Loan Documentation Flashcards

Question

U/W & Syndication

Answer 1

Underwritten or “Best Efforts”? U/W full or partial? Any Sub-Underwriting? Drawdown Pre- or Post-Syndication?

Answer 2

Detailed pre conditions for drawings. Much will be “boiler plate” -corporate approvals / legal opinions / consents & approvals

Answer 3

Defines repayment profile / methodology for scheduled repayment; alternative profiles for repayment; cash-sweeps

Answer 4

Describes Mandatory Prepayment Events (if any) and scope for voluntary prepayment / cancellation (available funds test)

Answer 5

Defines interest-rate basis, interest margin. Specifies margin / L/C commission rate Covers margin protection – gross-up, mandatory & increased costs, market disruption

Answer 6

Sets out front-end, work and agency fees. Also underwriting commissions and commitment fee

Answer 7

Statement of facts, opinions, and estimates lenders require as a condition for funding. Event of Default if incorrect

Answer 8

Binding Set of Do’s & Don’ts Much will be “boiler-plate”, Event of Default if incorrect Local law applies. Typically provided by: Shares in Borrower (Guarantees), Fixed Assets, Key revenue-generating contracts, Concessions / licences,Account balances

Answer 9

Events which allow Lender to call for immediate repayment of debt / enforce security

Answer 10

Generally a fixed calendar date (for term loans)

Answer 11

Funded contingency as the name says is an additional cost that is included in the project budget and funded as part of the debt and equity funding. In the beginning appraisal stage, the contingency can be estimated as percentage of total project cost or a percentage of the major project cost like the construction contract cost but will be further detailed as part of the appraisal of the project. The contingency provision should be shows as a separate line item in the uses of funds (project cost) statement and be expressed as a percentage of total project cost to allow or benchmarking with other similar projects.

Answer 12

How much contingency should be included in the project budget depends on: The Appraisal stage and availability of studies: In the early stage, where you don’t much information on the technical and risk details, you might have to rely on benchmarks and come up with rough estimates of 5% – 10% of total project cost and you need to me more conservative. As you get your hands on different studies especially technical studies (because in infrastructure projects physical costs are the main components of costs) then you can have different contingency provision for different cost items. Different stakeholders with different risk apatite: lenders and lender’s advisors might take a more conservative approach than sponsors and therefore, the amount of contingency required in lenders base case model might differ from sponsors point of view

Answer 13

As we said contingency cost is budgeted for unexpected events. We don’t know exactly when the unexcepted even would happen. However, how you spread the contingency cost is going to affect the total project cost. If it is fully drawn up-front, it will bear interest and increase project cost. If it is fully drawn at the end of construction then it will not bear interest and will increase total project cost by the total amount of contingency cost. Best practice is to spread it either equally throughout the construction or to ask the construction contractor to come up with the drawdown schedule base on the riskiness of different construction elements.

Answer 14

In a project financing transaction, the borrower will almost always be a limited liability SPV, set up by the sponsors in order to construct, own and operate the project. It is possible to use a limited-liability partnership to achieve the same objective, but the sponsors will generally be very keen, whatever the structure, to ensure that the lenders cannot “look through” to the sponsors’ balance-sheets.

Answer 15

There will not always be a guarantor of course in a project financing transaction. There may be one if the lenders are unwilling to accept limited-recourse risk pre completion, or if the sponsors prefer to guarantee up to project completion in order, for example, to maximise their flexibility in the area of construction contracting or to pay a lower interest margin during the construction period. Whether or not there is a guarantee, the “completion test” under the project loan agreements will be of significant importance – but it increases in importance where there is a guarantee. The satisfaction of the completion test will confirm the end of the construction period, trigger the change of interest margin and (if there is one) permit the release of the guarantee. A project lender’s completion test will frequently be based on the completion test under the construction contract(s), but if the lender feels that the construction contract test is weak, he may insist on a tighter test for completion under the loan documents. A sponsor providing a guarantee has a strong interest in knowing precisely what will be necessary to permit the release of the guarantee and allow the project to “go non recourse”. A lender’s completion test will usually be designed in conjunction with the lender’s independent technical consultant (ITC) and will generally include elements to test performance and reliability, because debt providers need to know that a project is capable of performing sustainably. Lenders will sometimes also seek a financial test for completion, under the terms of which completion can only be confirmed (and the guarantee released if one is in place) if the SPV shows at the end of the construction period that its projected cashflows still provide the same degree of debt coverage as at financial close. Thus, if the project debt has been sculpted using an ADSCR of 1.4:1, the project will need to show by means of an updated banking model that a minimum coverage of at least 1.4:1 is available at all subsequent repayment dates throughout the life of the facility.

