international project finance in a nutshell

WEST ACADEMIC PUBLISHING’S LAW SCHOOL ADVISORY BOARD JESSE H CHOPER Professor of Law and Dean Emeritus, University of California, Berkeley JOSHUA DRESSLER Professor of Law, Michael E Moritz College of Law, The Ohio State University YALE KAMISAR Professor of Law Emeritus, University of San Diego Professor of Law Emeritus, University of Michigan MARY KAY KANE Professor of Law, Chancellor and Dean Emeritus, University of California, Hastings College of the Law LARRY D KRAMER President, William and Flora Hewlett Foundation JONATHAN R MACEY Professor of Law, Yale Law School ARTHUR R MILLER University Professor, New York University Formerly Bruce Bromley Professor of Law, Harvard University GRANT S NELSON Professor of Law, Pepperdine University Professor of Law Emeritus, University of California, Los Angeles A BENJAMIN SPENCER Professor of Law, University of Virginia School of Law JAMES J WHITE Robert A Sullivan Professor of Law Emeritus, University of Michigan I INTERNATIONAL PROJECT FINANCE IN A NUTSHELL® SECOND EDITION by JOHN M NIEHUSS Adjunct Professor University of Michigan Law School Mat #41654610 II The publisher is not engaged in rendering legal or other professional advice, and this publication is not a substitute for the advice of an attorney If you require legal or other expert advice, you should seek the services of a competent attorney or other professional Nutshell Series, In a Nutshell and the Nutshell Logo are trademarks registered in the U.S Patent and Trademark Office © 2010 Thomson Reuters © 2015 LEG, Inc d/b/a West Academic 444 Cedar Street, Suite 700 St Paul, MN 55101 1-877-888-1330 West, West Academic Publishing, and West Academic are trademarks of West Publishing Corporation, used under license Printed in the United States of America ISBN: 978-1-62810-134-8 III This book is dedicated to, and was inspired by, the memory of my father, Marvin L Niehuss (1903–2003) He was an educator associated with the University of Michigan for over sixty years as a student, faculty member, and administrator serving as Vice President, Dean of Faculties, and Executive Vice President When he retired from active service in 1973 and became a Professor Emeritus of Law, the Regents of the University noted that his “commitment and service to the University have rarely been equaled” and that “few men in the history of the University have come to know it so well or done more to shape its destiny.” V PREFACE This is a book about the legal aspects of a very practical subject: how to raise funds for the construction and operation of major projects using a financing technique known as “project finance” One of the major challenges of the early twenty first century will be financing the massive investment required to expand the infrastructure needed for economic growth in both developed and emerging market economies The expected global demand for energy, minerals, and other commodities suggests that major new investment will also be required in these sectors Project finance will be one of the main methods used to raise funds for projects designed to meet these investment needs The book introduces the concept of project finance and then focuses on the main legal issues that arise during each phase of a typical international project finance transaction It is intended as a basic introduction for law students and lawyers who have had no previous exposure to the field and emphasizes basic principles and concepts while leaving details to more in-depth books and articles The focus is primarily legal in nature as the specific topics and issues covered are designed to provide a foundation for a young lawyer embarking on a career in project finance However, the book includes extensive coverage of financial and credit support issues and may be of interest to bankers VI and other non-lawyers looking for an overview of an international project finance transaction The content is based on materials used in a course taught at the University of Michigan Law School and is designed as a supplement to law school courses and other seminars on project finance that rely heavily on the analysis of sample documents and case studies of major projects This Second Edition has been revised and expanded to cover the use of project finance to fund PPP’s and infrastructure, the impact of the 2008 financial crisis and the resulting Basel III regulations on project finance, and other major developments over the past few years New chapters have been added to illustrate the practical application of project finance principles and techniques to projects in the infrastructure sector and the oil, gas and mining sectors The chapters on operating agreements have been substantially revised, and the discussion of syndicated loans has been expanded Additional appendices have been added to