detailed procedures by which these can

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be implemented in a uniform way by countries around the world. Australiais an active member of both organisations and has integrated the variousharmonising measures that the WCO has proposed into its customs laws.

This chapter begins with a description of the customs procedures thatapply when goods are exported, followed by a description of the proce-dures for imports. This discussion will emphasise that whether exportingor importing, there are several key matters that require further explanation.These are the identification and classification of goods for duty purposes,the valuation of goods for duty, tariff rates that will apply, and the effectof rules of origin on customs duty. It is also necessary to consider whenadditional rates of duty can be imposed when imported goods are either‘dumped’ or have been subsidised. In this chapter the reader should there-fore gain an appreciation of:� customs procedures for the export of ordinary and restricted goods;� customs procedures for the import of goods;� the classification of goods;� the valuation of goods for duty purposes;� determining the applicable rate of duty applying to imported goods; and� anti-dumping and countervailing duties.

C U S T O M S P R O C E D U R E S F O R T H EE X P O RT O F G O O D S

O RD I N A R Y G O O D S

The authority to control the export of goods is given to the AustralianCustoms Service (ACS) by the Customs Act 1901 as amended. An importantamendment was made by the Customs Legislation Amendment and Repeal(International Trade Modernisation) Act in 2001, which came into effectin 2004. This, and the other amending legislation introduced with it, wasthe outcome of the Customs Service’s Cargo Management Reengineeringproject (CMR). The aim of the CMR was to introduce an IntegratedCargo System (ICS) that allows exporters and importers electronic accessto the Customs Service to complete export and import requirements usingthe same system. The ICS allows registered clients to communicate withthe ACS electronically either via email with attached documents or directlyvia the Internet. In the past, the Exit system was used for exports and theCompile system for imports. The ICS replaces both of these systems. Italso gives the Customs Service more flexibility in monitoring compliancewith the Act and greater control over the movement of cargo.


In order to be eligible to use the Integrated Cargo System, an exporter orimporter must apply to be registered. To ensure the security of the system,each user is issued with a digital certificate that allows them access. Suitableidentification is needed to obtain this. Exporters can either be registered asan ordinary user of the system or, if they can meet the criteria, may applyfor accredited client status. In either case exporters can either use the ICSvia the Internet or via email. To use the Internet-based system the exportermust use a designated service provider and enter into a user agreement withthe ACS and they will be advised when they are registered. The registrationnumber will usually be the ABN number. An ABN is the number that allAustralian businesses must have for tax purposes. To become registered touse the email-based system, the exporter or importer must also enter intoa user agreement and obtain confirmation of registration from the ACS.Details of registration procedures are available on the Customs Servicewebsite (<www.customs.gov.au>). We now turn to the detailed procedurethat an exporter uses when exporting a shipment of goods.

When the exporter knows the approximate date that the goods will beexported it lodges what is known as an export declaration through theICS. To complete the declaration the exporter must enter a large amountof information. Some pieces of information are mandatory while othersneed only be provided for certain classes of exporters and certain classesof shipments. For example, special provisions apply if the goods have beenimported and then re-exported from a prescribed warehouse. Much of theinformation to be provided is in code form with the codes to be accessedvia drop-down boxes on the form itself. The following list shows the maininformation required when completing an export declaration:� the exporter’s ABN;� the owner of the goods or the agent acting on the owner’s behalf;� the exporter’s reference;� intended date of export;� unique consignment reference number;� name of consignee;� whether goods are being exported from a prescribed warehouse;� confirming or non-confirming exporter;� type of goods (from a range of options);� sea or air transport;� name of port of shipment;� name of port of first unloading;� name of port of final destination;� vessel number of the ship or aircraft;

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� voyage or flight number;� type of cargo (container, non-container, mixed, bulk);� number of packages (if non-container);� consolidation reference number (for freight forwarders; see later);� invoice currency;� FOB currency code;� FOB value;� AHECC code;� plain English description of the goods;� Australian state or territory of final manufacture;� temporary import number (if applicable);� net quantity in units as specified in the AHECC;� weight of goods; and� permit number (if applicable).

It is necessary to fill out a separate export declaration for every consignor–consignee relationship. Thus while only one declaration is required for aconsignment of a range of goods to the one buyer, if there is more thanone buyer for the goods or more than one consignor (as in the case of aconsolidated shipment), then separate declarations must be filled out foreach relationship.

A completed export entry is sent electronically to the ACS. Providedall required information is contained on the form, the ACS responds byissuing an export declaration number or EDN. If it is necessary to amendan EDN this can be done through the system. The system alerts customsto any goods that have an EDN and are not exported. Discrepancies canbe detected because entries for export are also forwarded to the ACS byauthorities in charge of areas where goods are delivered for export and thenagain by ships’ masters and aircraft as they depart. The ACS can then followup with any exporter whose EDN has not been acted on. The exporter mustthen amend or withdraw its entry. After 30 days from the date of intendedexport, an EDN is automatically revoked and the exporter must withdrawthe entry and reapply.

If a freight forwarder is filling out the export declaration on an exporter’sbehalf (as is often the case with consolidated shipments) then it must lodgewith the ACS what is known as a sub-manifest that sets out all the cargoit is consolidating for that shipment. The system allows freight forwardersto add new export declarations to their sub-manifest while they are in theprocess of consolidating the goods.

Those exporters who have accredited client status are able to obtainclearance simply by submitting an Accredited Client Export Approval


Number (ACEAN). Exporters (or importers) who want accredited clientstatus need to show that they have had a high degree of compliance withcustoms matters in the past, as well as the systems necessary to allow forACS monitoring of their activities. The agreement that the accredited clientwill have entered into with the ACS will allow accredited clients to be allo-cated a range of ACEANs for use each month. The agreement will also setout the range of goods that can be exported under the client’s accreditedstatus.

Once the goods arrive at the cargo terminal, the cargo terminal operatormust also report all goods to the ACS, which has the necessary informationfrom the pre-receival advices that have been forwarded by exporters. TheACS then advises the cargo terminal operator that the goods can be loadedfor export. The monitoring system does not end there. Once the goodsare loaded the master of the vessel must lodge a departure report withthe ACS before the vessel departs. The ACS then issues a clearance fordeparture. Within three days of departure the master of the vessel mustlodge a manifest with the ACS that shows all goods on board.

In some cases, it might not be possible for an exporter to specify preciselythe weight or value of the cargo before it is loaded onto the ship. This couldoccur, for example, with coal or other mineral shipments. Exporters in theseindustries can lodge applications to become what is known as a confirmingexporter. This status appears on their export entries and alerts the ACS tothe fact that the exact details of the shipment will be confirmed after thosedetails are known. This generally occurs once the cargo is loaded.

Chapter 3 suggests that in most cases the exporter will not be respon-sible for import clearance in the destination country. However, where theexporter has agreed to accept responsibility for delivery to the customer,it may well need to arrange import clearance. While the World CustomsOrganisation attempts to have all member countries maintain high effi-ciency and uniformity in their import procedures, significant differencesdo exist from country to country. The Austrade website contains informa-tion about import requirements in a number of countries in the countryprofiles section. In addition, customs departments in most countries havea website in English that also describes import procedures. However, ifthe exporter has entered into a contract that requires it to clear the goodsthrough customs in the country of the buyer, it is very common to employa customs agent in that country who is familiar with its import proceduresto handle customs matters.

In order for the exporter to comply with import procedures in the coun-try of import, it may be necessary for it to provide a certificate of origin of the

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goods that states that the goods are of Australian origin. These certificatesare issued by the official branch of the Australian Chamber of Commerceand Industry (ACCI) in the various Australian states. There are detailedrules for exporters to consult to ensure that their product meets the test ofAustralian origin. Evidence may need to be furnished to the Chamber ofCommerce before a certificate of origin will be issued. Essentially, the testfor Australian origin is whether the goods are wholly produced or manu-factured in Australia or whether a substantial transformation of the goodshas occurred in Australia. ‘Substantial transformation’ is not clearly definedin the rules of origin published by the ACCI, but as is the case in Australia,it is likely that the term is defined in the importing country’s import rules.It is therefore necessary for the exporter to ensure that the goods meet thetest of the importing country’s rules of origin if the exporter has negotiatedthe sale on the basis that the importer will receive a concessional rate ofduty.

The Customs Act gives ACS officers wide powers to monitor compliancewith the Act and to examine goods that are to be exported. The purposeof the monitoring powers is to allow ACS officers to enter premises tocheck whether the exporter is complying with customs laws, whether it hasadequate record-keeping in relation to its export transactions and whetherthe information it has been communicating to the ACS is correct. The ACSmust either obtain consent in writing to enter an exporter’s premises or, ifthis is refused, must obtain a warrant to enter. The Customs Act also allowsACS officers to inspect goods to be exported at the exporter’s premisesas long as the exporter agrees. When doing so, the ACS officers can takesamples of the goods and take copies of documents relating to the goods orquestion the exporter about the goods. If the exporter refuses to allow ACSofficers onto their premises for examination purposes, then the ACS maydecide to inspect the goods in detail when those goods become subject tocustoms control. This occurs when the goods are delivered to a place forexport (usually a cargo terminal).

The Customs Act provides a range of penalties if exporters, freight for-warders, cargo terminal operators or ships’ masters fail to comply with theirreporting obligations under the Act. Some offences are known as strict lia-bility offences. This means that if it can be proved that the event occurred,then an exporter is not able to raise the defence that it occurred withoutintent on its part. Examples of strict liability offences include interferingwith goods subject to customs control, failure to export without an EDN,failure to amend or withdraw an EDN if required, failure to provide man-ifests and sub-manifests, or for a ship to depart without a clearance. Other


offences require the ACS to prove fault on the part of the exporter. Examplesof these offences are the requirement that exporters provide information ifrequired to do so under the Act and failure to deal with goods in accordancewith the manner stated in the export declaration.

If the offence is one of strict liability, then the ACS must first issue whatis known as an infringement notice. This notice sets out the provision thathas been infringed and requires payment of a penalty. Failure of the exporterto pay the penalty may result in court proceedings for prosecution. In thecase of fault-based offences, the ACS has to prosecute the matter in courtto have a fine or other penalty imposed on the exporter.

R E S T R I C T E D G O O D S

By and large, manufactured goods only require an export clearance. Butthere is a range of goods that have an additional requirement of permis-sion from government authorities for export. An examination of the itemsthat make up Australia’s major exports reveals that most are agricultural ormineral commodities and most exports in these categories require a per-mit. Other exports that are restricted and need various permits includewood, wildlife and wildlife products, drugs and therapeutic goods, ozone-depleting substances, defence equipment, cultural items, human bodyparts, and blood products. There is no single authority that provides per-mits for all classes of restricted exports because the restrictions arise undervarious Acts of Parliament that are administered by different governmentdepartments. A complete list of goods requiring permits and the permit-issuing authorities can be found in the Customs Manual accessible throughthe ACS website.

For most agricultural products there is an ongoing attempt to stream-line the permission system through what is known as the EXDOCS sys-tem established by the Australian Quarantine Inspection Service, whichis located within the Department of Agriculture, Forestry and Fisheries.One of the main reasons that permits are required to export agriculturalgoods is to ensure that Australia’s food exports meet certain quality stan-dards, thereby maintaining the country’s image as ‘clean and green’ whenit comes to food. For goods that are covered by the EXDOCS system, theexporter electronically submits a request for a permit setting out variousparticulars relating to the export of the goods. These particulars are similarto those required to complete a request under the ICS described above.Once the request is received it is examined and if approved is forwardedon through the ICS automatically so that the approval that the exporter

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receives not only shows a permit number but also an EDN. The EXDOCSsystem can also issue health certificates, certificates as to condition of thegoods and phytosanitary certificates should the exporter need these docu-ments to have the goods accepted by customs in the buyer’s country. Goodspresently covered by the EXDOCS system include meat, dairy, fish, grain,horticulture, wool, skins and hides. However, the following examples ofprocedures for various products make it clear that there is more to theexport of restricted goods than simply obtaining a permit.

The necessary permits and other requirements for the export of agricul-tural products are set out in the Export Control Act 1982 and the variousOrders made under that Act. For the export of meat, a permit for eachconsignment is needed and can be obtained through the EXDOCS sys-tem. In addition, meat exporters also need to have entered into ‘approvedarrangements’ with AQIS as a way of ensuring that the premises wherethe animal is slaughtered and prepared for export comply with quality andhealth standards. Exporters who hold MSQA status (meat safety qualityassurance) will be eligible to have their premises approved. The export offish, dairy and eggs and products made from them also requires a per-mit obtainable through the EXDOCS system. The premises where foodis prepared or processed for export also needs either an approved qualityassurance program in place or a food-processing accreditation from AQIS.This allows the exporter itself to print and sign the permit once it is issuedelectronically by the EXDOC system. Additional requirements may alsoapply. For example, in the case of KFV Fisheries (Qld) v Kerrin (1984)56 ALR 573, the appellant questioned the rejection of prawns for exportbecause, upon inspection, the prawns were not stored at minus 18 degrees.The regulations provided that fish needed to be at this temperature duringmovement. The prawns were inspected the day before they were due tobe moved and found not to be at the required temperature. The court,however, found that the regulations only provided that the prawns be atthe required temperature ‘when being moved’. The decision to refuse thepermit was therefore quashed.

In the case of wheat and grain exports, a permit needs to be obtainedthrough EXDOCS and, where wheat is exported, a separate permission isusually also needed from the Wheat Export Authority. Wine, brandy andgrape products are not yet subject to the EXDOCS system; instead exportsof wine over a certain volume require a permit from the Australian Wineand Brandy Corporation.

Exporters of wood from natural forests need to be licensed by the Depart-ment of Agriculture, Forestry and Fisheries and need a permit from them


for each consignment. The permit cannot be obtained on the EXDOCSsystem. Similarly, mineral exporters need a permit from the Departmentof Industry, Tourism and Resources to export the particular mineral thatis being mined. There have been a number of cases regarding refusal ofpermits for mineral exports that arose under legislation in force at the time.Some of these illustrate the extent to which the government has been pre-pared to intervene in the export process. In the case of Curragh Coal SalesCo Pty. Ltd v Wilcox (1984) 1 Federal Court Reports 461, a permit forthe export of coal was refused because the exporter had not sold it at theprice the Minister required. Despite severe criticism of the refusal of anexport permit on these grounds, the court nonetheless held that the regu-lations were wide enough to allow the Minister to impose such an onerousrequirement.

In the case of wildlife and wildlife products such as some shellfish and livefish, a permit is needed from the Department of Environment. In the caseof the export of therapeutic goods such as some pharmaceutical productsand medicines, the exporter needs permission from the Therapeutic GoodsAdministration. Only those pharmaceutical goods that are included on theregister of therapeutic goods can be exported and then only in the nameof the person who is registered to produce that drug. If the pharmaceuticalcontains a narcotic substance a separate licence must also be obtained fromthe Department of Health.

These examples show that there are specific bureaucratic requirementsinvolved in many of Australia’s exports. The main reasons are health andsafety concerns, security issues, the preservation of the country’s environ-ment and natural resources, and the need to maintain the country’s imageas a high-quality exporter.

I M P O RT P R O C E D U R E A N DR E S T R I C T I O N S

The trade modernisation legislation, which came into effect in 2005, intro-duced important changes to the reporting and clearance system for imports.The following section traces the various reports and clearances that have tobe lodged when goods are imported into Australia. Emphasis is placed onthe obligations that the importer itself has in this process.

The operator of a ship or aircraft is obliged to report electronically to theACS the impending arrival of a ship or aircraft within given time-frames.The operator must then make a further report (arrival report) when theship or aircraft actually arrives. The exporter must also report the details

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of who will unload the cargo and details of the cargo (cargo report). If anyspace on the ship or aircraft has been leased to another party the nameof that party must be given and it is then the obligation of that party toreport the details of the cargo in their leased space. When containers arebeing unloaded the stevedoring company responsible for unloading mustmake ‘outturn’ reports every three hours giving details of the containersthat have been unloaded during that time. An outturn report is requiredfor aircraft within 24 hours after an aircraft has been unloaded. If the goodsare transferred to a depot before they are unpacked from a container, thedepot operator also has to make an outturn report relating to the goodsthe operator has received within 24 hours of receiving the container. Failureto make reports by any of the parties responsible is an offence under theCustoms Act.

The person or company that imports the goods also has obligations underthe Act. Its primary duty is to make an import declaration in relation to thegoods; in the case of most importers this will be an import declaration forhome consumption, which means that the importer will be using the goodsitself or reselling them in the domestic market. The import declaration ismade electronically. An importer that has accredited client status lodges arequest for cargo release. This allows it to get clearances issued quickly withdetailed returns of specific items that have been imported being lodged atthe end of every month.

As noted, the key document for the import of goods is the importdeclaration for home consumption. Importers who deliver goods into homeconsumption without making an import declaration commit an offence.The CMR section of the ACS website contains examples of the variousforms used for import and cargo reporting. Import declarations and allother forms relating to import can be completed online for those registeredwith ICS, although some provisions still exist for manual completion. Alarge amount of information is required to complete the entry for homeconsumption including:� the importer’s identification and reference number;� the port code where the goods will arrive;� the invoice term type (see trade terms earlier);� the effective duty date applicable to the goods;� the valuation date;� a code for the country of origin;� the bill of lading number;� the number of packages;� the ship or aircraft number;


� the voyage number;� the FOB value;� the location of the AQIS inspection (if required);� the tariff classification of the various goods in the shipment and a descrip-

tion of them;� reasons for any ‘amber’ status; and� whether duty is paid under protest.

Completing the import declaration requires specialised knowledge ofthe various codes that are used. For this reason those businesses that onlyimport occasionally tend to use the services of a customs broker.

Once the entry for home consumption has been completed and trans-mitted to the ACS, it will issue an authority to deal with the goods.Various mechanisms exist for the payment of duty, including direct debitof accounts or payment via the Internet. When physically collecting thegoods the importer will need to produce the standard documents relatedto the transaction. At the very least this will include an air waybill or bill oflading together with the commercial invoice, packing list and, if required,certificates of origin and other certificates that relate to the condition ofthe goods.

Importers need to be aware that the Commerce Trade Descriptions Act1905 requires that all imported goods be correctly labelled. The Act requirestruth in labelling and any infringement of this renders the importer liable topenalties. If an importer is not sure of some details regarding the importedgoods such as the appropriate tariff classification or proper origin, it ispermitted to give its entry for home consumption an ‘amber’ status untilit is able to supply the correct details. There is also a provision for animporter to advise the ACS that it is paying the duty under protest. Thisusually arises because the importer has a difference of opinion with theACS about the appropriate classification of the goods for duty purposes. Ifthe importer does not formally protest when paying the duty it will have noright to seek a refund at a later time (A&G International Pty Ltd v Collectorof Customs (1995) 129 Federal Law Reports 23). However, if the importerhas paid no duty at all and the ACS later on wants to take proceedings torecover the duty, the importer is not barred from challenging the rate atwhich such duty is imposed (Malika Holdings Pty Ltd v Stretton (2001) 204Commonwealth Law Reports 290).

While the entry for home consumption is the usual procedure forimporters to use, provisions also exist that allow for a warehousing entry ifthe goods are to be stored in an ACS-approved warehouse prior to release.

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There is also a separate type of entry for the release of the goods from thewarehouse for home consumption and a special form for entry for homeconsumption where the goods attract excise duty.

Provisions also exist in sections 162 and 162A of the Customs Act forthe temporary import of goods. Examples of this include the temporaryimport of vehicles for touring, commercial samples, scientific equipment,and goods to be used in trade shows. Those wishing to import eligible goodson a temporary basis have the choice of making a special application tocustoms on the prescribed form or using the ATA Carnet system. This is aninternational attempt to standardise procedures for the temporary importof goods and is administered by the authorised chambers of commerce ineach country.

When goods are to be temporarily brought into a country under a Carnetfor one of the purposes listed above, it is necessary for the person seeking tobring in the goods to make an application through the authorised chamberof commerce in their home country, which must be a participant in theCarnet scheme. When making the application it is necessary to give anundertaking that the goods will be taken out of the country after theirtemporary use and to lodge a security deposit with the chamber for theamount of duty that would otherwise be payable on the goods. This isrefunded when the goods are repatriated. The chamber issuing the Carnetgives the applicant two vouchers for every country into which they wish totemporarily import the goods. One of these vouchers is given to customsupon entry to the country and the other upon exit of the goods.

The ACS website contains a comprehensive list of goods that have importrestrictions attached to them. For each restricted item, the website showswhich authority can issue the relevant permit for the import of restrictedgoods. Some goods are prohibited from import altogether. An examinationof the list of restricted goods shows that restrictions are imposed for healthand safety reasons. Thus one finds goods such as drugs, some chemicals,weapons and even some children’s toys on the list of restricted imports.

C L A S S I F I C AT I O N O F G O O D S

As has been noted earlier, all exported and imported goods must be givena classification number for calculating the rate of import duty to be paid.Knowledge of how the classification system works is therefore important.Two issues arise in relation to the classification of goods. The first is howan item obtains a classification number in the first place; the second is how


to decide what number to give to the particular good that is being exportedor imported.

One of the major functions of the WCO has been to develop and updatethe International Harmonised Classification system. This work is carried onthrough a committee which includes representatives from member coun-tries who decide classifications for new categories of goods as well as hearingdisputes about the category into which a good should be classified. It doesthis by dividing products into several major categories and then devisesvarious subcategories, with the effect that every known product can befound in a subcategory with a number attached to it. Illustrations of thedifficulties that the Harmonised System Committee face are outlined onthe website. For example, should a high-fat cream cheese spread be given anumber in the section relating to cheese or in the section relating to dairyspreads?

Once the WCO has allocated a number, member countries adopt theclassification number in their own laws relating to tariff classification. InAustralia’s case the relevant law is the Customs Tariff Act 1995, which hasa schedule setting out the classifications of all known goods. This sched-ule is regularly updated to implement changes to the classification systemdeveloped by the Harmonised System Committee of the WCO.

The issue of most concern in the everyday business activities of exportersand importers is perhaps not how any particular good obtained the classi-fication number assigned to it but what classification they should attributeto the good they are exporting or importing. Schedule 2 to the CustomsTariff Act sets out some rules to assist traders in determining what classifica-tion number to give a particular item they are exporting or importing. TheAHECC number is an eight-digit number. The first six digits represent theinternational code for the item developed by the International HarmonisedClassification system of the WCO. Of these, the first two digits denote thechapter into which the item falls; the next two digits denote the headingand the third two digits refer to the subheading. The final two digits are theAustralian identifiers that Australia has for the item. The customs websitegives the following example for classifying lemons. The AHECC numberis ‘08053000’. The ‘08’ refers to the chapter that is entitled ‘edible fruits’;the ‘05’ refers to the heading ‘citrus fruits’; the ‘30’ refers to ‘lemons’. The‘00’ means that Australia has adopted the international code without anyadditional digits being applicable.

The first of the rules for classifying goods states that for legal purposesthe classification is determined by the headings and subheadings and the

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notes that occur at the end of each chapter in which the heading appears.Thus when attempting to classify a good it is necessary to have regard, in anobjective sense, to the description provided by the headings, subheadingsand notes. The classification that applies most closely to the good is thecorrect one. Second, goods will be given the same classification numberregardless of whether they are finished or only partly finished or assembled.However, when goods consist of a mixture of materials or substances andtwo or more categories of classifications are possible, the heading that pro-vides a more specific description is to be preferred to the more general one.If this is not possible then the goods are to be classified by the material thatgives them their essential character. Fourth, if it is still not possible to assigna classification then the goods are given the classification of the goods towhich they are most like.

Despite the fact that these rules are in place, disputes occur betweentraders and the ACS about the correct classification of goods. This occursfor imports more so than for exports because of the duty that is attached toimports. In the event that a dispute arises it is often necessary to identifythe goods before they can be classified. This means that the ACS may needto conduct tests on some goods to determine their composition before theycan begin to decide under what heading those goods may fall. For example,an importer may claim that a powder is made of a particular substance butmight require testing to be sure it is in fact made of that substance. Once itcan be determined what it is actually made of, the rules set out above canbe used to classify it.

Disputes between importers and customs are most likely to arise wherethere are significant differences in the rates of duty depending on theclassification. Significant differences tend to arise in industries whereAustralia has high tariffs. A useful example is auto parts. In a number of casesimporters have sought to argue that the goods in question fall into categoriesother than ‘goods of a kind used as replacement components in passengervehicles’. In Air International Pty. Ltd v Chief Executive Officer of Customs(2002) 121 Federal Court Reports 149, the importer sought to argue unsuc-cessfully that major components of automotive air-conditioning systemswere accessories rather than replacement components. The intention of theimporter regarding the use of the goods was held by the majority of thejudges to be irrelevant. In Pirelli Tyres Australia Pty. Ltd. v Chief ExecutiveOfficer of Customs (1999) 58 ALD 517, the tyre company was also unsuc-cessful in arguing that tyres did not fall into the classification of replacementcomponents.


As noted above, provisions exist in the Customs Act to pay the dutyassessed under protest and then to have the dispute heard. In Australiadisputes about the classification of goods and duty assessable are heard bythe Administrative Appeals Tribunal. There are some limited avenues ofappeal from the Tribunal to the Federal Court and on to the High Court.

VA L U AT I O N

A valuation of the goods must be made when both exporting and importinggoods. In the case of import, the valuation will determine the amount ofduty that is paid because the duty is calculated as a percentage of the valueof the goods. As will be noted below, there are considerable similarities inAustralia regarding the valuation of the goods, whether the valuation is forexport or for import.

We will first examine valuation for export. In order to obtain an exportdeclaration number it is necessary to enter the value of the goods on theapplication that is lodged through the integrated cargo system. In Australiathe appropriate value for export purposes is the FOB value. When FOB isused in the context of valuation it means all costs involved in producingthe goods including labour, materials and overheads, as well as Australiantaxes payable in respect of those goods, the cost of transporting them tothe port of shipment and an allowance for profit. Generally speaking, theFOB value equates to the price at which the exporter sells the goods. Butit does not include the costs of transport of the goods from the port ofshipment or any import duties or insurance that is payable. Thus while theFOB value should not be confused with the incoterm of the same name, itcan be seen that both adopt the same cut-off point as regards the exporters’costs, up to the point of shipment. The ICS also requires the value of thegoods to be entered in Australian dollars or in a range of other allowablecurrencies.

Valuation for import is more highly regulated because of the valuationprovisions that have been incorporated in the WTO agreement to whichAustralia is a signatory. The principles set out in the WTO agreementhave been significantly amplified by the World Customs Organisation,which has developed a lengthy valuation compendium to assist customsadministrations in the implementation of the various valuation principles.The valuation compendium is accessible on the WCO website.

The primary WTO principle for the valuation of goods for import dutyis the transaction value of the goods. The WCO website suggests that over

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90 per cent of world trade is valued for duty on this basis. Transactionvalue is largely equivalent to the price the importer pays for the goods. Butin Australia’s case this price is adjusted to bring it into line with the FOBvalue. Thus the price that the importer pays may need to be adjusted forfreight and insurance to arrive at the FOB value as at the point of shipmentfrom the overseas country. There is a range of other adjustments that areallowable in order to arrive at the transaction value. These are set out invery detailed provisions in section 161 of the Customs Act.

If transaction value cannot be used, the WTO provisions set out alter-native bases of valuation that must be applied in the order in which theyare set out. This order is as follows. The first alternative is the transac-tion value of identical goods. This might need to be used, for example, ifthe goods are being sent between related companies. If it is not possibleto use the transaction value of identical goods, then the transaction valueof similar goods should be used. If there are no similar goods, then thedeductive value of the goods must be calculated. This refers to the price atwhich either the goods or similar goods are ultimately sold in the importingcountry less various allowances to bring them back to what approximatesto the transaction value. The next alternative is the computed value. This iscalculated by totalling all the various costs associated with the productionof the goods plus the various other items that would normally be includedin the FOB value. Finally, there is a fall-back value that allows customs touse any reasonable method for calculating valuation that is consistent withthe overall principles of the WTO and GATT, using data that is availablein the county of import. However, the valuation that is used should not bethe selling price of the goods in the importer’s country, the selling price ofthe goods in the exporter’s country, or the selling price of the goods if theyare re-exported to a third country. Thus the fall-back value is quite difficultfor customs to apply. A detailed explanation of the various methods forcalculating value can be found on the WCO website.

Disputes have arisen between importers and the ACS over refundsof duty where the goods are defective and therefore worth less than theprice paid. In Hyundai Automotive Distributors v Australian Customs Service(1998) 81 Federal Court Reports 590, the cars purchased by the distributorwere defective. The distributor needed to spend a considerable amount tomake the cars merchantable but was reimbursed for this amount by themanufacturer in Korea. The distributor sought to argue that they shouldobtain a refund of import duty because the price that they paid did notreflect the true value of the goods on arrival. The court held that the


contracted price was the best indication of the value of the goods and nottheir market value at the time of importation.

R AT E O F D U T Y

The operation of the Customs Tariff Act is to impose a rate of duty (tariffrate) for every different classification of goods. The normal duty that is paidis the applicable percentage rate multiplied by the value of the goods. Thusto calculate the normal duty payable one needs to know the classification,valuation and rate of duty. But there are a number of circumstances wherelower than normal rates of duty will apply. First, Australia might have apreferential trade arrangement in place with the country of origin of thegoods. Second, a tariff concession order might apply to the goods. Third,the goods might be eligible for a drawback of duty or other scheme designedto assist exporters. These three scenarios will be addressed after some initialdiscussion of the process of setting normal rates of import duty.

While every country is theoretically able to set whatever rate of duty itlikes for any class of goods, a major objective of the WTO system has been toattempt to have those rates set as low as possible and applied as consistentlyas possible in the interest of promoting free trade. Thus member countriesof the WTO agree to notify the WTO of the rates of duty that they willimpose for all of the various classes of goods and to undertake to bind thoserates. Binding the rates means that the country agrees not to raise those ratesexcept in the limited circumstances set out in the WTO agreement. Thesecircumstances are discussed in more detail in Chapter 12. Thus rates ofduty notified to the WTO by Australia and incorporated into the CustomsTariff Act will stand until the country notifies and binds a lower rate inrespect of any particular good.

In Australia the Industry Commission Act requires consultation withindustry before tariff rates are lowered. The rationale here is that tariffsare not only imposed for the purpose of collecting revenue but also as adevice to protect local industries against stronger competition from over-seas. The merits of protection have been hotly debated for decades and itis not intended to canvass the arguments in detail here. However, in thepast decade there has been an overwhelming change in ideology towardsa free-trade position. The main area of disagreement is the pace at whichthe move to free trade should occur. Those who urge a gradual approachtend to do so on the ground that rapid liberalisation would result in seriousdislocation within countries as entire industries are wiped out due to lower-priced imports. Such dislocation could result in serious social and political

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instability as jobs disappear in industries that are no longer competitive.Thus there may be an argument that liberalisation needs to take place at apace that allows countries to adjust without serious instability resulting. Ofcourse there are also vested interest groups within countries who opposefree trade. If those groups have significant political influence then tariffrates may remain high regardless of the fact that reducing them would havemore economic benefits than costs. The Australian Industry Commissionlooks carefully at the impact that any reduction in tariffs will have in anattempt to balance the benefits and the costs of the tariff. If a reduction isrecommended, then the Customs Tariff Act is amended to reflect the lowerrate.

While the Customs Tariff Act prescribes a set rate of duty for each par-ticular class of goods, preferential arrangements with particular countriesmight result in a lower than normal rate of duty. Preferential rates of dutyarise because the WTO agreement allows developed countries to give pref-erential rates of duty to imports from developing countries and because italso allows countries to enter into bilateral or multilateral free-trade agree-ments that lower tariff rates between partners or members to the exclusionof those outside the group. The Australian government gives preferentialtariff treatment to goods from a range of developing countries. In addition,it has free-trade agreements in place with New Zealand, Singapore, theUnited States and Thailand, with the potential of further agreements withthe ASEAN countries and with China. Thus one may find that for any par-ticular good the rate of duty may be different depending on its origin. Thisraises the further question of how one determines the origin of the goods.

The WTO agreement does not contain detailed rules that can be used todetermine origin. Rather it sets out general standards that countries shouldadopt when determining their own rules of origin. These include obliga-tions not to use rules of origin for trade policy or to restrict or distort tradeand to make such rules transparent, to administer them impartially andprovide avenues of appeal. The Australian Customs Act contains provisionsin sections 153A–153S regarding rules of origin for imported goods. Inessence, the test to determine origin is that goods must either be ‘whollyobtained’ from the country of alleged origin or ‘substantially transformed’in the country of origin. ‘Wholly obtained’ is defined to mean that thegoods are wholly produced or manufactured in the country of origin. Todecide whether goods are ‘substantially transformed’, Australia adopts avalue-added approach. This means that at least 50 per cent of the cost ofthe manufacturing process of the goods must be incurred in the country oforigin. There are detailed rules that apply to decide which costs are to be


included in determining costs of manufacturing. Provided the goods satisfythe test laid down in the Act, the concessional rates of duty in the CustomsTariff Act for goods originating from countries with which Australia haspreferential arrangements will apply.

Concessional rates of duty might also arise if a tariff concession order(TCO) is in place for the class of goods being imported. Sections 269A–269P of the Customs Act allow for concessional rates of duty to be imposedon goods if there are no substitute goods produced in Australia, or, ifthere are substitute goods produced in Australia, the imported goods arenot likely to have any effect on the market for the Australian-producedgoods. The term ‘substitute goods’ is defined to mean that the use of theimported goods should be the same as those produced locally regardlessof differences in value or the way in which the goods function to achievethe use. Thus a TCO cannot be obtained for goods that appear quitedifferent but actually are used for the same purpose. If a TCO is grantedfor consumption goods those goods can be imported duty-free; if it isgranted for non-consumption goods the rate of duty will be 3 per cent.TCOs are not available for food, clothing or motor vehicles imports. It isclear then that a policy objective of TCOs is to reduce the cost of inputs forAustralian manufacturing industry to attempt to assist Australian exportersto be more internationally competitive.

To obtain a TCO the Australian importer must apply to the ACS on theprescribed form. The ACS will advertise the application in the governmentgazette to give local manufacturers the opportunity to object to the grantingof the TCO. Objectors have 50 days to object and the ACS has 150 daysfrom the date of application to decide whether or not to grant the order.However, if it is granted it applies from the date the application was made.Goods subject to a TCO are listed in Schedule 4 of the Customs Tariff Act.As is the case with many other customs matters, a right of appeal againstdecisions exists to the Administrative Appeals Tribunal.

Decisions refusing TCOs are frequently challenged in the courts byimporters on the ground that the market for the Australian ‘substitute’good will be not adversely affected by the imported good. In Leroy SomerPty Ltd v Chief Executive Office of Customs (1996) 40 ALD 319, an importerof motors with aluminium frames used in air-conditioning units appealedagainst a decision to refuse a TCO. The reason for the refusal was thatthere were locally made electric motors with iron frames that could be usedin air-conditioning units but were mostly used in the mining industry.The imported products were not suitable for use in the mining industry.The court decided to overturn the initial decision because the goods were

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not competing on the same market and the imported goods were notlikely to have adverse effects on the market for the domestically producedmotors.

The duty drawback scheme is a further avenue for reducing importduty for those who are importing goods for processing and re-export or asparts and components for exported goods. Claims for refund (drawback)of import duty are made by the person exporting the goods at the time thegoods are exported. Claimants need to show that the duty was paid on theimported goods and that the goods were not used in Australia before beingincorporated into exported products. Drawbacks of duty can be claimedshipment by shipment or on the basis of a representative shipment if regularshipment of the processed goods occurs. If the exporter has purchased thegoods in Australia from another party that has imported them, the exportermay not be able to obtain the import documents. In that case the imputationsystem for duty drawback allows the exporter to claim a drawback of theamount of import duty that was paid on 30 per cent of the value of thegoods.

An alternative to the duty drawback scheme is for exporters to applyfor a warehouse licence. This allows them to import goods for processingwithin a warehouse that is subject to customs control and then re-exportthe goods. As the goods at no stage enter the Australian marketplace, thosewith such a licence are able to get exemption from import duties.

In this section we have canvassed the situations where lower than nor-mal rates of duty will apply. But there are also cases where customs canimpose additional duties on imported goods. This occurs where goodsare ‘dumped’ in Australia or have attracted government subsidies in theircountry of export. These extra duties are known as anti-dumping dutiesand countervailing duties respectively.

A N T I - D U M P I N G D U T I E S

Imported goods are said to be ‘dumped’ when their export price is lowerthan the price for those goods in their home market. There are manyreasons why a firm in an exporting country may wish to sell goods overseasat a lower price than in their home market. It may wish to try to gain acompetitive edge in the overseas market against locally produced goods oragainst goods that are being supplied to that market from other countries.Alternatively, there may be excess supply of the goods in the home marketand the exporter simply wishes to dispose of the surplus at any price.


‘Dumping’ is considered to be an unfair trade practice because ofthe adverse impact it can have on industries in the importing coun-try. For that reason many countries have had procedures in place for along time to levy extra duties on dumped goods so that they are sold inthe importing country at a fair price. Australia has had an anti-dumpingregime since 1906, but international agreements on dumping only datefrom the mid-1970s when members of the GATT adopted an anti-dumpingcode in an attempt to ensure that the principles on which countries imposedanti-dumping duties were uniform and so would not be used as a ‘non-tariff barrier’. A comprehensive anti-dumping agreement was included inthe range of agreements entered into at the time of the formation of theWorld Trade Organisation in 1994. All member countries of the WTOhave adopted this agreement including Australia. In Australia, responsibil-ity for administering anti-dumping matters has been the sole responsibilityof the ACS since 1998.

The following sets out the process undertaken by the ACS in the impo-sition of anti-dumping duties. The process is set out in detail so that anunderstanding can be gained of the steps that have to be taken by anylocal producers who may feel that they are the victims of the unfair tradepractice of dumping. As noted above, the aim of anti-dumping duties isto redress what are seen as unfair trade practices that damage the interestsof local producers of goods similar to those that are being dumped. Butgovernments also have to consider the interests of consumers to obtaingoods at the lowest possible price. For that reason anti-dumping dutieswill not be imposed if there is no injury or threat of injury to domesticproducers.

An anti-dumping application can be made not only if actual injuryis being suffered by an Australian industry but also if there is a ‘threat’of material injury. As will become apparent in the following discussion,the process itself seems to be heavily weighted towards only imposing anti-dumping duties where it is very clear that there is, or will be, a serious threatof injury to domestic producers. The reasoning here is that the Australiangovernment (and other member governments of the WTO) does not wantto be seen to be using anti-dumping measures as a non-tariff barrier forprotecting Australian producers. If another country is of the view that anti-dumping measures are being used in this way, it is able to seek redressthrough the WTO dispute settlement body.

