All agreements should be in writing to provide security for the parties and to serve as evidence of their intentions at the time the deal was closed. However, every agreement is unique. Buying materials and equipment is not the same as buying a house, a business, or a car. Let’s review some of the most important provisions you want to include to have an agreement that works for you.
The applicable laws
Materials and equipment are considered goods. Accordingly, the applicable law, in this case, is the Uniform Commercial Code or UCC, Article 2, which regulates the sale of goods. Now, UCC Article 2 does not cover those aspects of a deal that involve services, specifically services performed together with the sale of materials or equipment. This means, that the obligations directly related to the sale/purchase of materials and equipment are governed by the UCC Article 2, and the obligation of the seller related, for instance, to training (to learn how to use the equipment) are governed by common law rules.
Leasing versus Purchasing
Before considering the most important provision of the purchase agreement it is also relevant to understand the deal. It is usual that merchants purchase or lease equipment, sometimes because of the cost and sometimes because of the particular industry. A lease is basically a rental agreement where “…the owner of the equipment allows the user to operate or otherwise make use of the equipment in exchange for periodic lease payments…”. [1] On the other hand, a purchase is a transaction where the owner of equipment transfers all proprietary interest to another in exchange for a single payment.
Some benefits of leasing equipment
1. Lower upfront costs. If your business is going through a tough situation or is only starting operations, probably, cash flow and debt are concerning issues. Accordingly, leasing equipment may be the best option. Additionally, leasing equipment will allow you to handle expenses better because it rarely requires a down payment. On the other hand, by purchasing equipment you may face higher costs and an up-front payment, usually between 20 and 15 %.
2. Easier access to updated equipment. While purchasing new equipment is important to keep a business up to date in terms of technology, equipment may become obsolete with time. Leasing may be a better choice if the business requires equipment that is constantly evolving. Depending on the characteristics of your business, some equipment may require frequent upgrading, especially to remain competitive or compliant with government regulations and industry standards. Thus, leasing may save you money by allowing you to change the leased equipment more often than it would be if you purchase it.
3. Testing before making a final choice. If you are entering into a new venture, you may be uncertain as to the type of equipment that actually fits your needs. To address this uncertainty and to avoid an undesired commitment leasing may be the best choice. If you lease the equipment you will have the opportunity to test performance and decide whether it fits your short and long-term needs.
Disadvantages of leasing
1. Overall more costs. Despite its benefits for new businesses with limited cash flow and resources, leasing is typically more costly than purchasing in the long run. The economics of the lease agreement work to make revenue for the leasor while keeping ownership of the equipment.
2. Timing may not fit the business needs. A business that engages in a long-term lease may be tied to an agreement that does not meet the business needs. Especially if the business is going through a process of developing its structure, a long-term lease agreement may be problematic. Additionally, if the business must re-negotiate or litigate the lease termination this can be problematic if the business wants to limit legal fees expenses.
3. There may be more costs. Depending on the lease a business may end up paying a monthly lease fee, maintenance, property taxes, and insurance fees.
Benefits of purchasing
1. Costs advantages. If a business can afford the up-front payment of purchasing equipment and the equipment is of the kind that has a long useful life, buying the equipment outright typically has cost advantages.
2. Alterations of the equipment. It may seem uncommon, but some businesses want to be able to make alterations to the equipment they integrate into their production process. By purchasing the equipment, a business can make alterations or dispose of equipment more easily if the needs of the business require it.
3. Technology update and recovery of costs. If a business is careful with the purchased equipment, it can sell the equipment to stay up to date in technology and to recoup some of its costs by selling it. This affords businesses the flexibility they would not have if the equipment was leased. The owner can sell at any time without restriction.
4. Full purchase price deduction. According to the Internal Revenue Code (IRC) Section 179, businesses may deduct from gross income the full purchase price of qualifying equipment purchased during the tax year, up to $1,000,000 (with a spending cap on total qualifying equipment purchases of $2,500,000 per year). Businesses are not required to spread out the deduction over the equipment’s useful life. This can be extremely advantageous for small and mid-sized businesses. For taxable years beginning after 2018, the $1,000,000 and $2,500,000 amounts will be adjusted for inflation.
Disadvantages of Buying Equipment
1. Typically higher initial up-front cost. As previously mentioned, the typical down payment for equipment is around 20%. Especially for small businesses, this cash outlay can make purchasing equipment outright prohibitive.
2. The cost to keep equipment current may be significant. Owning equipment affords businesses the freedom to make changes when necessary. However, if the equipment needs to be updated frequently, it will require potentially large outlays of cash in order to keep the equipment usable on an ongoing basis. By leasing, businesses may save the cost of constantly upgrading or updating equipment.
Key provisions of the Equipment Purchase Agreement
What are you buying?
It is very important to describe in detail the equipment. It may seem obvious. However, many businesses forget to properly define the equipment that is purchased. As a result of that, in the long run, pleading a breach of contract or a breach of warranty can be difficult.
Additionally, as we mentioned before, the UCC rules applicable to the sale of goods apply to the purchase of equipment. That means that to be conforming, the equipment must be in accordance with the obligations set forth in the parties’ agreement. NY CLS UCC § 2-106. Accordingly, the agreement must memorialize any relevant terms regarding the condition or qualities of the equipment, so that there is an objective gauge to determine whether the delivered equipment meets the terms of the parties’ agreement.