provide checklists and summary information on taxation and financial issues It is divided into eight main sections as follows: Part I—Introductory This section provides an explanation of the concept of project finance and outlines the role of the lawyer in an international project financing transaction Part II—Basic Project Preparation Part II describes the extensive preparatory work that must be done for each project to assess risks, conduct due VII diligence, plan for procurement, and create the basic legal structure of the project Part III—Project Documents This part of the book deals with the agreements that: establish the basic relationship between the host government and the SPV; allocate risk among the key project participants; govern the actual construction and operation of the project; and work together in an integrated way to create the revenue stream that serves as the foundation for raising finance for the project Part IV—Arranging Finance This section describes the main sources of finance and their characteristics and the process of developing a finance plan and arranging finance Part V—Credit Support This part covers the various forms of credit support commonly used in project financing including insurance, guarantees and bonding, security over project assets, and derivatives Part VI—Financial Documentation This section describes the various loan agreements and the other ancillary documents that govern the provision and administration of funding for projects, including analysis of loan agreement clauses and relations among the various creditors Part VII—When Problems Arise This part deals with the fact that the long term, complex nature of most project financings means that problems inevitably arise and need to be dealt with through VIII renegotiation and restructuring or various dispute settlement mechanisms Part VIII—Application of Project Finance to Specific Economic Sectors The final section discusses the application of project finance principles and techniques to specific economic sectors with an emphasis on infrastructure, oil and gas, and mining JOHN M NIEHUSS November 2014 IX ACKNOWLEDGMENTS I would like to thank Ned Neaher, an experienced project finance partner at the law firm of White & Case, for his significant contribution to this edition of the book As he did for the First Edition, he reviewed a draft of the manuscript, spent time answering my questions about current practices in the project finance field, and provided many valuable suggestions that led to changes that improved the final product Any errors or omissions are, of course, my own I would also like to acknowledge the contribution of W Joseph Wilson, a mentor for several years while I was working as an investment banker at Merrill Lynch White Weld Capital Markets in the 1980’s Joe was one of the best of the old school investment bankers who put client interests first He has an incredibly creative and innovative mind; and, in 1982, he created, developed and introduced to the US financial markets a form of U.S government zero coupon bonds This led him to, inter alia, pioneer the use of zero coupon government bonds as an institutional and retail investment vehicle and as collateral for various sovereign bond issues (e.g Brady Bonds) He supported my interest in international project finance advisory work and enabled me to gain valuable experience in the field XI ABBREVIATIONS XII FIXED PRICE CONTRACT, 127–128, 133 FLOATING CHARGE, 240 FORCE MAJEURE CLAUSE General, 105 Inconsistencies in force majeure clauses, 107–108 Required impact on performance, 108 Unavoidable event, 108 Unforeseeable event, 108 FOREIGN EXCHANGE (See “Currency”) FORM OF THE SPV Most common forms Corporation, 74 Partnership, 74 Unincorporated joint venture, 75 Options 72–73 FORWARD CONTRACT, 248 FRUSTRATION OF CONTRACT, 106–107 FUTURES CONTRACT, 248 GOVERNANCE As due diligence issue, 405 Nature of project governance, 82–84 GOVERNING LAW, 104, 122, 342, 412 GUARANTEES General, 10, 137–138, 219, 234–236 Completion guarantee, 22–23, 234 ECA guarantees, 232–233, 236 MDB guarantees Partial credit guarantee, 229 Partial risk guarantee, 228–229 HALO EFFECT, 231, 232, 313 HARDSHIP CLAUSE, 118 475 HEDGING, General, 47, 249 Hedge providers, 15 Intercreditor agreement issues, 314–315 HELL-OR-HIGH-WATER CONTRACT, 157 HOST GOVERNMENT ROLE, 12, 216–218 HUMAN RIGHTS, 43 HYBRID PROJECT FINANCING, 94 ICSID (International Centre for Settlement of Investment Disputes), 344, 351 IMPREVISION, 106 INDEPENDENT ENGINEER (See “Construction Contract”) INFORMATION MEMORANDUM, 273–274 INFRASTRUCTURE FINANCE General, 355–367 Power: fossil fuel, 368–374 Power: renewables, 374–379 Telecommunications, 384–387 Transport: airports, ports, light rail, 383–384 Transport: roads, 380–383 INPUT OR SUPPLY AGREEMENT (See “Supply Agreement”) INSURANCE Bond insurance, 