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How to reduce risks when signing an equipment purchase contract?
As a rule, the procedure of signing an equipment purchase contract takes a long time and is accompanied by inevitable pressure on the part of creditors, shareholders, members of the Board of Directors who are interested in having a project started as quickly as possible. Pressure is also exerted by perspective contractors who vividly describe the "bankruptcy-fraught expenses" they have already incurred to work out proposals for you, and who demand that the contract should be signed within the shortest time possible (or else they are going to quit and start working on another one). All these often compel a director to take hasty decisions and make mistakes.
However one should keep in mind that a company will usually receive the equipment, after having already paid its full price except the value of installation, start-up and adjustment and personnel training, the amount of which is insignificant in comparison with that already received by the contractor. In other words, by this time you will already be very much dependent on the contractor; your losses, especially if you have used loans to purchase the equipment, will grow as quickly as a snowball with every hour this expensive equipment is idle. For you to be able to feel safe in this situation it may be better to take time and spend another week on working with the contract until it is acceptable before it is signed.
We will take and study a most complicated case, i.e. when such a purchase contract involves import of the equipment which is a technological complex (for instance, a process line) for the manufacture of some product(s).
Let's consider the most costly mistakes managers have made in such circumstances.
Should one trust a partner?
Absolutely! But trust has nothing to do with the manager's duties and responsibilities. Let's assume that you have a very reliable contractor who enjoys a well-reputed name on the market; you have already completed successful projects with him and therefore you trust him full well. But even the most reliable companies are sometimes subject to failure. This is exactly what a manager has to keep in mind when he intends to enter into a contract. Besides, it would probably be very difficult for you to explain to creditors, shareholders, etc. that you have built your trust only on the partner's well-reputed name but have not taken all measures needed to stay safe, wouldn't it?
What should one do at the very start?
When you start serious negotiations it is necessary to get information about the potential recipient of your money: a simple request will provide you with information on how many companies with a similar name are registered in your city (country), who their founders, directors, managers are, whether the companies have immovable property, how many bank accounts they have and in what banks they keep them, as well as their balance sheet data for the last several years. Such a request will cost you about , and you get this information within 2 to 5 days depending on the country in question.
It happens that three or four more companies with almost similar names (one or two letters in the name are different) are registered at the address specified by your partner, and the contract entered into is in the name of the company which has no assets at all. It is a shame when the director becomes aware of it at the time when he is prepared to sue the party in default, i.e. the contractor, for several million dollar damages.
Therefore most thorough attention should be given to checking out the validity of your partner's name, address and bank accounts and further verification against the data you have received.
Supposing you are now convinced that your partner under the contract to be concluded makes no attempts to play such tricks on you and you start negotiating the contract.
How much can the incorrect language of the contract subject matter cost?
Probably the most common mistake found in contracts is vague, ambiguous or insufficiently clear or precise contract language which may result in considerable losses for the company that has purchased the equipment and which allows a dishonest partner to elude liability for damages.
When the equipment which is a technological (process) line is to be delivered under a purchase contract, it is important to make sure that the contract should contain a clear-cut statement that all accompanying documents including the certificate of quality conformance, the certificate of product manufacturer, cargo shipping documents, the bill of lading, etc. should specifically refer to the fact that the cargo is not just equipment, but a technological (process) line, otherwise it will go through the customs clearance not at the preferential 5% rate, but at higher rates provided for different types of equipment.
Equipment is almost never delivered complete in one shipment, in most cases delivery is carried out by several shipments, or lots on trucks, railroad cars, ships, etc.; most often such split deliveries are spread over a period of time. And in this case the customs authorities often try to clear the cargo as separate types or pieces of equipment, for instance, freezers under a freezer purchase contract, panels for compressors under a panel purchase contract, which is extremely costly and unacceptable for the importing party since he has all legal grounds to have his equipment customs cleared at the preferential 5% rate which may be forfeited due to the improper language and processing of documents under the contract.