The first step that a domestic producer must take if they think they aresuffering or will suffer serious injury from dumped goods is to lodge ananti-dumping application with the ACS. An application form is available

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on the ACS website. Before an application is accepted by the ACS, it musthave the support of at least 25 per cent of the Australian industry thatproduces goods that will be affected by the dumped goods. The thresholdfigure of 25 per cent means that firms supporting the application mustaccount for at least 25 per cent of the total production of the affectedgoods by Australian industry. In addition, the application must relate tomore than 50 per cent of the production of those goods by Australian firmsthat either support or oppose the application. These stringent rules makeit clear that anti-dumping duties are available to the industry as a wholeand not to particular firms.

The application requires that the goods being dumped are clearly iden-tified and described. The applicant is also required to identify the ‘likegoods’ that are produced in Australia that are affected by the dumpedgoods. ‘Like goods’ are those that are either identical to the dumped goodsor closely resemble them. It is also necessary for the application to iden-tify the country of export. If there is more than one, this needs to bestated because anti-dumping duties can apply to dumped products ema-nating from more than one source country. It is also necessary for theapplication to state specifically the Australian industry involved so thatthe ACS can be satisfied that the application has the requisite level ofsupport.

The application must estimate the normal value of the dumped goods aswell as their export price. The reason for this is that the dumping duties thatcustoms imposes will be the difference between the normal value (NV) andthe export price (EP). This is also known as the dumping margin (DM).Thus the DM = NV − EP.

The normal value is the price paid in the ordinary course of trade forlike goods in the country of export. If the normal value of the goods cannotbe ascertained in this way, the price at which like goods are sold by theexporting country to buyers in other countries can be used. Or the normalvalue can be computed by the cost of production of the goods includingan allowance for profit. If an importer can show that the price paid for likegoods in the domestic market of the exporting country is higher than theexport price because of abnormal costs within the exporting country (suchas excessive distribution costs or above-normal costs of meeting domestictechnical specifications compared to the international standard), they maylater seek to have allowance made for this in computation of the normalprice. Similarly, an exporter may claim an adjustment to allow for exchangerate if the terms of export of the goods to Australia require payment in acurrency other than the currency of the exporting country. The appropriate


time for an importer to raise this matter is when the application is beingconsidered by the ACS.

There have been a number of cases where the calculation of normalvalue by customs has been disputed. For example, in Mullins Wheels PtyLtd v Minister for Customs & Consumer Affairs (2000) 97 Federal CourtReports 284, the Minister refused to take into account a rebate that theSouth African government gave to exporters of wheel rims made of steel.The rebate for exporters was to compensate exporters for the tariff thatSouth Africa imposed on steel entering the country. The Federal Courtheld that the Minister was correct in refusing to discount the computednormal price by the value of the rebate given to the exporters. Deductionsfrom the computed value might be appropriate for domestic taxes and soon but not for a measure that directly assisted exporters. In this case therewere no domestic sales of the wheel rims in South Africa and accordinglycustoms had to compute the value. However, in Minister for Small Business,Consumer Affairs & Customs v La Doria Di Diodata Ferraiolli Spa (1994)33 Administrative Law Decisions 35, goods were also sold on the domesticmarket. The producers were assisted with production costs by the Italiangovernment. The ACS refused to accept that the selling price in Italy wasthe normal value and therefore computed a normal value. The FederalCourt held that the ACS had adopted the correct approach.

There are special provisions for calculating normal value in cases wherethe goods are exported from a non-market economy or from a transitioneconomy. This is necessary because in non-market and transition economiesthe government may set either the selling price in the domestic market or thematerials that are supplied to manufacturers, or the goods may be suppliedat non-market rates by state-owned enterprises in that country. In thesecases normal value can be determined by the value of like goods in anothercountry or the cost of producing the goods in another country or the valueof like goods produced and sold in Australia. In recent years China hasbeen arguing that it should be regarded as a market economy for dumpingpurposes because the application of non-market country rules seems toallow dumping authorities a wider discretion in determining normal value.China feels that some of its exports may have attracted anti-dumping dutyunnecessarily because of this. At the time of writing, negotiations are stillunderway between China, the European Union and the United States aboutmarket economy status. These matters may be resolved in the Doha roundof trade negotiations.

The export price is a little easier to obtain in an application for anti-dumping duties, which is the price paid by Australian importers of the

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goods less any freight, insurance and charges involved; in other words it issimilar to the FOB price.

The next matter that the application must address is the question of‘material injury’. The applicant must show what the material injury is thathas occurred or will occur and how the dumped goods have caused or willcause that injury. In a Ministerial Directive in 1991, the Minister of Tradedefined a material injury as one which is greater than that which wouldoccur in the ordinary ebb and flow of business. The injury must be to theindustry at large. The type of injury that the industry might suffer includesa loss of sales volume, a loss of market share or a reduction in profits. Areduction in profits can occur if Australian domestic producers have beenforced to lower their prices to compete with the dumped imports.

If the applicant is claiming that there is a ‘threat’ of material injuryit must show that a significant increase in imports of the dumped goodsis occurring and that this will cause injury if it continues. Alternatively,evidence of threat might be a greater capacity of the exporter of goods toproduce and dump these goods, taking into account its other markets andinventories of its product.

After the application is lodged with the ACS, a preliminary review isundertaken to determine if there is a prima facie case for a more detailedinvestigation. The ACS has 20 days to decide if the investigation will goahead. One reason for this initial step in the process is to weed out appli-cations that clearly do not show what is required. This stage of the processis confidential to protect the business interests of importers of the prod-uct from possible adverse publicity and negative flow-on effects that mightarise from dumping allegations. If the application is rejected at this stagethe applicant has a right of review by a body known as the Trade MeasuresReview Officer (TMRO). There is a further appeal to the Federal Court.

If the ACS decides to go ahead with an investigation they will publish for-mal notice of it in the Australian government gazette, inviting submissionsfrom interested parties within 40 days. Anyone making a submission mustlodge both a confidential submission and a public submission. The con-fidential submission will contain information that if known widely mightadversely affect the business interests of the person or firm making thesubmission. The ACS has 110 days to conduct the investigation. In doingso they may need to consult with importers, exporters and manufacturersof the dumped goods and the Australian industry in order to determinethe important matters of normal value, export price and material injury.It is also necessary that the dumping of the goods actually occurs duringthe investigation period or might occur in the future. It has been held that


dumping that occurred in the past cannot be considered (Pilkington (Aust)Ltd v Minister of State for Justice & Customs [2002] 71 Administrative LawDecisions 301).

The ACS can consider a wide range of matters in determining whetherthe dumped goods are in fact causing material injury. They may look atproduction levels in the industry, capacity utilisation, forward orders, cashflows and returns on investment of firms in the industry as well as theirability to raise capital. The objective here is to ensure that it is the dumpedgoods and not other factors within the industry or its constituent firmsthat are causing the injury. The ACS can also look at broader issues such aschanges in demand for the products that are allegedly affected, changes intechnology, changes in volume and price of imports and the overall exportperformance and productivity of the Australian industry. The point hereis that the government does not want to be seen to be using anti-dumpingmeasures to protect what are essentially declining industries in Australia.

During its investigation, the ACS may decide to take what is knownas a ‘security deposit’ from importers of the dumped product equal to theamount of the dumping margin. If the outcome of the investigation is thatdumping duties are imposed, then the security deposit will be applied tothese duties. If not, it will be refunded. The ACS can take a security deposit60 days after the investigation has commenced. In some cases, the takingof a security deposit may well be enough to discourage importers and theiroverseas suppliers from continuing to engage in the dumping practices.

Alternatively, if during the investigation it is found that the dumpingmargin is minimal (less than 2 per cent) or that the volume of importedproduct alleged to be dumped is negligible compared to overall imports ofthe product (less than 3 per cent) or that there is negligible injury, the ACSmay terminate the investigation. If it does so the applicant has a right ofreview by the TMRO and then a possible avenue of appeal to the FederalCourt.

After completing the investigation, the ACS is required to publish astatement of essential facts that shows whether the goods are found to havebeen dumped, whether Australian industry has suffered a material injuryand whether the dumping has caused the injury. All interested parties have20 days to respond to this statement. The matter is then referred to theMinister to make a decision on whether anti-dumping action should betaken.

The Minister has a range of possibilities in considering what actionshould be taken. It may be decided to impose anti-dumping duties equal tothe dumping margin. Alternatively, the duty imposed may be less than the

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dumping margin if it is considered that a lesser amount of duty would besufficient to undo the actual or prospective injury that Australian industryis suffering. This lesser rate of duty is calculated by the difference betweenthe export price and what is known as the ‘non-injurious price’ (NIP). TheNIP is in turn calculated from what is known as the ‘unsuppressed sellingprice’ (USP). The USP is the price at which like Australian products mightbe sold in the Australian market. The NIP is calculated by deducting fromthe USP the expenses of selling in the Australian market, customs duty andGST that applies to the goods, import expenses and a reasonable profit onsale. Thus the duties imposed in this case will be equal to the NIP–EP.It is also possible for the Minister to exempt the goods from duty if, forexample, there is a tariff concession order in place. Or it may be consideredto be enough to accept an undertaking from exporters of the goods tocease the practice. When giving such an undertaking the exporter willagree not to sell the goods to Australian importers below a certain price.If circumstances change such that the price needs to be changed, a newundertaking must be entered into. It has been held that an amendmentof a previous undertaking is not permissible within the framework of theexisting legislation (Australian Paper Ltd v Anti-Dumping Authority [1998]88 Federal Court Reports 367).

Once the Minister publishes the anti-dumping measures that are tobe imposed, those affected by the decisions have a right of review by theTMRO and then an appeal to the Federal Court. If anti-dumping duties areimposed they will be in place for five years, but importers can apply every12 months for review of the export price, normal value and non-injuriousprice (if relevant).

C O U N T E R VA I L I N G D U T I E S

Countervailing duties are imposed on imported goods that have attracted asubsidy in the country of export and that cause or threaten to cause materialinjury to Australian industry. The form that is used to make an applicationfor countervailing duties is the same as that used for anti-dumping duties,but there are some differences in the information that is to be provided andsome minor differences in the procedure. The following discussion dealsmainly with these differences.

The rationale for imposing countervailing duties is that subsidies pro-vided by a government of another country may give exporters in thatcountry an unfair advantage in trade because they are able to sell theirproduct at lower prices because of the assistance they have received. In an


application for countervailing duties by Australian industry, it is necessaryto show that the export price is lower because of the subsidy that has beenprovided. It is not necessary to show a ‘normal price’ unless the applicationis one for both anti-dumping and countervailing duties. A normal value isnot necessary because the price paid in the country of export may well belower for the very reason that the government subsidises the production ofthe goods in question. Therefore the relevant issue is the amount by whichproduction is subsidised.

This first step in an application that seeks countervailing duty is todescribe the nature of the subsidy that is provided in the exporting countryand the actual title of the subsidy. The government agency that providesthe subsidy should be spelt out as well as details of the recipients of thesubsidy and the amount that each receives.

As is the case with an anti-dumping application, the initial applicationand review by the ACS is confidential. The procedure in a countervailingduties application differs, however, in that at least 15 days before notifyinga formal investigation, the ACS has to consult with the government ofthe exporter’s country. The reasoning here is that it is the government thatprovides that subsidy and they need to be given an opportunity to commenton its legitimacy within the rules on subsidies in the WTO agreements.

Following this consultation, the ACS may decide to launch a formalinvestigation. This proceeds in much the same way as an anti-dumpinginvestigation. However, in a countervailing duty application the ACS mustdetermine whether the subsidy provided is one that is caught by the WTOAgreement on Subsidies and Countervailing Measures, which is incor-porated into the Australian Customs Act. There are a number of mattersthat must be shown. First, the subsidy must provide a financial benefitto the recipient. Second, this benefit must be conferred directly either bytransfer of funds, the forgoing of revenue, provision of free services, or sub-sidy by government purchase. Third, the subsidy must be specific in thesense that it is only available to particular firms or firms in a specific geo-graphic region or is related solely to export performance or requires domes-tic industry to use domestic goods rather than imported goods. Subsidiesfor research, development of disadvantaged regions, or assisting the govern-ment to obtain industry information are not actionable subsidies. In addi-tion, many measures regarding subsidies for agriculture are not actionable.This is an issue that is receiving wide attention in the Doha round of tradenegotiations.

Provided that the application has shown that the subsidy is one thatmight attract countervailing duty, then the ACS will launch a formal

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investigation. It follows the same course as an anti-dumping investiga-tion, including an investigation as to actual or threatened material injuryto Australian industry. Once the investigation process is complete it is nec-essary for the ACS to provide a statement of essential facts and then forthe Minister to decide what action will be taken. If a countervailing dutyis imposed it will be calculated by reference to the net benefit that therecipient of the subsidy receives. Thus the duty will reflect the amount bywhich the export price has been able to be reduced because of the subsidy.

Procedures for imposing a lower rate of duty in accordance with a non-injurious price or deciding not to apply any duty because injury is negligibleare as applicable to countervailing duty applications as to anti-dumpingapplications. The procedure by which an importer can ask for review ofthe duty imposed is also similar.

88 Exporting through anOverseas Representative

Many austral ian companie s have discovered that tosuccessfully gain entry to an overseas market for their products or services orto increase sales volume in that market it is necessary to have a representativethere. An overseas representative is a person or a firm that has a businessin the overseas market who can promote the products or services of theAustralian exporter in that market.

An overseas representative is a midway point between exporting directto the market and the firm establishing its own presence in the overseascountry. Exporting direct means that all arrangements relating to the sale arehandled by the firm in the exporting country. Exporting through an overseaspresence means that the firm has its own offices or plant in the overseascountry that either handles imports from the parent firm in Australia,sources imports for the firm in Australia, or manufactures the product orprovides the service directly in the overseas market. In the case of salesthrough an overseas representative, that representative will find customersfor the exporter. The exporter will usually either enter into contracts withthose customers directly or sell to the representative, who will in turn on-sellto customers.

The chief reason for appointing an overseas representative is to increasethe profits of the exporting company by increased sales. The overseas rep-resentative will have much greater familiarity with the local market andpotential customers than does the Australian exporter. This will help toincrease sales in a variety of ways.

First, in many Asian countries, for example, it is difficult to gain accessfor a product or service unless there is a local contact for the customer.Distribution systems in most countries are complex; often there are anumber of mid-level distributors before the product reaches the final

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consumer. In order to enter the distribution system it is often necessaryto have an overseas representative that has sufficiently good connections toget the exporter’s product into the distribution chain. Traditionally, Japanand the North East Asian countries have had very complex distributionsystems for consumer products. Retail outlets have been small and unableto carry large amounts of stock. In addition, many are either owned by orhave close connections with a multi-layered distribution network. It is notusual for overseas exporters to be able to sell directly to retail outlets thatdo not have the facilities to handle imports of stock. Entering the networkis therefore difficult for firms outside those connected with the networkin some way. For this reason an overseas representative with distributionnetwork connections is required. Further, Japanese buyers, in particular,insist on very high standards of quality, after-sales service, on-time deliveryand reasonable pricing. To meet these demands an Australian firm oftenfinds that it must have a representative in Japan.

Second, it is often the case that a product or service needs to be modifiedto suit customers in the overseas market. This can relate to the packaging,labelling or even shape and design of the product. An overseas representativeis much more attuned to local regulations and consumer tastes than is anexporter trying to determine these matters from Australia with only theoccasional visit to the overseas market. Similarly, an overseas representativecan advise when competing products come onto the market and whatupdates to the exporting firm’s products might be needed to deal with thecompetition.

A third role for the overseas representative is to assist in having goodscleared through customs in the overseas country. This will be important ifthe terms of delivery impose some obligation on the part of the exporterin the overseas country. In addition, an overseas representative can adviseof changes to various regulations relating to the need for inspection of theproduct and safety and technical standards that the product must meetif it is to enter the overseas market. Accessing this information can bedifficult from Australia. Previous chapters have noted the details of importprocedures that exist in Australia. Most overseas countries have equally, ifnot more, complex procedures and may also have slow-moving customsauthorities or even corruption in the customs service.

While there are many advantages in having an overseas representative,there are also disadvantages. The representative will need to be compen-sated for its services, thereby reducing the profitability of each particularsale as compared to exporting direct. In addition, it is necessary to payclose attention to the selection of the representative as well as its precise


obligations and functions. This will be covered in the agreement thatappoints the representative. Various legal problems can arise if the overseasrepresentative acts outside its authority. These will be discussed later in thischapter.

This chapter aims to impart an understanding of:� the various types of overseas representative and differences between

them;� factors to consider when appointing an overseas representative;� the terms and conditions of the agreement with the overseas represen-

tative; and� some legal matters that arise out of the agreements.

T Y P E S O F O V E R S E A SR E P R E S E N TAT I V E S

The two main types of overseas representatives that firms use to assist inthe sales of their product in overseas markets are agents and distributors.But as will be seen below, there are many hybrid arrangements that cannotneatly be classified as either agents or distributors in the sense in whichthose terms are normally used.

U S I N G A N A G E N T

The legal definition of an ‘agent’ is a person or firm that stands in theposition of the principal when dealing with third parties. The principalis the technical legal term for the person or firm that has appointed theagent to act on its behalf. The circumstances in which the agent can bindthe principal in transactions with third parties differ from jurisdiction tojurisdiction. Whether the principal has recourse against the agent for actingto bind the principal without the principal’s authority depends on the termsof the agreement. These complex legal issues will be discussed in more detaillater in this chapter.

At this point, however, the basic characteristics, functions and obliga-tions of an agent will be set out with reference to how these are seen inAustralian law. While there are some differences from jurisdiction to juris-diction that will be discussed later, the basic functions and obligations aresimilar.

It is important at the outset to distinguish an agency relationship froman employment relationship. In an agency relationship the principal and


the agent have separate businesses. In an employment relationship, on theother hand, the employee plays a direct part in some aspect of the employer’sbusiness. In an agency relationship the broad obligations of the agent areset out in the agency agreement or, if there is no written agreement, theyare implied into the relationship by the general law of agency in the placewhere the agent acts. In an employment relationship the obligations of theemployee are also often determined by an agreement between the employeeand the employer. However, the manner in which the employee carries outits duties is usually much more closely directed by the employer than in aprincipal–agent relationship.

The general function of the agent is to find customers for the princi-pal in the overseas country or to find suppliers if the principal wants topurchase goods from the overseas country. It is usual practice for the agentto refer customers on to the principal for them to reach agreement onthe terms and conditions of sale, such as payment, delivery and transportarrangements. Thus it is the principal that takes on the risk of each indi-vidual agreement with customers that the agent has found. It is not usualfor the agent to enter into contracts with prospective customers directly.If the agent does so without authority the principal will generally haverecourse against the agent should the principal suffer any loss. The posi-tion of the person with whom the agent has contracted varies accordingto the law of the place where the contract was entered into. This questionwill be discussed in more detail in the section dealing with third parties’rights.

In Australia, and in most other jurisdictions, general agency law providesthat in carrying out their duties as set out on the agreement between theprincipal and the agent, agents must act in good faith and with honestyand diligence. Agents usually have no authority to delegate their functionsto others. In many cases they are selected by the principal because of theparticular connections they have within the relevant industry. If the agentdelegates its role to another firm or person it would therefore not be actingin the principal’s best interests.

Agents are also required to account to the principal for the activities theyhave undertaken on the principal’s behalf. If the agent receives any moneyon the principal’s behalf it should keep it in a separate account. Agents alsohave duties to keep confidential any information they have obtained onthe principal’s behalf. They must act in the best interests of the principaland should not have a conflict of interest between their own business andthat of the principal. All of these duties are reflected in the terms of mostagency agreements and will be discussed in more detail below.


In exchange for carrying out tasks assigned to them by the agency agree-ment, the agent is entitled to a commission. How commission is calculatedand the time when it is paid will also depend on the agreement.

U S I N G A D I S T R I B U T O R

The relationship between an exporter and a distributor is quite differentfrom the agency situation. When an exporter wishes to use a distributor toaccess an overseas market it is effectively selling its product to the distributorfor the distributor to on-sell to the distributor’s customers or retailers inthat country. Typically, exporters will have a long-term contract with adistributor, agreeing to sell to the distributor a certain quantity of goodsover a set period at an agreed price. This is called a master distributionagreement. Each individual shipment will then be a separate contract thatadopts the payment, delivery and transport terms envisaged by the masteragreement.

The distributor usually on-sells the goods to wholesalers, retailers orend users in the overseas country at a significant mark-up, giving thema tidy profit. It is for this reason that many exporters prefer to attempteither to sell direct to wholesalers, retailers or end users or, at the veryleast, appoint an agent rather than a distributor to handle matters in theoverseas country. However, as noted earlier, in some markets and for someproducts, the use of a distributor will be unavoidable in order to penetratethe distribution system in that country. Japan has been a classic example,with the large Japanese trading houses often the only way to access thecomplicated Japanese distribution system for some products.

Many firms are reluctant to use the term ‘agent’ for their overseas repre-sentatives because of an assumption in some jurisdictions that dealing withan agent is the same as dealing with the principal and is therefore bindingon the principal. To avoid the legal connotations of the use of the word‘agent’ some exporters prefer to use the words ‘dealer’ or simply ‘represen-tative’. In this way the parties are free to negotiate the precise duties of eachand set these out in their agreement. As far as third parties are concerned,however, it may well be the case that a court has to decide whether the truecharacter of the relationship is indeed one of ‘agency’ or not in order todecide whether the principal or the ‘representative’ is responsible shouldthings go wrong.

While use of the word ‘commission’ would ordinarily alert one to thefact that the true relationship is one of agency, this is not necessarily the


case. For example, it is possible for a distributor to be paid a ‘commission’ ifit adds to its ordinary customer base and hence sells more of the exporter’sproducts. Another variation is for a representative ordinarily acting as anagent to purchase directly from the principal and then on-sell to customers.Thus not all representative arrangements fall neatly into one category orthe other.

FA C T O R S T O C O N S I D E R W H E NA P P O I N T I N G A N O V E R S E A SR E P R E S E N TAT I V E

The factors to consider when appointing a representative can be neatlygrouped into what might be called the four Cs: commitment, capacity,communication and commission.

C O M M I T M E N T

The commitment that the representative has to the sale of the principal’sproduct is perhaps the most important of all of these and the most difficultto ascertain when making a choice. If the representative fails to be con-vincing about how it will promote and sell the product, then there is littlepoint in appointing it as either agent or distributor. Most firms have severalmeetings with prospective representatives before finally entering into anagreement. Knowledge of local culture and customs is imperative whenmaking an assessment of the representations that are being made by thepotential representative about the extent to which it will go to sell a productor service. But there are other, more tangible ways to gauge whether what isbeing said will in fact occur. The reputation of the representative within theindustry and among its existing customers provides some objective measureagainst which to balance the assertions that are being made. The potentialrepresentative might also insist on a certain duration for the arrangementat the outset and that they have exclusive rights for a given territory. Ifthey are unwilling to agree to a review of the arrangements against spe-cific performance criteria, this may be an indication that commitment islacking.

The next matter to consider carefully in assessing commitment is thedegree to which the representative will have a conflict with the productsof the exporter’s firm and the products from other firms that they mightbe handling. In the case of distribution arrangements, it is quite commonfor a distributor to obtain similar products from various overseas and local


sources and then to on-sell these to its customer base. If the distributorhas similar products that it can obtain more cheaply from other suppliers,it would be unlikely to be able to sell a firm’s products to its customersahead of the cheaper alternatives. Competition from competing productsis even more important in agency arrangements. One of the basic duties ofan agent in most such arrangements is to refrain from handling competingproducts from other principals. If a firm agrees to appoint an agent despiteits handling of competing business, it will be difficult to know whetherthe firm’s products or services are being given equal weight to competingproducts or services. This builds mistrust in the relationship and is often asign that problems will develop. If it is necessary to have a representativethat also deals with competing products, it is useful to know whether theexporter’s product lines will constitute a significant proportion of its totalbusiness. If this is the case, the exporter’s products are more likely to begiven some priority.

C A P A C I T Y

The capacity of the representative to deal with the firm’s products must alsobe assessed. Most firms contemplating the appointment of a representativewill want to know the extent of the representative’s existing customer baseto assess whether that representative will be able to promote the productor service adequately to a wide enough target market. This will influence adecision on whether the representative should have exclusive rights (subjectto the law allowing this) or whether it is necessary to appoint a numberof representatives for the product or service within a given country. If therepresentative is to be responsible for promotional materials and advertising,some assessment must be made of its capabilities in this regard. The variouspromotional mechanisms used to promote other products it has handledand the resources it has on hand, including sales staff, will assist in makingthis assessment.

The financial capacity of the proposed representative also needs to becarefully considered in the case of distribution arrangements. The distrib-utor will need to be able to pay promptly for each shipment. If there aredelays in payment that others have experienced, this may be a sign of pos-sible problems. As is the case with ordinary direct sales, there are variousmechanisms for establishing the creditworthiness of a potential distributor.These have been dealt with in the earlier chapter on payment. The logisticscapability of a proposed distributor is also important. This includes thecapacity of the distributor to arrange for prompt transport and customsclearance at the delivery end, adequate storage facilities, and arrangements


to get goods to potential customers. The capability of the representativeto offer after-sales service, if this is required, is also important. Customerswill soon lose faith in a product if the representative is not able to deliverafter-sales service or spare parts in a timely manner.

C O M M U N I C A T I O N

The willingness of the representative to communicate regularly with theexporter is important in arranging shipments, communicating special cus-tomer requests, providing sales records, and the details of potential cus-tomers contacted. Representatives should also promptly update the exporteron possible competition and potential modifications or upgrading of theproduct that might be needed to meet the competition. Communication isa frequent problem in agency and distribution arrangements, and report-ing requirements that are written into agency agreements are often veryhard for principals to enforce. This is a constant source of frustration forsome Australian firms, particularly those that have agents in Asian countrieswhere traditionally business affairs are kept as closely guarded secrets.

C O M M I S S I O N

Finally, the rate of commission that an agent expects or the degree of profitthat a distributor expects needs to be carefully considered and weighedagainst what is usual in the industry and against what the firm’s experiencesare in other countries throughout the world. Too high a rate of commissiondeprives a firm of profits. Too low a rate might mean that the representativedoes not intend to give a product or service much attention.

Many arrangements for the appointment of representatives try to alle-viate some of these problems by carefully drafted written agreements. Wenow turn to some of the common clauses of such agreements and discusswhy those clauses might be necessary.

T H E T E R M S O F A G R E E M E N T S F O R T H EA P P O I N T M E N T O F R E P R E S E N TAT I V E S

Some Australian exporters do not have formal written agreements withtheir agents and distributors. They prefer to build a relationship of trustand, based on that relationship, change the arrangements as circumstancesvary. But many others who have had problems with agency relationshipstend to see some benefits in formalising the relationship in order to min-imise possible misunderstandings. The following discussion sets out somekey issues that exporters might consider when setting up a formal agency


or distribution agreement. There are several sources for obtaining sets ofterms and conditions for international agency and distribution agreements.One of these is the International Chamber of Commerce, which suppliesstandard sets of terms and conditions for a fee.

P A R T I E S T O T H E A G RE E M E N T

One of the essential features of an agency relationship is that the agent willact personally and use its best endeavours to sell the principal’s products.Identifying the agent in the agreement (whether it be an individual orcompany) is therefore important. It is equally important to have the businessaddress and address for communications clearly set out in case any formalnotices need to be sent to the agent.

G O O D S C O V E RE D

There are several reasons why it is important to negotiate what goods willbe covered by the agreement and then set this out in the agreement itself.In the case of distribution agreements, the exporter might want to tie thedistributor into selling all of their product lines to get maximum exposurein the market. On the other hand, the distributor might want to pick andchoose between the various product lines that the exporter has available,taking only those that they feel are the most competitively priced. Or theexporter might want to sell some of its products into the market directlyand only have certain products dealt with by the distributor or agent.Misunderstandings can arise if it is not clear what products are covered bythe agreement. It is equally important to set out what goods are covered inan agency agreement because this makes it clear for which goods the agentis authorised to seek customers and this has a bearing on the limits of theagent’s authority.

M A R K E T T E R R I T O R Y

It is common practice for Australian exporters to have just one agent ordistributor for smaller countries. For some products, however, it might beadvisable to consider more than one agent. It may be the case that businesspractices within the country are such that agents tend to deal only withina particular region because that is where they have their customer base andthey find it difficult to move outside that region. Both Korea and Japantend to have tight regional boundaries for business purposes, and for that


reason it may be advisable to appoint more than one agent. There areother sound reasons for clearly defining the territory, including avoidinga situation where two agents claim commissions from the one sale. Forexample, an exporter may have one agent in Korea and another in Japan.But the Japanese agent may find Japanese customers in Korea. The Koreanagent would then claim a commission as well as the Japanese agent. Thusclear definition is always best. The standard International Chamber ofCommerce agency agreement makes provision for reduced commissionswhen an agent finds customers outside its territory (as long as the customeris not within another agent’s territory).

A G E N T S ’ G E N E R A L O B L I G A T I O N S

It is as well to include a statement in the agreement that sets out the generalduties of the agent, such as acting with diligence in sourcing customers forthe principal, carrying out the obligations personally, and avoiding conflictsof interest. Such provisions might also include a statement about the limitsof the agent’s authority: for example, stating clearly whether they are entitledto sign agreements on behalf of the principal and in what circumstances orwhether all customers are simply to be referred on to the principal for thenegotiation of the detailed terms and conditions for the sale. Most agencyrelationships entered into by Australian exporters tend to limit the agentto finding customers and referring these on to the principal. This practiceis also sound for tax reasons. Some countries’ taxation laws will deem anoverseas company to have a ‘permanent establishment’ within the countryif the agent is actually authorised to sign contracts on the principal’s behalf.The tax authorities may then tax profits, claiming that those profits havetheir origin within the country where the agent is located.

E X C L U S I V I T Y

The question of exclusive arrangements has been discussed above in rela-tion to territory, but it needs further elaboration. A separate provision inthe agreement is desirable for both agents and distributors. The provisionshould make it clear whether the principal is to be able to sell directlyinto the territory and, if so, whether the agent or distributor is entitledto a commission or some other payment. Generally speaking, the use ofthe word ‘exclusive’ in an agreement means that if the principal does selldirectly into the territory then the agent is entitled to a commission. In thecase of a distributorship agreement, and depending on its precise terms,


a principal selling directly into the territory may find itself in breach of theagreement. Most distributors will want exclusive arrangements. If a princi-pal attempts to cut out the distributor by selling directly into the market,the result may be loss of reputation in the market, with no other distributorbeing prepared to act for it in the future.

C O M M I S S I O N

In the case of an agency agreement, the primary obligation of the principalis to pay the agent a commission. It is advisable to set out not only therate of commission but also to make it clear at what time commission willbe paid and what amount will be paid. Most exporters find it in their bestinterests to have commission payable only when the sale to the prospec-tive customer is complete and payment has been received. But prospectiveagents may negotiate quite hard on this point because they may have putin a lot of effort to secure a customer only to find things go astray at thelast minute. Other alternatives for timing of commission payments includewhen the principal receives a firm order or when the prospective customermakes contact with the principal. The amount on which commission ispayable is also important. Common practice is to pay commission only onthe net sales amount, exclusive of transport and other costs. The standardInternational Chamber of Commerce agreement takes this approach. Inthe case of Australian exporters, these costs will sometimes be quite consid-erable and accordingly will make a significant difference to the amount ofcommission that is payable if the agreement is not clear on which amountscommission is paid.

P E R F O R M A N C E C R I T E R I A

Most principals want to see their agents and distributors achieve a set min-imum level of sales of their products. There are a number of alternatives forattempting to tie the representative into a minimum target. It is possibleto provide for a minimum amount of sales over a set period in monetaryterms or in terms of volume. This type of clause should also provide whatwill happen if the agent fails to achieve the required target. Agents willwant to include provisions that excuse them from reaching minimum per-formance targets in certain circumstances. For example, the SARS crisisin early 2003 severely affected sales of some products in Asian countries,making it impossible for agents to realise sales targets. In Singapore andHong Kong, where there is a high level of tourism, sales plummeted. The


possibility of such unforeseen events occurring should be considered whennegotiating and drawing up the agency agreement.

R E P O R T I N G RE Q U I RE M E N T S

Many Australian exporters complain that it is very difficult to extract infor-mation from agents about the efforts they have been making to sell theprincipal’s products. While reporting requirements can be adhered to ini-tially, agents tend to be less inclined to provide regular reports as time goesby. There is no easy solution to failure to comply with reporting require-ments and often the only way to deal with this is to make regular visits tothe agent in the country concerned. Reporting requirements may also bean obligation of the principal. For example, the agent will want to knowwhen the sale has been completed so that it can forward its account forcommission. It is therefore as well to set out clearly what each party needsto communicate to the other and when.

C O N F I D E N T I A L I T Y

One of the duties of an agent is to keep the affairs of the principal confiden-tial. However, the experience of Australian exporters is that confidentialityis not respected to the extent that they would wish. For example, an exporterwho advises an agent in one country that it may offer products to its cus-tomers at a discount may find that its agent in a neighbouring countrysooner or later also asks for the same discount for its customers. Thus,while a confidentiality clause is essential in agency agreements, the bestway of protecting sensitive customer and other information is to build arelationship of trust with the agent, at the same time ensuring that theagent is aware of specifically what information it is to keep confidential.Customer lists are an obvious example but so too is any intellectual prop-erty that relates to the product. Agents who disclose sensitive informationabout the way in which a product is manufactured, materials used to makeit or design information run the risk that local manufacturers will quicklybe able to duplicate the product, thereby cutting the principal out of themarket.

C O M P E T I N G I N T E RE S T S

Standard agency agreements attempt to restrain the agent from dealing incompeting products. The reasoning here is that an agent cannot represent


two competing products equally well to potential customers. However,where the product is a specialised one and only a limited number of agentshave the market contacts and expertise to sell it, there may be no alternativebut to allow the agent to deal in competing products. Similar considera-tions apply in the case of distributors, where it is often necessary to use adistributor that deals in competing products. If this is the case, minimumperformance targets become even more important. The agent should notitself be in a business that competes with the business of the principal; fewexporters would tolerate this situation. But it is not always easy to discoverif the agent is dealing in competitive products. One may find, for example,that while two agents appear to have different businesses they are in realityowned by the same person, who has simply set up two different-lookingbusinesses in the hope of attracting more products to sell.

P RO M O T I O N A L M A T E R I A L A N DA D V E R T I S I N G E X P E N S E S

The promotion of the principal’s product in the target market is essential tomaximise sales. The division of responsibility for this between principal andagent needs to be negotiated at the start of the agency arrangement. Becauseexporters are keen to ensure that no misrepresentations are made regardingtheir products, they often prefer to produce the promotional materialsthemselves and have the agent distribute these to potential customers. Inthe case of distributors, the distributor may want the exporter to share inany promotional costs incurred when they engage in special promotionsthat might involve the exporter’s product.

A F T E R - S A L E S S E R V I C E , W A R R A N T YA R R A N G E M E N T S A N D P RO D U C TL I A B I L I T Y

It is advisable at the outset to establish the extent of the agent’s obligationsregarding after-sales service. The representative must have the capability ofdelivering whatever level of after-sales service is agreed on and, as noted,this is a key criterion in the selection of an agent or distributor. The supplyof parts is equally important. Is the agent expected to obtain the parts fromthe principal or can it substitute those parts with locally produced parts?Problems can arise if the agent is required to purchase all parts from the


exporter because this may amount to a restraint of trade and offend thecountry’s competition laws. When the exporter sells to a customer that theagent has found, it is clear that it will be liable if the product is defective.But when the exporter sells to a distributor who then on-sells to a customer,is it the exporter who should bear any action for product liability or thedistributor, who may have altered or repackaged the product? This matterneeds particular attention in master distribution contracts. In drafting suchclauses it is necessary to pay close attention to the product liability lawsin the countries of both exporter and distributor, whether insurance isavailable and if so, who should pay the premiums.

T I M E - F R A M E O F T H E A G RE E M E N T

There is no hard-and-fast rule regarding the period of time that an agencyor distribution agreement should operate. Experience among Australianexporters differs. Some prefer to have an indefinite period in the hope thatthis will allow them to discontinue the arrangement with minimal fussshould it be necessary. Others opt for one or two years initially and thenrenegotiate depending on how the agent has performed. Some opt for alonger-term agreement with a review of the arrangement every 12 months,which allows the exporter to terminate if performance has been unsatis-factory. In order to avoid misunderstandings and to minimise terminationproblems, time-frames should be clearly spelt out in the agreement.

TE R M I N A T I O N

Terminating an agency or distribution arrangement can cause major prob-lems for exporters because agents and distributors will sometimes demandcompensation if the arrangement is terminated. In some countries there arelaws that provide that compensation is to be paid if an arrangement is ter-minated. Yet termination may be necessary and justified. For example, theagent’s business may be acquired by a competitor of the exporter, therebymaking it impossible for the agent to continue selling the exporter’s prod-uct in a fair manner. An agent may simply not be performing or may havebreached the ‘no competition’ clause in the agreement. While terminationin these cases may be justified, close attention to the country’s laws is neces-sary in drafting termination provisions to ensure that the circumstances inwhich termination is legally permissible without compensation is reflectedin the agreement.


D I S P U T E RE S O L U T I O N

Should a dispute arise between the exporter and the agent/distributor itis as well to have a provision in the agreement that sets out how disputeswill be resolved. It is common for such disputes to be resolved througharbitration rather than the court system. Chapter 11 on dispute reso-lution applies as much to the resolution of disputes in agency and dis-tribution arrangements as it does to dispute resolution in ordinary salestransactions.

S O M E I M P O RTA N T L E G A L I S S U E S I NT H E A P P O I N T M E N T O F O V E R S E A SR E P R E S E N TAT I V E S

When appointing an overseas representative it is important to be aware ofprovisions of the overseas country’s laws that may affect the operations ofthat representative within that country. In this section we consider threeareas in which the laws of the country where the overseas representative isappointed may have significant implications for the exporter appointingthat representative. These three areas are competition laws in the overseascountry, laws that affect termination of the relationship, and the rights ofthird parties.

