Hell or high water clause

A hell or high water clause is a clause in a contract, usually a lease, which provides that the payments must continue irrespective of any difficulties which the paying party may encounter (usually in relation to the operation of the leased asset). The clause usually forms part of a parent company guarantee. It is intended to limit the applicability of the doctrines of impossibility or frustration of purpose. The term for the clause comes from a colloquial expression that a task must be accomplished "come hell or high water" that is, regardless of any difficulty.

History

Linguistic historian, Robert Hendrickson, claims in his book “Encyclopedia of Word and Phrase Origins” that the saying derives from a phrase used by sailors in the 1600’s “between the devil and the deep blue sea”.[1] The exact roots of the phrase vary significantly among unreliable online sources; some claim that the phrase finds its roots in the 19th century US Midwest, but others claim that it is much older, possibly tracing back to biblical times.

The first appearance of the Hell or High Water clause in United States law was in the February 2nd, 1960 case of Matits vs. Nationwide Mutual Insurance Co. In this case, Nationwide was attempting to deny insurance coverage to a woman that loaned her car to a friend who got into a collision. Due to the particular wording of the omnibus clause within the insurance policy, which in itself contains the Hell or High Water clause, the court ruled that Nationwide must provide coverage for the collision.[2]

Applicable Transactions

Equipment Leases

One of the most common uses for a Hell or High Water (HOHW) clause is the writing of equipment leases. Whether or not the phrase HOHW is explicitly written, the general meaning of it has been included in a majority of equipment leasing contracts over the past few decades.[3] The clause requires that the lessee assumes virtually the entirety of the risk associated with the rented equipment, even in extreme cases. This includes but is not limited to cases where the equipment is destroyed, lost in some way, deemed inoperable, neglected repairs, deemed unfit for use, or even when the purchaser dies. When both parties agree to a contract containing this clause, the only risk that the lessor assumes is the reliability of the lessee’s credit.[4] If the lessee defaults or their credit fails otherwise, the lessor is not legally able to require payment, but the lessor is entitled to compensation from liquidation during bankruptcy proceedings.[5]

Project Finance Transactions

Another key aspect of the protections provided by the HOHW clause is that it applies to the lessor’s funding sources.[3] In the industry of equipment leasing, lessees have two broad options: lease equipment from a company that owns the equipment or sign a contract with an equipment finance company which will pay for the equipment. Even if the person or organization that funds the transaction did not sign the contract between the lessor and lessee, they are still shielded by the clause and can rest assured that nearly all the risk is attributed to the lessee, except in the case of credit failure.[6] In cases where the lessor is viewed solely as a source for money, the lessor is provided special protections by Article 2A of the Uniform Commercial Code discussed in the “Enforceability” section of this article.

Real Estate Leases

The concept of HOHW exists in the real estate market, but only in commercial real estate. It is not very widely used in real estate, and is generally only used in bond leases, which are also referred to as “absolute triple net leases”, “true triple net leases” and the aptly named “Hell or High Water leases”.[7] Typical triple net leases require tenants to be responsible for paying rent, utilities, maintenance, HVAC expenses, roofing repairs, and even property taxes. HOHW leases take the typical triple net lease a couple steps further by making the tenant to be responsible for every fathomable expense related to the property, which in effect makes the HOHW lease the most extreme form of triple net leases. As with some other applicable transactions of HOHW, this type of lease makes the tenant responsible for payments associated with unexpected events which some refer to as acts of god. At no point is the tenant allowed to terminate the lease or receive rent abatements. If a property is condemned for whatever reason, the tenant must continue to pay rent despite not being able to inhabit the property. If the property is destroyed or damaged, not only does the tenant still need to pay the agreed upon rent, but the tenant must pay to either replace or repair the building regardless if the insurance claim covers the cost.[8]

Mergers and Acquisitions

When attempting to merge two businesses or acquire another, one big roadblock that companies typically come across is antitrust law, especially when the two companies are industry leaders. Companies must negotiate with each other regarding how to split the costs of potential litigation, fines, divestitures, and expensive antitrust investigations.[9] When the leverage of a company significantly outweighs that of the other party, they may consider utilizing a HOHW clause. This allows one party to assign all the financial risks associated with antitrust approval to the other party. From an outsider’s perspective, it may seem surprising that a company bearing all the risk would ever agree to a merger with a HOHW clause, but sometimes agreeing to the clause is the only way the party with less leverage can secure the deal due to other competitive players looking to merge with the stronger company. Additionally, companies may agree to a HOHW clause because they assess that the risk of antitrust complications is much lower than the other company believes, or even because they are being offered such a good deal that the extra risk is worth it in their eyes. It is very important to note that if a company agrees to take responsibility for all the risk by signing a HOHW clause they are required to take all actions possible in order to get antitrust approval from the FCC, otherwise the risk-bearing company can be sued by the other company for breaching the clause.[9]

High-Yield Bonds (Junk Bonds)

When a company’s credit rating falls to a certain level, it presents a problem for raising money via debt financing. Since it is riskier for a person to buy a bond from a company with bad credit, their bonds are rated below invest-grade and referred to as junk bonds, which yield a higher return since they incur a higher risk. To mitigate risk for noteholders, companies with low credit ratings that issue bonds must operate within a set of covenants that restrict the company from making needlessly risky decisions. Many of the covenants relate to the company incurring additional debt, but some covenants address changing ownership structure, paying dividends, or selling off assets.[10]

Despite all the restrictions of the covenants, companies are allowed some freedom through an idea called “baskets”, where the company is allowed to bypass a certain covenant, usually by incurring a limited amount of debt in specific, agreed upon situations. The concept of Hell or High Water comes into play with a special basket that is named either the Hell or High Water basket or the general basket. This basket allows the company to incur a limited amount of debt for any reason, especially come hell or high water.[10] It is very advantageous for a company to include this general basket in its bond agreements because hell or high water events are almost always unexpected, and sometimes companies will experience more of these events than they ever anticipate.

