Republic Airways and the Sanctity of Contracts Validly Formed

Article 1, Section 10, of the U.S. Constitution (the “Contract Clause”) contains a list of prohibitions concerning the role of the States in political, monetary, and economic affairs [1].  The laws of some countries require damages that may be recovered for breach of contract or other obligations be limited to the level of damage or loss suffered.  For example, in English law, any provision in a contract, such as a liquidated damages clause seeking to set damage levels, will be void if it exceeds what would be a genuine pre-estimate of damage.  It would then be for the court to determine the appropriate level of damages.

When parties are sophisticated and deemed to be on equal footing, U.S. contract law is generally treated as a matter of private law.  Yet U.S. Courts have adopted a distinction that Constitutional obligations mandated by the Constitution’s ‘Contract Clause’ preserve obligations under a contract but do not prevent the State from limiting remedies.  This doctrine rests on the idea that enforcing a contract is a matter of ‘public law’ since delivering justice is a public affair, done at the public’s expense. 

The market, the credit, the asset, and the transaction structure demand that documenting an equipment lease financing transaction requires a level of predictability.  By importing public policy considerations into contract law, Lessors have found it increasing difficult to identify  solutions Courts will allow when considering the enforceability of default remedies. We played a leadership role fighting to enforce validly formed contracts in the Southern District of New York (the Republic Airways [2] bankruptcy case).  The facts there were uncomplicated.  We acquired aircraft leases in the secondary market.  They included stipulated loss values commonly found in equipment finance lease agreements.  Those stipulated loss values were unconditionally guaranteed by the lessee’s parent. The original sale lease back had been renegotiated several times, but the stipulated loss tables had remained unchanged.  On default and the subsequent bankruptcy of both lessee and the parent guarantor we sought to enforce the express terms of the agreements we considered part of the consideration in originally acquiring the transactions.  Even in light of the specific provisions of Article 2A of the Uniform Commercial Code (“UCC”), and the sophistication of the parties involved, the Bankruptcy Court found the liquidated damages provisions (and ‘hell or high water’ guaranty) unenforceable under Article 2A-504 of UCC.  Why? The Court found they “violated New York ‘public policy’ and constituted unenforceable penalties.”  ‘Public policy’ bias explains, more than any amount of legal analysis might, the reception we received in New York. 

As much as we disagree, Lessors must now review and revise liquidated damages and related default provisions to maximize the likelihood of withstanding judicial review.  On default, if remarketing values go down, will the lessee still be bound by SLV agreements[3]? 

The sanctity of contracts require respect for the freedom of contract.  Solutions require both legal and commercial judgement[4].  We have that experience.  Call RESIDCO.  

[1]  Art. 1, Section 10, the Constitution of the United States of America, “No State shall …pass any law impairing the Obligation of Contracts.

[2]  In re Republic Airways Holdings Inc., 2019 WL 630336 (Bankr. S.D.N.Y. Feb. 14, 2019).

[3]  In Exxon Corp. v. Eagerton, 462 U.C. 176(1983), the Supreme Court found that a ‘broad societal interest’ was sufficient to justify a decision to prevent a company from asserting its explicit contractual right to pass on any increased severance tax to its consumers.

[4]  Also see ‘Republic Airways: Crash Landing for SLV Damages’, in Equipment Leasing and Finance, October 2019 by Stephen T. Whelan, ‘posted with permission from the Equipment Leasing and Finance Association’s Equipment Leasing & Finance magazine’.