C O M P E T I T I O N L A W S

It has been increasingly recognised throughout the world that competitionlaws are a necessary accompaniment to the process of freeing up trade toallow consumers to have access to goods and services at the best possibleprice globally. For example, even if a free-trade agreement between twocountries allows for goods to enter a country with no tariff and non-tariffbarriers, anti-competitive practices within that country may still make itvery difficult for the overseas supplier to arrange for the distribution andsale of the goods in that country. This could apply if all retailers in thecountry are tied into agreements that restrict them from buying other thanfrom local manufacturers.

The World Trade Organisation is currently attempting to have all mem-ber countries adopt competition laws to complement the measures it ispursuing in the free-trade area. While this will be a slow process because itattacks traditional business practices and traditional relationships between


business and government in many countries, there is nonetheless a trendtowards the adoption of competition laws and laws that prohibit restrictivetrade practices.

These laws have an impact on international distribution agreementsbecause if such an agreement is seen to restrain trade it may be subject toscrutiny and possible legal action against the distributor by competitionauthorities within the country where the distributor is located. There is arange of circumstances in which an international distribution agreementcan restrict competition. For example, provisions that may offend competi-tion laws include those that set the price at which the distributor can resellthe goods; limit the parties to whom the distributor can sell the goods;refuse permission to appoint a sub-distributor; restrict the volume of prod-uct that the distributor can sell; require that all spare parts and supplies beobtained from the exporter or require the distributor to buy all their prod-ucts from the exporter as a condition for the purchase of any one product. InAustralia, the Trade Practices Act contains a number of provisions (sections45–47) that, with limited exceptions, prohibit all of these practices forAustralian distributors. Failure to comply with the Act can result in actionby the Australian Competition and Consumer Commission, the body thatmonitors compliance with the Act.

Another matter of concern is the exclusive nature of the agreementand the effect this will have on competition. However, most countries donot outlaw distribution agreements merely for being exclusive because itis widely recognised that as well as having anti-competitive effects exclu-sive agreements may also have pro-competitive effects. For example, theappointment of an exclusive distributor can achieve efficiencies in the sup-ply, marketing and promotion of the product, thereby allowing greater com-petition with existing suppliers of the product and benefiting consumersby greater choice and price competition. In more established markets, it isoften the case that only an exclusive distributor will find it worthwhile tospend the necessary funds to promote the product and achieve the criticalmass to compete in the market.

The way in which countries regulate exclusive distribution agreementsdiffers. It is often the case that exclusive distribution agreements will notbe seen to be anti-competitive per se unless the distributor has more thana set percentage of the market for the product. This is often set in the25–30 per cent range (Japan and the European Union, for example). If thedistributor does have more than the designated percentage of the marketthen competition authorities will need to be satisfied that the agreementdoes not restrict competition.


Although there is a trend towards harmonisation of competition lawsthroughout the world, there are still many significant differences betweenthe competition laws in various jurisdictions and the way in which they areenforced. Even the United States and the European Union have differentapproaches to the problem. For this reason those contemplating an inter-national distribution agreement need to be familiar with the competitionlaws within the country where the distributor is to be appointed.

International agency agreements are much less likely to attract scrutinyby competition authorities. In a typical agency agreement, an agent onlyrefers customers on to a principal that is located in a different countryfrom the buyer, with the buyer usually having a choice of suppliers eitherdomestically or internationally. In addition, in an agency transaction, sellerand buyer are located in different countries and therefore any individualnational government finds it difficult to deal with practices of agents thatmight look as if they are restricting competition. It should be noted, how-ever, that the EU regulations on competition policy might also apply toagents in certain circumstances, particularly if the agent can sign a contracton the principal’s behalf.

T H E T H I RD P A R T Y P RO B L E M

There are good reasons why most exporters insist that their agents refer cus-tomers on to them for concluding the sale agreement rather than allowingthe agent to go ahead and conclude the sale. Exporters who allow agents toenter into agreements on their behalf take risks in their liability to third par-ties. This is well illustrated by the complexities of the common law positionwhere principals allow agents to enter into agreements on the principal’sbehalf.

Generally speaking, a principal (an exporter in the present context) willnot be liable for the acts of its agent if the agent goes beyond the authoritygiven to it by the principal. Thus an exporter appointing an agent withexpress authority to enter into agreements on the principal’s behalf to sellthe principal’s range of processed fruit products will not be obliged to supplya third party with whom the agent has entered into a contract to supplyprocessed meat products; the agent itself will be personally liable to the thirdparty. However, if the principal has allowed third parties to believe that theagent has authority to act, the principal may well find itself liable wherethe agent has entered into a contract beyond the express authority given toit. In the earlier example, if the principal has regularly visited the countryand promoted both its range of processed fruits and its range of processed


meats, a third party might well argue that it was under the impression thatthe agent had the authority to deal in both, even though this is not the case.In this situation the third party may be able to argue successfully that byits conduct the principal has allowed third parties to believe that the agenthas the ostensible (apparent) authority to deal in both ranges of products.If a court finds that this is the case, the principal will be obliged to honourthe contract made by the agent to supply processed meat products to thatthird party.

Further complications exist for both exporters and a third party wherethe agent enters into a contract to supply a third party with products forwhich it has the principal’s authority to deal but has not disclosed that itis acting as an agent. In other words, the third party did not know thatthe agent was in fact acting as an agent but thought that the agent wasacting on its own behalf. In common law countries (the UK and Australiaand others) a dissatisfied customer (third party) can elect to sue either theprincipal or the agent in these circumstances. Conversely the principal cantake action against the third party if it so wishes. However, in civil lawcountries (most of the EU, Japan, Korea and others), the third party canonly take action against the agent. Likewise, the agent is the only personwho can take action against the customer. The principal and the agent areleft to sort out their differences.

Because of these risks, most exporters prefer to enter into all sales agree-ments with customers themselves rather than allowing the agent to enterinto agreements directly.


As noted above, agency agreements frequently provide for an exporter tobe able to terminate an agency relationship as long as a certain amount ofnotice is given to the agent. Those agents that pursue their duties diligentlywill have spent much time and effort in attempting to secure customers forthe exporter and so may have added significantly to the business that theexporter would have otherwise been able to conclude in that territory. Manycountries therefore seek to protect agents from so-called ‘unfair termination’where, for example, a principal merely wants to terminate the agency sothat it can set up a permanent presence in the country to service thosecustomers directly.

The laws that seek to protect agents often provide that an agent is entitledto a termination payment. For example, in order to reflect the position ascontained in the European Commission’s Directive on Commercial Agents


(1986), the standard International Chamber of Commerce agency agree-ment allows parties to select a clause that provides for an indemnity for theagent equal to a maximum of one year’s commission. Of course such anindemnity would not be able to be claimed by the agent if the agreementwas terminated for breach by the agent. Laws that seek to protect the agentare common in Latin America, the Middle East and parts of Asia.

Those seeking to enter into agency agreements are therefore well advisedto check whether the particular country where the agent is to be locatedhas any laws relating to unfair termination.

99 Exporting via Licensing andFranchising Arrangements

Intellectual propert y r ights (IPR) are based onthe uniqueness of a product or service, whether that uniqueness hasoccurred by way of an invention, the development of a reputation based ona brand name, a novel product design, or the composition of an originalwork. In general terms inventions are protected by taking out a patent.Brand names are protected by registration of a trademark and designs areprotected by registration of that design. On the other hand original com-positions are protected automatically in most jurisdictions through what isknown as copyright protection.

Owners of intellectual property rights can exploit those rights them-selves for profit; they may also allow others to use them for a fee. Thislatter arrangement is referred to as a licensing arrangement and the feethat exporters extract in exchange for allowing others to use their IPR iscommonly referred to as a royalty. A franchising arrangement is a particularform of arrangement that invariably involves licensing of IPR and as suchwarrants special treatment in this chapter. This discussion includes the com-mon types of franchise arrangement: business format franchising; productor distribution franchising and production franchising; the methods mostoften used by franchisers to access consumers in overseas countries; andthe complex issues that a franchisor must confront when entering into afranchising agreement.

It is increasingly the case in the international marketplace that the valueof an exporter’s product or service depends on its uniqueness, or at thevery least, its degree of sophistication in relation to that of competitors.In addition, the development of a sophisticated or unique product or ser-vice usually requires the investment of a considerable amount of time and

203


money. For these reasons exporters will be interested in ensuring that theircompetitive position is protected.

Thus the first issue that arises for an exporter whose product or ser-vice depends on IPR for its success is how to protect the rights in thefirst place. Patents, designs and trademarks require registration for pro-tection, whereas copyright does not. To ensure protection for the IPR,exporters will not only need to register their patent, design and trade-mark rights in Australia but may also need to register them in overseascountries to which their goods may be exported or in which they mayhave set up a business producing those goods or delivering the services.Most countries have acceded to international treaties under which theyhave agreed to protect the intellectual property of citizens of other coun-tries that are also members of the treaty. The procedures that exportersneed to adopt to protect their intellectual property are therefore dis-cussed in more detail in relation to each form of intellectual propertyright.

The second question confronting exporters is how to prevent per-sons from copying the products or services that they seek to have pro-tected through IPR. Preventing the violation of IPR will only occur ifthose rights can be enforced. The enforcement of IPR poses difficul-ties in many countries. In most cases enforcement action needs to betaken in the country where the infringement is occurring. Its effective-ness will therefore depend on the overall effectiveness of the legal systemin that country. Detailed discussion of the extent to which enforcementof the various forms of IPR occurs globally is beyond the scope of thisbook. Those interested in the topic need to look in detail at specific casesof violations of IPR in countries in which they might be interested inorder to make an assessment of the likelihood of their own IPR beingprotected.

This chapter therefore aims to impart an understanding of:� the various forms of intellectual property and how these can be

protected;� an overview of franchising as a special illustration of licensing including

the common types of franchising arrangements used in internationalfranchising and alternative methods that can be used for implementingall such arrangements;

� important issues that must be addressed in franchising and licensingagreements;

� common types of regulations that might confront a franchisee or licenseeoperating in an overseas country.

L I C E N S I N G A N D F R A N C H I S I N G 205

P R O T E C T I O N O F I N T E L L E C T U A LP R O P E RT Y R I G H T S

P A T E N T S

A person who invents a new product or process of manufacture can applyto take out patent rights in a jurisdiction. If they are successful, therights they will gain will prevent others from making, using or sellingthe product without their consent in that jurisdiction. The website of IPAustralia (www.ipaustralia.gov.au) is a very useful source of informationfor those wanting to apply for a patent. It also provides some examples offamous Australian inventions that have been patented, including Cochlear’sBionic Ear, Dynamic Lifter, Hills Hoists, Hume Pipes and the AutomaticTotalisater.

Taking out a patent under the Australian Patents Act 1990 (Cth) involvesa number of steps. The first of these is to decide if the invented object orprocess qualifies for patent protection. There are four requirements for aninvention to be patentable. First, the applicant must demonstrate that theproduct involves a ‘manner of manufacture’. This means that the inventormust be able to show that the product has been artificially created. Thusdiscoveries of new minerals or even new species of plants and animalscannot be patented because no ‘manner of manufacture’ is involved.

Second, the applicant must show that the ‘invention’ is novel and inven-tive. In other words, the applicant must have been the first to come upwith the idea. If the product is being manufactured elsewhere, or even ifthe specifications of the product or process have been published in scien-tific journals, the invention will not be novel enough to attract a patentright. To demonstrate inventiveness, the applicant for a patent must be ableto show that their invention is not obvious. In other words, it must be acompletely new idea in the field to which the product or process belongs.An expert in that field determines this. In many cases, it is found that theidea is simply an improvement of an existing product or service. In thesecases, the proper method of protection is to take out an innovation patent(or utility model in some countries) rather than a patent. For an innovationpatent the applicant must be able to show an ‘innovative step’ rather thanan ‘inventive step’, thereby distinguishing the degree of novelty required.An innovative step involves a significant change to the product itself. Third,the invention must be useful. This means that the invention must be suchthat it can be put into use by following the details of the product or processcontained in the patent application. Fourth, the inventor must not havesecretly used the invention previously.


If the applicant wishes to apply for a standard patent or an innovationpatent, the applicant must lodge either a provisional or complete applica-tion. A provisional application gives the applicant protection from the dateof filing and allows the applicant 12 months to file the complete appli-cation. The complete application must contain all details of the patentedproduct or service and be sufficient to convince the examiners of the patentthat it satisfies the requirements. Completing a patent application usuallyrequires the services of an experienced patent attorney who is familiar withthe requirements of the application process. The application itself is filedwith IP Australia.

The applicant must then decide whether the application should be exam-ined immediately to determine its eligibility or whether the examinationshould be deferred. Deferral of an examination may be warranted in caseswhere the applicant does not want to manufacture the product immediatelybut wants to protect their rights for the future. In any event, an applicationwill lapse if no request for examination is made within five years. Once arequest has been made, the examination process will take six months. Theexaminers will conduct worldwide searches to ensure that the product isnovel. Experts will determine if it involves an inventive step. If it satisfies allthe criteria, it will be accepted for the grant of a patent. The patent appli-cation will then be published to allow time for others to object; the periodfor objections is three months. If no objections are upheld the inventor isissued with a patent certificate. Standard patents are protected for 20 yearsand innovation patents for eight years. If a person does not use their patentrights, it is possible for another person to apply for a compulsory licence.This means that the original patent holder must allow the other person tomanufacture the product on condition that royalties are paid to the patentholder. Situations where compulsory licences can be granted tend to belimited to products where it can be demonstrated that the patent holder iswithholding a product that might be socially useful.

There are three important international conventions that assist thoseinventors who intend to export the product or process or have it manufac-tured overseas. The first of these is the Paris Convention for the Protectionof Industrial Property Rights (the Paris Convention). This internationaltreaty arose because of the difficulties inventors had in protecting theirinventions in several countries at the same time. The problem becameapparent at a trade fair in Austria in the 1870s at which few inventorswere prepared to show their products because, even though they mighthave filed patent applications in their own country, inventions were likelyto be copied by nationals of other countries where they had not filed for


protection. The Paris Convention overcame the need to file simultaneouslyin every country by allowing inventors who filed in any member countrythe same priority date if an application was subsequently filed in any othermember country within 12 months. Thus an inventor had 12 months fromthe date on which they filed their application in their own country to fileapplications in any other member country where they desired protectionfor their invention. The second major initiative of the Paris Conventionwas that all member countries agreed to give each other’s citizens nationaltreatment on patent rights. This meant that citizens from other countriesfiling patent applications would be treated exactly the same as citizensof that country in the patent application and enforcement process. Thusthose taking out patents could be confident that their patents would beprotected to the same extent as the inventions for citizens for any countrywhere they took out patent rights. At present 169 countries have signed thistreaty.

The second major treaty that assists those wanting to protect their patentsin other countries is the Patent Co-operation Treaty (PCT) of 1974. Thistreaty, which now has 115 member countries, provides a simplified proce-dure for inventors who want to protect their patent rights in many countriesat the same time. Under the treaty a number of national patent offices aredesignated as being able to receive international patent applications. IPAustralia is a designated receiving office for international applications.Thus, if an Australian inventor wishes to protect their invention in severalcountries they may wish to file their initial application as an internationalapplication rather than one that has only domestic protection. Filing aninternational application in a designated office gives the inventor that pri-ority date in all member countries regardless of the countries in which theinventor eventually decides to lodge formal applications. Gaining prioritymeans that if the same or similar application is lodged after the first appli-cant’s lodgement at a designated office, the first applicant’s application willhave priority rights over the subsequent applications. Lodging in a desig-nated office does not, however, grant a patent to the invention in othercountries.

After receiving an international application, the designated patent officewill carry out an international search for the inventor to determine thestate of prior art in the field. The inventor will receive a report that sets outall other inventions, worldwide, in their field, allowing them to make anassessment of the novelty of their invention. The second advantage of aninternational patent application is that the inventor can ask for an inter-national preliminary examination that will determine if the application


meets the international standards for grant of a patent. These requirementsare slightly different from Australian domestic standards but their effect isquite similar. The international standards require that the invention mustdemonstrate novelty, an inventive step and industrial applicability (useful-ness). After the international preliminary examination, the internationalapplication is published, usually after 18 months. Applicants then have afurther 12 months to decide in which countries they wish to apply for-mally for a patent. The application will then be forwarded to the nationalpatent offices of those countries for the formal grant of a patent in eachcountry. It should be noted that while the PCT process facilitates the grantof a patent in a number of countries, it does not supplant the need forindividual countries to register patent rights. This is because there is as yetno international patent registration authority.

The procedure under the PCT attracts higher fees than does a purelydomestic application. Details of the fees can be found on the website of theWorld Intellectual Property Organisation (WIPO: www.wipo.int). How-ever, for inventors who intend to export their product to several countriesand who are concerned that it might be copied by reverse engineering,the PCT process is less expensive than if the inventor started the processindividually in all of the various countries in which they wanted a patentto be granted.

The third important international advance in the protection of patentrights is the WTO Agreement on Trade Related Aspects of IntellectualProperty Rights (‘TRIPS’). This is one of the agreements that membercountries of the WTO entered into in 1995 (see Chapter 12 on the WTO).The TRIPS agreement requires member countries to ensure their lawsprotect patents for a period of at least 20 years. It also seeks to carefullylimit the circumstances in which national patent offices can refuse to granta patent to nationals of other member countries. Of most significance is theexemption for medical diagnostic and treatment methods and biologicalprocesses for production of plant and animals. While there is now aninternational agreement on the IPR in genetically engineered plants, manydeveloping countries in particular are reluctant to grant patents for drugsand other medical procedures that allow the health of their citizens to beexploited for profit by multinational corporations. On the other hand,multinational corporations need some incentive to develop those drugsin the first place. This issue is still a contentious one and negotiationsto balance the rights of the respective parties are ongoing. The TRIPSagreement also requires member countries to have legal processes to enablea person to enforce their IPR. However, as noted above, the question of


enforcement depends on the adequacy of resourcing for national policingauthorities and courts. Many developing countries have greater prioritiesfor the use of scarce resources.

TR A D E M A R K S

A trademark is used to distinguish the goods or services that a person orfirm provides from the goods and services of others. The trademark itselfmust be used in relation to the goods or services. Registration of a trade-mark prevents others from using it in relation to their goods and services.Registered trademark owners are also able to prevent goods infringing theirtrademark from entering the country by requesting Australian customs toseize counterfeit goods. Some well-known trademarks of Australian goodsand services are Qantas, Redheads, Poppy Lipsticks and Chesty Bonds (see<www.ipaustralia.gov.au> for further details).

The first step for registering a trademark in Australia under the TradeMarks Act 1995 (Cth) is to conduct a search of the trademark register toensure that it is not the same as or similar to any other registered mark. If itconflicts with other existing marks it will be refused registration. Similarly,if it does not refer to actual goods or services, but instead only indicates apurpose for which the goods might be used, it will not be able to be reg-istered. Likewise, it is difficult to register geographic names as trademarks.This topic will be discussed in more detail below when dealing with theWTO and trademark protection.

As long as an applicant is satisfied that the trademark is eligible forregistration, the next step is to formally file an application for registrationwith IP Australia. The application must include a representation of the markthat is to be used and it must specify the class of goods or services to whichthe mark is to apply. There are over 30 classes of goods and 12 classes ofservices that are specified in the ‘Nice Classification System’. Details of thevarious classifications are found on the IP Australia website. The applicantmust select the one most relevant to their application. In addition to thesedetails, the application must describe the goods or services to which themark is to be applied.

After the application is filed, it will be examined by IP Australia todetermine if it is eligible for registration in accordance with the criteriamentioned above. Once it is accepted, it will be advertised in the officialjournal of trademarks to allow for objections. If no objections have beenreceived after three months, the mark will be registered. The owner of aregistered trademark shows that the trademark is registered with an ‘R’


inside a circle. An unregistered trademark is shown with ‘TM’ inside acircle.

The period of protection granted by registration is ten years. If thetrademark owner does not use the trademark, its registration may lapse, butif the owner does use the trademark, the ten-year period can be extended. If,for example, fees are continuously paid to a trademark owner, the protectionmay last indefinitely. However, if the product becomes so well known thatit becomes generic, then protection will no longer be granted. For example,cellophane was once a trademark, but the word ‘cellophane’ soon came toapply to any product that had a similar use to the original product. Thusthe term cellophane became generic; in other words it could no longer besaid to distinguish the producer of any particular good from any other. Feesapply to the registration process. Details of these can also be found on theIP Australia website.

Exporters of goods for which a trademark has been granted are likelyto want that trademark protected in countries to which those goods mightbe exported and in any other countries where the trademark might becopied. International registration of trademarks is important not only forthose exporting their goods but also for those who intend to produce goodsoverseas or who intend to enter into a franchising arrangement. Franchisingarrangements are discussed in more detail later in this chapter.

In 2001 Australia acceded to the Madrid Protocol. The Protocol allowstrademark applicants (or trademark holders) in one member country toapply for protection of their trademark in as many of the other membercountries as required. At present there are 56 members of the MadridProtocol including most of Australia’s major trading partners (China, Japan,the US and most EU countries).

To obtain international protection, an Australian trademark applicant,or an existing trademark owner, must file an application for internationalprotection with IP Australia. IP Australia will forward the application tothe International Trademark Bureau. This body then checks the applicationto ensure that it complies with all formalities. If it does, the InternationalBureau grants international registration of the mark and arranges for it tobe advertised in the international journal of trademarks.

International registration does not, however, mean that the trademarkwill be accepted for registration by all countries in which the applicant hasrequested registration. The International Bureau will forward the applica-tion to the relevant trademark offices in all countries where the applicanthas requested registration. Those individual offices then have 12 months(18 months in some cases) to advise the applicant whether the trademark


will be registered in that country. Because of the Paris Convention, theapplicants have the same priority date in the overseas countries as the dateon which they filed their application in Australia. Refusal to register bythose countries can only occur if their trademark laws prevent registrationof such a mark. For example, a country might refuse to register the markbecause it offends moral standards in that country.

Trademarks are also dealt with in the TRIPS agreement. This agreementrequires all member countries to give protection for trademarks for thestandard period of ten years. It also means that member countries cannotdiscriminate between countries when granting trademark rights. Thus evenif a country is not a member of the Madrid Protocol and an Australian firmwants to protect a trademark in that country by directly seeking registrationin that country, the country cannot refuse to register the mark other thanby relying on provisions in its own laws. One of the provisions of mostinterest in the TRIPS agreement is the protection of products that bear thename of the location from which they originated. Because of the TRIPSagreement, countries are now reluctant to register trademarks that bear thename of a geographic location.

D E S I G N S

The registration of a design under the Designs Act 2003 (Cth) enablesthe creator of a design in Australia to have the sole right to exploit thedesign in Australia for five years. Examples of well-known designs thathave been protected include Ken Done bed linen, the classic folding chairfrom the 1960s, toy building blocks and, as far back as 1917, a design forwrought-iron fencing. Today, successful Australian designers may also wantto protect their design in other countries because they may find it cheaperto manufacture their product and export it from an overseas location. Thissection first deals with the procedure for registration of designs in Australiaand then discusses the procedure for overseas registration.

A design refers to the way a product appears visually. It enables theproduct to be identified as unique. Therefore, to be entitled to register adesign, it is necessary to show that the design is ‘new’ in the sense that it hasnot been published previously in Australia, and also that it is distinctive. Adistinctive design means that it is substantially different from other designsthat are already known.

The first step in registering a design in Australia is to search the databaseof existing registered designs. As is the case with trademarks, designs alsohave a classification system. There are 32 classes and 223 subclasses into


which designs fall. Thus to search the design database it is necessary tocheck the classifications that might apply to the design. Some examples ofthe classes include furniture, clothing, medical and laboratory equipment,and games and toys. A full listing of the classifications can be found on theIP Australia website referred to above.

If the designer wants to proceed to register the design, it is necessary tolodge an application form together with five identical copies, drawings orphotographs that represent the design, and to pay the application fees. Therepresentation of the design is a significant part of the application becauseit is what the designer relies on to protect the design. Thus any diagramsor photographs must clearly show the features of the product that make itboth new and distinctive.

Applicants can request that their design either be registered or simplypublished without registration. Registration of the design is generally pre-ferred because it gives the author the right to take proceedings againstanyone infringing the design. Mere publication of the design, on the otherhand, prevents others from registering that design because, since it hasalready been published, it is no longer new. If registration is requested andthe design is accepted as new and distinctive, a registration certificate willbe issued and then registration of the design is notified in the Official Jour-nal of Designs. There are a number of designs that cannot be registered forpublic policy reasons, for example designs for notes and coins, medals ofhonour and the Olympic symbol.

Designers who wish to manufacture a product overseas also need toregister their design in countries where the goods bearing the design will beused or manufactured to ensure the design is protected in those countries.Once the design application is filed in Australia, the Paris Convention allowsapplications for registration to be made in any of the member countries ofthe Convention within six months of filing in Australia. Filing in anothermember country within six months gives the applicant the same prioritydate as applies to their Australian application. In other words, the date offiling in the overseas country is taken to be same date as that on which theapplication was filed in Australia. On the other hand, failing to file in theoverseas country within six months will not only mean that the applicantloses priority but it may also mean that the design will no longer be regardedas ‘new’ by the registering authorities in the overseas country.

A number of difficulties arise for designers wishing to file their applica-tions in other countries. First, there is no international registration system,and an application must be filed in each country where protection is sought.


The process can be expensive because as well as paying filing fees, it mayalso involve paying for the services of a patent attorney in the country toassist with the application. It may also be necessary to have the applica-tion translated into the language of the country concerned. The shortnessof time that an applicant has in which to file in an overseas country adds tothese problems. But if the design gains protection in the overseas country,the period of protection will usually be the same as in Australia: five yearswith an option to renew for a further five years. The Paris Convention is notthe only international convention applying to designs. The Hague Agree-ment concerning the International Deposit of Industrial Designs and theTRIPS agreement both assist those seeking to have their design protectedinternationally.

C O P Y R I G H T

Copyright is the name of the intellectual property right an author or creatorgains in their original work. Copyright protection attaches to a range ofwork including books, articles, computer programs, paintings, databases,musical compositions, films, sound recordings and television broadcasts.Copyright differs from the other forms of IPR discussed in this chapterbecause the author of a work does not need to formally register their copy-right in order for it to be protected. Thus copyright is said to be protectedautomatically. In Australia, the period of protection lasts for the lifetime ofthe author and up to 70 years after the author’s death.

In order to attract copyright in Australia, a work must satisfy the criteriafor protection. These are that the work must be original, it must be inmaterial form, and it must demonstrate a connection to Australia. However,it is the work itself that is protected and not the ideas behind the work. Thusto claim copyright infringement, it is necessary to show that the expressionof the ideas is essentially the same. Individual words, names, or slogansare not considered ‘works’ for the purposes of copyright protection. Thesecan be protected by other means including registration of a trademarkor a business name. Likewise, a person’s image cannot be protected bycopyright, though if it is displayed in a way that adversely affects the person’sreputation, defamation laws may apply.

In general, the person entitled to copyright protection is the person whocreated the work. In some cases, however, if the work has been createdin the course of that person’s employment, the copyright may belong tothe employer. An owner of copyright can transfer (assign) it to another


person; a useful example here is where the author of a book assigns thecopyright to the publisher. An owner of copyright can also grant a licenceto another person to use the copyrighted material in exchange for a licencefee. Licences can be either exclusive (granted to one person only) or non-exclusive (granted to more than one person).

In the absence of the consent of the owner by way of assignment orlicence, no one is allowed to copy, broadcast, perform or publish the workfor the period of its copyright. An infringement of copyright occurs wherethere is a substantial copying of the work without the owner’s permission.The author must show that there is a connection between the copied workand their own original work. In many cases this means that the personalleged to be copying must have seen the work. An infringement is notexcused on the grounds that the person copying the work did not make aprofit out of doing so; neither is it excused if the person simply copied thework for personal use.

One major defence to an allegation of infringement of copyright is thefair dealing defence. ‘Fair dealing’ allows copying of the work for specifiedpurposes such as study or research, review or criticism, news reporting orprofessional advice by lawyers. In each case it is the purpose or intent forwhich the copying of the work is carried out that will determine whetheror not the copying falls within the fair dealing exception. In some cases, theCopyright Act and regulations give more specific guidelines. For example,copying of a book for study is limited to 10 per cent of the book or onechapter. Any further copying may be a breach of copyright.

Australia is a party to a number of international conventions that seekto grant reciprocal protection of copyright to the citizens of member coun-tries. The most significant of these conventions are the Berne Conventionfor the Protection of Literary and Artistic Works and the Rome Conven-tion for Performers, Phonographic Producers and Broadcasters. The rightsprovided for in both of these conventions have been amplified by WIPO’sCopyright Treaty and Performers and Phonograms Treaty. The effect ofmembership of the treaties is that all other member countries give the cit-izens of every member country ‘national treatment’. This means that theauthor is protected in all member countries against the copying or per-forming or publication of the work. In addition, the period for protectionfor copyrights is standardised at a minimum of 50 years after the death ofthe author of the work. The TRIPS agreement also imposes obligations onmember countries to protect copyright.

The WIPO treaties also provide that copyright is automatically protectedand that there is no need to attach a copyright notice in order to claim


copyright. Several countries (such as the US) reserve the right to have a non-compulsory registration process for copyright. Other countries (UK andNew Zealand for example) require copyright works to contain a statementthat the author is asserting their moral rights to be regarded as author ofthe work if the author wants those moral rights protected. Copyright givesthe author of the work both moral and economic rights. Economic rightsare those that enable the author to exclusively sell the work and make aprofit from it. Moral rights are those that prevent others from copying,publishing or performing a work in a way that reflects badly on the originalwork and the reputation of the author.

The treaties also allow countries to protect against the import of copy-righted works. However, in the interests of enhancing a competitive inter-national marketplace, this is now being used more sparingly. In Australia,for example, very few imports of copyrighted material need permissionfrom the copyright owner, though imports of prints of artworks, printedmusic scores and feature films (contained on DVD for example) still needpermission from the copyright owner. In the past, imports of many othercategories of copyrighted goods needed the permission of the copyrightowner in order to be imported. An example provided on the website ofCopyright Australia (<www.copyrightaustralia.org>) is the labels on food-stuffs. Because some of these labels involved artwork that belonged to thecompany producing the product, the company had to give permission toany importer to import the product and sell it. But such protection caneasily be abused by a manufacturer to restrict the persons to whom theywill sell, thereby restricting competition. Thus in the interests of preservingcompetition, the category of imported goods needing permission from thecopyright owner has dwindled.

L I C E N S I N G A N D F R A N C H I S I N G

The owners of intellectual property rights may seek to gain profit fromthem by allowing others to use them or to make or distribute the productsthat attract the rights. Intellectual property rights can be licensed to covera variety of situations regarding the use of those rights by the licensees.The owner may simply wish to grant to others the right to use intellec-tual property, such as occurs, for example, when the author of a musicalcomposition grants rights to performers to perform the work at concerts.Alternatively, the owner may grant rights to others to manufacture and sellthe product for which a patent or a trademark exists. A related situation is


where the owner grants to another person the right to act as a distributorfor patented or trademarked products.

A franchising arrangement is a special form of licence agreement becauseit often involves the licensing of an extensive number of intellectual propertyrights and more extensive conditions on the use of those rights than innon-franchising situations. The following discussion of franchising as aspecial category of licensing makes it clear why this is the case. Later in thischapter we deal in detail with the provisions of a typical licensing/franchiseagreement. Franchising is a form of licensing and accordingly many ofthe provisions in a franchising agreement overlap with those in a generallicensing agreement. But it is first necessary to provide some backgroundon franchising itself.

A N O V E R V I E W O F F R A N C H I S I N G

The essence of a franchise arrangement is that the owner of a ‘brand name’(franchisor) allows others (franchisees) to use that brand name in exchangefor a fee. The use of the brand name is not simply a matter of the fran-chisor permitting a franchisee to attach it to products or services that thefranchisee produces. Franchise arrangements often include a range of asso-ciated features such as the method of production or delivery of the goods,or delivery of the service, to which the brand name is attached. Many fran-chise arrangements require strict adherence to a manual that sets out indetail the entire business system that must be adopted by the franchisee inexchange for them being permitted to use the brand name of the franchisor.Over the past 30 years, this arrangement has become ever more popular as ameans of allowing brand name owners (franchisors) to achieve rapid accessto potential markets for their products or services. In many industries suchas fast food outlets, hotel chains, petrol stations, auto repair shops and carretail companies, the same brand names are appearing in more and morelocations in both domestic and international markets.

A number of factors have contributed to the popularity of franchisingas a means of accessing overseas markets. First, the information and com-munication revolution means that consumers worldwide can be reachedmore quickly than ever before. A popular brand name in one countryseems to be rapidly accepted in many others. Second, greater acceptanceand enforcement of intellectual property rights in many countries meansthat franchisors feel more confident that the intellectual property rightstied up with their brand name will be enforced. If a third party attemptsto open a store with the franchisor’s brand name without the franchisor’s


consent, the franchisor can take action to have the store shut down, pro-vided that adequate steps have been taken to register the various intellectualproperty rights. Third, in many industries franchising is the most cost-effective means of achieving broad market coverage in either a domesticor overseas marketplace. As will be seen, a franchising arrangement meansthat the franchisor does not have to bear the expense itself of establishingall of the stores or product distribution outlets in the overseas country.Rather, they allow others to use their brand name and business system inexchange for a fee (royalty). The fees earned are often greater than the prof-its that would be made by a franchisor if it had to establish outlets itself.Chapter 10 outlines the difficulties of establishing a business in an overseascountry. A franchising arrangement is a way of avoiding these difficultiesin those industries that lend themselves to the practice.

Australian brand name owners are making increasing use of franchisingto penetrate international markets. The most recent survey of franchis-ing in Australia, published by Griffith University as Franchising Australia2004, reveals that 92 per cent of franchise systems operating in Australiaare of Australian origin. Nearly a third of these have expanded into over-seas markets. New Zealand is the most popular overseas destination forAustralian franchisors, with nearly 70 per cent of franchisors with inter-national operations saying they had New Zealand franchisees. This wasfollowed by Singapore (28 per cent), Malaysia (25 per cent), United King-dom and South Africa (21 per cent), the US and China (19 per cent),Hong Kong (17 per cent), with Canada, Indonesia and other Europeancountries each having 14 per cent. The most popular industries for over-seas franchising were property and business services and retail outlets. Inthese industries most Australian franchisors have expanded domesticallyand overseas via an entire business system whereby the franchisee must notonly use the brand name of the franchisor but must also abide by a standardmethod of running the business.

C O M M O N T Y P E S O F F R A N C H I S I N GA R R A N G E M E N T S I N I N T E R N A T I O N A LF R A N C H I S I N G

It has already been noted that most Australian franchisors who haveexpanded abroad tend to do so in industries that require franchisees to adoptthe entire business system of the franchisor. A business format franchiserequires the franchisees not only to use the brand name of the franchisorbut also to adopt a certain method of operating the business. This can


extend to the type of signage that is used, the layout of the premises, thetype of training that is given to staff, the advertising slogans that are used,the accounting and administrative systems for the business, the way inwhich products are packaged and, in some cases, the suppliers of prod-ucts and services to the franchisee. Common examples are fast food out-lets, car retail companies, hotel chains, and property and business servicecompanies.

Franchising can also involve the franchisee acting primarily as a dis-tributor of the products produced or supplied by the franchisor. This issometimes referred to as a product franchise or a distribution franchise.While this type of operation has traditionally been classified as a separatetype of franchising arrangement to business format franchising, it is nowmore often the case that what were once purely distribution outlets arenow more frequently required to adopt common business systems. Petrolstations are a good example here.

Production franchising is yet a third variation of franchising arrange-ments. Here a franchisor will provide a franchisee with the technology andknow-how to manufacture a particular product that will then be sold underthe brand name of the franchisor. Many multinational companies thathave well-established brand names in their home markets arrange for theirproducts to be made under franchising arrangements in low-cost coun-tries. For example, the manufacture of televisions, phones, microwaves,power tools and other household goods are often made under overseasequipment-manufacturing agreements which can be classified as franchis-ing arrangements because the manufacturer (franchisee) is permitted todirectly sell products bearing the name of the franchisor in exchange forpaying the franchisor a percentage of those sales. The franchisee usuallyagrees to manufacture the products according to the exact specificationsof the franchisor, often using manufacturing equipment supplied by thefranchisor.

It is apparent that some of these forms of franchising have much in com-mon with agency and distribution arrangements. For example, franchiseesmust often operate their business within a defined territory and, in the caseof distribution franchises, are tied to a source of supply for their productrange. In common with agency relationships, franchisees also can expectsome degree of support from the franchisor in the operation of their busi-ness. But there are some important differences. As compared to agency anddistributorship arrangements, a franchisor typically has much more controlover the manner in which a franchisee conducts the business than does aprincipal in an agency relationship or an exporter selling to a distributor.


For example, the franchised businesses all operate under the same name toobtain maximum sales because of the franchisor’s brand reputation. Fran-chisees must also pay ongoing service fees to the franchisor and, for businessformat franchises, they must comply with the operating manuals supplied.The franchisor also has obligations over and above those that exist in theusual agency and distribution arrangement. For example, the franchisorwill often provide training to the staff of the franchised business and willoften assist with site selection and occasionally with finance.

Likewise, franchise arrangements have common elements with licens-ing arrangements in that the franchisee, like the licensee, is entitled to usethe franchisor’s intellectual property in exchange for a fee or royalty. How-ever, franchising arrangements typically involve much greater control overthe operation of the franchisee’s business than is the case with a licensingagreement.

Franchising is thus a unique form of business expansion. We now turnto look at the methods by which a franchisor can expand overseas usingthis mechanism.

M E T H O D S U S E D T O E X P A N D T H EB U S I N E S S I N T O O V E R S E A S M A R K E T S

Australian firms that have been successful in franchising operations domes-tically may seek to expand their business into overseas markets. FranchisingAustralia 2004 found that the three main reasons Australian franchisorsengaged in overseas operations were to expand their business, because oftheir success in the domestic market, and as a result of direct requestsfrom overseas investors interested in operating that business in the overseascountry. At the same time, Australian franchisors found that there wereseveral barriers to operating overseas, mainly lack of knowledge of the over-seas market and lack of suitable potential franchisees. The lack of suitablefranchisees was a problem despite attempts by franchisors to recruit byadvertising in the overseas country or by using an agent to recruit potentialfranchisees in the overseas country.

Chapter 8 pointed to the factors that need to be considered when recruit-ing an agent or distributor in an overseas market. Similar considerationswill apply even more forcefully when selecting a potential franchisee. Itis much more the case in franchising that one ‘bad’ apple can spoil theentire box because a lack of adherence to the franchisor’s quality systems byone franchisee will quickly be imputed to the entire brand name, deterringcustomers from purchasing the product or service. Recent adverse publicity


surrounding the nutritional value of fast food demonstrates how brandnames can quickly become tarnished. The difficulties Australian franchisorshave in selecting suitable franchisees might suggest that they are very con-scious of the damage that can be done to the entire brand name by onewayward franchisee.

Although franchisors have experienced problems in entering overseasmarkets, there has been significant growth in Australian-owned businessesfranchising their operations internationally in recent years. Nearly 90 percent of all franchisors with international operations only began operatinginternationally after 1990. But there are also indications that franchisingfrom Australia may still be in its infancy: the average number of overseasoperations for each franchisor is only eight; this is much lower than theaverage number of units in the domestic market, which is 33.

Franchising Australia 2004 revealed that the most common method forAustralian franchisors to expand their business overseas was by a masterfranchise arrangement, with 65 per cent of respondents to the survey sayingthat they used this method to expand their operations internationally. Ina master franchise arrangement the franchisor in Australia enters into anagreement with a party in the overseas country, allowing that party inturn to select sub-franchisees. The Australian franchisor selects a suitablepartner in the overseas country and then allows that partner to use theirlocal knowledge and experience to enter into agreements with other firmsto expand the business to various locations throughout the country.

The advantages of a master franchise arrangement for the franchisor arethat it provides an opportunity for maximum expansion of the businessat minimum cost. The success of the business in the overseas country willdepend on the commitment and business skill of the head franchisee inthe overseas country as well as on their ability to monitor and control thesub-franchisees that they select. The main problem with master franchisingis that the Australian franchisor will find it difficult to monitor the qualityof the service or degree of compliance with a manual of operations becauseof their lack of direct control and direct contractual relations with thesub-franchisees.

The second most popular method of international expansion amongAustralian franchisors is to enter into joint venture arrangement withan overseas partner. Some 31 per cent of Australian franchisors reportedthat they adopted this method of expansion. In this case, the Australianfranchisor and the joint venture partner jointly operate the business inthe overseas country. Chapter 10 canvasses the general rationale for anddifficulties with joint venture arrangements. It needs to be reiterated that the


frequency of use of the joint venture as a way of international franchisingfrom Australia may arise mainly because of regulations in the overseascountry requiring a joint venture partner in the relevant industry. It canreadily be observed that most franchising arrangements can be classifiedas ‘service’-oriented business. Many countries require local participationin such industries. The reasons for this are also explained in Chapter 10.However, overseas countries have some special concerns about franchisingarrangements. These revolve around the very visible presence the businesshas in the overseas country and consequently its potential to attract criti-cisms of cultural imperialism. Some American fast food chains are partic-ularly vulnerable in this regard, being seen as the face of American culturalimperialism. Thus, by insisting on some level of local participation, anoverseas country government is able to partially deflect criticism that theyare aiding and abetting cultural imperialism.

The third most popular method for international expansion by Aus-tralian franchisors is by direct franchising. This occurs where the Australianfranchisor enters into separate agreements with each franchisee in the over-seas country. The difficulties with this method are that it involves morecost and is more limiting in terms of growth potential than is the case withmaster franchising. However, the franchisor gains much greater controlover the operations of the franchisees because of direct contractual rela-tions with each one. Monitoring quality and compliance with operationsmanuals is easy in theory but may be difficult to enforce in practice if legalaction is required in an overseas country. Chapter 11 on dispute resolutionhighlights the difficulties that can be faced when taking legal action in aforeign jurisdiction. Only 13 per cent of Australian franchisors adopt directfranchising as a way of expanding their business internationally.

A further alternative is for the Australian franchisor to enter into an areadevelopment agreement with a franchisee in the overseas country. Around11 per cent of Australian franchisors adopt this method for expanding theirbusiness overseas. An area development agreement is similar to a masterfranchise relationship in that the franchisor selects a partner in the overseascountry to act as the developer of that market. Generally, the developeris required to open a previously agreed number of outlets in that overseasmarket within a set period. The developer is responsible for training theoperators of each new outlet. The area development agreement differs froma master franchise in that the developer may either enter into sub-franchiseagreements for each outlet or run several outlets themselves and simplyemploy staff in each outlet. This is more flexible than a master franchisingarrangement. As is the case with master franchising arrangements, the


success of the overseas operation depends to a considerable degree on thecommitment and business skills of the developer that is chosen.

Finally, some Australian franchisors expand internationally by setting uptheir own subsidiary company in the overseas country and using it in turnto open outlets in that country. The process of establishing a subsidiary inan overseas country is discussed in detail in Chapter 10. It is both costly andtime-consuming. It means getting special approvals as a foreign investor,getting local licences applicable to the particular business being established,the establishment of the subsidiary company itself, and the need to complywith local regulations on employment, taxation, profit remission and theimport of any goods required in the business. Nonetheless, around 11 percent of Australian franchisors expand internationally by establishing anoverseas subsidiary. It is quite possible that this method is adopted becauseof the extent of control that it allows the franchisor to have and therebyminimises the risk of loss of intellectual property rights and damage to thebrand name.

T H E I N T E R N A T I O N A LL I C E N C E / F R A N C H I S E A G RE E M E N T

Licensing agreements are there to protect owners of intellectual propertyrights who seek to exploit the rights by having others make use of themto increase the profits that might be made from the invention, trademark,design or copyright works. The following sets out a number of mattersthat licensors and franchisors need to consider when entering into interna-tional franchising agreements. There are several sources of model contractsfor franchising agreements, including the International Chamber of Com-merce and UNIDROIT. Useful information on licensing agreements canbe obtained from a number of sources such as WIPO, which producespublications on the topic.

T H E L I C E N C E G R A N T E D B Y T H EF R A N C H I S O R / L I C E N S O R

A licensing/franchising arrangement is essentially the grant by the fran-chisor/licensor to the franchisee/licensee to use the franchisor’s/licensor’sintellectual property rights. Details should be set out in full concern-ing the trade names, trademarks, copyrights and patents owned by thefranchisor/licensor and licensed to the franchisee/licensee. In a franchiseagreement, it is also usual to specify that the franchisee is able to use these


rights only for the purpose of conducting the relevant business and only forthe duration of the franchise. If the agreement is a master franchise agree-ment the terms and conditions on which the franchisee may sub-licensethese rights need to be specified.

S T A T U S O F T H E F R A N C H I S E E

It has been noted earlier that franchise arrangements are a unique formof business operation. However, they have many similarities with agencyand distribution agreements and even contracts of employment. For thisreason it is advisable to include a provision that states that the franchiseeis an independent contractor in relation to the franchisor and is not anagent or employee. This situation is less likely to arise in other forms oflicensing agreements such as an agreement to use copyrighted works or tomanufacture patented products for sales in another country.

F R A N C H I S E / L I C E N C E F E E S

It is common practice for a franchisee/licensee to pay an up-front fee tothe franchisor/licensor followed by regular payments of royalties. This pro-vision should set out the manner in which royalty payments are to becalculated. Royalties are often a percentage of gross sales for a set periodand can be payable quarterly. Some franchisors/licensors may also wish toinclude a minimum royalty payable regardless of the level of sales. In deter-mining royalty amounts it is necessary to take into account withholdingtaxes that are commonly levied by host country governments at the rate of10–15 per cent of the amount remitted.

F R A N C H I S O R ’ S O B L I G A T I O N S R E G A R D I N GO P E R A T I O N O F T H E B U S I N E S S

This provision applies more to franchising arrangements than other licens-ing arrangements because of the greater control over business formats andsystems that exists in franchising.

The franchisee will need assistance from the franchisor in learning thebusiness systems of the franchisor. Accordingly, franchisors are often obligedto train the franchisee and sometimes key staff members of the franchisee’sbusiness. The agreement should be specific as to how this training is to becarried out and how follow-up training will be given to update franchiseeswith developments in the franchisor’s business systems. Franchisors are also


generally obliged to undertake promotions and advertising at a nationallevel, with franchisees sometimes having to contribute to the cost of suchnational campaigns.

Franchisors may offer to assist the franchisee to obtain a suitable sitefor the business. They may also occasionally agree to provide loans to thefranchisee to get the business started. It is also common practice for thefranchisor to provide the franchisee with standard shop fittings, stationery,signage and other physical material necessary to enable the franchisee tocommence operations. Finally, the franchise agreement often obliges thefranchisor to hand over the operations manual at a set time before the startof the work.

F R A N C H I S E E S ’ O B L I G A T I O N S R E G A R D I N GO P E R A T I O N O F T H E B U S I N E S S

The most important obligation of the franchisee is to operate the businessin accordance with the franchisor’s directions or the operations manual thefranchisor provides. The franchisee is also obliged to use its best effortsin the running of the business. This provision is used to ensure that thefranchisor’s overall brand reputation is not damaged by poorly run opera-tions. Franchisees are often required to supply franchisors with informationabout the running of the business, to enable the franchisor to confirm roy-alty calculations and to ensure that performance standards are being met.To further this objective, franchise agreements often require that franchisorsshould be able to inspect the operations of the business at regular inter-vals and, if necessary, hold consultations with customers and suppliers.The franchisee’s rights and obligations with regard to any advertising thatis its responsibility should be carefully defined so as not to conflict withnational campaigns run by the franchisor. Finally, it is usual to require thefranchisee to take out insurance for the business and to indemnify the fran-chisor for any action that may be taken against it in respect of the operationof the business by the franchisee. Licensing agreements also often providefor reporting mechanisms so that the licensor can be assured that qualitystandards are being maintained.

TE R R I T O R Y

Franchisees will usually insist on a defined territory for their operations.Often franchisors agree not to allow others to operate a franchise within thegeographically defined territory or to give the franchisee first right of refusal


of any new franchise opportunity that the franchisor considers warrantedwithin the territory. Conversely, in a licensing agreement to make or sellproducts, it is the licensor who may be more concerned about the territoryin which the product will be used or sold. Accordingly, the licensor maywish to limit the licensee’s territory to a particular geographic region. Orit may wish either to reserve the right to sell into the territory itself (a solelicence) or to grant the right to make and use the product to more thanone person in the territory (a non-exclusive licence).

R E S T R A I N T O F T R A D E

Franchisors will usually require franchisees to agree not to operate a similarbusiness for a competing company for a set time after the conclusion ofthe term of the agreement or to use the knowledge they have gained inoperating the business to open any other business during the term of theagreement. This provision is important because the entrepreneurial basisof franchising suggests that many of those who take up franchises maywell aim to eventually operate a business on their own account, free fromthe operational constraints and royalty payments imposed by a franchisingarrangement. In a licensing arrangement the licensor may want to preventthe licensee from distributing or manufacturing competing products underlicence from a competitor. The restraint of trade clauses must be stated tobe subject to any law regarding restraint of trade provisions in contractsgenerally and in competition laws. Each country’s laws will differ here andso it is advisable for such clauses to be drafted with regard to such laws.

C O N F I D E N T I A L I T Y

Of equal importance is a provision that requires the franchisees/licensees tomaintain the confidentiality of the intellectual property and other know-how of the business. Franchisors/licensors wish to avoid situations arisingwhere an associate or family member of the franchisee opens a businessthat uses many of the ideas and know-how of the franchised business orpatented or trademarked product.

T H I R D P A R T Y B R E A C H O F I P R

Most franchise agreements provide that the franchisor must take actionagainst any third party that is offending intellectual property rights. Inview of what has been said in the previous paragraph, it is also common


to require the franchisee to provide assistance on this to the franchisor.In licensing agreements, however, it is common for the licensor to requirethe licensee to take action if the intellectual property rights granted to thelicensee have been infringed.

I M P R O V E M E N T S

Both franchisors and franchisees typically have obligations regarding anyimprovements to the business system of the franchise. Franchisees are typ-ically obliged to communicate ideas for improvements to the franchisor,while any improvements made by the franchisor must be communicated tothe franchisee to allow their business to take advantage of them. In licenceagreements the situation is more fluid. Licensors may wish to preservetheir competitive position in the market vis-a-vis licensees by keeping onestep ahead with technological advances. They may also require licensees toreport regularly on any improvements that have been made to the productor process.

S U P P L I E R S A N D P R I C I N G

This provision is more applicable to franchising arrangements. In distribu-tion franchises it is common for the franchisor to supply all the productsthat the franchisee will sell. In business format franchises, the franchisormay require franchisees to purchase from a list of ‘approved suppliers’. Theaim of such provisions is to maintain the quality of the goods and servicesprovided by all members of the franchise chain. However, such provisionsneed to be carefully drafted to ensure that they do not offend competitionlaws by amounting to a restrictive trade practice. While it is generally per-missible to require that certain standards be met when buying products, itis generally not permissible to require franchisees to sell products or servicesat prices that are determined by the franchisor.

TE R M O F T H E A G R E E M E N T A N D R E N E W A L

Most international franchising agreements entered into by Australian fran-chisors have a set term of five years. Because of the significant investmentof time and money by the franchisee, it is equally common to allow fran-chisees to renew the agreement. The conditions on which renewal can be


made or refused need to be set out in some detail for the protection of bothparties. Licensing agreements, on the other hand, are quite variable as toduration. For example, a licence may be sought to use copyrighted work fora one-off performance; alternatively, a licence to manufacture a patentedproduct may last for the duration of the patent protection (20 years).

TR A N S F E R

It is often the case that the franchisee/licensee will want to reserve the right tosell its business during the course of the agreement. Franchisors/licensorswill want to ensure that any party to whom the business is sold will besuitable as franchisee/licensee. Many franchising agreements provide thatthe franchisor must approve any potential buyer, but at the same time itcannot unreasonably withhold its consent to a transfer of the business.Licensing agreements again tend to be more variable here. It is less usualfor the franchisor to sell its business. It is as well to include a provision thatallows the franchisor to sell its business to cater for the possibility, amongother things, that another company acquires the business.


Franchise and licensing agreements generally allow the franchisor/licensorto terminate the agreement if there is a breach by the franchisee/licensee.In a franchising agreement it is usual to stipulate that the franchisee mustsurrender the premises and all operations manuals to the franchisor. Ter-mination provisions frequently allow the franchisor to run the businessthemselves if there is a breach so as not to damage the overall reputa-tion of the brand and to preserve the customer base. A contentious issueupon termination is the question of goodwill. Generally speaking, a fran-chisee is not entitled to goodwill upon termination regardless of whetherthe goodwill has arisen through the personal efforts of the franchisee orbecause of the good name that the business has or because of the locationof the business. The main exception here is if the franchisor behaves uncon-scionably in terminating the franchise so as to deprive the franchisee of anygoodwill that the franchisee might have upon transfer or renewal of thefranchise. Thus the entitlement to goodwill upon expiration of the fran-chise is a matter that needs to be negotiated at the time of entering into theagreement. Standard agreements usually provide that the franchisee is notentitled to goodwill. Care needs to be taken not to terminate the agreementon minor or trivial grounds because the termination might be successfully


challenged in a court by the franchisee on the ground that it amounts toa breach of an express or implied obligation that the parties act in goodfaith.

A P P L I C A B L E L A W A N D D I S P U T ER E S O L U T I O N

In international franchising and licensing agreements, it is advisable to setout which law applies to the contract and the forum for the resolution of anydisputes. In the case of franchising, if Australian law governs the agreement,franchisors will be bound by the provisions of the Franchising Code ofConduct as set out in the Australian Trade Practices Act. The obligationsthat this imposes are discussed in the following section. The parties arealso free to select the manner in which disputes will be resolved. As notedin Chapter 11 on dispute resolution, arbitration is generally preferred tolitigation for the reasons given there.

L E G A L I S S U E S I N L I C E N S I N G A N DF R A N C H I S I N G A R R A N G E M E N T S

Licensors and franchisors need to be aware of the relevant regulatory envi-ronment in both their home country and the countries where they intendto establish franchising operations or license others to use their intellectualproperty. The following deals with some of the more contentious issuesthat arise.

T H E N E G O T I A T I O N P H A S E :F R A N C H I S E A G RE E M E N T S

Regulatory authorities in many developed countries appear to acknowledgethat the economic strength and bargaining power of franchisors can signifi-cantly affect the process of recruitment of franchisees and the negotiation ofthe franchise agreement. They tend to the view that if franchising arrange-ments were left totally unregulated, unscrupulous franchisors would takeunfair advantage of franchisees, resulting in many failed businesses andloss of livelihoods. For that reason there has been a trend to extend ‘con-sumer protection’ legislation to protect franchisees and, in many cases, torequire franchisors to disclose to potential franchisees significant amountsof information about the business operations of the franchisor.


Australia has adopted both of these approaches. Section 52 of the TradePractices Act provides that a corporation shall not engage in misleadingor deceptive conduct. A similar provision has been adopted by all statesand territories in Australia in relation to dealings by persons other thancorporations. Further, section 51A of the Act provides that the onus is on acorporation to show that it has reasonable grounds for any statements thatare made. Franchisors therefore need to be aware when making pre-contractrepresentations to potential franchisees that they may expose themselves tofuture litigation if they make misleading statements. Statements that willbe of particular concern to the franchisee relate to the territorial exclusivityof the franchise and the profitability of the business. In many cases broughtbefore the courts franchisees have lost money and have claimed that thiswas the result of representations made by the franchisors before enteringinto the agreement.

In Sanders v Glev Franchises Pty Ltd (2000) Federal Court of Appeal1332, the franchisees argued that they had lost a large amount of moneybecause of the representations made by the franchisor about the potentialturnover of the business. The franchisor operated the franchise of the fastfood chain ‘Pizza Haven’. The franchisors claimed that any statements theymade were true at the time and that, in any event, the representations werenot the main factor leading the franchisees to enter into the agreement.The franchisors claimed that the loss suffered by the franchisees was dueto the way in which they operated the business and that they failed to takesteps to mitigate any losses that they might suffer. As in many cases allegingmisleading and deceptive conduct, this case turned on whose version ofevents the court was prepared to accept. In this case the court preferred thefranchisor’s version of events.

Section 52 of the Trade Practices Act is not the only provision that dealswith misleading and deceptive conduct that might apply to franchisors.Section 53 contains wide prohibitions against misrepresentations regardinggoods or services to be supplied, and section 53A extends this to leases ofpremises. Section 59 provides that a misleading misrepresentation shallnot be made concerning the risk or profitability of a home-based business.Misleading representations under section 59 are not only likely to resultin action by franchisees but may also result in action by the AustralianCompetition and Consumer Commission in accordance with their powersto ensure compliance with the Act.

In Australian Competition & Consumer Commission v Will Writers Guild(2003) Federal Court of Appeal 1231, the Will Writers Guild was allegedto have breached section 59 because it sold franchises to persons to operate


a ‘will writing’ business, despite the fact that the drawing up of wills isusually done by those with legal qualifications. The laws of most states andterritories in Australia state that the carrying on of legal practice by non-qualified persons is unlawful. Because none of the franchisees were legallyqualified, carrying on of the franchised business would have exposed themto criminal liability. The court found that the representations that hadbeen made about the ability of the franchisees to carry on the businesswere in breach of section 59 and that the franchisors were therefore liableto compensate the franchisees. In addition, the franchisors were fined forbreaching section 59.

The Trade Practices Act is not the only legislative protection for poten-tial franchisees. In 1998, the Australian Franchising Code of Conduct wasincorporated into the Act by the insertion of a provision that requires cor-porations to comply with mandatory industry codes (sections 51AD and51AE). The Code of Conduct contains detailed provisions about the infor-mation that must be disclosed to potential franchisees before they enter intoa franchise agreement. There is an annexure to the Code that sets out amodel disclosure document that franchisors are expected to follow. It showsthat franchisors must reveal details of their business operations, any historyof litigation, details of existing franchises, the intellectual property theyown, the territory to which the franchisee will be entitled, the require-ments regarding use of goods from the franchisor, and provisions regardingpayments to be made to the franchisee as well as statements regarding theobligations of the franchisor and franchisee. The Code requires prior dis-closure of virtually all of the matters that are generally covered in the formalfranchise agreement. Further, it requires potential franchisees to obtain astatement from a lawyer, business adviser or accountant that they havesought advice about entering into the franchise agreement. It would seemthat if a franchisor complied with the Code in all respects and made noother representations to the franchisee, it would be very difficult for a fran-chisee to claim successfully that they were somehow coerced into taking onthe business. One of the purposes of enshrining the Code into law may wellhave been to attempt to stem the flow of litigation arising from misleadingand deceptive conduct in franchise arrangements. In this it appears to behaving some success, with Franchising Australia 2004 reporting that only15 per cent of disputes now involve misrepresentation issues.

The negotiation phase of franchising agreements is therefore highly regu-lated in Australia. Some form of pre-contract disclosure is required in manyother countries including the United States, Malaysia, Mexico, several EUcountries and some provinces in Canada.


R E S T R I C T I O N S I N F R A N C H I S I N G A N DL I C E N S I N G O P E R A T I O N S A N DC O M P E T I T I O N L A W

Some common practices in franchising/licensing appear to conflict with oneof the basic principles of competition laws: maintaining a freely competitiveenvironment for the sale and purchase of goods and services. Competitionlaws in most countries outlaw some restrictions such as setting prices for thesale of goods. Others, such as the designation of exclusive territory, are notseen as restricting competition unless the franchisee/licensee is prohibitedfrom filling orders that come from customers outside their territory becausethis would amount to a refusal to deal.

In franchising arrangements the practice that appears to cause mostproblems is the requirement that many franchisors have that franchiseespurchase goods and services either from them or from designated suppli-ers. Section 47 of the Australian Trade Practices Act contains provisions toregulate exclusive dealing practices. Exclusive dealing can arise either indistribution franchises where the franchisee is engaged in selling the prod-ucts of the franchisor or in business format franchises where the franchisorwants to have control over the products that the franchisee uses in orderto maintain quality. The supply of goods by a franchisor to a franchiseeunder distribution franchises does not offend the provisions of the Act aslong as it does not have the purpose of substantially lessening competitionin the relevant market. Requirements that a franchisee purchase all its sup-plies from designated suppliers in a business format franchise are likely tooffend the Act because the restraint goes beyond vertical relations betweenthe franchisor and the franchisee. In order to avoid breaching these pro-visions, franchisors must generally allow franchisees to purchase suppliesfrom whomever they wish but to protect quality by insisting on stringentstandards that those supplies must meet.

A P P RO V A L A N D RE G I S T R A T I O NRE Q U I RE M E N T S

In countries where competition law is still in its developmental stages, itis common for government authorities to require approval for all franchis-ing or licensing agreements that relate to business within their territories.Indonesia and China are two examples here. When approving these arrange-ments, authorities may examine agreements to determine their impact onlocal industries within the country. They may also look at the rate at which


royalties are payable, conditions for termination of the agreement, and thedegree to which the arrangements will result in technology transfer. It isimportant to ascertain if approval is required and if so the procedure thatmust be undertaken to obtain it and whether there are any guidelines thatmust be met in order to get approval.

I N T E L L E C T U A L P RO P E R T Y P RO T E C T I O N

An issue that is equally important is the extent to which intellectual propertyrights are protected in the country concerned. Most countries now have lawsthat protect these rights, provided that the rights are registered in accordancewith the requirements in those countries. Franchisors and licensors will needto ascertain the extent to which intellectual property rights are enforcedthrough court systems or other administrative bodies charged with thetask. Without adequate enforcement mechanisms they may find that theirpatented products, trademarks or business systems may be appropriated atwill by local competitors.

TE R M I N A T I O N I N F R A N C H I S I N GA G RE E M E N T S

Most franchising agreements permit termination of the franchise agreementby the franchisor for breach by the franchisee. Franchising Australia 2004reports that 55 per cent of disputes between franchisors and franchisees wererelated to compliance with the franchisor’s system and therefore presumablycould have resulted in termination proceedings. However, the AustralianFranchising Code of Conduct provides that if a franchisor is terminatingbecause of breach by the franchisee, the franchisee must be given notice andan opportunity to remedy the breach. Termination other than for breachand other than for the very specific reasons set out in the Code is verydifficult for the franchisor.

Because of these onerous provisions, some franchisors might be temptedto ‘freeze out’ the franchisee by withholding supplies or requiring the fran-chisee to undertake extensive retraining or other measures in order to bekept within the chain. However, sections 51AA–51AC of the Trade PracticesAct cater for such unscrupulous behaviour by proscribing ‘unconscionableconduct’. Attempts to thwart the business operations of a franchisee maywell be caught by these provisions, entitling the franchisee to damages andinjunctive relief as well as leaving the franchisor open to possible proceed-ings against it by the Australian Competition and Consumer Commission.

1010 Exporting via an OverseasBusiness Presence

Prev ious chapters have discussed in detail the proce-dures and legal issues confronting a firm when it exports directly to anoverseas customer or through agents or distributors as intermediaries. Thischapter discusses the issues facing a firm that intends to establish a presencein an overseas country to support its export efforts or to facilitate importsfrom that country.

A number of legal and procedural issues arise in establishing an overseaspresence. First, the firm needs to be clear why it is establishing an overseaspresence to assist its export efforts rather than adopting an alternative strat-egy. If an overseas presence appears profitable, the firm needs to weigh upthe options of establishing a completely new entity or acquiring an existingbusiness, provided this latter option is allowed by the country’s investmentrules. If a new entity is necessary then a decision has to be made whetherto establish a joint venture, a branch or a subsidiary. Regardless of the typeof entity that is proposed, the firm will need to assess the political andeconomic risks of doing business in the overseas country, the process forobtaining approval to commence business, company establishment pro-cedures, and the operating environment, which includes regulations foremploying local and expatriate personnel, importing and exporting, andborrowing and capital repatriation. Finally, the firm needs to weigh up thetaxation implications.

This chapter therefore aims to impart an understanding of:� the rationale for an overseas presence to assist export efforts;� the various types of entity that can be formed and the advantages of

each;� the importance of political and economic risk assessments;� approval and establishment procedures;

233


� regulations that will affect operations in the overseas country; and� taxation implications.

T H E R AT I O N A L E F O R A NO V E R S E A S P R E S E N C E

An overseas presence can occur either as a completely new entity establishedin the overseas country (sometimes called a greenfield investment) or byacquisition or merger with an existing entity in that country. When afirm is established or acquires a firm in another country it is said to havemade a direct investment in that country. On the other hand, when a firmmerely acquires a small percentage of the shares of a company in an overseascountry via the stock exchange (generally 10–15 per cent or less), it is saidto have made a portfolio investment. This chapter is concerned with directinvestment.

By way of introduction it is useful to canvass some factors that mightprompt a firm to establish an overseas presence. The most basic of theseis that establishing in an overseas country can boost profitability throughreduced costs or increased competitiveness in the overseas market. A firmthat decides to produce some or all of its goods overseas might do so becauselabour and raw material costs are lower, transport and import duty costswill be avoided, and it can directly market its goods to buyers in the over-seas country. Even if a firm does not decide to produce its goods overseas,an overseas presence can still make the firm’s goods more competitive byincreasing its presence in the overseas marketplace, thereby making poten-tial buyers more aware of what it has to offer. Similarly, an overseas presencecan facilitate the purchase of goods that may be needed either for resale inAustralia or as inputs for its Australian production operation. However, theestablishment of an overseas presence for the sole purpose of facilitatingimports is comparatively rare. It is generally more cost-effective to engagethe services of a suitable representative overseas to attend to this rather thango to the expense of establishing an entire operation merely for purchases.

An overseas presence is equally important for the export of those ser-vices that are to be delivered in the overseas country itself rather than fromacross the border or in the country of the exporter. Thus in the case ofconstruction, financial services, transport or media, an overseas presence inthe country where the service is to be delivered is often necessary. However,even in the case of services that are primarily delivered in the country of theprovider (such as education and tourism), an overseas presence can assistin either increasing market awareness or even in opening possibilities for

O V E R S E A S P R E S E N C E 235

expansion by delivering that service in both the home and the overseas coun-try. The establishment of offshore campuses by many universities is a case inpoint.

Over the past decade, the need for firms to expand beyond their bor-ders has been given more impetus by a trend towards consolidation inmany industry sectors. The late 1990s saw a rising trend in mergers in largeindustries such as automobiles, chemicals, pharmaceuticals, resources, busi-ness services, finance, telecommunications and media. This consolidationoccurred for a variety of reasons. First, firms saw that the quickest wayof reducing costs and increasing market share was to acquire or mergewith a competitor. Once several firms within an industry embarked onthis strategy, others quickly followed in an attempt to maintain their owncompetitiveness. This pattern was clearly evident in the automobile andtelecommunications industries, which saw a marked consolidation at thattime. Another factor pushing the consolidation of firms within industrieswas the revolution in communication provided by the Internet. Almostovernight it had become much easier to communicate internationally, mak-ing it less relevant where the various branches of a firm were located andcreating an illusion that many problems relating to international manage-ment had been solved and there was now no limit to the size to whichindustrial conglomerates could grow.

However, a slowdown in the global economy, the bursting of the dotcom bubble in the United States in 2000 and a series of corporate scan-dals in the same country, as well as the events of September 11, 2001created a pause in the frenetic merger activity of the late 1990s. In addi-tion, when many merged firms failed to deliver the promised increase inreturns to shareholders, it was becoming clear that not all mergers hadsound underpinnings. The difficulties of integrating the corporate culturesof two different entities had, it seemed, been underestimated. Thus thewhole rationale for expanding overseas by way of mergers and acquisitionswas questioned and the level of activity has not yet returned to the fastpace of the late 1990s. Some, however, argue that the initial drivers forthat spate of merger activity remain. These include increasing technologi-cal advances, greater global awareness, deregulation and liberalisation andincomplete industry consolidation. Accordingly, it is likely that we willcontinue to see mergers and acquisitions play a role as a major means bywhich firms establish an overseas presence.

While the establishment of an overseas presence by greenfield invest-ment or by merger and acquisition is often seen by firms as an effective wayto internationalise their business, an increasingly common alternative is for


firms in similar industries in different countries to set up alliances, witheach firm retaining its separate legal entity but nonetheless cooperating ina range of international business opportunities rather then openly com-peting with each other. The phenomenon of ‘strategic alliances’, as theyare called, is most obvious in the international airline industry, where wesee most major international airlines belonging to a consortium. Thus, forexample, Qantas and its One World partners in Europe and the Americasare able to code share flights, thereby reducing costs and maximising seatoccupancy as well as providing global connections for their customers. Notall industries lend themselves to such international cooperation. But evenin manufacturing and agricultural industries strategic alliances can be use-ful as a way of informally cooperating with a firm from another countryfor the mutual advantage of both firms. This could occur, for example, byjointly exploring and servicing international markets. In agricultural prod-ucts, such opportunities arise between Australian firms and firms in thenorthern hemisphere because of the different growing seasons.

T Y P E S O F O V E R S E A S P R E S E N C E

L I A I S O N O FF I C E

The simplest form of overseas presence is a liaison office (sometimes calleda representative office). The purposes of liaison offices are for firms to assessthe market potential for their goods and services, to survey possible sourcesof supply for their home operation, or to investigate the possibilities ofsetting up a more substantial presence. Liaison offices are generally restrictedto market survey activities and cannot engage in trading activities througheither buying or selling. Any enquiries are generally directed to their homeheadquarters.

Liaison offices are therefore not separate entities from their home coun-try firm. They are simply a part of the operation that is located in theoverseas country for the very limited purposes set out above. Nonetheless,many countries have a number of formalities that need to be completedwhen establishing a liaison office. For example, to establish a liaison officein Malaysia requires the approval of the Ministry of International Tradeand Industry. A detailed form has to be completed that requires elabora-tion of the reasons for the representative office, the personnel who willbe employed, the activities in which it will engage, the sources of fundsfor its operation, whether the parent conducts other business activities inMalaysia or elsewhere in South East Asia, and why the activities could not


be carried out by appointing a Malaysian agent. In addition, various doc-uments have to be produced including the parent company’s latest annualreport, a certified copy of its certificate of incorporation, a copy of anyexpatriate employees’ qualifications and particulars of the person who willbe the official ‘agent’.

B R A N C H

A branch is a much more formal presence of the firm in an overseas countrythan is a liaison office. The difference is that the branch is able to buy andsell. Yet it is also different from a subsidiary (see below) because the branchremains a part of the parent firm, meaning that the parent firm is liable forany debts or other obligations that the branch may incur in the overseascountry. Like the subsidiary, however, the branch is usually subject to taxon any income it makes in the overseas country and its business activitiesare also subject to the laws of that country.

To establish a branch in an overseas country also requires the comple-tion of various formalities. For example, an Australian firm wishing toestablish a branch in Malaysia needs to apply to the Companies Commis-sion of Malaysia. The documents that will be required include a certifiedcopy of the certificate of incorporation and of the company’s constituentdocuments (memorandum and articles of association or constitution). Alist of the directors of the parent company must be furnished along withtheir particulars. The names of any local directors must be provided aswell as the details of the person who is appointed as being able to officiallyaccept notices on behalf of the company. The company must also providethe address of its registered office in Malaysia. Once these processes arecomplete and provided that the Companies Commission is prepared torecognise the company, the branch can carry on the business activities ofthe parent company in the overseas country subject to any limitations thatthe overseas country has imposed.

Many overseas countries are reluctant to allow foreign firms to establishtheir business in that country through a branch. One of the reasons forthis is that branches are not amenable to as much control as subsidiaries,which have to be incorporated according to local laws and are subject tothe same (if not higher) levels of supervision and scrutiny by governmentofficials as local companies. There remains a suspicion in some countriesthat locals dealing with the branch of a foreign entity will have a moredifficult task obtaining redress if the branch defaults on its obligations, andthere is therefore a reluctance to allow a presence by way of a branch office.


In some industries, however, it is clear that it is preferable for the foreignfirm to establish its presence by a branch rather than by a subsidiary. In thefinance sector, governments prefer to see foreign finance providers establishbranches because any liabilities that the branch incurs can be met not onlyfrom the branch but also from the considerably larger resources of thefinance firm in its home country. This also suits the needs of financialservice providers, who are able to retain the same name and product imageif they establish a branch in the overseas country. Often a subsidiary needsto adopt a local name in order to obtain registration as a separate legalentity from its parent company.

J O I N T V E N T U RE

Joint ventures fall into two main legal categories. First, there is the equityjoint venture where a new legal entity is formed in the overseas countryand each party owns a percentage of the shares. This is the most commonform of joint venture used by manufacturing and service companies whenthey establish an overseas presence. The equity joint venture is most often aprivate company in which the shareholders of both the foreign and the localcompany together form the new joint venture company. The joint venturecompany is incorporated according to the laws in the country where itwill conduct business. An equity joint venture is usually established for thespecific purpose of engaging in a particular line of business. This needsto be contrasted with the situation where a foreign firm buys a numberof shares in a publicly listed company on the stock exchange. In suchwidely held companies the foreign firm will only be able to be involvedin the management of the company if it has enough shares to entitle it toappoint a director. The differences between private and public companiesare discussed in more detail below.

The main advantage that an equity joint venture has for the partiesforming it is that it is a separate legal entity. This means that the shareholdersare only liable to the extent of their shareholding and their separate assetsare protected should the joint venture fail. As long as the joint ventureagreement allows for it, either party can sell their shares to a new party. Anequity joint venture also allows for flexibility in financing in the sense thatit may obtain capital directly from its shareholders by contribution or, as aseparate legal entity in its own right, it can approach financial institutions toraise finance, usually with the initial backing of its individual shareholders.

An alternative to an equity joint venture is a contractual joint venture.Here the parties do not form a new entity but enter into an agreement that


sets out what each partner’s responsibilities will be and what share each willreceive of the profits from the project. Contractual joint ventures are mostoften used where the parties have a single project in mind that will lastfor a set period. This may be a partnership between private companies orbetween public companies or a mix of private and public companies. Suchpartnerships are most often formed between smaller private companiesbut may also occur between major public companies. They are commonin the mining industries but in some countries also occur in manufac-turing industries. China, for example, has a Contractual Joint VentureLaw that was enacted to govern arrangements between mainly HongKong and Taiwanese firms that were outsourcing the labour part of theirmanufacturing operations to entities in mainland China.

A major advantage of a contractual joint venture is that the arrangementallows each party to sell its share of the products separately. Thus in amining operation each party may take a proportion of the product andsell to its own customers that it has acquired from other operations. Thejoint venture can also be structured so that partners are taxed separatelyon their share of the profits. This allows any profit (or loss) arising from apartner’s share of the joint venture profits to be offset against other losses(or profits) that the company may have made. In an equity joint venture,the venture company itself will be taxed as a separate legal entity regardlessof the taxation position or other business of its shareholders. The jointventure agreement for a contractual joint venture can also provide greaterflexibility than the equity joint venture in terms of capital contributionsand return because the partnership agreement establishing it can allow theparties the flexibility to decide when and how capital contributions have tobe made or returned. However, the equity joint venture is a separate legalentity and is therefore subject to stricter legal obligations on shareholdersboth in terms of their capital contributions and the return of their capital.The contractual joint venture also avoids the complex procedures that applyin the winding up of an equity joint venture because a contractual jointventure is often established to exist only for the lifetime of a particularproject.

So far we have examined each type of joint venture and the advantages ofeach but have not yet dealt with the question of why firms enter into a jointventure arrangement rather than, for example, establishing a subsidiary thatis wholly owned by their parent company. It is to that issue that we nowturn.

Firms establishing an overseas presence through a joint venture tend to doso either because they see that such an arrangement contains advantages for


them over a wholly owned operation or because government regulationsrequire joint venture arrangements in their industry. One of the mainadvantages that firms see in a joint venture arrangement is that having alocal partner is necessary to enable them to maximise the sales of theirproduct. In many countries, for example, it is often difficult for a foreignfirm to break into the distribution industry because complex relationshipsbetween companies in the distribution chain have been established overmany years. The Japanese distribution system is well known for its relativeexclusion of outsiders. Having a joint venture partner in the distributionindustry may mean that the increased revenue from sales that a firm makeswill more than offset the share of profits that the joint venture partnerreceives.

The local partner brings a number of other advantages to a newly formedjoint venture entity. It will have local knowledge about demand for theproduct and, if it is to be manufactured, the best and most reliable materialsuppliers. It will be familiar with government rules and regulations, espe-cially in the complex field of labour relations and engaging and terminatingstaff. Further, a local partner might increase the opportunities that exist forthe joint venture to obtain government contracts. Many countries, includ-ing industrialised countries, restrict the award of government contracts toentities that have a significant proportion of local ownership. While thismatter is being addressed in the Doha round of WTO negotiations, equalaccess for foreign firms to be awarded government contracts seems sometime away yet.

