19MS207 - PROJECT FINANCE

UNIT V Legal Aspects in Project Finance

8
Project Agreements- Sub-Contracts and Other Related Agreements- Project
Finance Loan Documentation-Contemporary Issues in Project Finance-
Contractual Parties - Contractor -Purchaser - Operator – Supplier- Legal
framework in India for Project Finance
 Project Agreements- Sub-Contracts and Other Related
Agreements

The project financing transactions are voluminous and complex.

The documents can be broadly categorized as (a) Project
documents (the documents for design, construction, operation and
maintenance of a project); and (b) Financing documents (the
documents for financing and securing a project).
Project Documents

These are the incorporation documents of the project company and

its sponsors, the investment agreement (for equity investment by the
sponsors, its timing and form), project management agreement
(agreement for management of the project company), sponsor or JV
agreement (agreement for rights, responsibilities and obligations of
the sponsors and their inter-se relationships). The project company is
incorporated by the sponsor as per the requirement of the
Government authority or taken over from such Authority by purchase
of shares.
Operational Agreement
The Operational Agreement is the main agreement under which certain
rights/concession is granted by the Government Authority in favour of the project
company to develop, construct and operate the facility. It can be either
concession/development agreement or EPC contract. A concession/development
agreement would have conditions precedent (the conditions to be fulfilled by the project
company and the Government Authority), performance security, concession fees, project
development and maintenance, obligations of the project company and the Government
Authority, financial close, liability and indemnity, dispute resolution and jurisdiction, etc.
An EPC contract is a construction contract that provides for complete engineering,
construction, procurement and commissioning of project facility by the project company
by a certain date for a fixed price, the performance of which is guaranteed by the project
company for a certain duration. The risk of cost and time over-runs in such projects is
borne by the project company. A typical EPC contract would have clauses defining scope
of the project, obligations of project finance company and Government Authority,
Representations and warranties, performance security, change of scope, maintenance,
defect liability, payments and dispute resolution, etc.

Property Agreement
This is an agreement under which the property or the rights under the same are
transferred by the Government Authority to project company and can take the form of
deeds, leases or easements. The project company builds the facility on such property.
O&M Contract
The operation and maintenance of the project is sometime taken over by the
project company and sometime outsourced to another operator. One of the key
issues in O&M contract is efficient management of operations to maximize the
revenue so that lenders are paid in full. The operations and maintenance risks are
mitigated by engaging with an experienced operator who can manage and
operate the project efficiently and cost-effectively. This contract has liquidated
damages provisions to mitigate the risk of poor performance by the operator.

Supply Contract
This contract provides for supply of raw materials, fuel or other inputs necessary
for operating the facility. The supply can be of coal, water, gas or any other raw
material. The price and various terms and conditions of supply contract are
important considerations in structuring a project financing. The availability of
inputs, consequences of non-supply, minimum off-take, price of the inputs, price
escalation, political and force majeure risk should be taken into consideration
while negotiating such contract.

Off-take agreement
The off-take agreement is the agreement under which the off-taker purchases the
output from the facility built by the project company. The off-take agreement
provides constant revenue stream to the project company for timely repayment of
debt to the lenders and return to the sponsors.
Financing Documents
Financing documents are the set of contracts between the project company and the
lenders which lay out the terms and conditions of financing the project by the
lenders. The following are the main agreements:

Funding agreement
The funding agreement provides for funding of the project and contains the
following main clauses
Fulfillment of conditions precedent by the project company making the project
company eligible to borrow money from the lender.
The time duration during which the loan shall be available to the project company.
Repayment schedule and rate of interest payable by the project company.
The margin provisions, which protect the lenders from unexpected costs associated
with the project.
Representations and warranties by the project company on the basis of which
lenders provide finance to the project company.
Covenants by the project company. Some of these are submission of periodical
reports by the project company; financial covenants such as maintaining a certain
debt service coverage ratio and negative convent such as not incurring additional
debt.
Events of default upon happening of which the consequence of default provisions
will get triggered.
Investment agreement
The investment agreement is the agreement between the sponsor and the
project company for equity investment by the project sponsor in specified sums
and at specified times as per the financial model of the project company. The
investment agreement contain provisions that if the sponsor do not provide their
equity contributions, the letter of credit provided by them as security for their
obligations can be enforced by the lenders or the collateral agent.