Answer 16

Groups of banks acting as lead arrangers on a transaction will generally divide up among themselves the specialist tasks to be undertaken up to and beyond the provision of the financing. There is often competition among banks to act as the bank in charge of the syndication (the “bookrunner”). One of the lead arrangers will usually be responsible for negotiating the loan documentation on behalf of the group and it is quite common for this bank to become the facility agent after financial close, administering drawdown, debt service and borrower compliance on the basis of the documents it has largely been responsible for drafting. The facility agent bank frequently also acts as security trustee, holding the various elements of security on behalf of and for the benefit of the whole lending syndicate. Another of the lead arrangers may become modelling bank, responsible for maintaining the project economic model and ensuring that revised cashflows are produced in a timely fashion. In technically complex projects (power, upstream oil & gas) there may also be a technical bank who will be responsible for instructing and maintaining liaison with the ITC and/or other due diligence consultants Term-sheets will usually also set out who will act for the lender and borrower from a legal perspective, and identify the due diligence consultants who will act for the lenders in particular It is quite common also for borrowers to have rights of approval over single expenditures which exceed a threshold

Answer 17

Where a lender (or lender group) agrees to underwrite, for a fee, the syndication of a transaction, it is generally regarded to be accepting the risk that it will not be possible to sell down the financing to other banks. In such a case the borrower should be in a position to draw the full amount of the financing from the underwriter(s) and, logically, should not need to wait for the close of syndication before beginning to utilise the facility. The main alternative is a “best-efforts” or “book-building” syndication where no underwriting is paid and where the borrower effectively takes the risk of an unsuccessful syndication. Naturally in such a case the borrower will not be able to draw (even from the lead arrangers) before syndication is complete. Although in an underwritten transaction the right to draw the loan before the completion of syndication is arguably implied, I would always advise a borrower to ensure that this right is explicitly incorporated in the term-sheet and loan agreement.

Answer 18

This section of a term-sheet or loan agreement will define the amount of the project loan facility (rather than the cost of the project itself) and should set out the size and nature of any sub-sections into which the overall facility is divided – main senior debt facility, cost-overrun facility, subordinated junior loan facility etc. In its simplest form the amount of the loan may be a single monetary amount (“US$500 million” or “Up to US$500 million”). In other cases, it may be defined by reference to the agreed debt : equity percentage (“Up to 80% of the approved costs of the Project”).

Answer 19

This clause will generally tie the use of the funds very specifically to the project in question, reflecting the fact that the funding to be provided is not for general corporate purposes, but for a specific project and on a limited-recourse basis. It is usual for the project to be identified very clearly and perhaps for the construction contract by means of which it is to be built to be referenced.

Answer 20

Because a project financing is in almost all cases a term loan, it will have an availability period, during which it may be drawn, and a repayment period during which it will be paid back. The starting point of the availability period will occur when the borrower complies with the conditions precedent to drawdown (see d. below). It might be thought that it would end on the project’s anticipated completion date. Even a very short delay in construction completion would then mean that the facility would cease to be available, which is not really in anyone’s interest as all the lenders would need to consent to additional drawings. In practice, therefore the end of the availability period is usually stated to be on a “final completion date”, or perhaps the day before it, with this final date for completion being set 3-6 months after the project’s anticipated completion date. Failure to complete by this date, as well as blocking further availability, is usually also an event of default. Any amount of the facility which has not been used at completion of the project is usually cancelled. This is not contentious, since it normally implies that some cost savings have been made. The borrower will not, in any event, wish to continue to pay commitment commission on financing capacity which will not be used.

Answer 21

These are the detailed requirements which must be met before the borrower may draw upon the facility. Many of them will be very standard and non-contentious (and indeed from the banker’s perspective, non-negotiable), such as the requirement to execute the loan and security agreements, to provide evidence of corporate approval and signatory authority and so on. These clauses tend to use LMA language.