A local partner might also be able to facilitate financing for the jointventure. Local financial institutions are often more likely to lend to a firmthat has a solid local record rather than an incoming foreign firm that isnot known to them. Although problems in getting finance are being easedby the gradual liberalisation of capital markets worldwide, it remains thecase that in many countries foreign-owned financial institutions are not yetmajor players in the marketplace.

Synergies between the two partners might also mean that each derivesmore benefit from a joint venture arrangement than by going it alone in themarket. For example, the partners might have complementary skills andstrengths. As noted, Hong Kong and Taiwanese firms have for many yearsbeen using the cheap labour of mainland Chinese entities while supplyingknow-how and equipment for the manufacture of goods. The synergycreated by the two firms in a joint venture arrangement might also give themthe critical mass that they need to compete in the marketplace. Neither firmmight have the ability to do so alone. Further, a joint venture arrangement


limits the exposure of each of the parent companies to a new venture shouldit fail. A newly formed equity joint venture company will not only havelimited liability, thereby protecting each of the parent companies, but alsolimits the amount of loss of capital that each company might incur if theventure does not succeed.

While there are many positive reasons for foreign firms entering intojoint venture arrangements, they may have little option but to adopt thisbusiness form because of government regulations in their industry sector.Many countries still impose joint venture requirements in many industrysectors or require foreign firms to be limited to a certain percentage ofownership in some industries. Governments in many developing countriesimpose joint venture requirements in an attempt to ensure that the pro-duction technology and management and marketing skills that the foreignfirm possesses will be shared with the local partner. Eventually this knowl-edge will be diffused throughout the industry in the developing country,leading to an upgrading of all local firms in the industry to internationallycompetitive standards.

Developing countries incline to the view that if foreign firms wereallowed to establish wholly owned enterprises in whichever industry theychose, there would be little sharing of knowledge and therefore little ben-efit for local industry. While foreign firms do provide benefits throughdirect employment and increased exports, they are not the main enginesof economic growth in many countries. For example, other than in smallcountries such as Singapore, foreign investment in most countries amountsto only 10 per cent on average of total gross domestic capital formation.This means that foreign firms cannot be the main drivers of economicgrowth but can only act as catalysts for the upgrading and development oflocal firms and industries. It is these local firms and industries that providemost of the employment and other contributions to economic growth.

Thus developing countries impose joint venture arrangements in thoseindustries where they see that there is a potential for foreign firms to con-tribute to the upgrading of local industry capability or where they fear thatwholly owned foreign firms might simply wipe out smaller, less competitivelocal firms, resulting in a net loss of employment or other anti-competitiveeffects. Thus, in countries such as Indonesia, there are restrictions onwholly owned investment in industries classed as ‘small-scale’. Other coun-tries in East Asia also impose joint venture requirements in many sectors.The extent to which such joint venture requirements should be removedbecause of the deterrent effect on investment is a matter of hot debatebetween developing countries and the developed countries from which most


foreign investment originates. An attempt to significantly liberalise foreigninvestment rules by including the issue in the Doha round of WTO nego-tiations failed when some major developing countries refused to have theissue included.

However, developed countries themselves also maintain limitations onforeign ownership, mainly in what can be called sensitive service sectors:media, telecommunications, transport, finance, and energy productionand distribution. Australia, for example, maintains limitations on foreignownership in media companies and in some transport operations such asQantas. There are also limitations in the finance sectors where foreignbanks need to make special application for a licence to establish opera-tions in Australia. The level of foreign ownership in telecommunicationscompanies such as Telstra is controlled and the government also closelycontrols Optus, although it is now Singapore-owned. Australia is not alonehere. Most developed countries impose restrictions in these areas. Whilethis is not a joint venture policy as such because most large-scale serviceproviders are publicly listed companies that are widely held, the end resultis that wholly owned foreign firms are excluded from some industries inmost countries.

What then are the problems encountered in joint venture arrangementscompared to wholly owned operations? Here we will limit the discussionto the special problems faced by a private equity joint venture company.The difficulties that arise in the management of public companies wherethere are many shareholders, some of whom may be foreign, requires adiscussion of corporate governance issues that is beyond the scope of whatis covered here. Useful works on corporate governance in public companieshave blossomed in recent years, particularly in response to the corporatescandals that rocked some major US companies.

The role that each party will play in the management of an equity jointventure is often a key issue in the negotiation of the joint venture agreement.Each of the parent companies will wish to have a share in decision-makingand it is here that most problems arise with this form of business operation.Each of the parties will lose some of their independence in decision-makingsince they have to arrive jointly at shared strategic objectives. The partiesmay have very different expectations from the joint venture operation. Oneparty may wish simply to see the joint venture make a profit as quickly aspossible and distribute it to shareholders, while the other party may preferto reinvest profits for some years to develop its market share. If the jointventure is taking longer than expected to become profitable, the parties maydiffer about whether it should be continued or wound up. If it develops


new technology the parties need to decide if they will have equal access toit for use in other companies in which they may have stakes.

The day-to-day issues involved in managing the joint venture also createsome problems, such as the number of directors each party can appoint tothe board and the veto power the other party has over nominations. Thequestion of who will be the chairperson of the company and the CEO mayalso be hot topics of debate, and resolving deadlocks between the parties’appointed directors may also cause problems. Much has been written aboutthe causes of failures of many joint ventures between foreign and Chinesefirms. Many of the difficulties can be traced to different management stylesand objectives originating in different cultural and economic contexts andthe difficulties that these problems pose in finding an agreed middle course.This literature is essential reading for those contemplating joint venturearrangements, not only with Chinese entities but also in any country wherethe business management culture is significantly different from their own.

The negotiation of the joint venture agreement is therefore an importantmatter. The contents of the agreement will of course vary depending onthe nature of the arrangement, but some areas of concern common to alljoint venture agreements include:� dividend policy;� policy for the contribution of increased capital;� management rules for the joint venture;� conditions on which a transfer of shares will be permitted;� conditions on which the joint venture may be wound up;� procedure for the dissolution of the joint venture;� the ownership of any jointly developed technology; and� the need to keep confidential any intellectual property rights or other

know-how brought to the joint venture by each of the parties.

S U B S I D I A R Y

As we have seen, there are two main methods by which a firm can establisha wholly owned separate legal entity (subsidiary) in an overseas country.The first of these is establishing a completely new entity – a greenfieldinvestment. This requires those wishing to form the company to get therelevant approvals for the investment and to set up the business vehicle(usually a company). The second method is by acquiring an existing firmin the overseas country. Again, various approvals may be needed. Accord-ing to the statistics and commentary published in the annual editions ofUNCTAD’s World Investment Report, it seems clear that acquisitions remain


the major method for foreign direct investment flowing between developedcountries. However, foreign direct investment from developed to develop-ing countries tends to occur more through greenfield projects. One of thereasons for this is that developing countries have greater restrictions thandeveloped countries on foreign investment that occurs through merger andacquisition.

As noted above, a subsidiary differs from a branch because it is a separatelegal entity to the parent company that owns all or most of its shares. Abranch, on the other hand, remains a part of the parent company, withthe parent company remaining liable for all the branch’s obligations. As aseparate legal entity, the subsidiary is responsible for its own debts, withthe shareholder (the parent company) only responsible to the extent of itspaid-up share capital as well as the amount outstanding for any shares thathave been issued but not paid up in full. The procedures to incorporate asubsidiary are therefore different from those required to obtain permissionfor a branch to operate in an overseas country. Generally speaking, theestablishment of a branch requires the presentation of a range of documentsfor the recognition of the parent company by the authorities responsiblefor corporate regulation, whereas the formation of a subsidiary involves thepreparation of a range of documents required to establish a completely newlegal entity.

Before embarking on a detailed discussion of the process that firms followin establishing an overseas subsidiary, it is useful to reflect on some of themain reasons why firms often prefer to establish or acquire an entity overwhich they have control rather than, for example, proceeding by way of ajoint venture. A subsidiary differs from a joint venture because of the degreeof control that the dominant shareholder has in the day-to-day running of acompany. The whole purpose of a joint venture is to share the managementand control of the operation. How this control is shared is a matter for thejoint venture agreement as described above. In a subsidiary, control ofmanagement lies in the hands of the principal shareholder. Because a firmhas control over its subsidiary, all management decisions can be made bythe parent company in its own interests rather than having to compromise,as is often the case in a joint venture. As noted above, many joint venturesand mergers fail because of the conflict of corporate cultures. Establishinga wholly owned subsidiary does not solve this problem entirely because alocal workforce with a different corporate culture will be employed in thesubsidiary. But generally speaking it is much easier to integrate the activitiesof the subsidiary into the firm’s overall global operations if control restswith the parent company. In addition, greater control over the intellectual


property rights of the firm and its subsidiary can be exercised if there isno joint venture partner. It is for this reason that many countries wantingforeign investment in high-technology areas allow 100 per cent foreignownership in those industries. Foreign firms with leading edge technologyare somewhat reluctant to establish by way of a joint venture operation.

T H E E S T A B L I S H M E N T P RO C E S S

What follows is a discussion of the step-by-step process that a companymight follow when setting up an overseas presence, whether that is througha representative office, a branch, a joint venture or a subsidiary. Thedescription below also applies to establishment through greenfield invest-ment or investment through acquisition. Differences are pointed out wherenecessary.

P O L I T I C A L A N D E C O N O M I CR I S K A S S E S S M E N T

The first step for a firm wishing to increase its presence in an overseascountry is to make a political and economic risk assessment for that country.Or, if the firm has decided on a region for its overseas presence (for exampleSouth East Asia) but does not have a preference for any particular country,then a risk assessment will help it decide which country is most suitable.

Political risk refers in general terms to the risk that the firm’s operationsmay be adversely affected by political developments within that countryover its lifetime. These include security risks and the potential for politicalinstability and policy change. Economic risk refers to the risk that changesin economic conditions and the government’s economic management maypose for the firm’s profitability. This includes risks arising from the macro-economic policy that is being pursued, foreign exchange risks, and labourand infrastructure risks. Political and economic risks are related. For exam-ple, a government that has strong allegiances to particular groups withinthe country may be inclined to tailor its economic policy to suit thoseinterest groups. This may not only have adverse effects on the economy asa whole but may also lead to political instability. Thus a foreign investorwould not only be affected by deteriorating economic conditions becauseof poor policy-making but could also be caught up in any political turmoilor civil unrest that might follow deteriorating economic circumstances.

Over the past decade, political and economic risk assessment has becomebig business. Events such as the Asian economic crisis have pointed out to


firms the need to look carefully at the potential economic and politicalenvironment in any country where they intend to invest. But becausenone of us can predict the future, political and economic risk analysistends to be more of an art than a science. A general search on the Inter-net will reveal a range of private companies that specialise in political andeconomic risk assessments, usually for a fee. In addition, many compa-nies contemplating an overseas investment will rely heavily on the assess-ments that their financial institution or insurer makes of the proposeddestination.

Most risk assessment agencies tend to rank countries in terms of polit-ical and economic risk by giving a general risk score or rating and thenscores for each of the various subcategories of political and economic risk.Unfortunately not all risk assessment agencies use the same subcategories,and so one can find conflicting assessments of the same country by differ-ent agencies. Most agencies also have rather complex methods for decidingwhat score to assign to a particular risk (security, political stability, macro-economic, foreign exchange, infrastructure, labour and so on) and it isoften useful to try to understand the method employed so as to formsome judgement about the score assigned to a particular risk category. Thefollowing sets out some of the more common subcategories of political andeconomic risk used by risk assessment agencies and explains why they tendto be used frequently.

S E C U R I T Y

The basic concern of foreign investors is the question of security. If firmshave reason to believe that their property is at risk of being destroyed byterrorists or the personal safety of their staff is at risk in a particular countryor location, they will be reluctant to set up operations there. Threats tosecurity can arise from isolated events such as violent crime, acts of terrorismand kidnapping or from broader threats such as civil unrest or war. Oneneeds to be aware of what types of threats are being assessed. For example,a country may be considered most unlikely to be involved in a war in theforeseeable future and there may be little likelihood of major civil unrest inthe country as a whole, and yet there may be parts of that country whererandom acts of violence and terrorism occur. In these cases an overallsecurity assessment of the country is difficult because there may be littlethreat to foreign investors in, for example, specially designated economiczones in relatively developed areas while in more remote and isolated areasthe security of personnel and property may indeed be at risk. For these


reasons some agencies separate out threats to property and personal safetyfrom the more broadly based issues relating to war and civil unrest.

P O L I T I C A L S T A B I L I T Y

A second but related concern is that of a country’s long-term politicalstability. Any potential political instability is an important concern forforeign investors because it may lead to civil disturbances that will affect thesecurity of the firm’s operations and because an unstable political systemcan result in radical policy changes that may adversely affect a foreigninvestor’s business. For example, different political parties within a countrymight hold opposing views on the desirability of foreign investment andtherefore the policies that apply to it. If a party comes to power that isopposed to foreign investment, it is possible that changes in laws mightoccur that make it difficult for a foreign investor to continue to operateprofitably. For example, changes in the tax system might make an otherwiseprofitable investment no longer profitable.

In extreme cases a foreign investor might find that its entire investmentis nationalised by an incoming government, with the foreign investor beingleft to pursue compensation in a court system that might be unfavourablydisposed towards foreign interests. The taking over of the property of for-eign investors is referred to as expropriation, and while wholesale expro-priation is uncommon because of its deterrent effect on future investment,there are many current cases of small-scale expropriation or what is calledcreeping expropriation. Many of these cases are dealt with by the Interna-tional Centre for the Settlement of Investment Disputes (ICSID). At thetime of writing, ICSID has around 40 cases pending against Argentina.Many of these arose out of policy changes introduced by the Argentinegovernment after the economic crisis in that country in 2001–03.

Multinational companies have claimed creeping expropriation by actionsof many other governments as well. Examples of issues that have formedthe basis of some pending cases include a change in policy that deniedrefunds of VAT to certain businesses (Occidental v Ecuador); the provi-sion of subsidies to competing domestic plants (Noble Energy v Ecuador);takeover by a government of the building where the company was located(SGC International v Russia); changes in import quotas that raised the levelof competing imports when the multinational firm invested on the basisof existing import quotas (Cargill v Poland); and even where investmentauthorities approved a real estate investment which could later not proceedbecause planning laws (existing at the time of approval) forbade the type of


development that the investor had in mind (MTD Equity v Chile). A use-ful website that gives details of these and other cases brought by investorsagainst countries under various bilateral investment treaties can be foundat <http://ita.law.uvic.ca>.

G O V E R N M E N T E F F E C T I V E N E S S

Government effectiveness is a further concern for foreign investors. Manyof the political risk agencies rate countries not only on political stability andsecurity but also on various matters related to government effectiveness. Inmost countries the day-to-day operations of a firm’s activities require someinterface with government agencies. These include, for example, gaininginitial operating permits, registering the business with authorities respon-sible for corporate affairs, clearing goods through customs, labour dis-putes, and taxation matters. If government agencies are unable to respondpromptly and fairly to the needs of business, foreign firms will think twicebefore attempting to establish operations in that country. In many devel-oping countries slow-moving and corrupt bureaucracies have been a majorconcern for investors and in some cases have caused them to abandon theirbusiness operations simply because they are unable to work with govern-ment in that country. For that reason, the effectiveness of government needsto be assessed in the investment planning process.

C O R R U P T I O N

The prevalence of corruption in a country is an issue closely associated withgovernment effectiveness. In many developing countries public officials arenot well paid and seek to supplement their income by extracting additionalfunds from business in exchange for carrying out their duties promptlyand efficiently. In poor countries such behaviour is understandable andmay even be tacitly sanctioned. It is difficult for politicians and seniorpublic figures to take a stand against such activities when they themselvesmay be engaged in much more serious corruption by using their powerto award government contracts in exchange for personal or political gainor giving favourable treatment (sometimes including tacit approval of abreach of the country’s laws) to those willing to pay. Many industrialisedcountries including Australia now have legislation that makes it an offencefor their own business people to engage in corrupt practices in overseascountries. In Australia the Crimes Act makes it an offence for Australiansto bribe a foreign public official (section 70.2). Thus corruption not only


cannot add significantly to the costs of doing business overseas but may alsolead to criminal convictions in the home country of the person engagingin it.

Despite efforts by governments worldwide, corruption remains a prob-lem in all countries. The most industrialised countries are not immune.This was demonstrated in the 2001–02 spate of corporate scandals in theUnited States where a number of major US companies were found to havebeen engaging in corrupt practices including the covering up of financialproblems by key corporate officials so that those officials could make aprofit for themselves at the expense of shareholders. The HIH insurancescandal in Australia is an example of this closer to home. There are a num-ber of non-government organisations that publish various indicators of theextent of corruption in a range of countries. Transparency International,one of the better-known agencies (<www.transparency.org>), publishes anannual report on corruption each year including a corruption perceptionsindex. The index is compiled from a range of surveys of business people toarrive at a score for the level of corruption in any particular country.

T H E L E G A L S Y S T E M

The effectiveness of a country’s legal system is a further matter of con-cern to foreign investors and is closely related to levels of corruption andgovernment effectiveness generally. In its day-to-day business activities, aforeign firm will need to enter into agreements with local suppliers, work-ers and customers. If the legal system in the country makes it difficultto enforce such agreements, business certainty suffers and the potentialfor profits may turn out to be illusory. Similarly, firms will want to pro-tect their production technology and trademarks from appropriation bythird parties. Ineffective enforcement of intellectual property laws makesinvestments that introduce technology unattractive. Firms will also haveregular dealings with government agencies such as taxation and customsauthorities. If such agencies are not constrained from acting arbitrarily bythe legal system, foreign investors may find their business activities seri-ously impaired or even shut down at the whim of a government official.Thus an effective legal system is an important subcategory in any riskassessment.

There are several other aspects of a country’s business environment thatare often rated by political risk agencies and are more of an economic nature.These include overall macroeconomic management, foreign exchange risk,infrastructure, and labour issues.


M A C R O E C O N O M I C M A N A G E M E N T

Macroeconomic management by the government of a prospective hostnation is an important concern for those investors who are targeting thedomestic market in that country. Downturns in the economy caused byexcessive budget deficits, rising interest rates, spiralling inflation and labourcosts can quickly undermine sales and hence profitability. Thus risk assess-ment agencies look carefully at a government’s economic management intheir assessment of the overall investment environment. Serious economicmismanagement can also lead to political unrest, thereby worsening theprospects for local and foreign firms alike.

F O R E I G N E X C H A N G E R I S K

Foreign firms who export all of their production can also be adverselyaffected by economic mismanagement. A lack of confidence by the inter-national community can quickly put pressure on an exchange rate. A fallingexchange rate may seem favourable for exports but poses a serious prob-lem when it comes time for profit repatriation. Significant depreciation ofan exchange rate can lead to little real return to shareholders in the firm’sparent company unless insurance has been taken out to protect againstsuch possibilities. Most OECD countries have agencies that will insureinvestments by their nationals against foreign exchange and other risks. InAustralia, the Export Finance Insurance Corporation (EFIC) offers suchinsurance, but premiums can be substantial and investors need to weighup the costs of insurance against possible foreign exchange risk and otherrisks. There is also an international scheme operated by the MultilateralInvestment Guarantee Agency, which was established by the World Bankin the late 1980s to provide an insurance mechanism for those investingin developing countries. The aim was to increase investment into thosecountries through insurance protection.

I N F R A S T R U C T U R E

Infrastructure is also a major issue for firms in their assessment of thebusiness environment of countries where they are thinking of locating aninvestment. If electricity supplies, telecommunications networks and trans-port systems are of a poor standard and unreliable, the firm will encounterproduction delays and hence additional costs. In order to attempt to offsetdisincentives because of generally weak infrastructure, many developing


countries establish special economic zones for foreign investors whereinfrastructure exists that is of a superior quality to that in the countrygenerally. Often these zones are located close to major ports or airports,obviating the need for the transport of goods over long distances from fac-tory to wharf. However, economic zones will not entirely offset the disad-vantages of poor infrastructure and thus firms that aim to serve the domesticmarket will still need to deal with logistical difficulties in the country atlarge.

L A B O U R Q U A L I T Y

The quality of the local labour force also affects the potential profitabil-ity of a manufacturing or service-oriented business. If extensive trainingis required before locally recruited workers are able to perform the tasksrequired, this would add to costs and act as a disincentive to investment.Likewise many foreign firms may well avoid countries with a reputationfor militant unionism. As discussed below, a country’s regulations on localand expatriate labour also influence a firm’s investment decisions.

A P P RO V A L P RO C E S S E S

Most countries insist that some or all foreign investments are approvedby a government agency often established specifically for this purpose.In Australia the Foreign Investment Review Board is the body that hasbeen established to approve those classes of foreign investment that needapproval; it is attached to the Treasury Department. In other countriesapproval bodies are frequently attached either to Ministries of Commerce(China), Trade and Industry (Philippines, Malaysia), Economic Affairs(Korea, Japan) or the Prime Minister’s or President’s office (Indonesia,Thailand).

It is important to point out here what is meant by foreign investmentapproval. When establishing a business in any country, there is usuallysome required licensing procedure. Thus, for example, to set up a food-manufacturing business in most countries will require a licence from healthauthorities or other authorities charged with ensuring the suitability ofthe premises for the purpose. Manufacture of pharmaceutical products isalso regulated and needs a licence. Transport operators, financial serviceproviders, educational institutions and most professions also require somepermission or other from a government body. It is difficult to think of anybusiness that will not require some kind of licence. These licences must be


obtained whether the investor is a local resident or a foreigner. In manycases, however, to get permission to invest in their chosen area, foreigninvestors need to take the extra step of seeking approval from the bodiesthat administer foreign investment rules. After that the foreign investor isin the same position as a domestic investor and must go through all thenecessary licensing procedures.

The question of foreign investors needing this extra approval is a matterof international discussion. Investors from OECD countries in particularquestion why foreign investors need to undertake this two-step process.In other words, they argue that foreign investors should be treated equallywith local investors and should only need to go through the same licensingprocedures as those local investors. The technical term for this is ‘nationaltreatment in the pre-establishment phase’. But few countries give foreigninvestors the same rights of establishment as local investors for all classes ofinvestment. Most countries insist on foreigners going through a separateapproval process for at least some classes of investment.

The Australian case provides a good example here. The Foreign Invest-ment Review Board examines all applications for investment in finance,media, telecommunications and air transport. In addition, it examines allproposals to establish a new business involving amounts of A$10 millionor more, and it also examines any proposed acquisition of an existingAustralian business where the assets involved are more than A$50 million.A much higher limit applies to US investors under the terms of theAustralia–United States Free Trade Agreement, where US investors areable to avoid scrutiny for most classes of investment below A$800million. Proposed investments in urban real estate are also subject to closescrutiny.

There are several reasons for countries insisting on approving some or allclasses of foreign investment. Developed countries such as Australia tendto require special approval for investors in the politically sensitive servicesectors such as those mentioned above. The reasoning here is that govern-ments are concerned that a failed investment in a major service area suchas telecommunications, finance, transport or public utilities could lead tomajor economic dislocation. Therefore they wish to scrutinise carefully anyforeign firm that intends to invest in these areas. As well as this, even ifforeign firms are given approval to invest in these sensitive areas, many coun-tries impose limitations on the percentage of foreign ownership allowed.This was discussed above in relation to joint ventures. A second reason fordeveloped countries wishing to scrutinise foreign investments is because ofthe possible problems that concentration of ownership in any particular


industry could pose for competition within the industry. Australia’s ForeignAcquisitions and Takeovers Act 1975 deals with this and it is pursuant tothat Act that the guidelines relating to acquisitions of Australian businessby foreigners have been promulgated.

Developing countries also insist on approving many classes of invest-ment for the same reasons as those advanced above for developed coun-tries. But developing countries also have concerns about the effect of foreigninvestment on the development process. As noted above, governments ofdeveloping countries want to see foreign investment making a contributionto the development of local industry. By subjecting foreign investment toan approval process they are able to impose conditions on investors to try toensure a positive outcome for the local economy. These conditions are some-times referred to as performance requirements and may include conditionssuch as a requirement to enter into a joint venture arrangement, to spenda certain amount of money in training of local firms and employees, or toagree to some transfer of technology to local firms. The usefulness of perfor-mance requirements in achieving economic development outcomes is hotlydebated in organisations such as UNCTAD, the OECD and the WorldBank.

The investment agencies of most countries have websites that set outwhat a foreign investor needs to do to get approval for its investment. Insome cases the procedure is quite straightforward unless the investor wantsto avail itself of special incentives such as tax breaks offered by the govern-ment. Thailand is a useful example here. If a foreign investor’s investmentdoes not fall into an area that is restricted to foreigners by the ForeignBusiness Act of 2000 and the investor does not want incentives, then all itneeds to do is to establish a company through the Thai Ministry of Com-merce in much the same way as a local investor. But if the foreign investorwants incentives it will need the approval of the Board of Investment.The Board of Investments in the Philippines and the Malaysian IndustrialDevelopment Authority tend to operate in a similar manner.

Some countries also distinguish for approval purposes between greenfieldinvestment and investment by acquisition of an existing business. Whilemany developing countries are happy to receive foreign investment if itinvolves a new project, some are reluctant to see existing businesses takenover by foreigners. Despite solid arguments that foreign investment byacquisition leads to just as many economic benefits as a greenfield project(see UNCTAD’s World Investment Report 2002), foreign investment byacquisition remains a sensitive matter in many economies. While investorsmay find that they can obtain approval to start a new business in a particular


industry, acquiring an existing business in that industry may not be viewedas favourably by investment authorities.

Assuming that the foreign investor is able to negotiate the first hurdleto investment and gain approval for its investment, it must then obtain allthe various licences that even local businesses must get. Because this canbe quite a cumbersome process for foreigners who are not familiar withthe bureaucratic procedures in the country in which they want to invest,some countries have established what are known as ‘one stop shops’ staffedby representatives from many of the more common licensing agencies.Most ASEAN countries have one-stop shops. However, while the one-stop shop concept is a good idea in theory, investors sometimes find thatthe representatives of the various agencies can only advise them abouthow to get the necessary licence rather than actually issue that licence.Thus while investors may get some help with the process they are stillconfronted with having to wait for a decision to be made by someone inthe agency to whom the representative at the one-stop shop refers theirapplication.

While it may be possible for a foreign investor to get approval for its pro-posed investment before establishing the actual business vehicle – usually aprivate limited company – it is more difficult for it to get the necessary oper-ational licences until it has gone through the formal procedure of settingup either a branch of its existing company or a separate subsidiary. Becausea licence to begin in a particular activity needs to be issued to the entitythat is going to carry on the business, it is necessary for foreign investorsto have established the business vehicle before applying for a licence. Thusit is appropriate at this point to examine some of the matters that arise inestablishing the business vehicle.

E S T A B L I S H I N G T H E B U S I N E S S V E H I C L E

A variety of business entities are available to those wishing to establish a newbusiness. The most common forms of business entity are sole traders, part-nerships, private companies and public companies. Establishing a businessas a sole trader is the simplest. Here a person can just commence opera-tions provided they have any necessary government licences to engage inthat activity. In partnership arrangements, it is common for the partiesto have a partnership agreement drawn up that sets out their rights toshares of the profits and their obligations to contribute to the running ofthe business as well as their rights and obligations on dissolution of thepartnership.


In the case of either a partnership or a sole trader, if the parties wishto trade under a name other than their own name, they need to registera business name. In Australia the registration of business names for soletraders and partnerships is taken care of by the relevant state governmentdepartments that look after business and commercial affairs.

When establishing a business presence in an overseas country, the mostcommon business vehicle is a private limited company. This means thatan Australian firm wishing to establish in an overseas country has to gothrough the process of setting up a company that is a separate legal entityin the country where they wish to do business. The Australian investorwill, however, own all of the shares in the newly incorporated company inthe case of a subsidiary or a portion of the shares in the case of an equityjoint venture company. To establish a private limited company involves anumber of steps that are discussed below using Australia as an example.The advantage of a private limited company is that the shareholders willonly be liable to the extent of their shareholding in ordinary circumstances.Thus, if the newly established company in the overseas country incursliabilities, the shareholders will usually only be responsible to the extentof the amount they have contributed (or are liable to contribute) for sharecapital.

A private limited company has other advantages. Because it is establishedaccording to the laws of the overseas country where the business is located,it gives the entity a ‘local’ feel. In many cases the name of the company willhave to be displayed in the local language and its constituent documentsmay also have to be produced in the local language. Being incorporated inthe overseas country may also make it easier to borrow from local banksbecause banks can see that there are assets within the jurisdiction over whichthey may wish to take security. A locally incorporated company also helpswith government approvals. Some countries insist that to get a licence forvarious business activities it is necessary to establish a locally incorporatedcompany. It is also often the case that a locally incorporated company isneeded if foreign investors want to take advantage of various incentives thatmay be offered (see below).

A disadvantage of a locally incorporated company is that it is subject toall the laws of the host state and therefore to the same degree of govern-ment intervention as applies to all other locally incorporated companies.Thus it must comply with all reporting and other requirements that applyto local companies. As explained earlier, an overseas branch differs froma locally incorporated company because it remains a part of the parentcompany. A branch is more suitable if the parent company wishes to keep


greater control over the activities in the overseas country and greater con-trol over the assets. It can do this because in the branch situation all theassets of the branch belong to the parent company. The disadvantage of abranch is that because it is merely a part of the parent company, the parentcompany will be liable for any debts and other obligations of its overseasoperation.

The alternative to a private company or a branch is a public company.Usually investors start operations with a private company in the overseascountry and only go public once the company’s profile has grown in theoverseas marketplace and they wish to raise funds from the public at largethrough the local stock exchange. In most cases the process of ‘going public’involves the issue of a prospectus where all company details are disclosedas well as all company activities. The public is then asked to subscribefor shares. This is called ‘floating’ the company. As in the case of a privatecompany, all shareholders are only liable to the extent of their shareholding.However, in order to protect the ordinary shareholder who does not have asignificant voice in management, there is a much greater onus on companyofficials regarding public disclosure and reporting of company activitiesand financial dealings.

Because the private limited company is the most widely used businessvehicle for foreign investors, this section will deal with the steps neededto establish such a company. There is a surprising amount of consistencyinternationally in the process and types of documents required to set up(incorporate) a company. The following deals with what is required inAustralia. Almost all countries have a government agency dealing withcorporate affairs and in most cases the process of incorporating a companyis set out in detail. As use of the Internet grows, it is becoming morecommon to find that the relevant forms can be filled out online.

The relevant body that looks after company incorporation in Aus-tralia is the Australian Securities and Investment Commission (ASIC)(<www.asic.gov.au>). The website sets out a number of steps to incor-porate a company in Australia.

S T E P 1

The first step is to choose a name for the company. There is a nationalnames index against which proposed names can be checked to ensure thatno other company or business has the same or a very similar name. Somewords cannot be used in the company’s name, including ‘university’, ‘trust’,‘building society’ and other titles that may give a misleading impression


about the status of the company. It is possible to reserve a name if one doesnot want to run the risk of the name being appropriated by someone elsebefore the form for incorporation is lodged. Otherwise the proposed nameis simply inserted on the form requesting incorporation along with all ofthe other details as described below.

S T E P 2

The second step is to consider carefully the mechanisms of the company’sinternal governance, for example the rights of the various classes of share-holders, the procedure for company meetings and the obligations of com-pany office-holders. The companies legislation contains a set of internalgovernance rules that automatically apply to a newly formed private com-pany if it does not choose to establish its own constitution. If it chooses toeither amend the standard set of rules or to establish its own constitutionthen it must say so on the incorporation form. It does not need to lodge itsconstitution with ASIC but must keep a copy of it at its registered officeso that it can be inspected.

S T E P 3

The third step in the incorporation process is to get signed consents fromthe persons who will act as directors and secretary of the company. Again,these consents do not have to be lodged but must be kept at the company’sregistered office. The form for incorporation requires that the details of thecompany’s officers be set out on the form.

S T E P 4

The fourth step is to lodge the form with any of ASIC’s offices in the variousstates. An examination of the form shows that in addition to the details ofoffice-bearers, it is also necessary to set out where the company’s registeredoffice will be located, the names and details of the shareholders, and thetype and class of shares that those members hold, as well as the overallshare structure of the company. Frequently, private limited companies willonly have one class of shares – ordinary shares – that entitle the holderto one vote per share. But other classes of shares can be issued such aspreference shares. These give the holder priority to assets on a winding upof the company as well as a priority to dividends. Discussion of the detailsof the various classes of shares that can be issued is beyond the scope of


this book but any of the various sources on company law provide a goodintroduction.

S T E P 5

Finally, after the form for incorporation is lodged and the fees paid, ASICwill issue a company number as well as a certificate of incorporation. Thecompany number must then be noted on all company documents. Thereare other obligations regarding reporting and lodging of returns that applyto private companies. The main obligations of which company officersneed to be aware are discussed on the ASIC website and in more detail intexts on company law.

Establishing an overseas presence through acquisition rather thenthrough setting up an entirely new business vehicle will involve differ-ent procedural considerations. The company that is to be acquired willalready be established with its own name, board of directors, sharehold-ers, constitution and registered office. The acquisition of the company willrequire the existing shareholders to sell their shares to the firm that wishesto acquire the company. If the company is a private one, the terms and con-ditions of sale are negotiated between the shareholders and the firm thatwishes to make the acquisition. The firm making the acquisition needs toundertake a process of due diligence to establish that the assets and liabil-ities of the company to be acquired are as shown on its balance sheet andthat any representations that have been made by the existing shareholdersas to the company’s business are supported by independent evidence. Ifthe company is a public company it will be necessary for the acquirer topurchase its shares through the stock exchange.

Most countries have detailed regulations that must be followed in theacquisition process. As noted above, they also have some limitations onforeign ownership in certain sectors of their economy and these regulationsmust be followed whether the company is being established by acquisitionor as a completely new entity. In addition, to protect the rights of minorityshareholders and other stakeholders in public companies, corporate regu-lators carefully scrutinise acquisitions via the stock exchange with variousprocesses to be followed. If the acquisition is of a major company within thehost economy, then competition or fair trade laws will need to be compliedwith, particularly if the acquisition leads to a substantial lessening of com-petition in the market. The authorities that administer such laws have thetask of ensuring that the acquisition will not result in the acquiring com-pany gaining a position of market dominance. More detailed discussion oncompetition laws can be found in Chapter 8.


O P E R A T I O N A L I S S U E S

After getting approval for the investment (if required) and establishing thecompany, it is necessary to consider a number of issues that affect the day-to-day operation of the business. It has already been noted that most typesof business will require some licence or other from a government agency.The newly established company also needs to consider some operationalissues including the selection of a site for its business, the employmentof local and expatriate labour, whether to raise working capital locally orfrom the parent company overseas, and customs, laws and procedures inthe overseas country. It must also comply with all other relevant laws andregulations of the host country that apply to its business.

S I T E S E L E C T I O N

The type of premises that a company requires for its business will dependon the nature of the business. An export-oriented manufacturing operationmay well decide that it is best to locate in a special economic zone becauseof the generally superior infrastructure that exists there and also becausesome countries allow foreign ownership of land in special zones whereasordinary land ownership is prohibited to foreigners or companies controlledby foreigners. A service-oriented business, on the other hand, might decidethat it is best to lease land or premises rather than own them, even ifownership is possible under the country’s laws. A mining or agriculturalcompany faces much greater difficulty with land issues. In many countriesresource-based industries are tightly controlled and often this is achievedthrough significant restrictions on rights to land ownership and occupancy.One of the reasons for this is that agriculture is a particularly sensitive matterin countries the world over and, as a consequence, foreign investment inagriculture is also sensitive. Similarly, the ownership of mineral resourcesis politically sensitive and allowing foreigners to exploit these resources isa cause for political concern in many countries. Thus securing land orpremises is a major issue for the newly established company.

R E G U L A T I O N S F O R E M P L O Y I N G L O C A LA N D E X P A T R I A T E L A B O U R

The conditions surrounding the employment of local and expatriate labourare also a major concern. Apart from assessments of the quality of the locallabour force and its suitability for the type of business that the foreign


investor has in mind, it is also necessary to bear in mind how labouris recruited and the various regulations that govern employment. Moreoften than not, the process of recruitment of a local labour force involvesdealings with a local employment agency either directly or over the Internet.In some countries it is not possible for foreigners to recruit local labourwithout reference to a local employment agency. Familiarity with locallabour regulations regarding minimum wages, working hours, paid leaveand other entitlements is necessary not only to gauge an accurate pictureof labour costs but also to ensure that local laws are not breached, whichmay give cause to authorities to revoke any operating licences. It is alsonecessary to consider carefully the conditions on which employment canbe terminated should this be necessary and any legal provisions regardingthe resolution of disputes between labour and management. The rightsof the labour force to form or belong to a union and the attitude that arelevant union has to foreign firms is important if the work of the companyis to proceed without too much disruption. Potential difficulties with locallabour can be a deciding factor for a foreign company’s investment decision.

There are also serious bureaucratic obstacles in most countries surround-ing the hiring of expatriate personnel either locally or from the parent com-pany’s headquarters. It is often the case that a foreign firm will want to havesome senior managers in place in the newly established company to ensurethat the operation runs smoothly and meets the objectives of the parentcompany. Most countries require workers from overseas to have both a visaand a work permit. There are typically several classes of visa that one canobtain when entering a foreign country and for that reason it is importantthat the expatriate worker obtains the correct class of visa before enteringthe country to engage in work. It is usual for immigration authorities toinsist on several documents to accompany visa applications. Likewise, forthose countries that require a work permit in addition to a visa, there willbe a range of documentary requirements. It is also often the case that thenewly established company will need to satisfy immigration authorities thatno local person can be found who is able to perform the task for whichthe expatriate worker is being recruited. Because immigration authoritiesthe world over are very concerned about keeping outsiders on the outside,some countries’ investment authorities have obtained specific relaxationsof visa and work permit requirements for a set (but limited) number offoreign executives as a part of the incentive package they offer to attractforeign investors. But in exchange for this relaxation there are also oftenrequirements that foreign investors train locals to take the place of expatri-ate managers within a set time. This can readily be enforced because both


work permits and visas are issued for a set time and the renewal of them isusually a heavily bureaucratised process.

