What is a Hell or High Water Contract?
A hell or high water contract is a legal contract with a clause stating that the buyer needs to continue making payments regardless of any complications. The term for the clause comes from a colloquial expression meaning to complete a task regardless of any difficulty (“come hell or high water”). It is also referred to as a promise-to-pay contract.
How Hell or High Water Contracts Work
Hell or high water contracts are non-cancelable agreements. The buyer is accountable until the end of the deal to continue making the agreed-upon payments to the owner. Regardless of any difficulties, the buyer may experience during the period of usage of the leased property/equipment. In such a way, the lessor can ensure that the lessee continues to make payments as per the agreement.
Uses in Finance
Hell or high water clauses are used in financial transactions in the following context:
1. Equipment leases
The clause requires the purchaser of the equipment to continue making payments regardless of any defects in the sold goods or other performance problems.
2. Project finance transactions
The clause refers to a commitment by a party to complete an action as per the agreement with no contractual defense. The purchaser is obligated to pay for a product, such as electricity from a power plant or service such as transportation of gas or oil, even if the purchaser does not take delivery of the product or use the service.
It is also applicable to lease transactions where the lessee must make all rental payments related to the leased property. In both cases, the provision ensures that the seller, service provider, or lessor receives payment for services.
3. Mergers and acquisitions
The provision requires buyers to undertake the responsibilities required to get regulatory approvals. The purchasing party may negotiate to categorize antitrust risk.
4. High-yield indentures
The clause defines the issuers’ approval to sustain a stated sum of debt from outside parties in a general debt basket as per the agreement. The general debt basket or the hell or high water basket offers borrowers flexibility.
The basket lets them sustain allowed debt irrespective of restrictions in the agreement applicable to other exact debt approvals, such as an obligation that borrowers must meet a financial ratio test in advance acquiring any debt. The sole constraint on the borrower’s capacity to get debt under a general debt basket is the basket size.
Implementing Hell or High Water Contracts
There are provisions to impose hell or high water contracts in spite of any faults with the property/equipment leased. Equipment fault is not a valid reason for not paying installments. At times, the selling party is only dealing with the financial side of the agreement and is not involved whatsoever with the actual property (i.e., financing company).
There are instances where the leasing party does not directly deal with the property in the agreement. Often, the leasing party buys the property requested by the lessee and then transfers the ownership to the lessee post signing the hell or high water contract. In such scenarios, the lessee, rather than the lessor, will shoulder any defects that might affect the equipment after handover. Concerns for manufacturing flaws are between the manufacturer and the lessee.
Hell or high water contracts are not perfect; people try to take advantage of the loopholes. In some instances, the lessee sues the lessor, trying to escape the provisions of the contract. Often, the lessee accuses the lessor of persuading him/her into a hell or high water contract by distorting the facts about the state of property/equipment leased.
In the finance sector, hell or high water contracts are common in indentures, high yield bonds, takeovers, and venture finance dealings. Hell or high water contracts in takeover agreements make it compulsory for purchasers to make uninterrupted payments. Purchasers must also take accountability for any forthcoming lawsuits that may arise from antitrust regulations concerning the property/equipment.
One should keep in mind that the inclusion of such hell or high water sections in contracts can be challenging and discouraging, leading to potential buyers avoiding the deal.
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: