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The venerable, timehonored hell-or-highwater clause has been the mainstay of equipment leasing structuring and documentation for decades, particularly in connection with the underwriting of payment risk and the assignment of rental obligations to third-party funders. In the emerging marketplace of highly flexible managed solutions transactions, however, the usefulness and applicability of the HOHW clause are increasingly open to question.
The use of the hell-or-highwater (HOHW) provision in equipment leases has been ongoing since the beginning of equipment leasing as an independent discipline. Obligors under many forms of commercial transactions (including real property loans, trust deeds, mortgages, and personal property purchase money notes, to name a few) are required by these instruments to continue making timely payments regardless of the circumstances surrounding the possession and use of any property pledged to secure repayment. However, it has become customary to state this requirement in a specific contractual provision in equipment leases. This is the HOHW clause, and it is unique to our industry.
Although the actual language and formulation of the HOHW clause may vary from one transaction to another, virtually every U.S. equipment lease written over the past four decades has included such a provision. In a standard equipment lease or financing transaction, the lessee or borrower must expressly commit to continuing to make scheduled payments of rent (or of principal and interest) throughout the term of the transaction without regard to the physical condition, usefulness, or (in many cases) even existence of leased or collateralized assets (e.g., the loss by theft or physical destruction) without applying any setoffs or abatements and without the benefit of any defenses or counterclaims.
Such a provision has come to be considered essential in every equipment lease, primarily because it assures lessors and third-party funders alike of their right under all circumstances to continue receiving contractually defined streams of payments.
Such provisions effectively limit the exposure of lessors and funders to considerations of obli gor creditworthiness and ability to pay (and in some cases the realization of residual value) rather than to concerns over equipment repair, maintenance, availability, or value.
MANAGED SOLUTIONS TRANSACTIONS
In reality, however, HOHW provisions offer this protection only in transactions that are based on a defined term, fixed (or readily determinable) payment, fixed obligation...