Answer 22

The lenders will very often have been working from draft project documents such as the construction contract, sales agreement or operating & maintenance agreement, and will want to ensure that the final executed documents do not differ in a material way from the drafts they have reviewed;

Answer 23

In most limited-recourse transactions this will imply a model which has been independently audited, by a major accounting firm or one of the specialised organisations which undertake this work. Bank credit committees will often assume that a model will have been audited and it is for the business developer within the bank to justify using a model which has not been audited. Project finance spreadsheet models can be very large and the question is not really one of “Are they any errors?” but rather “How many errors are there?”. Errors in the treatment of tax and interest amount (and the interaction between the two) can have an enormous impact on calculated debt values and the higher the gearing of the project the more serious this impact will tend to be.

Answer 24

This is the normal method whereby permit and approval risk is transferred to the sponsor. By making it impossible to draw the facilities until all necessary permissions are in place, the lenders effectively require the sponsor to spend equity until such time as consents have been granted. In some jurisdictions consents are not granted in full at the outset, but in stages as the project is constructed and moves towards operation. In such circumstances lenders will have to take some risk, but they will generally incorporate a “draw-stop” mechanism to block further drawings if an anticipated permit is not received. Of course, having made some advances the lender will only be able by a draw-stop to stop his exposure increasing, but it does provide a means of exerting pressure on the borrower to expedite the arrival of approvals (if indeed he can do anything to speed up the process).

Answer 25

The most common way of arriving at a clear understanding of what is necessary to meet this CP is by reference to an agreed programme of insurance which may be attached to the loan agreement as an appendix. Compliance with the agreed programme will typically be confirmed by a “broker’s letter” confirming the level of cover, the amount of any excesses etc. and confirming that insurance premia have been paid.

Answer 26

The lenders will naturally wish to ensure that the equity funding to be contributed by the sponsor(s) has been paid into the SPV or at least irrevocably committed. It is usually a provision of the financing documents that any equity which has not been paid into the SPV at the time of an event of default can be called in by the banks. If this clause requires all of the equity funding to have been spent in settlement of project costs before loan drawings may be made, then the lender is almost certainly requiring front-ended equity injection rather than pro-rata contributions, even if this is not explicitly stated elsewhere.

Answer 27

The front-end or arrangement fees to be paid by the borrower are often covered in a separate fee letter, especially if the agreed term-sheet will be circulated to other banks which might join the lending syndicate. The lead arrangers will certainly not wish potential syndicate members to be aware of the amount of the fees being paid on the whole facility, because it is one of the key rewards of being a lead arranger to be able to pay a lower front-end fee to participants (expressed as a percentage of the debt amount provided by the participant bank) than is earned by the lead arrangers. The traditional method of paying fees was for the borrower to pay one lump sum fee amount to the lead arranger(s) – say 1.25% of the total amount of the loan facility. The lead arrangers would then pay a reduced fee to participant banks, with the level of their fee being driven by their lending amount within the bank group. An alternative and more recent method is for the lead arrangers to receive a specifically identified “work fee” to compensate them for their work in structuring and arranging. All the lender banks then receive a participation fee based on their “ticket” size, including the lead arrangers, on the basis of a sliding scale which is known to all lenders. The scale of the lead arrangers’ work fee is not, of course, usually known to the other banks.

Answer 28

Each of the banks performing a role (Facility Agent, Security Trustee, Modelling Bank, Technical Bank) is likely to receive an annual fee in return for the administration work it will carry out – arranging drawdowns and interest/principal payments, checking compliance with covenants, running and updating the project model, liaising with the ITC and so on). Generally, the Facility Agent’s fee will be the largest, with the size of the fee being driven mainly by the number of banks in the syndicate but also by the complexity of the financing and the likelihood of frequent approaches to the bank syndicate for amendments and waivers.

Answer 29

As already mentioned, for committed term loans banks will charge a commitment or non-utilisation fee which is levied on the unutilised amount of the facility and is payable periodically in arrears (usually semi-annually or quarterly). The logic behind it is that the lenders need to set aside capital for a facility which they have committed to provide, and the commitment fee compensates them for this reservation.

