Types of Freight Contracts

Freight contracts are the foundation of the logistics and transportation sector. They govern every detail of every shipment and protect parties throughout the supply chain. They serve as legal parameters for shipping relationships and payments, and they are fundamental for businesses managing risks and freight costs while ensuring the prompt delivery of goods to global customers. 

But freight contracts can be complex and confusing — and occasionally they even involve high finance concepts. In this guide, we provide a comprehensive explanation of the types of freight contracts and how they work in the logistics industry so you can make smart decisions about the contracts that are right for your business.

Introduction to Freight Contracts: The Backbone of Global Trade

The purpose of a freight contract is to set the requirements and legal boundaries of a transportation relationship and the movement of goods as per that relationship. Any commercial organization leveraging another commercial organization for shipment of goods needs a freight contract. They are vital for establishing legal and operational frameworks for transporting goods over land, air, and sea, and they allow shippers to control costs, set expectations with customers, and stay competitive. 

Some basic terms you’ll come across in freight contracts are:

• Shipper: The entity sending out the goods.
• Consignee: The entity receiving the freight. Consignee is the end of the line, destination, and end goal. Payment can be prepaid or handled by a third party.
• Accessorial: As shippers measure their shipments and determine their freight classes, they may also determine any “accessorials” which are instructions for the carrier at the destination. Accessorials may include specifications for unloading, where to deliver goods in certain areas of the destination, and more.
• Freight classification: There are several factors that go into determining a freight class, including weight, height, length, density, value, liability, and more.
• Freight broker: Shippers may choose to use freight brokers who function as a middleman entity between all parties involved in the shipping process, such as shippers, carriers, and consignees. The broker facilitates communication to ensure a streamlined shipment process.

Read on to learn about the most common types of freight contracts, including Bill of Lading, freight derivative contracts, and more.

Types of Freight Contracts: Exploring the Varieties

Below are common types of freight contracts.

Bill of Lading (BOL)

A Bill of Lading (BOL) is a legally-binding document your carrier provides to you, and it mainly functions as a type of receipt. This document protects both you and your carrier by establishing the details of the shipment and confirming it occurred as stipulated. 

A BOL can serve as a way to determine if theft occurred as well since the goods listed on it get confirmed by a receiving party. If anything is wrong or missing, the receiving party can flag the error and refer to the BOL for confirmation of what should have been delivered. 

The BOL must accompany the transported goods and be signed by an authorized individual. It should prove a few things:

• You and your carrier have a “contract of carriage” — a term meaning your negotiated contract of the transportation of your goods, including all stipulations such as volume of shipment, type, destination, etc.
• The carrier’s guarantee that your goods are on the vessel in a condition that abides by your contract.
• The title of goods that the carrier will provide to the party receiving your shipment.

Different types of BOLs serve different purposes:

• A negotiable BOL can be transferred to a third party, so any receiver in possession of the negotiable bill may receive the shipment.
• A non-negotiable BOL requires that the transfer of goods to only one, specified receiver. This type of document is also referred to as a straight BOL.
• An inland BOL is used for shipments over land.
• An ocean BOL is used for shipments over international waters.
• A through BOL allows for the transport of goods through both domestic and international borders.

If your BOL is delivered “clean” that means the carrier has confirmed everything has been shipped according to your contract and arrived in the stipulated condition. If you receive a “claused” BOL, the goods arrived in a defective state.

Charter Party Agreements

A charter party agreement is defined by Thomson Reuters as “a contract for the hire or lease of a vessel (such as a ship or aircraft) made between the vessel owner and a charterer.” The vessel owner manages the navigation and operation of the boat or ship, and the charterer is the entity that engages the ship to transport its cargo. 

The charter party agreement is essential for defining negotiated freight rates, destination ports, type of cargo, time period of shipment, and whether it’s a one-way or round-trip transport job. The shipping industry relies on charter party agreements for any logistics work involving a party leveraging a water-transport vessel for the movement of goods.

There are several types of charter party agreements:

• Voyage charters are used for one-way journeys between designated ports with specific cargo and rates.
• Time charters specify the amount of time for which the charterer rents the vessel and stipulates round-trip or one-way voyages. The Encyclopedia Britannica cites that the rate of hire in time charters is “expressed in terms of so much per ton deadweight per month.”4
• Bareboat charters are also time-based, but the charterer gains access to the vessel without crew, insurance, or any other support from the vessel owner.
• Lump-sum charters are contracts where the vessel’s owner ships a specified quantity of cargo from port to port for a predetermined sum.

Freight Derivative Contracts

Freight derivatives are financial values that hinge on future freight rate levels, and they are applied to trading markets and contracts that shipping entities might sign to hedge their bets against future market volatility.

For example, a vessel owner may sign a type of freight derivative contract known as a Future Freight Agreement (FFA) that locks in a freight rate for a particular cargo shipment in the future because that vessel owner is concerned the freight rate will plummet. The owner wants to ensure they will be paid a certain rate for shipping regardless of what the market does and how it might affect freight rates. 

The advantage of an FFA in this instance is that the owner will not suffer decreased rates in the future for that particular cargo. The disadvantage is that, if the rates become favorable, the owner will have missed out on capitalizing on those rates because they are locked into the FFA.

