In most equipment supply contracts, both parties have a lot on the line. The buyer is making a substantial expenditure on equipment it plans to own and operate for many years--an estimated useful life of twenty-five years is not uncommon--and that it anticipates will increase its production and profitability. The seller is devoting substantial resources to the project, typically reserving space in its workshops and production facilities and potentially passing on other projects. Financially, one bad project for a seller can make a bad year. Further, because most sellers sell production equipment to a limited number of buyers, the seller's reputation is on the line even more so than in other transactions.
For these reasons, making sure the sales contract is both clear and fair to both parties is especially important. Although some inexperienced purchasing departments want to try to put all risks and responsibilities on the seller, that can be short-sighted. First, most supply contracts involve a team effort between the buyer and seller. For example, the buyer will typically be responsible for preparing the site, the foundations, the factory building, and will often be responsible--either directly or through a contractor--for supplying the labor for installation of the equipment. Second, because of the long expected life of production equipment, the buyer will in all probability need the seller's expertise on many occasions for repair, maintenance, and upgrade of the equipment. Simply stated, a mutually beneficial approach is almost always best.
With that background, and although equipment supply contracts often go on for many pages, the big issues in contracts always seem to boil down to the following, which I loosely refer to as the "Big Five." Although other issues will probably arise, the "Big Five" will for sure.
1. The Sales Price and Payment Security. These issues are largely business issues. International companies need to understand, however, that typical practices in Europe, for example, may not apply here. U.S. customers may resist providing a letter of credit or other payment security. There are other options for payment security, but they need to be thought through and understood before signing the contract.
2. Warranty Obligations and Remedies. Warranty obligations should be clearly stated, as should the remedies for warranty claims. From the seller's perspective, it is important to disclaim implied warranties. Failing to do so can result in unintended warranty obligations over a longer period of time than anticipated. Disclaimers should always be drafted by counsel. Remedies should also be clearly stated. If the intended remedy is for the seller to repair or replace defective components at its expense during the warranty period--typically a reasonable alternative--it should be specified.
Performance warranties--sometimes referred to as performance guarantees--require special attention. The warranted production criteria should be carefully specified, along with defined performance testing procedures. Remedies for the performance warranty should be carefully considered and negotiated.
3. Indemnity Obligations. Indemnity obligations are always demanded by buyers, but are seldom fully understood. Essentially, a party providing an indemnity is agreeing to "hold harmless" the other party from claims and demands. Certain indemnity provisions are reasonable, but many are not. Many corporate buyers seek what I refer to as "anything bad" indemnities. Such provisions seek to require the seller to indemnify the buyer if anything bad happens even if the seller is completely without fault. Indemnity obligations should be reasonable and should reflect the responsibilities assumed by the parties. As noted above, most equipment installations involve a mutual effort, so mutual responsibilities should normally apply. Ideally, indemnity obligations should be backed by insurance, which is to the benefit of both the buyer and seller. In most instances, it is possible negotiate a reasonable indemnity provision, but this should be left to experienced counsel.
4. Limitations of Liability. Limitations of liability come in a number of forms. In equipment sales, it is customary to exclude liability for incidental and consequential damages, including the buyer's lost profits. Liability caps are also common. These provisions are necessary for a simple reason: Machinery suppliers will not be able to stay in business for very long if they are potentially liable for underwriting their customers' profits.
5. Dispute Resolution. Many parties do not consider dispute resolution until the last minute, and dispute resolution provisions are thus often not carefully considered or negotiated. These provisions can be especially important for international companies. A international supplier will be understandably wary of the U.S. civil litigation system and may insist that all disputes be resolved by international arbitration under well-established rules (e.g., ICC, ICDR, AAA, JAMS or others). Domestic suppliers also need to pay attention to dispute resolution, and beware of provisions that, for example, require all disputes to be resolved in the customer's home court system.
Of course, many other issues may come into play in a complex equipment sale. However, the "Big Five" surely will. Sellers should carefully evaluate the Big Five and develop a risk profile that sets forth risks they are willing to assume, and, equally importantly, risks they are not willing to assume. Experienced counsel can assist in developing a risk profile. Once the risk profile is developed, sellers and their counsel need to stick to it during negotiations.
Written byJohn Watkins