Answer 30

Much of the language relating to interest rates in a project financing term-sheet and/or loan agreement will be very conventional (LMA-style). These clauses will specify the interest-rate basis and the method of setting it for individual interest periods. There will also usually be standard language protecting lenders against the impact of changes in taxation or banking / accounting regulations on their agreed return. The effect of these clauses is usually to ensure that the lender achieves the same return after the change as before it so that the impact on the lender is neutral – but the additional cost of achieving this is borne by the borrower. Term-sheets and loan agreements have always included “market disruption” clauses designed to deal with situations where the lenders were unable to obtain a market rate for interest-setting purposes or where the interest calculation basis included in the documentation became otherwise unworkable.

Answer 31

In most project financing term loans, the final maturity date will be a fixed calendar date. In resource-based transactions involving reserves, however, there is always a possibility that the reserves may be downgraded, advancing the timing of the Reserve Tail Date (a concept we encountered in Module 5). In such transactions, therefore, the final maturity date is frequently defined as being the earlier to occur of a fixed calendar date and the reserve tail date.

Answer 32

In its simplest form the repayment clause will refer to a repayment schedule which has been defined during detailed economic modelling and which is attached to the loan agreement as an appendix. This is often the case for infrastructure and PPP projects where the repayment profile has been calculated using a single ADSCR value. Where the repayment profile is driven by the net present value of future cashflow available for debt service, however, the repayment clause will often define the repayment methodology rather than setting out a defined schedule of repayment amounts. Thus, the clause might define the repayment amount as being “that amount which will ensure that the amount outstanding after the repayment does not exceed x% of the net present value of Loan Life Cashflow”. There may a choice of repayment schedules, depending on the performance of the project, with the borrower being obliged to move to a more aggressive repayment programme (the “Target Repayment Schedule” as opposed to the “Minimum Repayment Schedule”) if cashflow permits. This might be used in cases where the lenders are anxious to reduce the level of debt outstanding and (through prepayment in inverse order of maturity) to shorten the life of the loan. It should be seen in the same light as a cash-sweep, which will have a similar effect. It is critical, of course, for a borrower to understand to what extent prepayment can be required because f the negative (and potentially unpredictable) effect this can have on sponsor IRR.

Answer 33

As is the case with most syndicated loans, the borrower generally has the ability to prepay all or part of a limited-recourse loan facility at will. Often this can be done without additional cost to the borrower provided that the prepayment takes place at the end of an interest period. If the borrower chooses to prepay during an interest period, the lenders have the right to charge “break funding costs” to compensate them for any losses incurred as a result of their being unable to place the prepaid funds at the same return until the end of the interest period. Most borrowers who choose to prepay therefore do so at the end of an interest period to avoid such costs. When market conditions favour lenders, or when a lender is the only potential source of finance, debt providers may seek to include prepayment penalties with a view to limiting the risk of their being refinanced. Clearly it is in a borrower’s interest to clarify whether prepayment penalties are contemplated before moving from the term-sheet to the granting of a mandate and drafting of loan documentation. Most borrowers will wish to protect their ability to refinance without penalty.

Answer 34

It goes without saying that the protections incorporated into these clauses will be designed to safeguard the interests of the lenders. Once again, a number of the clauses will have quite standard (LMA-type) drafting – the inclusion of failure to pay an amount due as an event of default being an obvious example.

Answer 35

It is tempting to treat “reps” & warranties as a statement of the obvious and non contentious. Neither lenders nor borrowers should forget, however, that: * these are statements which the lender requires the borrower to put into writing as a condition for the advance of the loan facility; * any breach of a rep or warranty constitutes an event of default; * it is usually explicitly stated in the loan agreement that the reps & warranties will be regarded as being repeated at each drawdown of the loan facility and at each rollover of an existing outstanding.

Answer 36

* attempt to “dilute” the content of reps & warranties by suggesting the inclusion of phrases such as “to the best of our knowledge and belief” or by subjecting a particular statement to a materiality trigger; * distinguish between those reps which they are prepared to repeat and those which they are not. Lenders need to be very careful about how far they allow the reps to be diluted. It might be acceptable, depending on the circumstances of the borrower, to agree to a rep confirming that no material litigation is proceeding against the company. To include that “to the best of our knowledge and belief” the loan documentation is binding and enforceable or “to the best of our knowledge and belief” the SPV has full title to its assets would be dangerous. The appropriate response from a lender in such circumstances would be to resist the watering-down of the rep and to insist, if necessary, on verification. Covenants Also known as “undertakings”, covenants represent a binding set of promises by the borrower and they are usually separated into a list of positive covenants (promises to do certain things) and negative covenants (promises not to do certain things). I have been surprised to find how many trainees (even from banks) do not appreciate that any breached covenant creates an event of default. Once again, lenders will not wish to call an event of default on the basis of a trivial, inadvertent or technical breach of a covenant. The prudent borrower, however, will want to avoid giving the lender the opportunity to call a default due to a covenant breach by modifying the lender’s proposed covenant wording to provide more latitude to the SPV and/or the sponsor.