Intercreditor agreement
The Intercreditor agreement is an agreement that deals with the competing
interest of the creditors in the project company. The Intercreditor agreement will
usually provide a restriction on the payments to the junior lenders upon the
occurrence of event of default under the senior lender credit agreement. These
provisions are referred to as "payment blockage" provisions. If a payment
blockage provision is triggered, all payments to the junior lenders will usually be
blocked, including interest on their loans.
Security documents - The following are the typical security documents in project
finance:
Security Agreement
The security agreement provides for grant of all the security interests in the project
company in favour of lenders for repayment of debts and interest thereon. In security
agreement, the project company grants the security interest to the collateral agent all
the right, title and interest in the project company's assets. These include all the rights
of the project company in the project documents such as off-take agreement,
concession/EPC contract and O&M contract, etc. In case of default, the lenders can
foreclose the loan and recover the outstanding debt by sale of all the assets of the
project company or sell the shares in the project company. Alternatively, the lenders
may take control of the project and carry out its operations.
Pledge Agreement
Under the pledge agreement the sponsors pledge all their shares in the project company
to lenders as security for performance of their obligations under the financing
agreement. In case, the project company defaults, the lenders can foreclose the pledge
agreement and sell the equity shares to a third party. Alternatively, the lenders may
take control over the project and run the same
Mortgage or deed of trust
The project company mortgages all of its interest in it's assets, including rights in the
project site (whether free or leasehold). In the event of default by the project company,
the lenders can foreclose the mortgage and recover their outstanding by sale of
mortgaged assets or take control of the project site and run the same.
In India, the project finance is not very old. The project finance has
evolved as the tool for ever evolving need for financing of projects on
stand-alone basis, where the revenue stream is certain over a period of
time. The project finance being document intensive, all the agreements
should be carefully drafted and negotiated so as to mitigate the risks and
protect the interest of all the stakeholders.
 Project Finance Loan Documentation

Loan and Security Documentation

Project Loan Agreement

In most projects this will be a syndicated loan agreement entered into

between the borrower, the project lenders and the facility agent. It will
regulate the terms and conditions upon which the project loans may be
drawn down and what items of project expenditure the loans may be used
for. The agreement will contain the usual provisions relating to
representations, covenants and events of default found in other syndicated
loan agreements but expanded to cover the project, project documents
and related matters. The provisions relating to the calculation and
payment of interest will be similar for standard Euro-currency, loans except
that in most projects interest will be capitalised during the construction
period or until project revenues come on stream.
Security Documents

The form of these will vary from jurisdiction to jurisdiction and will
depend on the nature and type of assets that are the subject of the
security. A more detailed description of the type of assets and security
found in project financings is set out in section 6. In common law based
jurisdictions the taking of security in relation to project financing is
usually through a fixed and floating charge covering all of the property
and assets of the project company. In civil law based and other legal
systems, however, the position is usually more complex, with different
documents being required for different categories of assets
Project Documents
In many projects, particularly Build-Operate-Transfer (“BOT”) projects, the
concession agreement will be the key project document as it is the document that
will vest in the project company the right to explore, exploit, develop or operate, as
appropriate, the concession or other relevant rights to the project. At the other end
of the spectrum, all that may be needed for a project company to be vested with
the necessary legal rights to exploit is a licence. Thus, for example, in an oil and gas
financing in the UK continental shelf, the project vehicle will be a beneficiary of (or
the beneficiary of a share of) a licence issued by the Department of Energy and
Climate Change which entitles it to explore for and exploit hydrocarbons on the
terms set out in the licence (and certain model clauses applicable to the licence).
On the other hand, in a BOT project, it will invariably be the case that the project
vehicle (or its sponsors) will be granted a concession by the host government (or
one of its agencies) with respect to the project.