O B T A I N I N G F I N A N C E

A third major concern for the newly established company is where to obtainworking capital. A large range of options exist here including borrowingfrom overseas, borrowing locally, or getting a loan from the parent company,which itself may have borrowed the money in the home country. Thedecision on whether to borrow locally or from abroad will depend on factorssuch as differences in interest rates, the soundness of financial institutions,the terms and conditions of loans for working capital, the stability of theexchange rate, and the willingness of local financial institutions to lend toforeign-controlled companies. Some countries regulate local borrowing byforeign firms. However, with increasingly open capital markets and a globaltrend towards consolidation in the financial sector, a foreign investor mayfind that its bank in its home country has a branch in the country wherethe investment is located. This allows greater flexibility in borrowing termsas both the parent company and the newly established subsidiary can beinvolved in negotiating the terms and conditions of any loan in order tominimise problems with interest rate differentials and exchange rate issues.

I M P O R T A N D E X P O R T R E G U L A T I O NA N D P R O C E D U R E

A further concern for those firms engaged in importing and exportingare the laws, regulations and procedures that govern these matters in theoverseas country. Customs, laws and procedures in Australia have been dis-cussed in detail in Chapter 7. The World Customs Organisation is workingto harmonise laws and procedures across its 150 members, but uniformityin customs matters is far from complete and not all countries are efficient intheir customs administrations. In addition, the movement of goods acrossboundaries has long been a prominent area where corrupt practices makedoing business difficult. For these reasons detailed knowledge of customslaws, practices and procedures is essential for the intending investor.

TA X A T I O N

Tax rates and incentives can be a deciding factor in the investment decision.If all the other issues that affect the investment decision are more or less


equal, the final choice of where an investment should be located can comedown to the country where taxation treatment is most favourable. Severalmatters need to be addressed in any discussion of taxation. These includethe range and type of taxes that apply, any taxation incentives that areoffered, and the tax treatment of repatriated profits by both the host andhome country governments.

Current international trends in taxation are towards harmonisation oftaxation rates and simplification of the range of taxes. Most countries arerationalising their tax systems to consist of one major direct income taxlevied on both persons and corporations (though at different rates) andone major form of indirect tax, usually a form of value-added tax. Therates of income tax on corporations (corporations tax) trend around the30 per cent level. Rates of value-added tax are typically of the order of10 per cent. There are various mechanisms for levying value-added tax.Perhaps most commonly, it is levied at each stage of the on-selling process,with the final consumer bearing the incidence of the tax. Those further upin the selling chain can offset any value-added tax that they pay against anyreceipts of value-added tax from those that they sell to further down thechain. Because the final consumer has no one to sell to they bear the finalincidence of the tax.

Other forms of tax include duties levied on imports. As noted in Chap-ter 7 on customs and Chapter 12 on the WTO, there is a trend towardsreducing this form of tax, although complete elimination of import duties(a global free-trade system) is some way off. Most countries also levy someform of tax on agreements for the purchase and sale of land, motor vehi-cles or other physical assets. They are generally a fairly low percentage ofthe sale price. These taxes are sometimes referred to as stamp duties. Mostcountries also levy what is known as a withholding tax when profits are sentabroad. The withholding tax generally applies at different rates dependingon whether the profit is sent abroad as a dividend, royalty or interest pay-ment. Withholding taxes, when applicable, tend to be in the range of 10–15per cent. Thus the actual profits that a shareholder in the home countryreceives will be the income that the subsidiary has made less income taxand less the withholding tax that is charged on the profits (after incometax) that are sent abroad.

Competition among countries for foreign investment has becomeintense in the past decade as more governments accept that there are benefitsto be gained from it. In the past, international opinion among developingcountries was that borrowing capital that could not be provided throughdomestic savings and obtaining technology other than through foreign


direct investment was a better way to aid the development process. Butthe risks of large levels of public sector borrowing became apparent inthe 1980s as some countries’ exchange rates devalued, thereby markedlyincreasing the amount of debt that had to be repaid. With rapid advancesin technology, it also became much more difficult for countries to engagein the practice of reverse engineering of products. Countries were thereforeleft with little option but to accept foreign investment to act as a catalystin their development process.

In order to compete for foreign investment, many countries offer a rangeof incentives to foreign investors. Opinion is sharply divided about whethertaxation incentives make any difference to a foreign investor’s investmentdecision. A number of studies have concluded that tax incentives are welldown the list of issues that a foreign investor considers. The matters dis-cussed above (political risk, approval and establishment processes, opera-tional issues and overall rates of taxation) tend to weigh more heavily indecision-making. However, if two locations are approximately equal on allthese other factors then it is admitted by almost all studies that taxationincentives could be the deciding factor. Thus many countries offer tax hol-idays or reductions in the formal rate of taxation, reductions in importduty, mechanisms for the recovery of indirect tax paid by exporters oreven exemption from withholding tax in order to entice foreign investors.In addition, some countries offer double deductions for various expensesincurred in running the business such as marketing expenses, infrastructureexpenses or training costs. Double deductions reduce the amount of tax-able income and therefore reduce the tax payable. The array of investmentincentives in some countries is so extensive that one wonders whether theastute foreign investor need pay any tax at all in those countries.

However, in the absence of some form of tax avoidance measure, taxincentives do not usually increase the amount of profits received by theshareholders in the home country. This is because most home countrygovernments will impose tax on remitted profits if those profits have notbeen taxed in the overseas country. Thus an investor will find that whilethe host country government may offer generous tax incentives, therebyincreasing their profit in the country in which the investment is located,once those profits are repatriated to the home country, the home countrygovernment will note that no tax has been paid on the profits overseasand will accordingly levy its own tax on those profits. Most countries haveentered into double taxation treaties with countries where there are largetwo-way flows of direct investment. These treaties cover a range of issuesbut are primarily aimed at making sure that the profits from the investment


are not taxed twice. The treaties typically give a credit to home countryshareholders for taxes that have been paid in the overseas country. Mosttreaties, however, have the effect that if the host country government doesnot tax the profits made there, then the home country government willdo so. Even in the absence of a double taxation treaty, most countries nowhave a system for taxing income from worldwide sources, thereby ensuringthat if tax has not been paid overseas it will be paid in the home country.

There is one limitation on the ability of home country governments totax profits that have not been taxed in the overseas country. This occurswhere the overseas country government and the home country govern-ment have in place a double taxation treaty in which there is a provisionthat allows any profits exempted from tax by the overseas country govern-ment to be also exempted from tax by the home country government. Thisis known as a tax-sparing provision. In the past some developed countries(including Australia) included tax-sparing provisions in their double tax-ation agreements with developing countries because it was felt that theseprovisions would promote investment in those countries. The current trendin Australia and elsewhere, however, is to revise double taxation treaties toeliminate tax-sparing provisions. It is now more difficult than ever fortax incentives to be effective as a means of attracting investment. Yet mostdeveloping countries will not abandon them for fear they might miss out onsome investment. Developing countries also observe practices in Europe,the United States and elsewhere where overseas investors are given hugehandouts by governments simply to locate a manufacturing plant in theircountry or within a region of their country. Competition between stateswithin Australia and within the United States for greenfield investmentprojects is fierce, and often the investor goes where the most generouspackage is offered. It is usually very difficult to discover just what the costto local taxpayers has been of these handouts to overseas investors. Thepractice continues because governments are of the view that the spin-offs(especially employment) from the foreign investment more than outweighthe costs of the handouts.

1111 Dispute Settlement

D i s putes ar i s ing bet ween part ie s to an interna-tional business transaction are usually sorted out by informal means. Fail-ing that, the parties can hire an external mediator to help them resolve thedispute. If this does not succeed, the parties might have to resort to time-consuming and expensive arbitration or litigation. Apart from the timeand expense involved, this can also do irreparable damage to an otherwisesuccessful business relationship.

International arbitration and litigation can be fraught with difficultiesbecause of the different legal regimes that potentially apply to the legalrelations between the parties. There are, however, a number of strategiesthat can be adopted to reduce the risks and expenses of international disputeresolution. If the business dealings are likely to be ongoing, one of the beststrategies is for the parties to develop good communications and makearrangements to meet informally as often as reasonably possible. Otherstrategies minimise the risk of non-payment for the delivery of goods andservices. As we mentioned in Chapter 4, letters of credit are one way ofensuring payment. Other risk strategies should also be employed that areappropriate to the particular business arrangement that exists.

On some occasions even the adoption of a range of risk strategies will notavoid the loss of considerable sums of money without pursuing legal action.In this chapter we outline the reasons for taking at least the rudimentarystep of ensuring that any contract between the parties includes a choiceof law clause and an arbitration clause. Sometimes, however, the contractbetween the parties is simply a faxed or emailed order for goods. Evenhere, there should at least be the addition of those two clauses in the fax oremail to avoid risking the enormous additional expense of resolving a legaldispute without those clauses.

265


This chapter outlines the processes involved in resolving disputesthrough international arbitration, and the ways in which arbitral awardsand court judgments can be recognised for the purposes of enforcing them.Enforcement will be futile, of course, if the loser of any arbitration or litiga-tion has insufficient assets to pay damages. It is therefore important beforeany legal action is taken to find out whether the other party has sufficientassets and to gain an idea of the country in which those assets are located.

This chapter aims to provide the reader with an understanding of:� resolving international commercial disputes by mediation;� the importance of a choice of law clause;� resolving international commercial disputes by arbitration and the rele-

vant rules of procedure; and� resolving international commercial disputes through litigation and

enforcing the judgments obtained.

M E D I A T I O N O F D I S P U T E S

The parties to a dispute may well attempt informal ways of resolving thedispute. If this fails the parties may, if they wish, refer the dispute to an inde-pendent mediator. Occasionally, the contract between the parties specif-ically requires the parties to engage in mediation as a first step towardsresolving the dispute. A mediation clause may state something along thefollowing lines:

If a dispute arises out of or in relation to this contract, the parties agreein the first instance to discuss and consider submitting the matter to set-tlement proceedings under the [specify the appropriate Alternative DisputeResolution rules].

There are a number of Alternative Dispute Resolution rules available(or as the International Chamber of Commerce prefers to call it, ‘AmicableDispute Resolution’ clauses). The Chamber, for example, offers a set ofalternative dispute resolution rules at <www.iccwbo.org/index adr.asp>

Even if the parties have a mediation clause in their contract, mediationcannot be forced onto them. If one or both parties believes, after makingattempts at mediation in good faith, that little more is to be gained from theprocess and refuses to proceed any further with it, then further mediationwill obviously be futile.

The parties to a dispute can agree to engage a mediator, even if theyhave not agreed to do so in the primary contract under dispute. There aremediators throughout the world who specialise in resolving international

D I S P U T E S E T T L E M E N T 267

commercial disputes. Each has their own methods for attempting to dealwith the dispute. Generally, a mediator will invite each party to a room inwhich the mediator outlines the steps that they propose taking, and assureseach party that they are independent and will treat confidentially anythingtold to them in confidence and that they will only reveal confidences tothe other side with the express permission of the party concerned. Eachparty will then be invited to present their perspective on the matters indispute.

The mediator will then usually ask one of the parties to leave so thatthey can discuss matters with the other party. The mediator will theninform the party present about the amount of money that is at stake andthe risks involved in pursuing the matter to arbitration or litigation, andask if the party will make an offer that could be put to the other side toresolve the matter. After receiving or not receiving any offer, the mediatorthen proceeds to the room in which the other party is present and repeatsthe process. The mediator will then go back and forth between the twoparties, attempting to narrow the differences between them. This processcan require a considerable amount of compromise between the parties. Itcan also reveal personality disputes, old grudges and misunderstandingsthat developed between the parties that stimulated the dispute in the firstplace.

If the parties do manage to reach an agreement to resolve the dispute,the mediator will ask them to have the agreement put in writing and signit. If one of the parties later refuses to abide by the agreement, a difficultlegal question can arise as to whether the agreement has any legally bindingeffect. Care therefore needs to be taken to ensure that the agreement arrivedat as a result of the mediation includes requiring the parties not to takefuture legal proceedings in relation to the dispute that has been mediated,and to frame the agreement in a way that is legally enforceable.

If the parties do not reach agreement, they are free to take formal legalproceedings against each other.

C H O I C E O F L A W C L A U S E

International trade arrangements involve parties that have their place ofbusiness in different jurisdictions, potentially adding much complexity tothe business and to the legal arrangements and agreements between them.A legal dispute between the parties is likely to raise difficult questions aboutwhich law applies to the resolution of the dispute. One way of reducingthese complexities is for the parties to include a choice of law clause in


their contract. A choice of law clause typically states something along thefollowing lines:

This Agreement is governed by, and is to be interpreted in accordance with,the laws of [name of country, or a State or Province in the country]. Theparties irrevocably submit to the non-exclusive jurisdiction of the Courtsof [the named country, or a State or Province in the country] regarding allmatters arising under or relating to this Agreement.

If a contract does not include a choice of law clause, a court must decidewhich law governs the contract: is it the law of the country in which theseller has its place of business, or the country where the buyer has its placeof business? In the absence of a choice of law clause, this question canbe quite complex. A court will need to decide where the contract has its‘closest and most real connection’. In deciding this, the court will take intoaccount:� the domicile, residence or business address of the parties;� the place where the contract was made;� the place where the contract is performed; and� the nature and subject matter of the contract’s performance.

F O R U M D I S P U T E S

The choice of law clause also attempts to lessen the chances of the partiesarguing about the jurisdiction in which the dispute should be decided byrequiring them to submit to the jurisdiction of the courts of a specifiedcountry. If there is no choice of law and submission to jurisdiction clausein the agreement, time-consuming, expensive and somewhat unproductivedisputes can arise about which court in which country should hear thedispute. If a contract dispute arises and one party is in Australia, for example,and the other is in Germany, it is possible, in the absence of a choice oflaw and submission to jurisdiction clause, that the courts in both countrieswill have jurisdiction to hear the matter. One party might commence legalproceedings in Australia and the other in Germany. The question thenbecomes, how can it be decided which court should hear the matter? Tocompound the problem, the courts in each jurisdiction have their own lawsfor deciding whether they can ultimately hear the dispute, and these lawsmay conflict with each other.

The example clause mentioned above refers to the ‘non-exclusive’ juris-diction of the courts of a particular country. This opens some room fora forum dispute, because it allows some flexibility regarding the forum.It allows the parties, for example, to agree at some later time to submit


to another jurisdiction. A submission to the exclusive jurisdiction of thecourts in a specified country would greatly reduce the possibility of a forumdispute, but this can have its downside. As an illustration of the problemsthat can arise, in Celltech R&D Ltd v Medimmune Inc. [2004] Englandand Wales Court of Appeal (Civil) 1331, Celltech granted Medimmunea licence to use Celltech’s US patents in return for royalty payments. Theagreement had a jurisdiction clause in which the parties submitted to theexclusive jurisdiction of the English courts. During the course of the agree-ment, Medimmune failed to make the royalty payments, and Celltechbegan court action in England. Medimmune sought a stay of English pro-ceedings because an unrelated patent revocation action involving part ofthe technology being licensed was being settled in the United States. Med-immune argued that there was a danger that the English and US courtswould reach inconsistent decisions on the patent if both actions continued.The English court refused to stay the action because of the exclusive natureof the jurisdiction clause.

FORUM NON CONVENIENS

If a choice of jurisdiction clause does not exist in the contract, problems ariseif courts in more than one country have jurisdiction to hear the dispute andthe parties argue about the appropriate country in which the matter shouldbe heard. Problems arise if, for example, the plaintiff commences an actionin a court in one country (which for convenience is called a ‘forum’) and thedefendant seeks to stop the matter proceeding in that forum (the defendantasks the court to stay – that is, to dismiss – the proceedings) so that thedefendant can commence or continue proceedings in another forum.

The courts in common law countries attempt to resolve these forumdisputes by applying the doctrine of forum non conveniens. The doctrinewas initially developed by Scottish courts in the nineteenth century, but(to add to the confusion) has been further developed in different waysin various common law countries. The aim of the doctrine is to allow acourt to take account of the forum that will best serve the interests ofthe parties and the forums themselves. Staying proceedings might impactharshly on the plaintiff’s rights, so the burden is on the defendant to provethat the plaintiff’s choice of forum is inappropriate and that another moreappropriate forum exists. Generally, the defendant faces an uphill battle inmaking its case for staying proceedings.

Under Australian law, a court will take two steps in deciding the appro-priate forum; first it will decide whether it has jurisdiction to hear thedispute, and second, if it has jurisdiction, it will proceed to deal with


the dispute unless the defendant can prove that Australia is a clearlyinappropriate forum for hearing the matter and that continuing the casein Australia would be oppressive or vexatious. The High Court case ofRenault v Zhang (2002) 210 Commonwealth Law Reports 491 illustratesthe uphill battle a defendant will have in convincing an Australian courtto stay the proceedings because it is a clearly inappropriate forum. In thatcase, Mr Zhang, an Australian resident and citizen, was injured while driv-ing a hired Renault in New Caledonia. Zhang sued the Renault com-pany in an Australian court, claiming his injury arose from its negligentmanufacture and design of the car he was driving. Renault (the defen-dant in the court of first instance) argued that the court was a clearlyinappropriate forum because the company had no office or employees inAustralia and that the law applicable to the accident was French law as itapplied in New Caledonia. The High Court found, however, that the casecould proceed in Australia because Renault had failed to prove that if thecase proceeded it would be oppressive of Renault’s rights in the sense ofbeing seriously and unfairly burdensome, prejudicial or damaging. Nor,concluded the court, could Renault establish that Zhang was being vexa-tious, in the sense of causing Renault serious and unjustified trouble andharassment.

English courts are more inclined to consider where the trial can mostconveniently be heard, in the interests of the parties and the benefit ofjustice. An English court will stay proceedings if it believes the action maymore efficiently and fairly be tried elsewhere. The aim here is to ensurefundamental fairness to the parties. Again the onus is on the defendant toprove that a court in another country is a distinctively more appropriateplace for the matter to be heard.

In Australia and England a court will consider a range of factors indeciding the appropriateness or inappropriateness of the forum, including:� the nature and location of the evidence, such as the location of docu-

ments and witnesses;� the convenience for the parties taking account of their place of residence

or business;� the law that will apply to deciding the matter. If the law applying to the

dispute is English law, for example, this would suggest an English courtwould be appropriate;

� the likelihood of gaining recognition and enforcement of any decisionmade in the forum; and

� whether the plaintiff’s case would be fairly dealt with in the foreignjurisdiction.


On the question of fairness, an English court will not allow a matter toproceed in England (if in all other respects the overseas forum is moreconvenient) simply because the plaintiff would probably gain higher com-pensation in England or would have better access to pre-trial evidence inEngland. The parties must take their jurisdiction as they find it.

In the US, a foreign plaintiff faces the onus of establishing that it cannotfind an alternative jurisdiction to the US. The alternative jurisdiction doesnot have to be comparable to the US, in fact it can be a far from perfectjurisdiction. Indeed US courts have gone so far as staying proceedingsbrought by a foreign plaintiff unless it can establish that staying proceedingswould deny them any alternative forum at all. A number of commentatorsclaim that over time the US courts have become increasingly unpredictablein dealing with forum disputes involving foreign plaintiffs.

If an action is commenced by a plaintiff in a European Union countryagainst a defendant who is a resident of or has its place of business in anotherEU country, the issue of jurisdiction is governed by the Brussels Regulation(EC 44/2001) on Jurisdiction and the Recognition and Enforcement ofJudgments in Civil and Commercial Matters. The regulation effectivelyoperates on a first come first served basis. That is, if proceedings involvethe same cause of action between the same parties, but are brought indifferent member states of the EU, then the court first seized of the matteris to proceed with the matter and the court in the other member stateis required to stay the matter in its jurisdiction. The regulation has beencriticised for encouraging a mentality of racing to the court. It has also beencriticised because it allows difficult legal issues to arise in complex disputesbecause a decision has to be made by the courts on whether the actionsbrought in different jurisdictions are in fact the ‘same cause of action’.

Most continental European countries (that is, civil law countries) do notsubscribe to the forum non conveniens doctrine when dealing with mattersinvolving a non-EC litigant. Civil law countries generally operate on afirst come first served basis. If the law of the dispute is the law of anotherjurisdiction, a court generally calls expert witnesses on the law of the otherjurisdiction to inform it of the other law. A German court dealing witha contract dispute governed by Italian law, for example, can call expertwitnesses on Italian contract law to inform them on Italian contract law.

Given the complexities and potential additional costs involved in resolv-ing forum disputes, it is wise for parties to a contract to include a choiceof jurisdiction clause in their contract for the sale of goods or services.Courts will usually defer to the parties’ choice of law and jurisdictionclauses, unless there are public interest reasons for not deferring to party


choices. Clauses primarily designed to evade tax or other significant reg-ulatory requirements may lead to a court refusing to accept a choice ofjurisdiction clause on public policy grounds.

I N T E R N AT I O N A L A R B I T R AT I O N

Forum disputes suggest that parties believe they have particular advantagesif they have their dispute dealt with by the courts of one particular countryrather than another. There can also be a sense that if a dispute is dealtwith in the country in which one of the parties resides or has its place ofbusiness, that party will have a home advantage. That party may have greaterfamiliarity with its legal system and legal culture, for instance, and may havemore ready access to the better lawyers for dealing with international tradedisputes. Or it may be felt, rightly or wrongly, that the home courts willfavour the home party.

These concerns can be alleviated to some extent by having the disputedealt with by international arbitration. The parties need to agree, eitherin their contract for the sale of goods or services (or whatever else theirprimary contract deals with) to have disputes between them dealt with byarbitration, or they can agree when a dispute arises to have it dealt withby arbitration. Alternatively, an arbitration clause in the contract will typ-ically state that the parties agree to have any dispute between them dealtwith by arbitration, and will specify the language in which the arbitrationwill be heard, the country or venue in which it will be heard, and thearbitration rules that will be used for deciding the dispute.

If the parties agree to arbitration, this often prevents them from goingdirectly to a court to have the dispute resolved, except for limited purposes,which are explained below. In many countries the courts will refuse to heara dispute if a contract includes an arbitration clause. In the past, the losingparty to arbitration would effectively appeal the ruling in a court. Courtstend to be more reluctant, or may be prohibited by law, from re-hearingdisputes that have been dealt with by international arbitration – thoughthey may be able to deal with complaints about bias or abuse of process byan arbitration tribunal.

Arbitration allows a dispute to be dealt with by a single arbitrator or apanel of three arbitrators chosen by the parties. The parties generally seekto appoint arbitrators they believe are impartial and competent to deal withthe issues in dispute. The panel does not necessarily have to consist only oflawyers. It could include one or more arbitrators who are familiar with the


industry in which the parties operate, or have some engineering or otherexpertise that may be required to fully understand the factual matters indispute.

The parties have greater control over how quickly the dispute can beresolved if they proceed by arbitration rather than through a court system.They can agree on the times when the arbitration panel is to convene,whereas with litigation in courts the parties have substantially less controlover the speed at which the matter is handled. Arbitration also has theadvantage of being dealt with in private, which can reduce any reputationdamage that can arise out of a public hearing in a court.

Arbitration does not come cheaply. The parties are required to pay thearbitrators’ fees, whereas in litigation the parties are not generally requiredto pay any judge’s fees. The parties are often required to pay for the hire ofthe venue (which is not a cost in litigation) and must pay for any transcribersand translators. Witness fees and expenses must also be paid, along withlawyers’ fees and other miscellaneous expenses. Some of these expenses aredefrayed for the winning party if the tribunal makes a favourable order forcosts.

T H E M O D E L L A W

A number of countries, including Australia and New Zealand, have giveneffect to the Model Law on International Commercial Arbitration. It aimsat harmonising national laws regarding international arbitration. It alsooffers gap-filling provisions regarding rules governing arbitration itself, andprovides for the recognition and enforcement of arbitral awards. In otherwords, if the parties to an international dispute have agreed to arbitratetheir dispute but have not set out the rules for dealing with the dispute orhave adopted rules that are silent on certain salient points, the Model Lawoffers gap-filling clauses on the procedures to be used by the parties andthe selection of arbitrators to resolve the dispute.

The Model Law also largely attempts to give effect to the choice madeby the parties to have their matter dealt with by arbitration by requiringcourts not to intervene in the dispute, except on very limited grounds.The grounds are limited to allowing a party to go to court to challengethe appointment of an arbitrator (Articles 11, 13 and 14), to challenge thejurisdiction of the tribunal (Article 16), or to have a court set aside an arbitralaward (Article 34). Court assistance can be obtained for taking evidencefor the tribunal (Article 27), for gaining recognition of the arbitration


agreement and court-ordered interim measures (Articles 8 and 9), or forgaining recognition and enforcement of arbitral awards (Articles 35 and36). Beyond these instances, there is very little capacity for involving courtsif the Model Law applies.

The Model Law was developed by UNCITRAL and was adopted by it in1985. The Model Law itself has no legal effect but is a template documentfor national or state parliaments to use as a basis for the enactment of a lawthat exactly or closely copies the template. The more closely a parliamentfollows the template, the more closely it meets the objective of internationalharmonisation of laws on this issue. To date, 42 countries have given legisla-tive effect to the Model Law, including, as mentioned, Australia and NewZealand, along with Canada, Germany, the Hong Kong Special Adminis-trative Region of China, India, the Macau Special Administrative Regionof China, New Zealand, the Republic of Korea, the Russian Federation andSingapore. The Model Law has also been adopted by Scotland and North-ern Ireland, and in the United States by California, Connecticut, Illinois,Oregon and Texas. In Australia, the Model Law appears as a Schedule tothe International Arbitration Act 1974 (Cth) and is given effect in NewZealand by the Arbitration Act 1996.

The Model Law applies to an international commercial arbitration if theplace of the arbitration is in a Model Law country. So, for example, if theparties have agreed to an international arbitration to take place in Australia,the Model Law will apply (Article 1 ML). An arbitration is internationalif the parties to an arbitration agreement have their places of businessin different countries; if the place of arbitration, the place of contractperformance or the place of the subject matter of the dispute is in differentcountries; if the place of the subject matter of the dispute is in a differentcountry; or if the parties agree that the subject matter of the arbitrationagreement relates to more than one country.

T H E A R B I T R A T I O N R U L E S A P P L Y I N G T OT H E D I S P U T E

An arbitration clause will typically state that the parties will refer any disputebetween them to arbitration. It will also typically specify the arbitration rulesthat will apply to the arbitration, the language in which the arbitration willbe heard, and the place at which it will be heard. One example of anarbitration clause is the one proposed by the International Chamber ofCommerce:


All disputes arising out of or in connection with the present contract shall befinally settled under the Rules of Arbitration of the International Chamberof Commerce by one or more arbitrators appointed in accordance with thesaid Rules.

There are numerous arbitration centres around the world, which offera venue and various support services for undertaking arbitrations. Mostof these centres have their own set of arbitration rules. The more com-monly used centres include the London Court of International Arbitra-tion (LCIA) and the International Chamber of Commerce, based in Paris.There are numerous other centres throughout the world, such as the Amer-ican Arbitration Association, the China International Economic and TradeArbitration Commission and the Australian Centre for International Com-mercial Arbitration. Each centre has its own arbitration rules and providesa range of facilities and assistance with initiating the proceedings and locat-ing tribunal members. The services of these centres are provided for a fee,usually calculated on a percentage of the amount in dispute.

The International Chamber of Commerce was founded in 1919 in Pariswith the aim of promoting trade and investment. It is headquartered besidethe River Seine on the right bank, more or less opposite the Eiffel Tower.It has numerous member companies and associations around the world.It provides arbitration facilities and assistance with appointing arbitratorsand getting proceedings off the ground. Chamber arbitrations do not haveto be heard in Paris and can be heard at locations throughout the world. Itreceives over 500 new cases a year.

The City of London Chamber of Arbitration was established at Guildhallin 1891 under the administration of the London Chamber of Commerceand the London City Corporation, which has since evolved into the presentday London Court of International Arbitration. Unlike the InternationalChamber and many other arbitration centres, the LCIA does not calculatethe costs of its services on the amounts in dispute. Like the InternationalChamber, it has a Court of Arbitration, which is the final authority forthe proper application of the LCIA Rules; it appoints tribunals, decides onchallenges to arbitrators, and deals with disputes about a tribunal’s awardsof costs.

The United Nations Commission on International Trade Law or UNCI-TRAL is unusual in that it offers a set of arbitration rules but does not offerany venue or support services regarding arbitrations.

Arbitration rules typically deal with issues such as the selection of an arbi-tration panel, the place of arbitration and a range of other issues, including


Table 11.1. Provisions of the Model Law and selected arbitration rules

Topic Rules Model Law

UNCITRALArbitrationRules

SCCArbitrationRules

LCIAArbitrationRules

Selecting anarbitration panel

Chapter III Section II Arts 7–12 Arts 5–11

Place of arbitration Art. 20 Art. 16 Art. 14 Art. 16Language of

proceedingsArt. 22 Art. 17 Art. 16 Art. 17

Law applying to thedispute

Art. 28 Art. 33 Art. 14 Art. 22(c)

Tribunal’sjurisdiction

Art. 16;Arts 34 &36

Art. 21 Art. 23

Power to orderinterim measures

Art. 17 Art. 26 Art. 23 Art. 25

Parties are free toagree onprocedure

Art. 19 Art. 14 & 19

Procedural fairness Arts 18, 25 Arts 9–12; 15 Art. 18–22 Art. 14Making an award Arts 29–31 Section IV Art. 25 Art. 29Costs Arts 38–41 Arts 30–31 Art. 28

those set out in the table above of comparative provisions in the ModelLaw and a number of other arbitration rules.

S E L E C T I N G A N A R B I T R A T I O N P A N E L

Chapter III ML sets out gap-filling procedures for the appointment ofarbitrators, challenging the appointment of an arbitrator (for example, onthe ground that he or she is biased), terminating the tribunal’s mandate andreplacing an arbitrator who falls ill, or for some other reason cannot proceedwith the matter. As gap-filling measures, they only apply if the parties havenot adopted a set of arbitration rules for dealing with their dispute (such asthe International Chamber of Commerce rules or UNCITRAL arbitrationrules) and have not agreed on any other set of procedures for dealing withthe dispute.

Procedures for the appointment of arbitrators are set out in most arbi-tration rules. For a fee, the International Chamber of Commerce provides aservice for arranging and commencing proceedings. The parties are required


to assist with the process before the arbitration proper takes place by filingcertain documents and meeting other requirements for selecting arbitratorsand defining the matters in dispute.

Article 12 ML requires a person who is approached to be an arbitrator todisclose any circumstances that might raise doubts about their impartiality.An arbitrator can only be challenged under the Model Law for lack ofimpartiality and independence or lack of qualifications required of thearbitrator by the parties. The parties can agree on a process for challenges,or in the absence of agreement, a party must make the challenge within15 days of becoming aware of the constitution of the tribunal or afterbecoming aware of the lack of impartiality or qualifications. The ModelLaw offers an advantage not necessarily found in non-Model Law countriesby allowing the parties to challenge the appointment of an arbitrator in acourt, and the court has the power to appoint an arbitrator. The court’sdecision cannot be appealed (Article 11 ML). The aim of this provision is toenable deadlocks to be resolved as quickly and conveniently as is reasonablypossible.

P L A C E O F A R B I T R A T I O N

The parties will often mention in the arbitration clause in their primarycontract the city or country in which they want the arbitration to takeplace. If it is not mentioned in the contract, the parties can later agree on aplace of arbitration. In the absence of such agreement, the arbitral tribunalcan decide the place of arbitration, having regard to the circumstances ofthe case and the convenience of the parties (Article 20 ML).

L A N G U A G E O F P R O C E E D I N G S

Again, the parties often agree in the contract on the language in whichthe arbitration will be heard. Failing that, the parties can later agree onthe language in which it will be heard. If the parties do not agree on this,under the Model Law the tribunal will decide the language in which itwill be heard. The tribunal can also order that documentary evidence betranslated.

L A W A P P L Y I N G T O T H E D I S P U T E

There are two questions to be considered regarding the law applying to thedispute; first, what law applies to the way the arbitration is conducted, andsecond, what law applies to the primary issues in dispute, for example any


alleged breach of contract? The law governing the arbitration is normallythe law of the place where the arbitration tribunal is sitting, unless theparties agree otherwise.

The law governing the primary matters in dispute is the law agreed bythe parties. Usually this is mentioned in a choice of law clause appearingin the contract, which may be the focus of the matter being arbitratedupon. Article 28 ML mentions that the parties can choose the ‘rules oflaw’ applying to the dispute, not simply the ‘law’ applying to the dis-pute. This means that the parties have a wider selection than merelythe laws of a particular country, and can choose to have rules that havebeen developed by an international body apply to the primary issues indispute. This means, for example, that rather than choose, say, the lawof Italy to apply to the dispute, the parties could choose to have theUNIDROIT Principles of International Commercial Contracts 2004 apply(<www.unidroit.org/english/principles/contracts/main.htm>).

If the parties have not chosen a law, or legal rules, to apply to the dispute,the tribunal must apply what is known as ‘conflict of laws’ principles todecide which law applies to the dispute (see the discussion above under theheading ‘Choice of law clause’).

Article 28(4) ML requires a tribunal to take account of trade usages indeciding the dispute. This means that if there is an industry practice ormethod of dealing that is regularly observed in the industry in which theparties are engaged, these practices can be implied into the terms of theircontract, or can be taken into account in some other way when judgingthe parties’ conduct.

TR I B U N A L ’ S J U R I S D I C T I O N

The Model Law adopts two principles regarding jurisdiction: (a) an arbitra-tion tribunal can rule on its own jurisdiction; and (b) an arbitration clausecan be separated from the remaining clauses in a contract (Article 16).This means that the arbitration clause will be valid and operational evenif the remainder of the contract is invalid for some reason. In effect, thearbitration clause is independent of the other terms in a contract.

A tribunal can therefore rule that it has no jurisdiction to hear the matter,or that the contract between the parties, excluding the arbitration clause,is null and void. If the tribunal ruled the entire contract, including thearbitration clause, void, it would, paradoxically, void the arbitration clause,which would in turn render the tribunal itself a nullity and therefore itsruling that the contract was void would be of no effect!


Under Article 16 ML, a party objecting to the tribunal’s jurisdictionmust raise the objection as soon as possible. A party can seek a court rulingon the tribunal’s jurisdiction under Article 16, but it only has 30 days ofa tribunal ruling on its jurisdiction to take the matter to court. The courtruling on jurisdiction cannot be appealed.

P O W E R T O O R D E R I N T E R I M M E A S U R E S

A significant issue for parties in relation to both arbitration and litigationis ensuring that the winning party gets the losing party to comply withany orders of the tribunal or court. Problems that occur too often includethe losing party, in anticipation of an adverse finding, shifting its assetsout of the jurisdiction, or refusing to comply with procedural orders ofthe tribunal. Problems also arise if one of the parties ‘loses’ or destroysdocuments or other vital evidence in advance of the tribunal or courthearing the matter. It is becoming increasingly common for parties toarbitration to seek interim orders either from the tribunal or from a court,either before or during the arbitration.

Various arbitration rules, including the International Chamber of Com-merce and UNCITRAL rules, state that a party is not in breach of thearbitration proceedings if it seeks an interim order in a court before orduring the arbitration. The Model Law makes a similar statement. TheLCIA allows a party to apply to a court for an interim or ‘conservatory’measure before the formation of the arbitral tribunal, and only in excep-tional circumstances after its establishment. It states that by agreeing toarbitration under the LCIA rules, the parties are taken to have agreed notto apply to any state court or other judicial authority for any order forsecurity for its legal or other costs that are available from the tribunal underArticle 25.2.

What, then, are interim orders? A number of legal systems have variousmechanisms allowing courts to deal with the problem of parties undermin-ing proceedings by removing or destroying assets or evidence. The destruc-tion of evidence can in some circumstances lead to punishment or otheraction for contempt of court. In some jurisdictions courts can deal with theremoval or destruction of assets by ordering the freezing of a party’s assetsor requiring search and seizure of assets if there is a real prospect of thembeing removed from the jurisdiction in anticipation of an adverse finding.This is a rather drastic course of action because it can harm a business’soperational capacity, liquidity or credit rating, and so courts are generallyreluctant to make the order unless there are compelling reasons for doing


so. A court will often require a party seeking the order to undertake topay for losses suffered by the defendant because of any unfair applicationof the injunction because of the plaintiff ’s erroneous account of the facts.Another less drastic approach a court can take is to order a party to makepayment of a specified amount of money in an escrow account as securityfor the other party.

In Australia and England an application can be made to a court toprevent a party removing its assets from the jurisdiction. The applicationis made for a court order known as a mareva injunction, which can alsoapply to third parties such as banks, requiring them to freeze the party’sbank accounts. The order can be made against a party that does not haveits place of business within the jurisdiction. The name ‘mareva’ derivesfrom the English case of Mareva Compania et Naviera SA v InternationalBulk Carriers Limited [1980] 2 All English Reports 213. A court orderinga mareva injunction can:� compel or restrain the performance of an act within its jurisdiction, but

the court cannot create jurisdiction where it would otherwise not exist;� prevent the removal of the party’s assets from the jurisdiction and prevent

the dissipation of its assets;� require a third party, such as a bank, to freeze the bank account of the

defendant.The process for obtaining a mareva injunction is very flexible as the

applicant can obtain it at any time before the hearing of the matter orafter judgment has been given, and arguably it can be applied against assetsthat were originally, but are no longer, in the jurisdiction. A court will,however, be reluctant to make an order against the defendant unless theplaintiff has a strong arguable case and there are real grounds for expectingthat the defendant will remove its assets from the jurisdiction or dissipatea substantial portion of them.

In addition to mareva injunctions, courts in Australia and England havethe power to order search and seizure of property, and require a partyto provide security for costs. Courts, then, have various powers to makeinterim orders to prevent the removal or destruction of assets and evidence.The question then is, to what extent can an arbitral tribunal issue interimorders? Swiss law is probably the most generous in allowing a party to applyto a tribunal to order a provisional or protective measure, unless the partieshave previously expressly excluded the tribunal from exercising the powerto take interim measures. The Swiss also allow a tribunal to seek assistancefrom a competent court to enforce the measure. Italian law, on the otherhand, prevents a tribunal from ordering interim measures of protection.


The laws of other countries, including England, France, Germany and theUnited States, lie somewhere between these two extremes.

Even if a tribunal has the capacity to make interim orders, it cannotmake orders binding on third parties. This is because a tribunal owes itscreation to the mutual agreement of the parties to a dispute. Consequently,its orders can only bind those parties and cannot bind those who are notparties to the agreement – that is, third parties. As a result, a tribunal cannotrequire a third party, a bank for instance, to freeze the money in a bankaccount held by one of the parties to the dispute. Nor can it require a thirdparty to produce documents that would provide evidence for the case.