Answer 37

These are the triggers which may be invoked by the lenders to make the project loan immediately due and repayable. Failing repayment by the SPV, the lenders will have the ability to enforce their security rights. As noted above, some of the event of default drafting will be of standard LMA form, while other parts will be more project orientated and tailored. A frequent request by borrowers to lenders is that the events set out should not trigger the right to call an event of default immediately but only after a certain “cure period” has passed without the situation being resolved. This can be a useful method of reducing the risk for the borrower that a minor or short-term problem or a genuine dispute on a project contract will trigger the lender’s right to call default. It is not appropriate for all cases, however. Although some banks do concede a cure period for a non-payment (albeit usually for a few days at most) this is not something I would recommend, given the potential need for a lender to take rapid action if a borrower cannot pay.

Answer 38

Given the sheer volume of debt which lenders are usually providing, they will normally be the dominant creditors of the SPV. The interests of the equity providers will be formally subordinated to those of the lenders until the latter have been repaid. It is a general principle of most legal systems that unsecured creditors rank equally (the “pari passu principle”), with the exception of a few classes of preferred creditors such as the tax authorities and (frequently) employees for a limited amount of unpaid wages and salaries. The lenders cannot defeat the preferential creditors but by registering security interests against the SPV they can rank ahead of other, unsecured creditors if the company is liquidated. In this way they can ensure that they have their debts repaid before any lower-ranking creditors (suppliers, other banks providing unsecured credit) have access to the assets and revenues of the SPV.

Answer 39

It is a key element of taking security that the lenders should have the right, following default, to take possession of the assets over which they hold security rights and to dispose of them. The lenders may choose to sell the project immediately to a third party. They may decide instead to operate the project for a period before sale, bringing in their own experts for this purpose. If the project has not yet been fully constructed, there is quite a strong likelihood that the debt-providers will feel that completing the project prior to sale will increase their chances of a full recovery of their debt. There will usually be a reluctance to “break up” the project into its component assets and sell these off piece-meal. Banks rarely achieve full recovery from a “fire-sale” situation, not least because potential buyers will be well aware of the lenders’ situation. Whatever disposal approach the lenders decide to employ they will be very careful regarding any liabilities they might assume through entering into possession of the assets. They will not wish, for example, to take over the responsibility of a borrower SPV for environmental liabilities (e.g. ground seepage of oils at a refinery site).

Answer 40

If they enjoy security interests, lenders can usually require that the relevant assets are properly maintained and insured. They will often also enjoy rights of inspection. Through these rights the lenders can try to ensure that the assets which underpin their lending do not deteriorate in value other than through normal wear and tear.

Answer 41

The existence of security interests frequently also limits the borrower’s right to sell and otherwise deal with the assets which are the subject of the interests, and/or to grant security rights to third parties. This reduces the possibility of a leakage of security – e.g. through a sale of assets at less than their full value.

Answer 42

The lenders’ ability to enforce against the project or its assets following a default strengthens their bargaining position considerably when negotiating with a failing borrower and its owner(s). The banks will certainly see enforcement as a last resort, and they will most definitely prefer a solution which does not require it, but which still protects their interests. Some form of “work-out” is almost always preferable to enforcement of security. The fact that the lenders can, in the last analysis, seize the project or its assets does, however, tend to concentrate the borrower’s and sponsors’ minds.

