Understand risk of loss to cut costs

Larry Covell

Larry Covell

Shipment of goods by common carrier can be a major part of small business transactions. The goods could be manufactured, inventory for resale, or office equipment. One key concerns that a small business owner should be aware of in shipment of goods is risk of loss.
Many risks are unforeseen such as weather, fire or theft; and the loss may not be covered by the business owner’s insurance policy or if the loss is covered, the policy may be insufficient to cover the entire amount. If the value of the shipped goods is insufficient, there is little impact on business operations. However, if the value of the goods is significant, the loss could seriously impact the survival of the business.
In most circumstances, the law of risk of loss is set out in New York’s Commercial Code. In absence of breach of contract, the code provides that the terms of the sales contract assigning risk of loss are to be applied. If the contract is silent on risk of loss terms, the code allocates the risk of loss based on delivery terms, which means that the financial loss falls on the party who has control over the goods. In either case, the business owner should fully understand the risk of loss terms in their sales contracts or understand the key concepts of the code’s risk of loss allocation.
The timing of when risk of loss is transferred from the seller to the buyer is established by the use of delivery terminology called, F.O.B. (an acronym for free on board.) The term F.O.B. began in the maritime shipping business to denote that the buyer would pay the cost of shipping, but today it is defined in New York’s Commercial Code.
The risk of loss is different in a sales transaction depending on the perspective of the seller or buyer. If the term used is F.O.B. seller’s location, the seller is not required to deliver the goods to a particular destination since that burden falls on the buyer. The risk of loss passes to the buyer when the seller delivers the goods to the common carrier. This is called a shipment contract. In a shipment contract, the buyer has both the expense of transportation and the risk of loss during transit. Therefore, F.O.B. becomes a delivery term since it establishes who incurs the costs and the risk of loss during transportation. If the buyer authorizes the seller to employ a common carrier on the buyer’s behalf, the seller must transport the goods to the common carrier and make a contract for their transportation with regard to the nature of the goods.
If the terms of the sales contract are F.O.B. buyer’s location, the seller is required to deliver the goods to a particular location as determined by the buyer. Furthermore, the seller is obligated to tender the goods in such a manner so as the buyer to take possession. The risk of loss passes to the buyer when the goods are delivered to the named location so that the buyer can take possession. The seller has the cost of transportation and risk of loss during transportation until the goods are delivered to the buyer’s specified location. This is called a destination contract.
In this circumstance, F.O.B. place of destination is a delivery term that places the burden of the expense of transportation and risk of loss on the seller until goods are delivered to buyer. The seller is also obligated to notify the buyer of the approximate time of arrival of the goods, while the buyer on the other hand has to provide suitable facilities to receive the goods.
Finally, small business owners, by understanding the F.O.B. delivery terms, can plan with their insurance representative to determine when insurance coverage is to take place and amount of coverage, hopefully, reducing their operating costs.

 Larry Covell is a professor of business at SUNY Jefferson and an attorney. Contact him at lcovell@sunyjefferson.edu. His column appears every other month in NNY Business.