Sometimes companies in an attempt to reduce their costs of long equipment storage in customs warehouses agree to the terms and conditions of customs clearance set forth by the customs authorities. In this case one should keep in mind that the company's losses incurred due to the wrongful requirements of the customs authorities may be recovered from the latter. Therefore the contract should have a clear-cut unambiguous reference to the fact that the subject matter of the contract is the purchase of a technological (process) line as a whole complex designed to manufacture or produce a certain type of product(s), but not purchase and delivery of "an equipment lot which conforms to the appropriate certificate". Wrong or inaccurate language may cost the company thousands if not hundreds of thousands of dollars, and in that case your lawyers may be powerless to do anything.
However it is necessary to make sure that you get an appropriate proof in writing that the customs authorities required that you should pay unduly high amounts and that you get a lawyer's statement in writing that the proof will be valid and acceptable in a court of law.
Sometimes a company thinks it more expedient to customs clear their cargo at a higher rate, and then to sue in arbitration court for recovery of the amount of the customs duties paid in excess of what was due. Though this is a longer and costlier way.
Do you agree that part of equipment will be manufactured or designed by other companies chosen at the contractor's discretion?
If not, you must have an appropriate provision for that in the contract. Practical experience shows that there are cases when all main components and units of the process line were manufactured in different countries, and the contractor failed to put them into operation and make them work together after assembly and installation. If yes, then discuss it with your partner and specify all the subcontractors involved in the contract: all of them are recipients of your money. By the way, it may happen that after this discussion you will no longer want to continue dealing with this contractor because he might prove to be an inadequately knoWGedgeable intermediary.
A simple contract reference to the fact that the equipment should be brand new and specifically manufactured to meet the requirements of your contract will help you prevent the practices widely spread even among reputable contractors when they partly take used equipment and rebuild it in a pre-sale preparation to increase their profits. In this case, especially after the equipment has been tested it becomes almost impossible to prove that the contractor is guilty of acting in bad faith.
How to reduce the risk of purchasing defective equipment?
When specifying the procedure of payment for the product under the contract it is necessary to keep in mind that as a rule at the time of shipment you will not be able to make sure that the quality of the equipment to be delivered is just right. What can become the quality guarantee? Insist on having the certificate of quality conformance for the process line, but not for the separate individual components and units of the line. The point is that in order to obtain such a certificate the exporting party will have to assemble and start up the line before shipment, then summon a certificate commission from the local SGS office and test the process line in the presence of that commission.
Also remember to specify this document in the list of documents against which payment is made for the batch of equipment to be shipped.
It is insufficient to have in the contract a provision like this: "the equipment shall be tested, marked and packed...". In this case, the contractor may as of right take advantage of your inaccurate statement and test only separate parts and units of the process line. The test procedure and schedule, if you think it fit to specify them, should be described in detail in the contract. It is also necessary to specify and describe the documents which contain the test results and reports as well as transfer of these documents to you. You can also include these documents in the list of documents against which payment is effected.
What do you have to know about payment by a L/C?
If the terms and conditions of payment is an L/C, then the documents will be presented by the exporting party at his bank in the place of its location. Here it is extremely important to keep in mind that any bank's responsibility to check and verify these documents irrespective of your agreement with the contractor or the bank is regulated and limited by the Uniform Rules and MTP practices for documentary L/C's (UPO 500, 1993) and consists only in checking for compliance with the terms and conditions of the L/C based on external attributes. In accordance with Clause 15 of the URP a bank shall not be held responsible either for the form, or completeness, or accuracy, or validity, or falsification, or judicial substance of the documents, nor shall it be held responsible in any other cases of non-conformity of the documents to your requirements.
Practical experience shows that there are cases when the exporting party presents to the bank several certificates for separate units and components of the technological line instead of the certificate of quality conformance for the complete technological line, and the foreign bank notifies the Russian bank which issued the L/C that the documents have been received and verified; the importing party in its turn receives the appropriate notification and issues instructions to effect payment. In this case, we have direct evidence of negligence on the part of the foreign bank which misinformed the Russian bank which provides services to the importing party, and the latter misinformed its customer.
Therefore in the occurrence of consequences unfavourable for the importing company, i.e. the defective equipment delivery, the equipment non-conformance to the contract, etc. you have the right to lay claim for recovery of the paid amount not only against the dishonest contractor but also against the bank which processed the L/C, and the latter has the right of recourse to lay claim against the bank that is guilty of negligence.