Answer 43

A critical issue in the structuring of security packages for project financings is the question of governing law. Many, but by no means all, project financing loan agreements are written under English law or New York law. Even lenders for whom these are not the law of their home country can derive significant comfort from the fact that English and New York law are well understood and have been employed for many project financing transactions, even where the project itself is located in a third country with a very different legal system. A prime consideration, therefore, for project lenders seeking security will be the governing law of the assets or contracts to be charged7. For the physical assets this will usually be the law of the country where they are located. A lender will require local legal counsel’s input and will wish to consider in particular: * what documentation is required to create an effective security interest; * whether and how the security can be voided or set aside by the courts or otherwise by the operation of law; * what registrations must be made (e.g. at a central company registry or a local trade register) to perfect a lender’s position; * what notices must be given in order to create an effective security right - e.g. to contract counterparties under a sales agreement; * what rights the local security instruments confer on a lender to enforce against the project SPV or its assets – e.g. by appointing a receiver or administrator.

Answer 44

Regardless of the location of the project and/or its owner SPV, lenders will wish to carry out due diligence on the borrower company, in particular to verify that: * the borrowing being contemplated falls within the powers and purposes of the company, as laid down in its constitutional documents (company statutes; memorandum & articles of association; extract from the trade register etc.); * the borrowing, granting of security and all other related issues have been properly approved by the appropriate company bodies (in the UK, for example, this would be a resolution of the board of directors); * the individuals who will execute the loan and security documents have been properly authorised to do so; * the borrower has full title to the assets which are to be taken in security (if necessary, through the carrying out of title searches and other ownership due diligence).

Answer 45

It is perhaps not strictly correct to speak of guarantees as a form of security, since a guarantee is essentially an unsecured undertaking to pay the debt of another and the beneficiary of the guarantee (usually the lenders in the case of project financings) does not – at least in English law – enjoy security rights over the assets of the giver of the guarantee. Project lenders who will be basing their loan in part on a guarantee will generally insist on using their own tried and-tested guarantee format which will have been developed over time with the assistance of their lawyers to ensure that it provides, as far as possible, complete protection of their interests. In English law documents, for example, it will include language to convert the guarantee into a guarantee and indemnity and clauses by means of which the guarantor agrees that his obligation will not be extinguished if the terms of the original debt are varied by the lender Perhaps the most frequent use of guarantees in project financing occurs in cases where the sponsor is required – or wishes – to provide a guarantee of the project debt up until completion of the project. In a few sectors lenders are not prepared to accept pre-completion risk or technology / commissioning risk. In other cases, a sponsor wishes to guarantee the debt up until completion for his own reasons – perhaps to maximise his flexibility in construction contracting. Sponsors who might have preferred to finance a project corporately but who agreed to project finance on the insistence of a joint-venture partner may wish to provide a guarantee during the construction phase because this will result in a lower risk margin being paid to the lenders. Pre-completion guarantees are generally full financial guarantees, which require the sponsor(s) to pay back the accumulated debt of the SPV together with all accumulated interest. The trigger for such a claim is commonly the failure of the project to pass the completion test set out in the loan agreement by a certain date (often the “Final Completion Date” or “Longstop Completion Date”, which will fall perhaps 3-6 months after the scheduled completion date). Failure to complete by that date will trigger an event of default and if the SPV does not repay the debt – which will be the case given that it has no cashflow – the guarantee may be called. In project finance, bonds are used most frequently in the context of the project’s construction, in support of the commitments made by an engineering, procurement and construction (EPC) contract. The contractor provides bonds as evidence of his good faith and his ability to perform his obligations under the contract. The ability to call (demand payment under) the bonds, which may be issued by banks or by insurance or specialised surety companies, provides the owner of a project with significant comfort that the contractor will perform, as well as a source of finance which can be used to remedy any shortcomings if he does not. Project lenders will wish to take security over contract bonds – in English law situations they will require the benefit of the bond to be assigned to them (see also below regarding contract assignments) and the right to call the bond in the event of default by the contractor. In other law systems the form of the security may vary, but the lenders’ objectives will be the same.

Answer 46

Lenders will have few illusions about how much of their debt will be recovered from a piecemeal disposal of the assets if the project is broken up. All the more important, therefore, that other creditors’ claims should be made junior to those of the project lenders. Project lenders’ security over the physical assets of the project is thus essentially defensive.