The Model Law enables a tribunal, unless the parties agree otherwise, toorder an interim measure of protection. It does not deal with enforcement ofthe measures, but the tribunal can seek court assistance to enforce the order.

P A R T I E S F R E E T O A G R E E O N P R O C E D U R E

The parties are free to choose the arbitration procedures they considerappropriate for dealing with their dispute. Generally, the parties will choosea set of arbitration rules in the primary contract, be it the InternationalChamber of Commerce, the LCIA, the American Arbitration Association,UNCITRAL or some other set of arbitration rules. Article 14 LCIA rulesstates that the parties may agree on the conduct of their arbitral proceedingsconsistent with the tribunal’s duty ‘to adopt procedures suitable to thecircumstances of the arbitration, avoiding unnecessary delay or expense, soas to provide a fair and efficient means for the final resolution of the parties’dispute’.

There is, however, a tendency these days to deal with as much of thedispute as possible on paper so as to reduce the amount of time in oralargument and the examination and cross-examination of witnesses. Article19 LCIA and Article 24 Model Law allow a party to ask for the matter to beheard orally, unless the parties have agreed to a documents-only arbitration.

Typically, the arbitration tribunal will, through an exchange of letters,seek to have the parties agree on the arbitration process. The tribunalwill seek to get the parties to agree on dates for each party to outline itsclaims and counter-claims and defences in writing; for exchanging copiesof letters, documents and other material to be put in evidence; and forhearing witnesses and oral submissions.

A tribunal will often commence the oral hearings by inviting the partiesto make brief verbal submissions setting out the matters in contentionand stating the factual matters that the parties agree on. Depending on


the nature and complexity of the dispute, the tribunal will seek to have theparties communicate with each other in the absence of the tribunal in orderto narrow down the factual matters in dispute. Article 24 UNCITRALArbitration Rules allows a tribunal to require a party to deliver to thetribunal and to the other party a summary of the documents and otherevidence that the party intends to present in support of the facts at issuethat are set out in its statement of claim or statement of defence. Oncethe factual issues in contention are identified, the tribunal may then invitethe parties to present it with copies of letters, emails, contracts, witnessstatements or affidavits and other documents that may throw light on thematters in dispute. Article 19 LCIA allows the tribunal to send the partiesa list of questions it wants to ask during the hearing, and can set time limitsfor meetings and hearings.

The tribunal may then set down a date for hearing of witness testimony,if necessary, and for allowing the parties to present their final oral argu-ments. Some tribunals may set a time limit for each party to present itsfinal legal submissions (maybe allowing one hour for each party). Arti-cle 24 UNCITRAL Arbitration Rules states that each party has the bur-den of proving the facts relied on to support its claim or defence. Formore detail on the ways in which an arbitration can be handled, UNCI-TRAL offers a very useful set of ‘Notes on Organizing Arbitral Pro-ceedings’ at <www.uncitral.org/pdf/english/texts/arbitration/arb-notes/arb-notes-e.pdf>.

P R O C E D U R A L F A I R N E S S

The Model Law and many arbitration rules require that arbitrations complywith the principles of procedural fairness. The parties, for example, arerequired to be treated equally and each party is to be given a full opportunityto present its case. Article 24(3) ML requires that all statements, documentsand other information supplied to the arbitral tribunal by one party mustbe communicated to the other party. In addition, any expert report orevidentiary document on which the arbitral tribunal relies in making itsdecision must be communicated to all the parties. The parties must alsobe given the full opportunity to be present at any hearings or occasions onwhich evidence is being examined or inspected (Article 24(2) ML).

M A K I N G A N A W A R D

Once the tribunal has finished hearing the matter, its members will write adraft decision setting out the conclusions of fact drawn by the tribunal andits reasons for its rulings on the law. Often the tribunal will send the draft


decision to the parties and allow them an opportunity to point out anyerrors of law or fact. The tribunal would normally set a tight deadline ofbetween two and four weeks for any comments from the parties on its draftdecision. The tribunal is not bound to incorporate any of the responses inits final determination. The final determination will also include an ‘award’.This might be a ruling that one party pay the other an amount of moneyfor the loss suffered by the other party as a result of the first party’s breachof contract, plus an amount for interest on the award for damages.

If there is an arbitration panel, as opposed to a single arbitrator, hearinga matter and they do not arrive at a unanimous opinion on the award, thenunder the Model Law the award is to be decided on a majority vote (Articles29–31). The Model Law also requires that the award be in writing, be datedand set out the reasons underlying the tribunal’s decisions in making theaward. If the parties before or during the process of the arbitration reachagreement, then the agreement must be set out in the award, and it must benoted that the parties reached agreement. It is important that any agreementreached be recorded as an award by the tribunal, even if reaching agreementdid not involve the tribunal. The reason is that an award by the tribunalcan be used for enforcement purposes, whereas an agreement by the partiesthat does not have the formal status of being an arbitral award is far moredifficult to enforce.

C O S T S A N D I N T E R E S T

Generally, a tribunal will order that costs follow the event. That is, theloser will pay the costs of the arbitration, unless the parties agree otherwise.The costs can be considerable and include the arbitrators’ fees, travel andaccommodation expenses and the cost of the facilities, transcribers and anyinterpreters. A tribunal will often not make an order regarding the paymentof the winner’s legal costs by the loser, or will make a nominal order forthose costs. Specific provisions about the power to award costs are set outin most sets of arbitration rules.

A party to an international arbitration in Australia can apply to havethe costs taxed in the Supreme Court to the extent that they have not beentaxed or settled by the tribunal. Section 27 of the International ArbitrationAct provides a mechanism for compelling a tribunal to award costs if it hasfailed to do so.

The International Arbitration Act allows a tribunal hearing a disputeunder Australian law to add a reasonable interest rate to the award, unlessthe parties have agreed otherwise in writing. If the Convention on theInternational Sale of Goods applies to the dispute, and a party fails to pay


the price or any other sum that is in arrears, a tribunal can include interestin the award (Article 78 CISG), unless the parties derogate from or varythe effect of any of Article 78. The CISG does not, however, state howinterest is to be calculated.

E N F O RC E M E N T O F T H E A W A RD

If all goes smoothly, a tribunal will make an award requiring the loser tomake payment of a specified amount of money to the winner, and theloser will promptly make that payment. This, however, does not alwayshappen and a winner may be compelled to take enforcement action againsta recalcitrant loser. The first step in recovering the amount owed is to findout the jurisdiction where the loser has most of its assets, or at least enoughassets to meet the amount of the award and any enforcement costs.

Once the jurisdiction in which the assets are located is identified, thesecond step is for the winner to seek to have the award ‘recognised’ bythe appropriate court in that jurisdiction. If the award is recognised by thecourt, the tribunal’s award will be registered with the court and treated asif it were a judgment of that court. This then allows the winner to pursuethe loser using all the options available to a litigant who has a favourablejudgment in that jurisdiction. This might allow the winner to seek to havethe loser bankrupted, or if the loser is a company, have the company woundup. Appropriate amounts of the proceeds of the bankruptcy or winding upwill then be paid to the winner.

How, then, does the winner go about having the award recognised ina relevant court of the country in which the loser’s assets are located? Thefirst step requires finding out whether that country has adopted the UnitedNations Convention on the Recognition and Enforcement of Foreign Arbi-tral Awards, New York, 1958 (the New York Convention) or whether it hasgiven legislative effect to the Model Law. Oftentimes a Model Law countrywould have earlier adopted the New York Convention. Both the ModelLaw and the New York Convention provide for the recognition of foreignarbitral awards.

The New York Convention is one of the most successful internationalconventions in existence, with over 135 countries parties to it. An awardmade by a tribunal in one Convention country is recognisable by the courtsin another Convention country, and enforceable as if it were a judgment of acourt in that other country. A court in a Convention country can, however,decline to recognise an award if the party against whom the arbitrationaward was made (that is, the loser) proves that:


� there was a lack of capacity of the parties to enter into the arbitrationagreement;

� the arbitration agreement was invalid under the governing law of thearbitration;

� the loser was not given proper notice of the appointment of the arbitratoror of the arbitration proceedings or was otherwise unable to present itscase to the arbitral tribunal;

� the award was outside the proper scope of the arbitration;� the composition of the arbitration tribunal or the arbitration procedure

was not in accordance with the arbitration agreement, or with the lawof the country in which it took place;

� the award has not yet become binding on the parties, or has been setaside or suspended;

� the subject matter of the dispute is not capable of settlement by arbitra-tion under the law of that country; or

� the recognition or enforcement of the award would be contrary to thepublic policy of that country.A court can refuse recognition of an arbitral award along much the same

lines under the Model Law. Under the Model Law, the arbitral award muststate the place at which the arbitration took place, so as to avoid confusionabout the law applying to the arbitration. The Model Law makes it clearthat an interim order of protection or an order regarding security for costsor the award made by a tribunal are capable of recognition.

L I T I G AT I O N

If the parties have not agreed to arbitration, then one or both may com-mence legal proceedings in a court in a country that has jurisdiction tohear the dispute. As mentioned in the section above dealing with choiceof law, it is wise for the parties to include a choice of law clause in anycontract. If they do not, complex legal disputes can arise about which courthas jurisdiction to hear the dispute, and if courts in more than one countryhave jurisdiction, forum disputes can arise.

Using a court to resolve a dispute has a number of disadvantages. First,a party may have a ‘home advantage’ over the other party if the matteris litigated in the party’s home country. Second, the parties have no realcontrol over who is the presiding judge, or the timing of handling thedispute. Arbitration offers the advantage of allowing the parties to selectthe arbitrators, including, for example, choosing an expert in the indus-try as one of the arbitrators, which can be useful if highly complex and


specialised industry knowledge is required to fully understand the facts ofthe case. Third, court proceedings are open to the public, which may allowembarrassing or sensitive information to be revealed to the market.

Courts do, however, have some advantages. They can be better at dealingwith complex legal issues regarding the law applying to the dispute. Also,the parties are not required to pay for the costs of using the court, otherthan fairly nominal court costs. And if urgent action needs to be takento prevent the defendant removing its assets from the jurisdiction, courtscan prove to be surprisingly quick, nimble and effective in preventing thedefendant from undermining the process in this way.

If litigation is pursued, then obviously the particular laws of the countryin which the matter is being litigated come into play. A party will requirespecific legal advice on their prospects and the ways in which the matter willbe dealt with in a particular country. Assuming, however, that a disputeis dealt with by a court and it makes an order in favour of the winningparty, the next question is how is the order to be enforced against theloser?

E N F O RC E M E N T O F J U D G M E N T S

As with arbitration awards, ideally the loser complies with a decision of thecourt and pays the winner the amount set out in the court order. If not,enforcement proceedings need to be taken, which may ultimately result inthe loser being bankrupted, or if it is a company, being wound up, and anymonies resulting from this process may be paid to the winner.

If the loser’s assets are in a different country from the one in whichthe court proceedings were held, the winner will need to get the court’sjudgment recognised by an appropriate court in the country in which theloser’s assets are held. In the case of a party seeking to have a judgmentmade outside Australia recognised by an Australian court, the party willneed to turn to the Foreign Judgments Act 1991 (Cth), which provides forrecognising the judgments of the courts of some overseas countries. Theregulations to the Act, namely the Foreign Judgments Regulations 1992(Cth), list the countries and the courts whose judgments are recognisableby an Australian court.

In the case of a party seeking to have an Australian judgment recognisedoverseas, a good starting point is to check the courts listed in the For-eign Judgments Regulations. There is a strong possibility that the courtslisted there will recognise Australian judgments because the Act and theRegulations operate on the basis of mutual recognition. That is, Australia


will recognise the judgments of courts that will recognise Australianjudgments.

In the case of a party seeking to have an overseas judgment recognisedin Australia, the Foreign Judgments Regulations need to be checked to seewhether the overseas court is mentioned. As an example, a judgment ofthe British Columbia Supreme Court is recognisable as a judgment of anAustralian Supreme Court.

If a judgment is recognised by a court, it effectively treats the overseasjudgment as if it were a judgment of that court. This allows a party to takeenforcement action using the recognised judgment as the basis for takingsuch action. Say, for example, that the British Columbia Supreme Court inCanada made an order against a defendant requiring it to pay the plaintiff$1 million, and the defendant refused to pay up. Assume also that thedefendant had considerable assets in New South Wales but not in BritishColumbia. The plaintiff would then seek to have the order of the BritishColumbia Supreme Court recognised by the NSW Supreme Court. If thejudgment did get recognised by the NSW Supreme Court, the order wouldbe treated as if it were an order of that court, and would be enforceableagainst the defendant’s assets in New South Wales. Action could be takento bankrupt the defendant, or if it is a company, have it wound up.

The Foreign Judgments Act provides for the recognition of judgments byoverseas ‘superior’ courts and overseas ‘inferior’ courts. These courts arespecified in the regulations. In the case of New Zealand, for example, thesuperior courts are the Court of Appeal and the Supreme Court. In Italy,for instance, it is the Corte Suprema di Cassazione, the Corte di Assise,the Corte d’Appello and the Tribunale; and in Japan the Supreme Court,the High Courts, the District Courts and the Family Courts. The superiorcourts of other countries include specified courts in Fiji, France, Germany,the Hong Kong Special Administrative Region of China, Israel, Korea,Papua New Guinea, Poland, Singapore, Sri Lanka, Switzerland, Taiwanand the United Kingdom, as well as the superior courts of the CanadianProvinces of Alberta, British Columbia and Manitoba.

The inferior courts specified in the regulations include the DistrictCourts of New Zealand, the County Courts of England, Wales and North-ern Ireland, the Sheriff Courts of Scotland, the Provincial Court of Alberta,British Columbia and Manitoba, and the Bezirksgerichte, ErstinstanzlicheGerichte, Arbeitsgerichte and Mietgerichte of Switzerland as well as theDistrict Courts of Poland.

A judgment of a court mentioned in the regulations is recognisable bya relevant Australian court if it is a final and conclusive enforceable money


judgment. A judgment is final and conclusive even if it is being appealed inthe overseas country. The winner must apply to the relevant Australian courtto have the overseas judgment registered within six years of the judgmentbeing made in the overseas country. If the overseas judgment is appealed,registration in Australia must be applied for within six years of the lastjudgment in the overseas proceedings. The Australian court can extend thetime beyond six years if requested.

An overseas judgment cannot be registered if at the time of the applica-tion for registration the judgment has been wholly satisfied (that is, paidup) or it could not be enforced in the overseas country. The Australiancourt must set aside the registration for the other grounds set out in theAct, including if:� the judgment being registered is for an amount greater than the amount

owed;� the registration is a breach of the Foreign Judgments Act;� the overseas court had no jurisdiction to make the judgment;� the debtor was not informed in sufficient time of the registration appli-

cation in Australia;� the judgment was obtained by fraud;� the judgment was reversed on appeal or set aside; or� the person making the application was not entitled to do so.

In the case of an Australian judgment being recognised by an overseascourt where the law allows for the recognition of Australian judgments,it cannot be assumed that the overseas country will readily do so. Somecourts will place enormous procedural hurdles in the way of recognisinga foreign judgment, including Australian judgments. Japanese courts, forexample, tend to be very reluctant to recognise a foreign judgment, some-times allowing the process to take many years. The courts will sometimesallow a defendant to painstakingly trawl through the possible grounds forrefusing recognition as a way of frustrating a plaintiff ’s attempts at gettingrecognition.

Given the difficulties that arise, it is wise for parties to develop strategiesin their original contract or at the time of entering into a business relation-ship to protect their future position should any problems arise during thecourse of their business relationship. Suffice to say, international disputescan be extremely costly to resolve. Arbitration and litigation are a last, ratherthan a first, resort.

1212 Exporters and the WTO

No book on export law and practice would be completewithout a discussion of the significant role that the World Trade Organisa-tion now has in the regulation of trade by individual countries. This chapterfocuses on the relevance of the WTO agreements for Australian exportersof manufactured goods, agricultural products and services. There is a largeamount of information on both the WTO website (<www.wto.org>) andon the website of the Australian Department of Foreign Affairs and Trade(<www.dfat.gov.au>).

The year 1995 marked a turning point in international trade regulation.In that year almost 150 countries agreed to become members of a newWorld Trade Organisation and to accede to the six main agreements thatset out their rights and obligations. These agreements impose binding legalobligations on the signatory countries and for that reason considerablyextend the influence of international regulatory regimes on the ability ofindividual countries to regulate trade in whichever way they see fit. The aimof the WTO and its constituent agreements was to signal a new beginningin the efforts to achieve global free trade.

Prior to the WTO agreements, the main form of international regulationof international trade was the General Agreement on Tariffs and Tradeoriginating from the Bretton Woods conference in 1944 which finallycame into effect in 1947. Despite several rounds of negotiations betweencountries that expanded and clarified the GATT, it had failed to dealadequately with several significant issues that became prominent duringthe 1970s and 1980s. These included an escalation of non-tariff barriers, acontinuing high level of protection of agriculture, inadequate enforcementof intellectual property rights in many countries, an ineffective disputeresolution mechanism and the GATT not applying to the increasing trade

289


in services. The Uruguay round of negotiations commenced in 1986 inan attempt to address these issues. The new agreement to establish a newworld trade body, the WTO, emerged several years later but arguably, onlyafter it became apparent that failure to come to an international consensusmight have meant the splintering of the world trading system into severalmajor competing trade blocs with consequent dangers for internationalpeace and global economic prosperity.

The new international trade regime comprises six major agreements. Inturn, each of these has ancillary agreements and schedules of commitments.The following discussion outlines the broad objectives of each of the agree-ments before detailed discussion later in this chapter of the impact of theWTO on Australia’s manufactured goods exporters, agricultural exportersand services exporters.

The foundation agreement of the new international trade system is theAgreement to Establish the World Trade Organisation that sets out itsstructure and functions. Figure 12.1 shows this in diagrammatic form. Ithas been adapted from the diagram of the WTO structures that appears onthe WTO website.

The body that has the primary role to decide any matter relating toany of the agreements, including their implementation or variation, is theMinisterial Conference. The Ministerial Conference meets at least onceevery two years and consists of the trade ministers of all member countriesmeeting in general session. Decisions are usually made by consensus andfor this reason any major issues to be decided by the Ministerial Conferenceare generally preceded by considerable diplomatic manoeuvring and manymeetings of smaller groups of countries to establish common approaches tothe matters for decision. Despite the consensus approach being dominant,provisions do exist for decisions to be taken by vote. A decision on theinterpretation of any of the agreements making up the WTO can be madeas long as three-quarters of the WTO members vote in favour. Similarly, adecision to waive any member’s requirements under any of the agreementscan also be made by a three-quarters majority. Decisions to amend any ofthe agreements can be made by a two-thirds majority but they bind onlythose members voting for the amendment. Usually amendments to theagreements have to be made by consensus after a ‘round of negotiations’.Decisions to admit a new member (most recently China and Taiwan) canalso be taken by a two-thirds majority.

In between meetings of the Ministerial Council, another body, knownas the General Council, carries out the day-to-day work of the WTO. Eachmember country has a representative (usually at ambassador level) stationed

WO R L D TR A D E O R G A N I S A T I O N 291

Ministerial Conference

Council for TradeRelated Aspects ofIntellectual PropertyRights

Council for Tradein Goods

Committees on Committees ontrade in financialservicesspecificcommitments ofmembers

Working PartiesGATS rules

Plurialteral agreementstrade in aircraft

domesticregulation

market accessagriculture

anti-dumpingcustoms valuationrules of originimport licensingTRIMssafeguards

technical barriersto tradesubsidies andcountervailingmeasures

sanitary andphytosanitarymeasures

Council for Trade inServices

Other Committees andWorking Parties

General Council– includes meeting asDispute SettlementBody and as TradePolicy Review

Figure 12.1 Major structural features of the WTO

in Geneva to represent them in the General Council. The General Councilperforms three functions. It oversees the obligations of member countriesand the ongoing negotiation process required by several of the agreements; itacts as a dispute settlement body; and it also carries out reviews of membercountries’ trade policies as required by the Trade Policy Review Mecha-nism. The Council General is supported by a secretariat that has a staff ofapproximately 500.

Under the General Council there are three specialised councils dealingwith trade in goods, trade in services, and trade-related aspects of intel-lectual property rights. It will become apparent in the discussion that


follows that each of these three broad areas has many subsidiary issuesand therefore has several subcommittees. The Council for Trade in Goodshas 12 subcommittees with each specialising in a particular issue and theCouncil for Trade in Services has two subcommittees and two workingparties. All of these subcommittees deal with matters relevant to Australianexporters. Because the matters dealt with require specialised knowledge,member countries often dispatch officials with the requisite knowledge tothe various meetings rather than having a large staff stationed in Geneva.

The second agreement entered into by member countries is the Agree-ment on Trade in Goods. As noted above, the Council for Trade inGoods administers this agreement under the supervision of the GeneralCouncil and ultimately the Ministerial Conference. In addition to set-ting out the general obligations of member countries for trade in goods,this agreement has 12 annexed agreements dealing with specific issues(agriculture, health regulations for farm products, textiles and clothing,product standards, investment measures, anti-dumping, customs valua-tions, pre-shipment inspection, rules of origin, import licensing, subsidies,and counter-measures and safeguards). It can be noted that the subjectmatter of each of these agreements closely parallels the titles of the varioussubcommittees of the Council for Trade in Goods.

The third agreement is the Agreement on Trade in Services administeredby the Council for Trade in Services. As with the agreement for trade ingoods, there are several agreements annexed to the more general agreementthat set out the various obligations of member countries. The specificagreements that are annexed cover issues relating to the movement of naturalpersons, air transport, financial services, shipping and telecommunications.

The fourth agreement is the Agreement on Trade Related IntellectualProperty Rights or TRIPS. This agreement seeks to have WTO membersprotect the intellectual property rights of non-citizens on the same basisas the rights of citizens (national treatment) and to require members toactively enforce those agreements.

The fifth agreement is the Understanding on Rules and ProceduresGoverning the Settlement of Disputes. This agreement has overhauledthe previous dispute settlement procedures, making it obligatory for coun-tries to follow its rulings. Since 1995, Australia has been complainant andrespondent in a number of disputes. Some of the more important of thesewill be discussed below.

Finally, there is an agreement that concerns the review of member coun-tries’ trade policies. This agreement, the Trade Policy Review Mechanism,


requires members to submit their trade policies to peer review at least everysix years and requires them to notify the WTO regularly about any mea-sures they have taken for the implementation of the various agreements.The purpose is to monitor compliance with obligations under the vari-ous WTO agreements and commitments that have been made under thoseagreements as well as to provide member countries with suggestions on howtrade policies can be improved in the interests of promoting freer trade.

It should be apparent that many of the matters dealt with in earlierchapters of this book are within the purview of the WTO. This meansthat when framing laws and regulations (such as customs, anti-dumping,valuation procedures, intellectual property, rules of origin or phytosanitarymeasures), the Australian government must have regard to its obligationsas a member of the WTO. Thus the WTO agreements affect Australianexporters indirectly. This chapter therefore aims to impart an understandingof:� how WTO agreements affect regulations governing the export of man-

ufactured goods;� how WTO obligations affect regulations governing the export of services;� how WTO obligations affect regulations on agricultural exports; and� the steps that can be taken if an exporter is affected by a government in

another country failing to comply with its WTO obligations.

M A N U FA C T U R E D G O O D S E X P O RT E R SA N D T H E W T O

It could be argued that the exporters of manufactured goods have beenthe major beneficiaries of the new WTO agreement. Reducing tariff andnon-tariff barriers to manufacturing has been easier to achieve becausemost countries see that the benefits from their firms and citizens obtainingmanufactured goods at the best possible global price outweigh any costs thatarise from the closure of some manufacturing industries in their countriesbecause they are no longer competitive globally. However, as we will seebelow, the more sensitive issues of agriculture and services do not attractsuch broad consensus. It is also the case that the WTO’s predecessor, theGATT, dealt primarily with manufactured goods and there is therefore alonger history of attempting to reduce barriers for those goods.

The following discussion outlines the most significant of the principlesthat the WTO applies to the regulation of international trade. These aretariffication, non-discrimination, and most favoured nation.


TA R I FF I C A T I O N

Tariffication means that the only barriers that member countries shouldapply to imported goods are tariff barriers (as opposed to quotas). Further,members should aim to reduce any tariffs they have on manufactured goods.They must also notify the WTO of their bound tariff rates. ‘Bound’ tariffrates means that countries cannot increase tariff rates or impose additionalrates of import duty on goods except in very limited circumstances. Threeof the most important of these are where exported goods are ‘dumped’ orare ‘subsidised’ or where ‘safeguard measures’ are necessary because therehas been a surge in imports that threaten a domestic industry. The way inwhich the WTO regulates the implementation of these exceptions requiresfurther discussion.

Chapter 7 sets out the procedures the Australian government can adoptwhen goods are ‘dumped’ in Australia or attract ‘subsidies’ from export-ing countries. Dumping means that the goods are being sold in Australiaat prices below the prices of those goods in the exporting country’s mar-ket. Subsidised goods means that the exporter’s government has providedspecific subsidies to exporters of the product. The procedures that theAustralian government follows in applying anti-dumping duties or coun-tervailing duties must comply with the principles set out in the WTOagreements on anti-dumping and on subsidies and countervailing duties.These two agreements are annexures to the Agreement on Trade in Goods.Thus Australian exporters are entitled to expect that if anti-dumping orcountervailing duties are applied to their goods by other WTO membercountries, then those countries will also be following the WTO procedures.If not, then the Australian government can take the matter up with the gov-ernment of the importer’s country in accordance with the WTO disputesettlement procedures. Any anti-dumping duties or countervailing dutiesmust be reported to the relevant WTO committees.

There are several WTO cases brought either by or against Australiathat have involved anti-dumping duties and subsidies. In WT/DS119,Switzerland requested consultations with Australia about anti-dumpingduties that were provisionally applied to coated wood-free paper. Japanand the European Union joined with Switzerland in the matter. The dis-pute was settled after consultations with the parties by Australia agreeing tocease the anti-dumping investigation and return the provisional paymentsthat had been made. In WT/DS126, Australia was taken to task by theUnited States because of an alleged subsidy that it provided to an automo-tive leather-manufacturing company. The US complained that grants and


loans given by the Australian government to a company under the ImportCredit Scheme were in violation of the subsidies agreement. In this casethe initial panel held that grants were in breach of the subsidies agreementand that Australia had to take action to remedy this. Initial action taken bythe government did not go far enough and the US asked that the matter bereferred back to the original panel that had complained about Australia’scompliance with the decision. After Australia again lost this hearing a nego-tiated settlement was arrived at whereby Australia recovered some of thegrant monies from the company, agreed not to provide any more subsi-dies, and relaxed tariff rates on a fairly extensive range of unrelated goodsexported by US companies to Australia.

Another significant case involving Australia, the US and several othercountries is WT/DS217. This case involved a piece of US legislation thatsought to return any anti-dumping duties and countervailing duties toproducers in the affected industries. This was challenged in 2001 and hasresulted in some of the countries agreeing to accept US assurances thatthe offending legislation will eventually be changed, while other coun-tries have imposed retaliatory measures. This case is discussed in moredetail later to illustrate the workings of the WTO dispute settlementbody.

A further exception to the bound tariff principle applies to allow coun-tries to temporarily restrict imports of a product if there has been a ‘surge’in imports of that product with the effect that a domestic industry is threat-ened. A surge in imports can either be an absolute increase in volume or anincrease in the relative share that imports have in the market for the productin the country seeking to impose the ‘safeguard’ measures. The SafeguardMeasures Agreement annexed to the General Agreement on Trade in Goodsestablishes criteria that the government of the importing country must fol-low in determining whether serious injury is occurring or is threatened.While safeguard measures can include quantitative restrictions or quotas,these should not restrict the level of imports to below the average quantityof imports over the previous three years.

N O N - D I S C R I M I N A T I O N

It is also a key principle of the WTO regime that members cannot dis-criminate against individual countries when imposing tariff barriers. Inother words, all members must apply the same rates of tariffs to allother members (with some exceptions). This also applies when imposing


safeguards unless imports from particular countries can be established ascausing serious injury to the domestic industry. To deter countries fromimposing safeguard measures, the agreement allows exporting countries toseek compensation or even, after a set time, impose retaliatory measureson goods from the country imposing the safeguards. Countries seeking toimpose safeguards also have to report the measures to the WTO commit-tee on safeguards, thereby making it public to all prospective exportingcountries.

M O S T F A V O U RE D N A T I O N

The most favoured nation principle means that members of the WTOmust extend the same rates of tariffs to all other members. Again, there aresome exceptions to this principle. Perhaps the most significant of these isthe exception that allows countries that have free-trade agreements withothers to apply lesser rates of duties to imports from those countries thanthey apply to other WTO members. These free-trade agreements or pref-erential arrangements occur either bilaterally (between two countries) orbetween several countries within a region. The most prominent examplesof regional associations are the European Union and the North AmericanFree Trade Agreement. In recent years Australia has also sought to moveforward with a number of bilateral free-trade agreements. These includeagreements with Singapore, Thailand and the US, and negotiations areunder way for free-trade agreements with Malaysia and China as well asthe ASEAN group as a whole. Australia is not exceptional here; manyother countries are also moving towards bilateral free-trade and investmentagreements.

The exception to the most favoured nation principle in the form ofregional and bilateral trade deals attracts criticism from those who advocateglobal free trade because it tends to create trade blocs. Others do notsee such preferential arrangements as contradicting the basic goals of theWTO. Because of their current popularity, it is worth reviewing some ofthe arguments for and against these preferential arrangements.

Those who criticise the preferential arrangements do so on severalgrounds. They argue that preferential arrangements between countriesincrease the trade between those countries at the expense of more compet-itive suppliers that may exist outside the group. Thus preferential arrange-ments have what economists call a ‘trade diversion’ effect that lowers con-sumer welfare because goods are not imported at the lowest possible prices.Critics also suggest that to implement preferential trade arrangements


means establishing new institutions, particularly if such preferential dealsoccur at a regional rather than purely bilateral level. Thus, as well asthe WTO rules and regulations, countries and exporters have to considerthe special rules and regulations that apply to their own group. Further,the critics argue that there is danger that liberalisation of trade will stop ata regional level, resulting in a ‘new protectionism’ that threatens to causeconflict between regional groups in the long run.

On the other hand, the proponents of free-trade deals argue that sucharrangements are a first step towards truly free trade at a global level. Theyargue that it is easier to reduce barriers between a smaller number of coun-tries as an initial step because of the complexities of negotiations on a globalbasis. Once trade barriers are reduced among a small group of countries,it will be easier to reduce barriers globally. Reducing barriers through pref-erential trade arrangements may even act as a lever to global reductions.APEC is a good example here. APEC adopts a policy of open regionalism,which means that any reductions in trade that are negotiated between themembers are offered not only to members of APEC but to the whole WTOmembership.

Proponents of regional integration also argue that the natural expansionof firms beyond national boundaries tends to occur first at a regional levelbecause, as the old adage says, we trade with those who are nearest to usgeographically. Therefore it makes sense first to remove barriers betweencountries that are nearest to each other because this will result in the cre-ation rather than the diversion of trade. Proponents of preferential tradearrangements also argue that such arrangements tend to reduce tensionsbetween countries within the group, thereby leading to less tension globally.They also tend to be somewhat suspicious of movements towards globalgovernance exemplified by such bodies as the WTO and argue that suchbroadly based institutions leave many smaller countries without effectivenegotiating power over the rules of world trade.

However, preferential trade deals, whether at the bilateral or regionallevel, have some difficulties. One of these is that if preferential treatmentis being extended to goods from a free-trade partner (or group of part-ners) it is necessary to know whether the product actually originated fromthat trade partner. Hence ‘rules of origin’ are required. The WTO doesnot have a model set of such rules. Because of a long history of region-alism and therefore slight differences in definitions of origin between dif-ferent regional groupings, unanimity on this matter has not been pos-sible so far. All that has been possible is that the WTO agreement setsout broad principles on which rules of origin should be based. These


require members to ensure that their rules are transparent and do nothave the effect of restricting international trade, and that they are properlyadministered.

S U B S I D I A R Y A G RE E M E N T S T O T H EG E N E R A L A G RE E M E N T O N TR A D E I NG O O D S

There are several other agreements annexed to the General Agreement onTrade in Goods that seek to facilitate international trade or to preventmembers from restricting it. These include an agreement on the principlesand procedures that countries should adopt for issuing import licences, forpre-shipment inspection services and for valuation of goods for customsduty. In WT/DS91 Australia and a number of other countries challengedthe quantitative restrictions and import licensing procedures that Indiaimposed on a range of goods that included textiles and cosmetics. India wasfound to be at fault and was required to remove the quantitative restrictionsand bring its licensing procedures into line with the WTO agreementon import licensing. Similarly, in WT/DS169, Korea’s import licensingsystem for beef imports along with several other aspects of its distributionarrangements for imported beef were held to be in breach of its WTOobligations.

There is also an agreement that prevents countries from imposing cer-tain trade-limiting restrictions on firms that establish business presencesin their countries. This is known as the Trade Related Investment Mea-sures agreement (TRIMs). Thus investment agencies are prevented fromrequiring foreign investors to source a certain percentage of their suppliesfrom local producers, limiting foreign investors’ levels of imports or requir-ing a certain level of exports. These limitations are set out in detail in theTRIMs agreement. Each of these areas has WTO committees that havebeen established to monitor compliance with the terms of the agreement.

Despite the exceptions to the basic principles of tariff reduction andmost favoured nation treatment, the WTO system has achieved consid-erable success in reducing tariff rates on manufactured goods. The WTOwebsite reports that the average rate of tariffs on industrial products amongdeveloped countries is now only 3.8 per cent, down from 6.3 per cent in1995. Further, only 5 per cent of imports into developed countries attract atariff rate greater than 15 per cent. Tariff rates that are now bound amountto 99 per cent of product lines for developed countries and 73 per cent fordeveloping countries.


A G R I C U LT U R A L E X P O RT E R S A N DT H E W T O

The WTO agreements (specifically those on agriculture and phytosan-itary measures) affect Australia’s agricultural exporters in a number ofways in addition to those raised above for manufactured goods. Thoseadditional matters most relevant to agricultural exporters include a spe-cial regime for tariffs on agricultural products, domestic supports, andexport subsidies provided by some countries for their agricultural sectors,as well as the quality standards that countries use for agricultural imports.The following discussion details how the WTO agreements affect agri-cultural exporters in each of these areas. It will become apparent thatthe WTO system still has some way to go before trade in agriculturalgoods approximates the gains made in relation to industrial products.It is for this reason that Australia continues to be an active member ofthe Cairns group of countries, all of whom are agricultural exporters andwish to see revisions to the WTO system to free up trade in agriculturalproducts.

TA R I FF S F O R A G R I C U L T U R A L G O O D S

The WTO agreements require countries to have all agricultural barrierssubject to tariffs rather than the old system that allowed countries to setquotas on the amount of agricultural products they would accept. Thisis a considerable step forward in that most countries have now compliedand further, have bound their agricultural tariff rates. However, the WTOagreement on agriculture allows countries to effectively set two tariff ratesfor agricultural goods. The lower rate applies to a given quantity of imports,the higher to imports of agricultural products in excess of that quan-tity (above quota tariffs). Thus while tariff rates might be quite low (say10 per cent) for a limited quantity of imports of a particular product,any imports of that product over the set quantity might be as high as80 per cent. The WTO agreement on agriculture requires countries toreduce these higher tariff rates by 36 per cent. But even taking thisinto account, the result for Australia’s exporters is that exports of manycommodities to many countries over a certain quantity still attract hightariffs.

There have been several cases where Australia has challenged the rightof countries to impose increased tariff rates. In WT/DS178, Australia andNew Zealand challenged the imposition by the US of new rates of duty


as high as 40 per cent on lamb imports from Australia. The US arguedthat it needed to apply these higher rates of duty to safeguard its domesticindustry. The Appellate body of the WTO found that the actions of theUS were in breach of the agreement on agriculture because it had failed toprove that it was imports that were causing damage to its sheep industry.Australia successfully argued that the decline in the US industry was due toother factors including lack of economies of scale in US sheep farms. TheUS implemented this decision and removed the above quota tariffs that ithad imposed.

The current Doha round of WTO negotiations proposes cuts to tar-iffs on agricultural goods, with those goods with the highest tariffs subjectto the greatest cuts. At the time of writing, negotiations were continuingon this matter. In the meantime, Australia’s free-trade agreement negotia-tors have attempted to address this issue in the bilateral agreements thathave been negotiated. But the results have been mixed. For example, theAustralia–US Free Trade agreement provides for US tariffs on all agriculturalproducts (other than sugar and dairy) to be eliminated but only over an 18-year period. Some products will have tariffs eliminated more quickly thanothers – over four or ten years, for example. The US also reserved its right toapply safeguard measures and the suspension of tariff reductions if importscause serious damage to domestic industry (as occurred in the case of lambimports). Periodic reviews of the agreement may produce access earlier thanthe dates established by the agreement. However, Australian agriculturalexporters are likely to simultaneously pursue further bilateral negotiationswith the US and multilateral initiatives for a more liberal global agriculturalregime.

D O M E S T I C S U P P O R T M E A S U RE S

The second issue that confronts Australia’s agricultural exporters is thedomestic support measures that countries provide to agricultural pro-ducers. The WTO agreement has had the effect that payments to agri-cultural producers that have a direct effect on production and tradehave been reduced by 20 per cent by developed countries. But this stillleaves considerable latitude for developed countries to provide supportfor farmers in their agricultural sectors. And some government supportshave been excepted from the reductions. These include not only genuinepolicies such as support for agricultural research, drought relief and dis-ease control but also some payments to farmers to get them to cut backproduction.


E X P O R T S U B S I D I E S

The third issue is that of export subsidies. While developed countrieshave reduced the value of the export subsidies they have given agricul-tural exporters by 36 per cent and the quantity of goods subject to exportsubsidies by 21 per cent since 1995, and have notified subsidy levels tothe WTO, the current situation still means that Australian exporters faceunfair competition from farmers in other countries where the governmentprovides considerable assistance both for production and for export. InWT/DS290, Australia, Brazil and Thailand challenged export subsidiesprovided by the European Union to its sugar exporters. Australia arguedthat the EU was not complying with its commitments in the agreement onagriculture to limit export subsidies to the amount set out in its schedule.The EU argued that a footnote to its schedule of commitments allowed itto provide higher levels of subsidy. The panel hearing the dispute foundin favour of the complainants and an appeal by the EU was unsuccessful.The result requires the EU to reduce its export subsidies on sugar by someA$1.7 billion. At the time of writing implementation of these outcomes isawaited.