Lender Requirements for Project Agreements

Because project agreements play a central role in allocating risks between the
parties in any project financing, lenders will take great care to review the terms of
the project agreements to satisfy themselves that these documents accurately
record the agreed risk allocation.
 Contemporary Issues in Project Finance

The above is a simple explanation which does not cover the mining, shipping, and
delivery contracts involved in importing the coal (which in itself could be more
complex than the financing scheme), nor the contracts for delivering the power to
consumers. In developing countries, it is not unusual for one or more government
entities to be the primary consumers of the project, undertaking the "last mile
distribution" to the consuming population. The relevant purchase agreements
between the government agencies and the project may contain clauses
guaranteeing a minimum offtake and thereby guarantee a certain level of
revenues. In other sectors including road transportation, the government may toll
the roads and collect the revenues, while providing a guaranteed annual
sum (along with clearly specified upside and downside conditions) to the project.
This serves to minimise or eliminate the risks associated with traffic demand for
the project investors and the lenders.
Minority owners of a project may wish to use "off-balance-sheet" financing, in which
they disclose their participation in the project as an investment, and excludes the debt
from financial statements by disclosing it as a footnote related to the investment. In the
United States, this eligibility is determined by the Financial Accounting Standards
Board. Many projects in developing countries must also be covered with war risk
insurance, which covers acts of hostile attack, derelict mines and torpedoes, and civil
unrest which are not generally included in "standard" insurance policies. Today, some
altered policies that include terrorism are called Terrorism Insurance or Political Risk
Insurance. In many cases, an outside insurer will issue a performance bond to
guarantee timely completion of the project by the contractor.

Publicly funded projects may also use additional financing methods such as tax
increment financing or private finance initiative (PFI). Such projects are often governed
by a capital improvement plan which adds certain auditing capabilities and restrictions
to the process.
Project financing in transitional and emerging market countries are particularly risky
because of cross-border issues such as political, currency and legal system
risks. Therefore, mostly requires active facilitation by the government.
 PARTIES TO A PROJECT FINANCING

Project finance transactions are complex transactions that

often require numerous players in interdependent
relationships. Because of this complexity, not all projects
follow the same structure and not all of the
participants described below partake in all projects. A typical
project finance structure looks like as follows :
Project Company

The project company is the legal entity that will own, develop, construct,
operate and maintain the project. The project company is generally an SPV
(Special Purpose Vehicle) created in the project host country and therefore
subject to the laws of that country (unless appropriate ‘commissions’ can
be paid so that key government officials can grant ‘exceptions’ to the
project). A project company can be created in one of two ways:
when the host government solicits bids and selects the best candidate
among the bidders;

or a company or group of companies may initiate a project on their own,

with or without soliciting host government involvement.
However, most projects have government involvement and backing. The
SPV will be controlled by its equity owners.
• Sponsors.

• The equity investor(s) and owner(s) of the Project Company can be a

single party, or more frequently, a consortium :
Industrial sponsors, who see the initiative as linked to their core business
• Public sponsors (central or local government, municipalities, or
municipalized companies), whose aims center on social welfare
• Contractor/sponsors, who develop, build, or run plants and are interested
in participating in the initiative by providing equity and/or subordinated
debt
• Purely financial investors
Lenders. Typically including one or more commercial banks and/or multilateral
agencies and/or export credit agencies and/or bond holders.

Host Government. It is the government of the country in which the project is

located. The host government is typically involved as an issuer of permits, licenses,
authorizations and concessions. It also might grant foreign exchange availability
projections and tax concessions. It might also be involved as an off-take purchaser or
as a supplier of raw materials or fuel.

Offtaker. More typically found in utility, industrial, oil & gas and petrochemical
projects. One or more parties will be contractually obligated to ‘offtake’ (purchase)
some or all of the product or service produced by the project.

Suppliers. One or more parties provide raw materials or other inputs to the project
in return for payment.

Contractors. The substantive performance obligations of the Project Company to

design and build (D&B), and operate the project will usually be done through
engineering procurement and construction (EPC) and operations and maintenance
(O&M) contracts respectively.