Answer 47

The fact that it may be difficult to take security over physical assets will in many cases make the lenders even more anxious than usual to create security interests over the shares in the SPV held by the sponsors. This form of security is perhaps one of the most useful taken by lenders, since it will usually confer on them the right to sell the borrower company intact rather than having to break it up and realise its individual assets. Having the right to enforce this security and step into ownership of the shares, the lenders may decide to sell the project company immediately, to delay sale (e.g. to complete construction) or to operate the project in order to repay the project borrowings. Security over the shares of the borrower company may also go some way towards dealing with some of the shortcomings of physical asset security in some jurisdictions. While the energy ministry of a particular country may reserve to itself the right to approve the transfer of an interest in an oil license, it may not be able to cancel the license on a change in the ownership of the license holding company, giving the lender banks the option to sell the asset-holding company rather than its license interest if approval of a license transfer appears likely to be problematic.

Answer 48

Project banks will wish to have security rights over the benefits, but of course not the obligations, of key project contracts such as the construction contract, any supply contracts for fuels and raw materials, and sales contracts for the disposal of the project’s output. These contracts can only, of course, have security interests created in respect of them in conformity with the laws to which they are subject. So, a lender, supported by legal counsel, will need to ascertain what steps are necessary to create a first-ranking charge which will be fully effective against the contract counterparty (offtaker, supplier, contractor etc.). Whatever the jurisdiction it is critically important to establish beyond doubt at an early stage that the contract is capable of being charged by way of security. It is not unknown for it only to become clear shortly before financial close that a key contract contains wording which prohibits this

Answer 49

Providers of project debt will wish to take security over the control accounts which we discussed above (proceeds account, debt service reserve account, maintenance reserve account and so on). These accounts will be established in the name of the SPV at the agent bank, or at the lender bank if there is a single lender, clearly marked to show that the lenders have a security interest in them and with specific documentation being taken to establish those security rights. In the event of a default the lenders will then have the right to access those balances. In the case of the reserve accounts the agent bank will have the right to access balances even before an event of default in order to make up cashflow shortfalls.

Answer 50

Insurances are project contracts entered into by the SPV. There are a number of features peculiar to insurance contracts, however, which makes them worth considering separately. Almost all projects will have insurance coverage applicable specifically to the construction period, such as contractors’ all-risks insurance, marine cargo coverage in respect of equipment and materials being transported to the site and, of course, third-party and employee liability insurance. When the project is completed, coverages tailored to the risks of the operating period will come into play, such as operators’ all-risks insurance and environmental / pollution cover as well as, of course, continuing third-party and employee liability policies. Specialist insurance products may well be added in particular cases – for example policies dealing with: * Delay in start-up * Advance loss of profit / business interruption * Sabotage & terrorism * Political risk insurance Banks will usually wish to have security rights over the benefits of insurance policies (in English law, the benefits will be “assigned” to them), and to have themselves named as “loss payees”. This means that in the event of a payment under the insurance policy the funds will be paid to the Compensation Account of the Borrower held at the agent bank – rather than simply to the order of the Borrower. As well as being loss payees, lenders will also seek to have a number of conventional “bankers’ clauses” incorporated into the policies.

Answer 51

Direct agreements are normally put in place between the lenders and other project counterparties (apart from the Borrower), such as the EPC contractor, the grantor of a concession or the buyer of the project’s output. The agreements frequently involve the counterparty agreeing to limit the exercise of the powers which it has under the main project contract to which it is a signatory. Thus, a direct agreement with a power buyer would probably involve the buyer agreeing not to terminate the power agreement for default by the SPV – at least until the lenders have had an opportunity to remedy the default. In entering into direct agreements, the lenders will normally have 2 main objectives – to protect the project agreements on which their debt service relies against the risk of termination; and to put in place a set of rights for themselves in the event that default does occur and they wish to enforce their security. To meet the first objective the banks will usually seek to ensure that they have formal advance notice of the project counterparty’s intention to terminate and also the right to step in – at least for a limited time-period – to remedy the default and thus prevent termination. Where appropriate they may be granted the right to substitute an alternative for the defaulting party. In a PPP project, for example, the lenders might have the ability to replace an under-performing facilities management company with a new operator. If the position deteriorates to the point of actual default, lenders will want to be sure that their right to dispose of the SPV or its assets is protected. They may wish to transfer the SPV itself to a trade buyer, in which case it will be important that the company can be passed to the buyer with its assets and agreements intact. The direct agreements will therefore frequently include language to remove the right of the project counterparty to terminate key agreements.