FFAs are just one type of contract under the freight derivative umbrella. Others include swap futures, container freight swap agreements, and exchange-traded futures — a trading concept where a trader might buy or sell a futures contract in order to hedge their bets against the market volatility of that particular asset. In shipping, the asset is usually a specific shipping route or index.

Freight derivative contracts are important for stabilizing the shipping industry in the context of global economic fluctuations, market uncertainty, and disruptive factors like pandemics and supply chain disasters. Exchange-traded contracts, for instance, standardize freight agreement terms — enabling parties to partake in them without fear of rate fluctuation. Freight derivative contracts can encourage market participation where parties like cargo owners and vessel owners might otherwise freeze their engagement if they sense pending unfavorable market volatility.

Service Level Agreements (SLAs)

SLAs are applied across dozens of industries to measure performance and ensure that service providers adhere to protocols and requirements. In logistics, an SLA is essential for defining the timeframe in which a carrier will deliver goods, the standards for handling packages, and how shippers will be compensated should any of these terms be violated. 

For example, an SLA might stipulate that the business shipping the goods receives compensation for every hour of delivery delay — or, at the very least, compensation for damaged goods. Carriers often seek to cut a competitive edge with more stringent SLAs, committing themselves legally to faster delivery times and high standards of package handling.

An SLA may include specifications for:

• Pickup timeframes, dictating when the carrier will obtain the goods from the shipper
• Delivery day timeframes, noting skipped days for holidays and other exclusions like weekends 
• Cut-off times which stipulate the hour and minute after which the delivery is considered late
• Conditions in which packages and goods must be delivered
• Any other performance criteria such as frequency of communication
• Penalty clauses for violating any of the terms in the SLA

Choosing the Right Freight Contract

Here are the key factors to take into consideration when selecting a freight contract for your business:

• Shipping requirements: What is your cargo volume and target destination? Answering this question will narrow down your freight contract choice to start as it will indicate you’ll need a carrier that can deliver your specific amount over either land, air, or sea.
• Potential obstacles: It’s important to consider any recent disruptions in the shipping landscape, such as canal blockages or global strife in certain areas affecting trade. Planning around these disruptions will inform your choice of freight contract.
• Competitive offerings: Aside from rates, it’s smart to look at what certain carriers are capable of and what they might offer in their contracts. Does a carrier ensure delivery within a timeframe as part of their SLA? Do they apply fuel surcharges? Looking at the fine print is key to controlling costs.
• Compliance with trade laws: It’s vital to choose a contract that complies with trade laws and regulations — especially if you are shipping internationally. Establish a contract that abides by the International Maritime Organization (IMO) standards for global shipping and/or any of the regional bodies’ rules, including the European Maritime Safety Agency (EMSA), the Federal Maritime Commission (FMC) for the United States, or the Maritime Safety Administration of the People’s Republic of China (CMSA).

When negotiating or renewing freight contracts, it’s best to do so at an off-peak time of year for the cargo shipping industry. In slower seasons, you are more likely to obtain favorable rates.

It can feel daunting to try to ensure you’re choosing the right freight contract for your business, especially with how complex these contracts can get. Software solutions like Lojistic can help with optimizing your freight contracts so you get the best shipping rates. Lojistic offers discounts across the freight marketplace as well as shipping reporting and analytics.

Mastering Freight Contracts for Business Success

A well-chosen freight contract can have a direct impact on your bottom line as a shipper. From ensuring your goods arrive on time and intact to protecting you from market volatility, freight contracts can contribute to your business’s scalability and competitive edge. 

If all the moving parts of freight contracts feel overwhelming, choosing a software solution like Lojistic can drastically simplify and streamline your shipping needs. Lojistic helps you compare costs for parcel shipping, negotiate freight contracts in your favor, uncover invoice errors, and much more. Get a demo of our solution today.

References:

1. Negotiable Bill of Lading. Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/commercial-lending/negotiable-bill-of-lading/
2. Bill of Lading: Meaning, Types, Example, and Purpose. Investopedia. https://www.investopedia.com/terms/b/billoflading.asp#toc-types-of-bills-of-lading 
3. Charterparty agreement. Practical Law. Accessed April 18, 2024. https://uk.practicallaw.thomsonreuters.com/w-011-1311?transitionType=Default&contextData=(sc.Default)&firstPage=true 
4. ‌Charter party | contract. Encyclopedia Britannica. https://www.britannica.com/topic/charter-party 
5. ‌Short Guide on Freight Derivatives | Overview & How it Works. upstox.com. Published September 21, 2023. Accessed April 18, 2024. https://upstox.com/learning-center/futures-and-options/a-short-guide-on-freight-derivatives/ 
6. ‌The Basics of Trading Futures Contracts. Schwab Brokerage. https://www.schwab.com/learn/story/basics-trading-futures-contracts

Author

Rich Harkey

Rich Harkey

Senior Strategy Manager

Rich Harkey is a results-driven professional with extensive experience in the logistics and supply chain industry.

As the Senior Strategy Manager at Lojistic, Rich leverages over three decades of expertise to help businesses improve their shipping strategies and reduce costs. With a deep understanding of the requirements of shippers and the operational intricacies of carriers, he excels in everything from optimizing business rules and managing carrier invoices to negotiating carrier contracts.

Rich's comprehensive knowledge of the logistics industry, combined with his strategic insights and passion for data analysis, has enabled thousands of companies to gain visibility into their shipping expenses, driving impactful results.