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Published on May 6, 2020 in Equipment Finance Advisor. Republished here with permisson.
The COVID-19 pandemic has resulted in dramatic shifts in the way many companies operate. A recent spate of government restrictions have closed or limited nonessential businesses, and, although they vary by state, many of these restrictions have impacted banks, finance companies and companies that lease personal property. For example, operations in companies that have been deemed “nonessential” have ground to a halt, leaving these companies cash-strapped and in the unfamiliar position of potentially defaulting on their loan and lease obligations.
While many businesses are seeking to invoke contract defenses such as force majeure, impossibility of performance, commercial impracticability and frustration of purpose to excuse performance, lenders are searching for and, where applicable, relying on hell-or-high-water provisions in response. A hell-or-high-water provision is a contractual clause that irrevocably shifts the risk of a performance-preventing event to one of the parties to a contract. Hell-or-high-water provisions are typically found in finance and lease agreements and act to irrevocably bind a party to its obligation to make payment under any and all circumstances, including if the purchased or leased equipment or product is lost or destroyed. A typical hell-or-high-water provision will describe an obligation to make payment as being “absolute and unconditional,” and it also will include a waiver of defenses, setoffs and counterclaims to an enforcement action pursued by a contract adversary. While application of the law may vary from state to state, courts have routinely found hell-or-high-water provisions to be enforceable in contracts negotiated by sophisticated commercial parties, including when a party claims impossibility of performance or frustration of purpose. The rationale for these rulings is that, through the hell-or-high-water provision, the parties specifically contracted for the assignment of all risk.
In addition, with respect to the enforceability of hell-or-high-water provisions by finance companies and lenders, the Tenth Circuit Court of Appeals has noted:
The essential practical consideration requiring liability as a matter of law in these situations is that these clauses are essential to the equipment leasing industry. To deny their effect as a matter of law would seriously chill business in this industry because it is by means of these clauses that a prospective financier-assignee of rental payments is guaranteed meaningful security for his outright loan to the lessor. Without giving full effect to such clauses, if the equipment were to malfunction, the only security for this assignee would be to repossess equipment with substantially diminished value.
Colo. Interstate Corp. v. CIT Grp./Equipment Fin., Inc., 993 F.2d 743, 748 (10th Cir. 1993) (quoting In re O.P.M. Leasing Services, Inc., 21 Bankr. 993, 1006-07 (Bankr. S.D.N.Y. 1982)).
An example of the application of a hell-or-high-water provision is found in General Electric Capital Corp. v. FPL Services Corp., 986 F. Supp. 2d 1029 (N.D. Iowa 2013). There, a lessee sought to avoid its obligations to make payment on a lease for copiers after the equipment was damaged when the lessee’s offices were flooded during Hurricane Sandy. The lease in General Electric Capital Corp. contained the following language:
“[FPL’s] payment obligations hereunder are absolute and unconditional and are not subject to cancellation, abatement, reduction, recoupment, defense or setoff for any reason whatsoever,”
“[i]f any item of Equipment is lost, stolen or damaged . . . Rental Payments will continue to accrue without abatement,” and
“[FPL is] responsible for loss and damage to the Equipment from any cause whatsoever on and after delivery thereof.”
G.E. Capital brought suit for breach of the lease. In response, FPL claimed its obligations were excused under the doctrines of impossibility of performance and frustration of purpose. FPL also challenged the hell-or-high-water provision, arguing that it could not have assumed the risk of loss because Hurricane Sandy was not reasonably foreseeable, and FPL could not have been expected to have insured against it. Rejecting that argument, the court concluded that “the contract explicitly assigns to FPL the risk of loss from ‘any cause whatsoever’ and requires FPL to make monthly payments regardless of whether the copiers get damaged.” Because the contract made FPL’s performance unconditional and assigned the risk of loss to FPL, the court found that FPL could not rely on supervening impracticability or frustration of purpose to discharge its performance.
It is important to note, however, that hell-or-high-water provisions are not absolute. Courts have excused a lessee’s performance obligation notwithstanding the presence of a hell-or-high-water provision when some intentional or willful act by the lessor impaired the lessee’s ability to obtain the benefit of its bargain under the lease. Courts have refused to enforce a hell-or-high-water provision when the party relying on it engaged in intentional or willful wrongful acts or violations of public policy. See, e.g., Equitex, Inc. v. Ungar, 60 P.3d 746, 750 (Colo. App. 2002). Other defenses include the fact that the lease never went into effect or conditions precedent to a lessee’s performance were never satisfied. See, e.g., Wells Fargo Bank Minn. Nat’l Ass’n v. Nassau Broad. Partners, L.P., 01 Civ. 11255 (HB), 2002 U.S. Dist. LEXIS 17191, at *6 (S.D.N.Y. Sep. 12, 2002).
Ultimately, the extent of a lessee’s obligations in light of COVID-19 restrictions will depend on the nature of the restriction, the particular language of the lease, the governing law, and the factual circumstances regarding the nonperformance. While companies work through these restrictions and their new (and hopefully short-term) business realities, they may seek exceptions to hell-or-high-water clauses. In response, a finance company or lessor should take the following steps:
Ensure there are no conditions precedent to the obligation to make payment that were not otherwise satisfied.
Examine the contract language to determine whether the contract contains a hell-or-high-water provision and/or waiver of defenses and set-off language. In all contract disputes, the precise language of the contract is very important.
Determine whether the finance company or lessor has taken any actions (intentional or otherwise) that a lessee may claim excuse the lessee’s performance.
Evaluate the relationship with the lessee, and the likelihood that the lessee will ultimately be able to meet its obligations under the contract, even if its performance is delayed. Some lessees will be better positioned to survive the economic impact of COVID-19 restrictions, especially if they reach agreements with their finance company to forbear on obligations in order to create additional cash flow.
If the finance company decides to exercise its rights under hell-or-high-water clauses or other contractual remedies, it should make sure that its paperwork is in order and includes the contract, promissory note or lease agreement; any mandated notices, including a notice of default; and an accurate accounting of amounts due. Better organization on the front end can save time and expenses in litigation.
As of this writing, COVID-19 restrictions remain in place throughout the country, and business limitations are likely to continue for the foreseeable future. But companies can already learn from the lessons of COVID-19 by protecting their interests under their existing contracts and ensuring that they draft future contracts with precision to adequately recognize assumptions of risks, including risks associated with epidemics, pandemics and government restrictions.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.