The Doha round of WTO negotiations has produced agreement toeliminate all export subsidies and to cut back significantly on domesticsupport for agriculture. There is still some way to go before the specifics ofthese commitments will be realised.

O T H E R A G RE E M E N T S A FF E C T I N GA G R I C U L T U R A L E X P O R T S

Despite these shortcomings the WTO regime has attempted to reduceinformal barriers to agricultural exports by agreements on sanitary andphytosanitary measures and technical barriers to trade. The PhytosanitaryAgreement and the Technical Barriers to Trade Agreement both aim to makeit easier for agricultural exporters by requiring WTO member countries tohave scientific justification for any standards that they apply to agriculturalimports and to apply these standards only for the purposes of protectinglife or health. While countries can set any product safety standards thatthey wish, they are encouraged to use prevailing international standards.Countries are required to notify their standards and any changes in thesestandards to the WTO, thereby making them transparent. Australia is notexempt from complaints that standards are being applied too rigorously.Australian quarantine restrictions on fruit and vegetable imports have been


challenged by both the Philippines (WT/DS270) and the EU (WT/DS287).At the time of writing these disputes have not been finalised.

Aspects of the Trade Related Intellectual Property Rights Agreementalso affect agricultural exporters. The agreement seeks to prevent producersusing a name for their product that could mislead consumers into thinkingthat the product originated from a specific location in another country.For example wine producers, other than in the Champagne district ofFrance, are not permitted to use the word ‘champagne’ for their product.However, although an agricultural product such as cheddar cheese mighthave originated in a specific location, the term is now used so genericallythat consumers would not be likely, when buying cheddar cheese, to expectit to be from Cheddar in the UK. Not surprisingly, attempts at developinga list of products that do have a particular geographic claim to intellectualproperty protection have not been successful; talks aimed at developing alist for the wine and spirits industry have so far been inconclusive. Australiaand the US are currently challenging EU legislation that is seeking to protecta range of products with names that originate from locations within theEU. Examples include ‘feta’ cheese and ‘kalimata’ olives. The outcomes ofthis dispute are not yet known.

S E R V I C E S E X P O RT E R S A N D T H E W T O

Australian exporters of services are confronted by three major issues whenconsidering services exports: the countries to which their services can beexported; the way in which those services can be exported; and any lim-itations that exist. The General Agreement on Trade in Services (GATS)requires each member country to provide a list of commitments to theWTO that sets out for each service industry the way in which services inthat industry can be exported to a country and any limitations that existfor each method of export.

The GATS recognises that there are 12 broad categories into whichservices can be classified:� business� communication� construction and engineering� distribution� education� environment� finance� health


� tourism and travel� recreation, cultural and sporting� transport� other.

The GATS also recognises that there are four ways (modes of delivery)by which services exports can take place:� through cross-border delivery of the services (as in information technol-

ogy export);� through delivery of the service in the home country of the exporter

referred to as consumption abroad (for example tourism);� through movement of natural persons to deliver the service in the over-

seas country (for example construction and engineering);� through establishment of a permanent presence in the overseas country

(for example banks).In order to establish whether any particular service can be provided

in or to a country, that country’s schedules of commitments need to beconsulted to see whether foreign service providers are permitted to deliverthat service, by what modes service delivery can occur, and if there are anyspecial limitations.

Special limitations might arise because countries are allowed to placeconditions on service delivery. They might have a particular limitationthat applies to a particular mode of delivery regardless of what serviceis being offered. For example, the delivery of any type of service by apermanent presence in the country may be subject to the approval ofinvestment authorities. If a limitation applies generally across all categoriesof services for a particular mode of supply, it is known as a horizontallimitation.

In addition to horizontal limitations, there are also specific limitationsthat might apply in a particular industry. These specific limitations tend tobe either limitations on national treatment or limitations on most favourednation treatment. The national treatment limitation means that countriescan treat foreign service providers differently from domestic service suppli-ers. They might do so by limiting the number of foreign service providersin a particular industry, for example domestic air transport, or by limit-ing the percentage of foreign ownership in a particular industry. However,subject to any horizontal and national treatment limitations set out bycountries in their schedules, member countries are generally not allowedto discriminate between service providers on the basis of the country fromwhich the service provider originates. Thus services, like goods, are subjectto the most favoured nation principle. As in trade in goods, there are some


exceptions to the most favoured nation principle arising from bilateral orregional free-trade agreements.

To illustrate these principles let us look at education services. If an Aus-tralian educational institution wishes to export its services to a particularcountry, it first needs to consult that overseas country’s schedule of com-mitments under the GATS to determine the modes by which educationservices can be exported to that country and any limitations that exist. Theresult may be that the export of education services from Australia to con-sumers in that country, via the Internet for example (cross-border deliveryof services), is permitted. It might also be the case that students from theother country are free to travel to Australia to undertake their studies inAustralia (consumption abroad). Australian academics may also be permit-ted to travel to the overseas country to teach courses to students in thatcountry. But if such a mode of delivery were open it would probably besubject to a horizontal limitation that the academics be eligible for a workvisa for immigration purposes. Such a limitation would be likely to applyto all service categories in the list above as a horizontal limitation. Finally,the educational institution might find that while it can deliver services inthe overseas country by establishing an offshore campus there, all foreigneducation providers are limited to only one campus for the country.

There are a number of special annexures to the GATS that provide forspecial arrangements in the sensitive services sectors of finance, air transportand telecommunications. The finance annex allows countries to maintaintight controls over all banks operating within their territory in the interestsof security of the financial system as a whole. The telecommunicationsagreements, on the other hand, require member countries to allow foreigntelecommunications providers to have access to the basic telecommuni-cations infrastructure. This infrastructure was often established at a timewhen the telecommunications industry was a government monopoly andis simply now too expensive to duplicate. Air transport services is alsoa sensitive area and has been governed by bilateral agreements for manyyears, pursuant to which individual countries negotiate with each otherover landing rights and flight routes. Thus international air services havebeen excluded from the GATS.

In addition to these special provisions, there are several other mattersthat need to be clarified in relation to the international services trade. Theseinclude when countries are able to implement emergency safeguard provi-sions to protect their services sector from a surge in foreign competition;the extent to which government procurement of services should be sub-ject to the GATS; and the limitations that should apply in relation to


subsidisation of services by member countries. The WTO committees onservices continue to work in these areas along with continuing negotiationsfor a gradual opening of more services sectors by more countries.

E N F O R C I N G W T O R U L E S

Individual firms that are disadvantaged because a country is not carryingout its obligations under one of the WTO agreements are not permittedto take action directly against the offending government. Only memberscan take action against other members and as the members of the WTOare all sovereign states, only sovereign states can initiate action to enforceobligations arising under the agreements.

In the case of Australian exporters who are adversely affected by breachesof any of the WTO agreements, the first step is to lodge a complaint withthe Department of Foreign Affairs and Trade at the WTO disputes enquirypoint. Firms should provide all details of the potential breach and how itis affecting their exports. The WTO Trade Law branch of DFAT examinesthe facts to determine if there is a likely breach of WTO rules and if so inwhat respect.

The next step is to hold formal consultations with the government inquestion. Many disputes are resolved at this stage, thereby obviating theneed for formal recourse to the WTO dispute resolution procedures. How-ever, if consultations fail to solve the problem the Australian governmentmust request the WTO dispute settlements body to convene a panel tohear the dispute.

The hearing of the dispute by a panel is the centrepiece of the WTO’sdispute settlement process. The DSB decides the membership of the panel.There are limited rights for either country involved in the dispute to objectto the panel’s membership. Once the panel is convened, each party putsits case to the panel in writing, after which the panel formally hears oralevidence from each side. The panel can call experts to inform itself of thematters in dispute if it sees fit. Once the panel has formulated its findings offact it submits them to the parties, giving then an opportunity to respond.Following this the panel goes on to make its findings and again submitsthese to the parties for a response. Finally the panel submits its final reportto both parties and then circulates it to the WTO membership at large.The report is then submitted to the Dispute Settlement Body (DSB) itselffor adoption of the panel’s findings into a formal ruling.

This, however, is not the end of the matter. The country that loses thecase has a right of appeal to the DSB’s permanent appellate body of seven


members. If the country lodging the appeal loses, the matter again goes tothe DSB to formally accept the appeal findings. Then the losing party mustnotify the DSB of what it intends to do to implement the findings. If thewinning party is not satisfied with the measures proposed to implement thedecision, the matter may be referred back to the original panel to decide ifthe measures are adequate to implement its decision.

The losing party may request a reasonable time in which to bring itsmeasures into conformity with the WTO agreement that has been breached.If there is disagreement about what amounts to a ‘reasonable time’ forimplementation, the matter may be referred to an arbitrator to decide.If the losing party still fails to implement the decision within the timerequired, it must enter into negotiations with the party adversely affectedas to appropriate compensation. Again, the possibility exists at this stagefor the offending party to seek arbitration if the parties cannot agree toappropriate compensation. After this step, if the offending party still doesnot comply then it is possible for the affected party to ask the DSB forpermission to impose suitable retaliatory measures.

Figure 12.2 sets out the steps that should be adhered to. There are settime limits for all stages of the process. In theory, if a losing party takesthe case all the way to an appeal it should still be obliged to correct theoffending measures within about 18 months of the initial proceedings bythe complaining country. But theory does not always translate into practice,as the discussion of the following case (WT/DS217) makes clear.

In October 2000, the US passed a law that allowed it to return theamounts that it collected from countervailing and anti-dumping duties toAmerican firms that were affected by the import of products on which thecountervailing and anti-dumping duties had been collected. The amountcollected was in the vicinity of US$200 million by December 2001. Aus-tralia and a number of other countries complained that this law contravenedseveral of the WTO agreements, including that on subsidies, because thereturn of revenue to producers constituted a subsidy to them.

The complaining parties requested that a panel be convened in July2001. The panel was duly established in August 2001. The panel reportedin September 2002 and its findings were accepted by the DSB. The USappealed the panel’s decision in October 2002 with the appeal being held inNovember 2002. The final report of the appellate body was accepted by theDSB in January 2003. Thus far, the timetable required for the resolutionof disputes had been followed fairly reasonably.

In February 2003, the US indicated to the DSB that it would implementthe appellate body’s ruling within a reasonable time, but negotiations as


AUSTRALIAN exporterraises the matter

with DFAT

consultations withoffending country

panel convenedto hear

the dispute

approach toappellate body

DSB formallyaccepts finding

implementation includingnegotiation and possiblearbitration re time-frame

and possible return topanel re implementation

failure to implement leadsto retaliatory measureswith possible further

arbitration before sanctioning by DSB

Figure 12.2 Flowchart of dispute resolution procedures in the WTO

to what was a reasonable time broke down. So the complaining countriesrequested arbitration to determine what would be a reasonable time forthe US to amend its laws to bring them into conformity with the ruling.The arbitration was held in April 2003, with the arbitrator handing downhis finding in May 2003. The US had argued before the arbitrator that 15months was a reasonable time for it to have the necessary amending leg-islation passed. Australia and the other complaining countries argued thatsix months would be appropriate. The Japanese arbitrator took a middlecourse and found that 11 months would be a reasonable period. In other


words the US had to bring its legislation into conformity by December2003. This was 11 months after acceptance of the ruling of the appellatebody by the DSB.

The US failed to pass the legislation by December 2003 and accordinglyin January 2004, the complaining parties requested the DSB for authori-sation to impose measures against US exports to their countries. Not allof the complaining parties sought to take such measures. Three of them(Australia, Indonesia and Thailand) agreed to give the US an extension oftime to implement the legislation. But the other countries (the EuropeanUnion, Canada, Brazil, Chile, Japan and Korea) wanted to impose retalia-tory measures. The US response to this was to ask for arbitration, sayingthat the retaliation proposed by these countries was unreasonable.

The arbitrator was appointed in February 2004. Shortly afterwards, inMarch 2004, legislation that would give effect to the original findings wasintroduced into the US Senate, but it had not been enacted by the timethe arbitrator handed down his decision on what constituted a reasonablelevel of retaliation. In August 2004, the arbitrator found that the affectedparties could retaliate against US exports to their countries to the extent of70 per cent of the anti-dumping and countervailing duties that the US wasillegally imposing on their exports. In November 2004, the DSB allowedthe affected countries (other than those that had agreed to give the USmore time) to impose the retaliatory measures proposed by the arbitrator.In March 2005 further legislation was introduced into the US Congressby the US government to bring their laws into conformity with the WTOrulings as from the 2006 budget year. However, the EU and other affectedcountries began applying retaliatory measures from May 2005.

This case shows that the implementation phase can be long and drawnout. Despite all formal decision-making processes having been completedwithin 18 months (as envisaged in the WTO dispute settlement agreement),it took a further 28 months for the EU to be able to finally impose retaliatorymeasures. In this case the difficulty in implementation can be attributed tothe difficulty that exists in the US of amending any legislation if Congressis not in favour of the amendments. In this case, there seems to have beenunwillingness on the part of Congress to comply, perhaps because it wasfelt that it was only reasonable that the revenue from the duties should havebeen returned to those producers who were adversely affected in the firstplace. But this is not what is authorised by existing WTO agreements.

Index

A Clauses 145A&G International Pty Ltd v Collector of Customs

166above quota tariffs 299acceptance of an offer 56–58Accredited Client Export Approval Number

(ACEAN) 159acquisitions, see mergers and acquisitionsAdvance (NSW) Insurance Agencies Pty Ltd v

Matthews 140advertising, see marketingadvising bank 91after-sales service, via an agent 190, 196agency relationships, see also customs agents;

factoringagreements for 191competition laws and 200definition of 186franchising and 218in education services 38law relating to 187

Agreement on Trade in Goods 292Agreement on Trade in Services 292, 302–305Agreement on Trade Related Intellectual

Property Rights (TRIPS) 292on agricultural commodities 302on copyright 214on designs 212on trademarks 211

agricultural commodities 1, 299–302AHECC 156, 168Air International Pty. Ltd v Chief Executive

Officer of Customs 169air transport 84, 109, 124–127, 139air waybills 124, see also bills of ladingAkedian Co Ltd v Royal Insurance Australia Ltd,

Sun Alliance Australia Ltd 140

All risks clauses 145Alternative Dispute Resolution rules 266anti-dumping duties, see dumpinganticipatory breach of contract 70–71APEC 296–298AQIS 8, 154, 162Arbitral Award 9887 of August 1999 (ICC) 51arbitration 265, 271, 272–285area development agreements 221Argentina, expropriation cases 247argentine bolita bean case 101Asia Pacific Economic Cooperation group

296–298ATA Carnet system 167Australia

adopts CISG 44barriers to trade 45, 175–181, 242, 301bills of lading for shipping from 119–124business expansion methods 219–222carriage legislation 130–132Customs Service, see customsForeign Investment Review Board

251–254foreign judgments recognised by 286franchising from 217Free Trade Agreement with US 252, 300incoterms relating to 81–87major exports 162–164mergers and acquisitions 41Model Law in 274requires insurable interest 134rules for shipments from 117WTO cases 294, 302

Australian Centre for International CommercialArbitration 275

Australian Chamber of Commerce and Industry160

309

I N D E X310

Australian Competition and ConsumerCommission 199, 229

Australian Customs, see customsAustralian Franchising Code of Conduct 229Australian Industry Commission 172Australian Paper Ltd v Anti-Dumping Authority

180Australian Quarantine and Inspection Service 8,

154, 162Australian Securities and Investment

Commission 256

B Clauses 145back-to-back credit 97banks

documents issued by 10letters of credit from 91, 92–96overseas banks approved by 103

bareboat charter 113barratry 137Berger & Co Inc. v Gill and Dufus 101Berne Convention for the Protection of Literary

and Artistic Works 214bills of exchange 10, 99bills of lading 10, 92, 114–117, 118, 119–124Bolero System 94, 113bound tariff rates 294–295, 298branches, overseas 237brand names 216breach of contract, fundamental 49, 59, 66–70Britain, choice of forum in 270Brussels Regulation on Jurisdiction 271,

272–285bulk cargo 113business expansion methods 219–222business format franchise 217business vehicle for subsidiary 254–258buyers

gap-filling obligations 61grounds for avoiding contract 69taking corrective measures 64

C & I incoterm 130C Clauses 145‘C’ incoterms 84–86, 114Cairns group of countries 299Cape Asbestos Co Ltd v Lloyds Bank Ltd 93Cargill v Poland 247Cargo Management Reengineering project 157carriage, see shippers; transportationCarriage and Insurance Paid 84Carriage of Goods By Sea Act of 1991 116,

119–124Carriage of Goods By Sea Regulations 1998 117Carriage Paid To 84carriers, see shippersCelltech R&D Ltd v Medimmune Inc 268

certificates of origin 9, 160CFR incoterm 85charters 113, 114, 118, 147China 45, 178choice of jurisdiction clause 271choice of law clause 45, 265–272, 288CIC Insurance Ltd v Midaz Pty Ltd 139CIF incoterm 85, 129CIP incoterm 84CISG, see Convention for the International Sale

of GoodsCity of London Chamber of Arbitration 275civil commotions 150civil law systems 52claims on insurance 150classification of goods 167–170claused bills of lading 115CMI 131CMR 157collection orders 99combined transport bill of lading 117Comite Maritime Internationale 131Commentary on the UN Convention on the

International Sale of Goods 50Commerce Trade Descriptions Act 1905 166commercial invoice 9commission payments for agents 187, 188, 191,

194common law systems 52, 67, 201communication with overseas representative

191, 235competition 189, 195competition laws 198–200, 225, 231computed value 171conditions of sale 7conditions vs. warranties 66, 142confidentiality 187, 195, 225confirming exporters 160conflict of laws principles 278conformity with contract 78conservatory measures 279–281‘consideration’ 55consolidation of businesses (mergers and

acquisitions) 41, 234, 243consolidation of shipments 110construction industry 39consumer protection legislation 228–230container transport 9, 83, 111–114, 116, 117contracts

arbitration ruling on 278avoidance of 66CISG on 54–59for the sale of goods 59, 75ICC standard 6in forward exchange 107of carriage 114–119, 124

contractual joint ventures 238, 239

I N D E X 311

Convention for a Uniform Law on theFormation of Contracts for theInternational Sale of Goods 43–72

Convention for the International Sale of Goods(CISG) 43–72

corrective mechanisms in 64–66fundamental breach of contract under 66–70gap-filling terms 60–64interpretation of 49–53opting out of 53Part II 54–59Part III 52structure of 54

copy prevention 204copyright 213–215corporations tax, see taxationcorrective mechanisms in CISG 64–66corruption in overseas government 248Cost, Insurance and Freight Paid 85, 129Costs and Freight Paid 85Council for Trade in Goods 292Council for Trade in Services 292Council General of the WTO 290counter-offers 58countervailing duties 181–183cover notes 133CPT incoterm 84credit, see letters of creditcredit risk assessment 103creeping expropriation 247Crimes Act, forbids bribery 248Curragh Coal Sales Co Pty. Ltd v Wilcox 163currency options 107customers, different classes of 102customs 154

Australia 154clearance through 82, 185documentation and procedure for 8duties levied 262duty drawback scheme 175legislation 156, 157, 161, 168, 171,

172–175customs agents 160

‘D’ incoterms 86–87, 114DAF incoterm 87damages 73–75dangerous goods declarations 112DDP incoterm 87DDU incoterm 87dealers, see agency relationshipsdeclared goods, liability for 122deductive value 171defective goods, valuation of 171deferral of patent examination 206delay 101, 121, 147Delivered at Frontier 87

Delivered Duty Paid 87Delivered Duty Unpaid 87Delivered Ex Quay 86Delivered Ex Ship 86delivery of goods 5, 60, 79, 87delivery of services 303

direct to consumer 38–39through in-country presence 40–42through personnel movement 39within home country 37

demand guarantees 98demise charter 113demurrage costs 86, see also delayDepartment of Foreign Affairs and Trade 1,

305departure report 160DEQ incoterm 86DES incoterm 86description of goods 4Designs Act 2003 211–213designs, as intellectual property 211–213developing countries 70, 241, 253DFAT 1, 305Diplock, Lord Justice 67direct franchising 221direct investment 234disclosure, for insurance 104, 133, 138–141dispute resolution 265–288

classification of goods 169franchise agreements 227provision for 5under CISG 49–53valuation of goods for duty 171with overseas representatives 197WTO procedures 307

Dispute Settlement Board 305distribution arrangements 39, 184, 239distribution franchise 217distributors v. agents 188documentary collection 5documentary letters of credit, see letters of creditdocumentation and procedure 6

costs of 80establishing overseas branches 237payment against documents 98–101

Doha round 300, 301domestic law 45, 52domestic support for agricultural product 300double taxation treaties 263draft bill of lading 112drafts, see bills of exchangedumping 175–181, 294–295, 306Durham Fancy Goods Ltd v Michael Jackson

(Fancy Goods) Ltd 92duty, see customs; tariff rateduty of disclosure, see disclosureduty of good faith, see good faith

I N D E X312

‘E’ incoterms 81economic and moral rights 215economic risk 245–251economic zones 250Economides v Commercial Union Assurance plc

141EDN 8, 159–183, 198education services

delivery of 37, 38, 304prepayment for 90

EFIC 250electronic documents 94, 113employees v. agents 186enforcement

choice of forum for disputes 286–288of arbitration awards 284–285WTO decisions 305–308

equity joint ventures 238–243establishing overseas subsidiaries 245–264European Union 271, 272–285, 301,

302exclusive dealing 146, 193, 231excusable delay 121EXDOCS system 8, 162expatriates 260Export Control Act 1982 8, 82, 163export declaration 8, 158, 159–183, 198Export Finance Insurance Corporation 250exports 1, 301expropriation 247Exworks incoterm 81

‘F’ incoterms 82–84Factor Chain International 106factoring 105fair dealing 214, 282family use of goods 47FAS incoterm 84FCA incoterm 82FIATA Multimodal Transport Bill of Lading

117financial arrangements 88, see also payment

methodsoverseas subsidiaries 261with overseas partners 240

financial sector 238, 242, 304floating subsidiary companies 256–258flowcharts

export of goods transaction 12letter of credit procedure 93payment against documents 100WTO dispute resolution 307

FOB incoterm 83, 130FOB value 170‘follow the leader’ mergers and acquisitions 41foodstuff exports 163, 215, see also agricultural

commodities

force majeure 71–73Foreign Acquisitions and Takeovers Act 1975 252foreign exchange risk management 106–108,

250foreign investment, competition for 262, see also

overseas business presenceForeign Investment Review Board 251–254Foreign Judgments Act 286foreseeability, and damages 74formalities, obligations to provide 78forum disputes 268, 269, 278, 284–285forwarding instruction 112Four Montreal Protocols 125–127franchise agreements 222

CISG not applied to 47legal issues 228–232v. licensing 215–232

Franchising Australia 2004 217, 219–222,229

Free Alongside Ship 84Free Carrier 82Free of Particular Average clauses 145Free on Board 83, 130free-trade agreements 296–298freedom of contract theory 53, 131freight forwarders 110Fu Hong Inc v Hua Yun Da Group Ltd 90Full Cover clauses 145fundamental breach of contract 49, 59, 66–70

gap-filling terms of the contract 60–64General Agreement on Tariffs and Trade

(GATT) 154, 289, 298general exclusions from insurance 148–150Gibbs v Mercantile Mutual Insurance 137good faith 54, 133, 141goods

CISG applied to contracts for 46–49classification of 167–170combined with services 39contracts for the sale of 59covered by agency agreement 192customs procedures for export 157–164inherent vice 146modification for overseas markets 185sale in transit 135terms and conditions for sale of 4–6

goodwill, franchise arrangements 227governments

approval of subsidiary companies 251–254domestic agricultural support 300effectiveness of 248labour regulations 259regulations for imports and exports 261require joint ventures for government

contracts 240required to approve franchise 231

I N D E X 313

Great China Metal Industrial Co Limited vMalaysian International ShippingCorporation 120

greenfield investments 234, 243, 253, 264, seealso overseas business presence

Guadalajara Convention 125–127

Hague Agreement on designs 212Hague Protocol 125–127Hague Visby Rules 116, 117, 119–124Harmonisation and Simplification of Customs

Procedures 156Harmonised Commodity Classification System

155, 168health certificates 163HIH Insurance scandal 249Himalaya clause 116, 121home consumption, imports for 165Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen

Kaisha Ltd 67Honnold, J. O. 57house bills of lading 117household use, goods for 47Hyundai Automotive Distributors v Australian

Customs Service 171

ICA, see Insurance Contracts Act 1984ICC, see International Chamber of CommerceICC clauses 85, 144ICS 157ICSID 247illegality 48implied warranties 143imports

declarations 165obtaining clearance for 160restrictions on 155, 164–167

impossibility of performing contract 71–73improvements to business by franchisees 226inactivity, does not constitute acceptance 57incentives for foreign investment 263incorporation by reference 77incorporation of a company, see private limited

companies, as subsidiaries; publiccompanies, as subsidiaries

incoterms 3, 62, 87origin of 5relating to Australia 81–87

India, WTO case against 298Industry Commission Act 172inferior overseas courts 287information technology services 38–39infrastructure, overseas 250infringement of copyright 214inherent vice 146innominate terms 67innovation patents 205

insolvency of charterer 147inspection certificate 11inspection of goods 80Institute Cargo Clauses 85, 144insufficient or unsuitable packing 146insurable interest requirement 133–138insurance 128–153

additional cover 150‘C’ incoterms 84–86documents required for 9for investments 250obligations to provide 78policies for 129responsibility for 85risk minimisation with 103–105

Insurance Contracts Act 1984 130–132on subrogation 153on warranties 143reduces refusal of claims 138

Integrated Cargo System 157integrators 124intellectual property 61, 63, 232, see also

Agreement on Trade Related IntellectualProperty Rights (TRIPS); licensingarrangements

interest payments, arbitration on 283interim measures 279–281interim receipt – forwarding instruction 10Intermediate Cover clauses 145international arbitration, see arbitrationInternational Arbitration Act 1974 274, 283International Centre for the Settlement of

Investment Disputes 247International Chamber of Commerce

Amicable Dispute Resolution 266commentary on CISG 51incoterms 5international arbitration by 275on electronic documents 94on multimodal transportation 123proposed arbitration clause 274standard agency agreement 191standard sales contract 6Uniform Customs and Practices for

Documentary Credits 92–96Uniform Rules for Collections 99, 101

International Deposit of Industrial Designs212

International Federation of Air Transport 124International Harmonised Classification system

168International Institute for the Unification of

Private Law 43International Trademark Bureau 210Internet

consolidation of businesses via 235electronic documents on 113

I N D E X314

Internet (cont.)fraud over 90marketing via

IP Australia 205–211IPR, see intellectual propertyirrevocable letters of credit 93IT services 38–39

Japan 184, 192, 288joint venture arrangements 220, 238–243, 244jurisdiction, forums for 268, 269, 278,

284–285

KFV Fisheries (Qld) v Kerrin 163Kirby J 121Korea 192, 298

labelling requirements 166, 215labour, overseas 251, 259lack of conformity 59, 64lamb imports, US duty on 299land transport 117, 139language of arbitration proceedings 277LCIA 275lease arrangements 63leather theft case 136legal issues

arbitration 272, 277effectiveness of overseas legal systems 249franchise agreements 227, 228–232in the absence of arbitration 285–288overseas representatives and 198–202

legal proceedings, obligation to cooperate with151

Leroy Somer Pty Ltd v Chief Executive Officer ofCustoms 174

letters of credit 10, 91–98liability

CISG not applied to 47for air transportation 125–127for sea carriage 119–124of carrier 119–122of overseas representatives 196

liaison office 236liberalisation of trade 164–167, 289

encourages mergers and acquisitions 41tariffication and 294–295WTO efforts 172

licensing arrangements 203–215agreements for 222for subsidiary companies 251–254franchising v. 215–232intellectual property 39legal issues 228–232obligations under 78royalties 203, 223

like goods 177

Lindsay v CIC Insurance Ltd 139litigation, see legal issuesLloyds 129logistics 111–114, 124, 190London Court of International Arbitration

275loss, definition of for insurance 105loss minimisation 151–153

M&A 41, 234, 243Macaura v Northern Assurance Co Ltd 134macroeconomic management 250Madrid Protocol 210Malika Holdings Pty Ltd v Stretton 166Mallesons Stephen Jacques 72management issues 242, 260manifest 160manufactured goods 1, 293–298Mareva Compania et Naviera SA v International

Bulk Carriers Limited 280mareva injunction 280‘marine adventures’ 135, 137Marine Insurance Act 129, 130–132, 134

disclosure for insurance purposes 140duties under 151good faith requirements 141

marketingadvertising, in franchise 224territory for 192via overseas representatives 190, 196via the Internet

master distribution agreement 188master franchise 220material injury 179materiality of facts 138, 141mediation of disputes 266mergers and acquisitions 41, 234, 243methods of payment, see payment methodsMIA, see Marine Insurance Actmineral exports 163minimalist approach 6Minimum Cover clauses 145Minister for Small Business, Consumer Affairs &

Customs v La Doria Di Diodata FerraiolliSpa 178

Ministerial Conference of the WTO 290misconduct of insured 145Model Law 273, 283monetary recompense 73–75money market hedging 107Montreal Protocols 125–127Moonacre case 136moral and economic rights 215most favoured nation principle 296–298, 303motor vehicles, export levels 1MTD Equity v Chile 247MTO 122–124

I N D E X 315

Mullins Wheels Pty Ltd v Minister for Customs &Consumer Affairs 178

Multilateral Investment Guarantee Agency 250multimodal transportation 117, 122–124

national treatment limitation 252, 303negotiation phase of franchising 228–230New Zealand 45, 274newly industrialising economies (NIEs) 41Nice Classification System 209Noble Energy v Ecuador 247nominated bank 91non-conforming goods 52non-disclosure 104, 133, 138–141non-discrimination principle 295non-exclusive jurisdiction 268non-injurious price 180normal value 177Notes on Organizing Arbitral Proceedings 282notice of avoidance 68notice of delivery 79, 81NSW Leather Co Pty Ltd v Vanguard Insurance

Co Ltd 136

Occidental v Ecuador 247ocean bill of lading 114offers, CISG on 55Official Journal of Designs 212one stop shops for foreign investors 254open account payment 5, 101open cover insurance policies 144open regionalism 297operational issues, subsidiary companies 259orders for goods 6ordinary leakage 146outsourcing 39outturn reports 165overseas business presence 233–264overseas representatives 184–202, see also agency

relationships

packaging 80, 146packing list 9Pan Atlantic Insurance Co v Pine Top Insurance

Co Ltd 140Pang, Justice 94paraflying injuries case 137Paris Convention for the Protection of

International Property Rights 206, 212partners, overseas 220, 238–243, 244partnerships, subsidiaries as 254party autonomy 53, 131patents 205–209payment methods 4, 108, 109

customs duty 166for agents 187for arbitration 272

for franchisors 223on open account 5, 101on termination of agreement 201

PCT 207performance criteria, overseas representatives

189, 194performance guarantees 40Performers and Phonograms Treaty 214permanent establishment, agent as 193personal use of goods 47Philippines, WTO cases 302phytosanitary certificates 8, 155, 163, 301Pilkington (Aust) Ltd v Minister of State for Justice

& Customs 180Pirelli Tyres Australia Pty. Ltd. v Chief Executive

Officer of Customs 169political risk, overseas subsidiaries 245–251portfolio investment 234postal rule 57pre-receival advice 9, 112precedent, in domestic law 53preferential trade arrangements 173, 296–298prepayment methods 89‘preponderantly for the supply of goods’

contracts 46price

distinguished from payment 88in anti-dumping applications 178in franchise agreements 226non-injurious 180offer must specify 55payment of 78setting, competition laws and 199unsuppressed selling price 180

primary products 1, 299–302private limited companies, as subsidiaries 254procedural fairness in arbitration 282procedure, see documentation and procedureproduct catalogues 56product franchise 217production franchise 218proforma invoices 7, 89, 91promotion, see marketingproof of delivery 80property, see title to goodsprovisional patent application 205public companies, as subsidiaries 256–258purchase orders 4

quantity of goods 55quarantine restrictions 301

rate of duty 172–175rats, damage by 148receipts, bills of lading as 117received for shipment bills 112, 116red clause credit 96

I N D E X316

regulations, see governmentsRenault v Zhang 270renewal of franchise agreements 226repeat business 3replacement goods 68, 174reporting requirements, overseas representatives

191, 195representative office 236representatives, see agency relationshipsrequest for an import licence 11request for cargo release 165residual law, CISG as 53restraint of trade, franchise agreements 225restricted goods 162–164retention of title clause 99revoking offers, under CISG 56, 58revolving letters of credit 96riots 150risk in goods

FOB incoterm 83from overseas subsidiaries 245–251from prepayment 90letters of credit 92–96management of 103–108obligations regarding transfer 79open account payment 102passing to buyer 62

Rome Convention for Performers, PhonographicProducers and Broadcasters 214

royalties, see licensing arrangementsrules of origin 156, 173, 297

Safeguard Measures Agreement 295sale of goods in transit 135Sale of Goods (Vienna Convention) Act 1989

44sales contracts, see contractsSanders v Glev Franchises Pty Ltd 229sanitary certificates 8, 301Scandinavia 44SDRs 121sea transport see also shippers 111–124

‘C’ incoterms 84disclosure for insurance purposes 140goods requiring 109liability under 119–124waybills 117

Seaconsur Far East Ltd v Bank Markazi JanhouviIslami Iran 95

security deposits 180security issues, overseas subsidiaries 246security over goods 63sellers

corrective mechanisms under CISG 65gap-filling obligations 60grounds for avoiding contract 68

sensitive service sectors 242, 252

servicescombined with goods 39export of 37–42franchising in 220overseas business presence for 234sensitive service sectors 242, 252trade in 2WTO involvement 302–305

SGC International v Russia 247shipped bills 112, 116shippers 119–124, see also sea transport

documents issued by 10letter of instruction 10liability of 112, 119–122

Shipping Company of India Limited v GamlenChemical Company 120

ship’s rail, passage over 83Siemens Ltd v Schenker International (Australia)

127sight bills 99silence, does not constitute acceptance 57sites for subsidiary companies 259sole traders, as subsidiaries 254Southland Rubber Co Ltd v Bank of China 94Special Drawing Rights 121Spinney’s (1948) Ltd v Royal Insurance 149stainless steel wire, defects in void contract

69stamp duties 262standby letter of credit 98strategic alliances 236strict liability offences 161strikes, insurance against 150students, see education servicessub-manifest 159subrogation 152subsidiary companies 222, 243–245subsidised goods 181–183, 294–295, 301substantial detriment 49substantial transformation requirement 160,

173substitute goods 68, 174sugar, export subsidies on 301superior and inferior overseas courts 287suppliers, franchise arrangements 226surety arrangements 98surge in imports 295SWIFT system 91, 113Switzerland 280, 294synergies between partners 240

tariff concession orders 174tariff rates 172–175, 299taxation 193, 261–264TCOs 174telecommunications 304telegraphic transfer of funds 89

I N D E X 317

telemarketing 39temporary imports 167term bills 100termination

avoidance of contract 66of agreements with overseas agents 197, 201of franchises 227, 232

terms and conditions for the sale of goods 4–6territorial range of overseas representatives 192,

224terrorism, risk from 149Thailand, subsidiary companies in 253The Model Law on International Commercial

Arbitration 273, 283The Moonacre 136therapeutic goods 164third party problem 200third party rights, freedom from 61, 63,

225through bill of lading 117time charter 113title to goods 49, 62tourism services 38trade 2–4, 48, 278, 296, see also liberalisation of

tradeTrade Marks Act 1995 209–211Trade Measures Review Officer 179Trade Policy Review Mechanism 292Trade Practices Act 199, 228–230, 231Trade Related Aspects of Intellectual Property

Rights, see Agreement on Trade RelatedIntellectual Property Rights (TRIPS)

Trade Related Investment Measures agreement298

trademarks 209–211transaction value of goods 170transactions for trade 2–4transfer of franchise 227transferable credit 97transportation 109–127, see also air transport;

sea transport; shippersarranging 7contracts of carriage 114–119land transport 117, 139multimodal 117, 122–124obligations to provide 78

TridentGLOBAL sample export documentation14

TRIPS agreement, see Agreement on TradeRelated Intellectual Property Rights(TRIPS)

UCP 92–96ULDs 124UNCITRAL, see United Nations Commission

on International Trade Lawunconscionable conduct 232

UNCTAD, see United Nations Conference onTrade and Development

Understanding on Rules and ProceduresGoverning the Settlement of Disputes 292

unfair termination of agreements 201UNIDROIT 43Uniform Customs and Practices for

Documentary Credits 92–96Uniform Law for International Sales Under the

1980 United Nations Convention 50Uniform Rules for Collections 99, 101unions, overseas 260unit load devices 124United Nations Commission on International

Trade Law 43–72arbitration rules 275, 282commentary on CISG 50The Model Law on International Commercial

Arbitration 274United Nations Conference on Trade and

Development 123, 148–150, 152, 280United Nations Convention on the Recognition

and Enforcement of Foreign ArbitralAwards 284

United Statescorruption in 249courts favour alternative jurisdiction

271Free Trade Agreement with Australia

300not bound by Article 1 of CISG 45requires insurable interest 134WTO cases involving 294, 295, 299, 306

unloading costs, responsibility for 85unseaworthiness 148unsuppressed selling price 180unvalued insurance policies 144URC 99, 101

valuation of goods for duty 156, 170–172value added tax, see taxationvalued insurance policies 144verbal offers 58vermin, damage by 148vice, inherent 146voyage charter party 113

war risk 149, 150, 246warehouse licences 175warehousing entry 166warranties 66, 142–144, 196Warsaw Convention, on air waybills 124,

125–127WCO 154, 155, 168weapons of war 148–150wheat exports 163wheel rim case 178

I N D E X318

wholly obtained goods 173wildlife and wildlife products 164wilful misconduct of insured 145will writing case 229WIPO 208, 214With Particular Average clauses, see B Clauseswithdrawal 56, 58withholding taxes 262wood exports 163World Customs Organisation 154, 155, 168World Import Regulations Directory 11World Intellectual Property Organisation 208,

214

World Trade Organisation (WTO) 154,289–308

supports trade liberalisation 172TRIPS agreement, see Agreement on Trade

Related Intellectual Property Rights(TRIPS)

valuation provisions 170WT/DS90: 301WT/DS119: 294WT/DS126: 294WT/DS169: 298WT/DS178: 299WT/DS217: 306

australian export: a guide to law and practice

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