project finance legal guide

project finance legal guide

Comprehensive Guide to Project Finance Legal Frameworks

1. Introduction to Project Finance

In project-financed projects, project finance is the method by which a company, the project company, is created and funded in order to carry out a particular project in a particular way. That is, project finance is a method of financing a project in which an investor contributes equity, borrowings, and/or retained earnings in a project company which provides access to the assets of the project itself, and the cashflows which the project is expected to generate. The major characteristics of project finance are then: the creation of a project company which undertakes a particular project (or collection of projects) which uses the assets of the project as the means for returns to the owner of the project.

The main focus of project finance is the financing of a project in which the repayment of the financing with interest, the construction and operational risk, and the return on the investment are derived from the cashflows generated by the project. The cashflows of the project are the result of the sale of goods and services generated by the project. The project is developed by entrepreneurs or sponsors who establish a company, the project company, to carry out the project. The construction, financing, ownership, and the operation of the project by the project company are the responsibility of the project company.

2. Key Legal Concepts in Project Finance

To clarify the legal patterns of project finance, this guide is divided into seven parts. Parts 1 and 2 discuss the basic legal structure and concepts of commercial (in this case, referring to privately owned projects) project finance. The expansion of public-private participation operations also warrants coverage of public project finance. Due to its growing importance, Chapter 3 is devoted to this topic. Parts 4, 5, and 6 describe power plant project finance operations. The sequencing is decided by the contract with the most weight in this kind of project.

What a free-spanning bridge project and a concession to build and operate a power plant have in common? They are examples of project finance, each in its own field, that is, the former dealing mainly with public works and infrastructure while the latter involves commercial or privately run operations. Despite differences in the nature and the performance of projects, project finance involves similar contractual patterns. In the case of power plants, project finance is intertwined with a dynamic web of agreements, in which the off-take agreement normally prevails as the chief contract in power plant project finance.

3. Structuring and Negotiating Project Finance Agreements

At the starting point of structuring project finance transactions, the financing agreements, namely the loan agreement and the related security documents, are chosen. Those security documents secure the cash flows from the project, and as such are the contractual arrangements that endow security to the project finance lenders to recover the loans provided in case of borrower default. Then, project agreements, such as construction contracts and long-term operation and management contracts, are selected, finally the shareholders’ agreements are structured. These agreements are part of the main agreements of a project finance transaction along with the other security and guarantee documents, and they generate the specifics of the guarantees.

This chapter sets forth a comprehensive guide to most issues to be considered within project finance legal frameworks such as financing agreements, security structure, and certain legal and financial aspects of project agreements. This chapter covers developed and detailed standard clauses project finance practitioners must consider when negotiating the agreements on a project finance transaction. It clarifies points of potential disagreements between attorneys, values in controversy, and, most importantly, the resolution of those issues within each of these agreements.

4. Regulatory and Compliance Considerations in Project Finance

The legal environment that a project exists in is not just the law of the land, it is also the policy measures and detailed regulation imposed by the government, the Parliament and various other governmental/municipal organizations. The presence of regulation always introduces itself into different facets of a project, sometimes subtle, sometimes direct. In a transport-based project such as a toll road that is constructed with a concession agreement, the terms of the concession agreement and the obligations of the project company, the authority, the lenders, the EPC contractor, the operator and the sub-contractors will need to comply with the legislation which allows the construction and operation of a toll road. In the energy sector, in the case of public-private partnership or finance of a coal fire or natural gas power plant, the project company will have to comply with a number of far-reaching environmental legislation and other detailed permits and direction letters issued by the Ministry of Environment. Compliance with the various undertakings and the fulfillment of the detailed undertakings made in the Power Plant Investment Plant will carry substantial information and a detailed due diligence investigation will be necessary to be able to establish sensible commitments and relate these to potential liabilities or shortfalls in the debt service coverage ratios.

One of the main attractions of project finance is the limited or non-recourse nature of the loan. The lender needs to be satisfied with the future cash flow of the project to recover its loan, and so will not usually make a loan without a completed and financed project. Inherent within this concept is the need for regulatory checks and approvals prior to the financial close. There are various considerations that need to be taken into account and satisfactorily concluded before the morning of the next business day following the financial close.

By Barış Kalay

5. Case Studies and Best Practices

Five of the best international asset and liability restructuring firms, all with project finance experience, accompanied the sponsors and project lenders in this process. On one side, with a flawed strategy or lack of urgency in the negotiations, the creditors appointed also the best New York financial and arbitration lawyer firms. The techniques examined were based on the combination of project finance and government finance techniques developed for several years, with other techniques observed in cases not solved through project finance, and with new techniques derived from the merger process. The depression costs between the project’s operation date and that date would be paid to the project’s creditors’ dependence on the extraordinary degree of commercial financing defined in the project’s restructuring plan. Without commercial debt (the level was the highest one) financing at that time (since the project was unable to pay such anticipated levels of interest from operations), Yacyretá had to depend on the behavior of the Argentine and Paraguay governments in relation to increase in the debt and to the extraordinary commissioning amounts.

Its debt, raised with the support of the governments of Argentina and Paraguay (about US$2,000 million of official goods), was affected by the difficulties of implementation of power projects obtained from the late 1980s until the early 1990s. Taking the estimates provided by the project’s sponsor (Yacyretá General Account Administration) for the commissioning effects into account, on December 27, 1990, the government of Argentina and Yacyretá Inter Team signed the Start of Construction Bonus Agreement, where the following commissioning periods were agreed. According to the agreement, the project has to be 55% commissioned before December 31, 1995; 90% by December 31, 1997; 100% by December 31, 1998; and 50% of the remainder by December 31, 1999. As all these schedules were not met, the technical and legal teams began the construction of the negotiations table with the objective to define the rescheduling of the project’s debts through increasing the grace periods, lengthening the amortization period, adjusting the interest rates to the project cash flow, and recognizing the completion benefits obtained through the revision of the project’s estimated construction costs. All these agreements are at the limit of 0%.

Case study: Yacyretá’s restructuring The process of the restructuring of the Yacyretá debt, analyzed here, is a good example of this type of refinancing. Yacyretá, a binational entity, is a public-power dam construction project shared by Argentina and Paraguay. Yacyretá initiated with the usual optimism that larger investments could solve the economic stagnation of the 1980s.