1) I added more weapons, rusty are the basic ones. Maybe will change the term, but in practice the basic sword is that one, with slightly reduced damage vs previous version.
2) ah that's a bug since the PC should be able to equip ANY weapon in the game (except Mage stuff)
About the difficulty, what Korval said. You should NOT play the game at Hard, and quit because is too hard!! The level you should be play is Normal. Quitting a game because you can't win at Hard level, when you can easily switch to Normal or even Easy before every battle, makes no sense (if you couldn't change the level anymore once you start, ok that would be different).
I tried that battle, it's indeed difficult, however I managed to win by simply not rushing in the battle (As you should do at Hard level, was made for EXPERT roleplayers who like grinding!).
1) do several tasks in grandtree. Even if you lose them, you don't lose the game, so you can try as much as you want. Each fight, you gain XP, new items, gold, and fame so you can buy items in grandtree cheaper
2) repeat 1, until you can afford to buy a good amount of healing and restoration potions (that resurrect your members). Or/and better equipment, armors are very useful. In my case though I just did 3 battles and was ready to go.
3) now you're ready to go kick dark elves asses
I tried the battle and with the new stuff it was just fine (not even too hard).
So if you just want to go on with the story, play at Normal level, not Hard! When you choose it the game warns you that it's for experienced roleplayers only. I never play any game I buy at hard level mysefl