How to design technical documentation?
Often the contract itself does not contain any specific reference to the technological line performance; the performance data specified in technical documentation is imprecise and the technical documentation itself is not made in the form of an appendix to the contract and is not signed by the parties under the contract. It is not surprising that the contractor is all too willing to use this mistake to his own advantage, thinking it unnecessary to adjust and bring the line up to the required performance.
The technical documentation describing the equipment and precise parameters of all types of the final product (including drawings, sketches, all kinds of quality characteristics) should be specified in the text of the contract as an appendix to it which is an integral part of the contract, and each page of the documentation, drawings, sketches, technical characteristics should be signed by the parties in the same order as in the contract.
What needs to be specified in the contract in the software description?
It is necessary to describe in detail who the software designer is, what the software functions are, how it will be maintained, supported and serviced and whether it is subject to be transferred to the importing party. In practice there were cases when the contract did not contain any clear description of the software and procedures for software transfer which resulted in great complications for the plant that received the equipment: the contractor, an engineering company, ordered design and development of the software to a third party, as a result the equipment could not be put in operation for a very long time, the software company responded to all claims made by the plant by saying that it would delete all the software and quit because the contract did not contain any provision for the software transfer.
It is certainly not difficult from a legal point of view to prove in court that the software is part and parcel of the equipment and is subject to transfer to the plant, however, as a result of this mistake the operating plant suffered great damages due to the downtime of the equipment.
How to use the "Penalties" section?
Your contract may be used as an effective instrument to regulate your relationships with the partner, if you are wise enough to make good use of this contract section. Penalties should be provided for non-fulfilment or delay in the execution of each step under the contract as well for some non-compliance of the equipment to the contract requirements. Whether this section is accepted by the partner depends on the strategy you employ in your negotiations. To begin with, ask your partner to let you know his version of the contract performance schedule and then add several days but not more that a week to each schedule time frame and only after that set strict penalties for non-fulfilment of this schedule. Since in real life circumstances the schedule time frames are seldom observed, it may happen that the amounts payable to the contractor for installation and start-up jobs will considerably decrease.
How to come to agreement with the partner on arbitration, applicable law and legal proceedings language?
Of course, the best option for a Russian customer is to specify in the contract the jurisdiction in accordance with applicable laws, the laws of the Russian Federation and the Russian language for legal proceedings. With jurisdiction in accordance with applicable laws you will have the right to select: either to sue in the country of the defendant or in the country where the contract is executed and where the disputed property is located, i.e. in the arbitration court of your country. The advantages are obvious: the proceedings in the court closest to your location, a chance have state duties payment postponed until the court judgement is issued with a further transfer of this payment against the losing party, well-defined court procedures, availability of appeal, cassation, supervision and prosecution authorities for lodging appeals in case you disagree with the court judgement.
When a dispute is referred to the International Commercial Arbitration Court (ICAC) at CTC in Moscow, you will have to pay a fee. The amount of the fee may be reduced, if the arbitration stipulation contained in the contract specifies that the dispute shall be referred for a decision to one arbitrator. If the contract does not contain such a provision, then after the dispute arises the parties usually fail to agree on referring the case for the sole decision of one arbitrator and the plaintiff has to pay the collegial procedure fee. The ICAC is a tribunal arbitration court, its decision may be subject to appeal only on restricted procedural grounds, but such appeals are practically not filed.
However, even when a dispute is referred to arbitration courts in Paris, Stockholm, etc. the opportunity to have arbitration proceedings conducted in the Russian language with application of the laws of the Russian Federation still remains valid - these courts have Russian arbitrators - if this is specified in the contract arbitration stipulation or is later duly agreed on by the other party involved in the case. You can find a sample text of the arbitration stipulation in 16 languages on this site.
And, of course, when you attempt to enter into an international contract it is best if you do not disregard this general recommendation: make sure that you hire several, not in any way connected with each other lawyers specialising in international law to make independent conclusions on your version of the contract or the version proposed by your partner. This will allow you to save a lot of time and money, and if the equipment value is substantial with respect to the company's assets, then it will help you to avoid bankruptcy.
Aida Roushmanova,
Director General, 'Whales Legal' Law Firm.
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