Who determines the purchase price?
As opposed to other agreements, the sale of equipment must include quantity but it may lack price. In that case, the price must be determined by the parties, a third party, or a judge. The price of the equipment should be included. If the agreement will involve multiple shipments, the seller may want to include in the agreement the right to establish and/or change the pricing terms.
Under New York law, transactions where the price will be fixed by the seller, such price must be established in good faith. In transactions where the agreement is silent as to price or the price is to be based upon some agreed-upon market or other standards to be set by a third party, the price will be a reasonable price at the time of delivery. However, it is best for both parties to agree on the price from the beginning to avoid misunderstandings.
If the parties agree that they do not intend to be bound unless the purchase price is fixed or agreed upon, and the price is not fixed, absent the price there is no contract.
Where will you receive the equipment?
It is also fundamental that the parties agree about their obligations with respect to the delivery of the equipment. That means that the agreement should be clear as to the time and location for delivery and the parties’ respective obligations regarding the costs associated with shipment.
Payment terms
Once the parties have agreed on whether the deal is for the sale or lease of equipment, it is necessary to establish the payment terms. Depending on the seller’s position regarding risk, the seller may prefer payment at the time of delivery, such as in cash or by certified funds. Usually. starting with a down payment when equipment is expensive. Payment can be made in money or something other than money. Regarding this point, the UCC provides that payment is due (unless otherwise agreed upon) at the time and place the buyer receives the equipment.
Warranties and Representations
An agreement to the sale of equipment may include express and implied warranties.
Express warranties can be created by, among other things, any affirmation of fact or promise made by the seller, any description of the equipment, or any sample or model, which becomes part of the basis of the parties’ negotiation.
With respect to warranties, the UCC provides that goods must be merchantable, unless such warranty is modified or excluded expressly. Additionally, unless otherwise expressed by the seller, it is the seller’s obligation to warrant that the equipment will be delivered free of any third party claim. However, in transactions where the equipment is produced pursuant to the buyer’s specifications, the buyer must hold the seller harmless from any third-party claim.
What about disclaimers? Under the laws applicable to consumers, and those applicable under the UCC, warranty disclaimers must be clear and conspicuous. Thus, to exclude or modify the implied warranty of merchantability, the disclaimer language must mention “merchantability.”. To exclude or modify any implied warranty of fitness for a particular purpose, the exclusion must be in writing and conspicuous (no oral disclaimers are allowed).
A seller can also disclaim all implied warranties by use of expressions such as “as is,” “with all faults” or other similar language that makes it clear to a buyer that there are no implied warranties.
Did the seller perform as expected?
Both parties expect that the agreement will be executed properly and that each party will perform under the terms of the deal. However, it is fundamental to include a liability provision. This is helpful to establish the rights of the buyer if the equipment is not as expected and for the seller to limit its responsibility.
A proper clause for the limitation of liability should provide the buyer with at least a minimum adequate remedy, especially to avoid an agreement that a judge could set part for being manifestly unfair.
Under New York law the parties can agree to substitute the remedies provided by the UCC, of course, subject to certain limitations. The parties can also agree to:
– Limit the measure of recoverable damages.
– Limited or excluded consequential damages.
– Exclude cumulative damages.
The Perfect Tender Rule
Under the UDD the sale of equipment (or goods in general) delivery by the seller must conform with the specific terms of the agreement between the parties. Thus, under the perfect tender rule, the buyer might declare the seller in breach of contract if the goods are delivered as agreed. In other words, unless otherwise agreed to by the parties, the goods and tender of delivery must be conforming, and any defect, no matter how minor, provides the buyer the right to reject the goods prior to acceptance.
Here, it is important to understand that is performance is not conforming, the parties may voluntarily and after the fact modify the agreement in case of an unexpected situation. However, if the agreement includes a provision that requires modifications in writing, an oral agreement may have no effect regarding the breach of the contract.
Where can you sue?
Being clear about the parties’ rights and obligation is as important as knowing where the parties are entitled to enforce their rights. It is common for big companies to agree to arbitration. However, for small businesses, it depends of their specific circumstances. Arbitration has many benefits like providing a shorter process to resolve controversies and allowing the parties to keep their dispute private, but arbitration can also be very expensive. Depending on their circumstances, the parties at least want to agree as to the venue where a lawsuit may be brought.
What about the attorney’s fee?
Some states provide for the recovery of legal fees in civil contractual disputes. However, in NY unless the parties agree to it, each party is responsible for its own legal fees and costs in litigation. Considering this, the parties may want to agree that the prevailing party will be responsible for the costs and the legal fees of the litigation.
To conclude…
Starting a business is costly and small businesses usually start with cash flow limitations. Considering this, it is important to understand the nuts and bolts of an agreement for the sale/purchase of equipment. Much litigation involving this type of contract can be avoided by careful drafting and an understanding of the legal issues involved in the transaction.
How can we help?
Even though spending in legal fees adds to your costs, there is nothing more costly than a badly defined agreement. At G.A.M. Law Office we understand the situations that have the power to affect businesses, our professionals can support you and handle a wide variety of business transactions. To start call (646) 397-2396 or schedule a free 15-minute consultation here!
1. https://definitions.uslegal.com/e/equipment-leasing/