Enforceability

In both United States law and U.K. law, the HOHW clause has historically been upheld in numerous cases. In the United States, this clause is given special protection under Article 2A of the Uniform Commercial Code when the agreement is classified as a finance lease. The article states that this special protection applies to a lease that “consists of an overall three-party transaction in which: (1) the lessor does not select, manufacture or supply the goods, (2) the lessor did not own the goods before the lease was arranged and (3) the lessee either approves the purchase contract or receives specified warranty and supplier information before signing the lease agreement”.[11]

Exceptions

There are however, some exceptions to the enforceability of the HOHW clause:[4]

• Fraud- The HOHW clause is not enforceable when fraud is present at any point in the relationship. If the lessor allegedly lures a lessee into a dubious arrangement the agreement may be determined to be null and void.[12] Another example of this is when the employees of an equipment vendor fraudulently represent themselves as agents of a finance lessor.[13] See McNatt vs Colonial Pacific case.
• Purchaser refuses to accept goods- Unless it is explicitly specified otherwise in the contract, lessees can generally break an equipment leasing contract if they refuse to accept the goods, especially if the equipment or goods are faulty upon arrival.[4]
• Intentional or Willful Acts of Lessor Violating Public Policy
• Intentional or Willful Acts of Lessor to Prevent Lessee from Fulfilling Contract

Effects of COVID-19

Due to the lengthy process of litigation, the final effects of the COVID-19 pandemic on the enforceability of HOHW clauses are yet to be seen. Court decisions involving HOHW clauses have been upheld in 2020, but the disputes addressed in those cases predate the pandemic and therefore they are not an accurate representation of the pandemic’s effect. Many lawyers believe that HOHW clauses will still be upheld given that pandemics are seen as an act of god, and because in the past acts of god such as Hurricane Sandy have not exempted lessees from their obligations under a HOHW clause.[14] The difference with COVID-19 though, is that the government forced many businesses to shut down; some lawyers think that courts would be hard pressed to rule in favor of the lessor in this situation, but their beliefs must be taken with a grain of salt as they are just speculation.[15]

Notable Cases

General Electric Capital Corp. v. FPL Services Corp., 986 F. Supp. 2d 1029 (N.D. Iowa 2013)

Hitachi Data Sys. Credit Corp. v. Precision Discovery, Inc., 17-Cv-6851 (SHS), (S.D.N.Y. Sep. 24, 2020)

McNatt v. Colonial Pacific Leasing Corp., 221 Ga. App. 768 (472 S.E.2d 435) (1996)

Equitex, Inc. v. Ungar, 60 P.3d 746, 750 (Colo. App. 2002)

Matits vs Nationwide Mutual Insurance Co. 59 N.J. Super. 373 (1960) (described in “History” section)

References

1. Hendrickson, Robert (1997). The Encyclopedia of Word and Phrase Origins. New York: Facts on File.
2. Matits vs Nationwide Mutual Insurance Co. 59 N.J. Super. 373 (1960)
3. January 2018, Paul Bent. "'Trial of the Century' Takes on Hell or High Water". LawJournalNewsletters.com. Retrieved 2020-12-18.
4. "Hell or High Water Clause | UpCounsel 2020". UpCounsel. Retrieved 2020-12-18.
5. "§ 2A-504. LIQUIDATION OF DAMAGES". LII / Legal Information Institute. Retrieved 2020-12-18.
6. "Structured Finance and Revenue Streams: Not Absolute and Unconditional". Monitordaily. Retrieved 2020-12-18.
7. Sandra Patterson says (2018-04-10). "Triple Net VS Absolute Net Lease". Corporate Realty Advisors. Retrieved 2020-12-18.
8. "Absolute Net Lease Properties Offer Low-Risk, High-Yield Investment Opportunities; Colliers International Presents $216.4M Industrial Portfolio with Significant Scale and Mass". PR Newswire, April 5, 2011 Tuesday. advance-lexis-com.proxyiub.uits.iu.edu/api/document?collection=news&id=urn:contentItem:52JJ-SX71-F18Y-Y02C-00000-00&context=1516831. Accessed December 17, 2020.
9. "When Mergers Go Bad: How Merger Agreements Deal with Antitrust Risk in Today's Market". JD Supra. Retrieved 2020-12-18.
10. “High Yield Bonds - An Issuer's Guide (US Edition).” Perspectives & Events, Mayer Brown, www.mayerbrown.com/en/perspectives-events/publications/2016/12/high-yield-bonds--an-issuers-guide-us-edition.
11. "U.C.C. - ARTICLE 2A - LEASES (2002)". LII / Legal Information Institute. Retrieved 2020-12-18.
12. "Hell or High Water Contract Explained". The Business Professor. Retrieved 2020-12-18.
13. "Attempting to avoid the Hell or High Water Clause by alleging Fraudulent Inducement". www.bakerdonelson.com. Retrieved 2020-12-18.
14. "Enforceability of 'Hell or High Water' Clauses in the COVID-19 Business Environment". JD Supra. Retrieved 2020-12-18.
15. Blundell, Steph (2020-04-30). "Come hell or high water, or Covid-19: Managing contractual risks". Planning, BIM & Construction Today. Retrieved 2020-12-18.

See also

• Hardship clause
• Force majeure

External links

• Article: "Are Hell or High Water Clauses and Waiver of Defence Clauses Enforceable?"
• Article: "Hell or high water clauses: Make them work for you
• Article: Mergers and Acquisitions
• High Yield Indentures (Junk Bonds) Guide
• Uniform Commercial Code