United States: FSMA’S Potential Impact On Your Commercial Contracts And Other Business Arrangements

Pet Food & Animal Feed Update (No. 2)

PART II - Title And Risk Of Loss

In the first installment of our series of articles on FSMA's Potential Impact on Your Commercial Contracts and Other Business Arrangements, we discussed how FSMA has increased the importance of force majeure clauses in you commercial contracts. In this installment, we explore the impact FSMA may have on title and risk of loss provisions.

Title and Risk of Loss Provisions

Title and risk of loss are two related, but independent concepts. Risk of loss simply refers to whether it is the buyer or seller who bears the risk if the contracted goods are damaged, lost, stolen or destroyed. Title, on the other hand, refers to who is the owner of the contracted goods. Often, title and risk of loss go hand-in-hand.

Many day-to-day commercial contracts do not explicitly state when the risk of loss transfers from the seller to the buyer. In such cases, risk of loss is typically covered by the default terms of the Uniform Commercial Code ("UCC") and any applicable shipping term, such as FOB or FAS. Generally, the UCC provides that, unless the contract states otherwise, if there is no breach, the risk of loss passes to the buyer when the seller has fully performed its delivery obligations. Therefore, for example, if the contract calls for delivery to a particular destination, the risk of loss would pass from the seller to the buyer when the goods are duly tendered at the delivery location so as to enable the buyer to take delivery.

Those involved in international transactions may also be familiar with the Incoterms rules. The Incoterms rules are the International Chamber of Commerce rules for the use of domestic and international trade terms, such as FOB and FAS. Generally, Incoterms rules will apply to a contract only if the contract specifically states that the Incoterms rules are incorporated. Unlike the UCC, the Incoterms rules do not contain a general default provisions with respect to the transfer of the risk of loss. However, similar to the UCC, the Incoterms rules do specify when the risk of loss transfers in its definitions of the various shipping terms, such as FOB, CIF and EXW. For example, under the Incoterms rules, for goods shipped EXW, the seller is obligated to deliver the goods by placing them at the disposal of the buyer at the agreed upon place. Once the seller completes its delivery obligation, the risk of loss passes to the buyer. Like the UCC, the Incoterms rules allow the parties to modify the shipping terms in a particular contract, including the transfer of the risk of loss.

The UCC also provide for default provisions with respect to when title to the goods passes from seller to buyer. Generally, unless the parties otherwise explicitly agree, title passes to the buyer when the seller completes performance with respect to physical delivery of the goods. Unlike the UCC, the Incoterms rules do not provide any default provisions with respect to when title passes from the seller to the buyer.

So, what does FSMA have to do with title and risk of loss? First, as noted in Part 1, FSMA increases the risk that goods will be seized by the FDA. A seizure, whether or not temporary, may or may not be considered a loss under applicable law. While it may not be practicable to spell out specifically in your commercial agreements when a seizure constitutes a loss, you should nonetheless be mindful of the additional seizure risk posed by FSMA when negotiating the delivery term and any related risk of loss provision.

Second, Section 301 of FSMA requires that "importers" perform risk-based foreign supplier verification with respect to their foreign suppliers. An "importer" is the US owner or consignee of the article of food at the time it enters the United States, or if none, then the US agent or representative of a foreign owner or consignee at the time the article of food enters the United States. As foreign supplier verification is likely to be costly and cumbersome. If your contract involves the importation of goods into the United States, thought should be given to when title to the imported goods should pass. It may be that by providing for title to pass only upon delivery at your facility in the US, you may be able to avoid being classified as an "importer" and therefore be able to avoid the related foreign supplier verification obligations.

While the passage of title can be controlled easily in your contracts, whether or not you are considered a "consignee" is more difficult to control. "Consignee" is not defined by FSMA. However, a consignee is generally the person to whom goods are shipped. Hopefully, when the FDA issues the FSMA rules, the rules will clarify who is a consignee and who bears the foreign supplier verification obligations in cases where the owner of the goods and the consignee of the goods upon entry into the US are different entities.

Conclusion

In short, as with force majeure clauses, there is no one answer that is appropriate for all parties or situations as the facts and circumstances of each contract are different. However, with FSMA's potential impact on your commercial relationships, this is an appropriate time to take a fresh look at the title and risk of loss and title transfer provisions in your commercial agreements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.