227, 209–210, 233 Commercial, 221–228 Cut-through clause, 226 From export credit agencies, 232, 236 Lenders’ interest in insurance, 221–222 Loan agreement provisions, 226–227 Non-vitiation clause, 224–225 Political risk General, 230–231 From bilateral agencies, 233 From export credit agencies, 232 476 From MIGA, 230–231 From OPIC, 233 From private insurers, 224 Reinsurance, 225 Scope of coverage General, 222, 224 Construction period, 222–223 Operational period, 223–224 INTEGRATION OF PROJECT AGREEMENTS, 103–104 INTERCREDITOR ISSUES General, 307–308 Hedge providers and derivatives, 256, 314–315 Intercreditor agreement, 308–309 Negative pledge clause, 315–318 Offshore trust accounts, 318 Pari passu clause, 294, 308–309 Pledge of shares, 318–319 Preferred creditor status, 310–314 Sharing clause, 295, 308–309 INTEREST RATE SWAPS, 248, 252, 255 INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION (ISDA), 250 INVESTMENT LAW As due diligence issue, 46–47 Bilateral investment treaties, 46, 343–346, 348–349, 352 Energy Charter, 47, 343 NAFTA, 343 ISDA DOCUMENTS Definitions, 251 Confirmations, 251 Credit Support Annex, 251 Master Agreement, 250 Schedule to Master Agreement, 250 ISLAMIC FINANCE Characteristics, 204 Compatibility with project finance, 205–206 477 Istisna’a, 205 Shariah boards, 204 Sukuk, 204 Techniques, 204–206 JOINT VENTURE, 70, 75, 78, 80–82 KYOTO PROTOCOL, 202 LAWYERS, ROLE OF General role, 30 Work by project phase Completion testing/start-up, 33 Construction, 32 Feasibility, 31 Operation, 33 Preparation and procurement, 31 LEASE FINANCING, 91–93 LEGAL DUE DILIGENCE, 40–42 LEGAL OPINIONS, 299–300 LENDER CONCERNS General, 9, 13, 85–86, 185–186 With concession clauses, 123–125 With construction contracts, 132 With offtake contracts, 155–156 With operational contracts generally, 143–145 LETTER OF CREDIT, 219, 220 LEVERAGE, 9, 176, 182 LIMITED RECOURSE FINANCING, 7–8 LIQUIDATED DAMAGES General, 135 Delay damages, 135 Delay in construction, 117 Performance damages, 135 LOAN AGREEMENT (GENERAL) Basic structure, 279–282 478 Closing memorandum, 276, 298 Common terms agreement, 275, 297–298, Appendix 7, 455 Legal opinions, 276, 299–300 Syndicated loan Administration, 300–306 Function, 270 Funding, 277–278 Process, 271–276 Types, 270–271 LOAN AGREEMENT (SPECIFIC CLAUSES) Change of Circumstances Clauses Illegality, 290 Material Adverse Change, 290–291 Dispute Resolution Clauses Governing Law, 296 Submission to Jurisdiction, 296 Waiver of Immunity, 296 Lender Protection and Control Clauses Conditions Precedent, 283–284 Covenants, 284–285 Events of Default, 285–286 Loan Acceleration, 286 Representations and Warranties, 283 Reserved Discretion, 288–289 Right of Set-Off, 289–290 Margin Protection Clauses Broken Funding Clause, 293 Capital Cost, 292 Increased Cost, 291 Market Disruption, 292 Tax Gross-Up, 292 Relations Among the Lenders Cross-Default, 293–294 Negative Pledge, 295, 315–318 Pari-Passu, 294 Sharing of Payments, 295 MANAGEMENT AND CONTROL, 79–80, 186, 259–260 MANDATE LETTER, 271–272 479 MARKET FLEX CLAUSE, 272 MASTER LIMITED PARTNERSHIP, 75, 97–98 MATERIAL ADVERSE STATE ACTION CLAUSE, 118 MEDIATION, 337 MEZZANINE FINANCE, 185, 201–202 MIGA (MULTILATERAL INVESTMENT GUARANTEE AGENCY), 230–231 MINING PROJECT FINANCE, 395–396 MULTILATERAL DEVELOPMENT BANKS (MDB’s) Characteristics of MDB finance, 197–199 MDB credit support B-loan programs, 229, 311–314 Currency devaluation mitigation, 231 Halo effect, 231, 313 Output based aid, 232 Partial credit guarantee, 229 Partial risk guarantee, 228 Political risk insurance, 230–231 NAFTA, 343 NEGATIVE CARRY, 194–196 NEGATIVE PLEDGE CLAUSE, 295, 315–318 NON-RECOURSE FINANCE, 7–8 OFF-BALANCE SHEET FINANCE, 4–6 OFFERING MEMORANDUM (See “Information Memorandum”) OFFTAKE/USER AGREEMENTS Capacity charge, 162 Due diligence, 155–156 Lender preferences, 159–161 Price adjustments, 163–164 Specific types of agreements 480 Hell-or-high-water, 157 Retail, 154 Take-or-pay, 157–158 Throughput-and-deficiency, 158 Tolling, 158 Wholesale, 154–155 OFFSHORE ESCROW ACCOUNTS, 318 OIL AND GAS PROJECT FINANCE Characteristics, 389–390 LNG projects, 394–395 Risks, 391–392 Techniques used to finance, 392–394 ON BALANCE SHEET FINANCE, 4–6 OPERATING AGREEMENTS General, 141–143 Lender interests, 143–145 Concession, 115–125 Offtake/User contract, 153–168 Operation and Maintenance Agreement, 148–152 Supply agreement, 146–148 OPERATIONAL PHASE, 24, 33 OPERATION AND MAINTENANCE AGREEMENT, 148–152 PAITON PROJECT, 331–334 PARI PASSU TREATMENT, 294, 308–309 PARTIAL CREDIT GUARANTEE, 229 PARTIAL RISK GUARANTEE, 228–229 PARTICIPANTS IN A PROJECT FINANCING Advisors, 17 Contractors, 14–15, 130, 132 Credit support providers, 15 and see “Credit Support (Providers)” Engineers, 14, 130 Hedge providers, 15–16 Host government, 12, 216–218 481 Input suppliers, 16 Lenders, 13, 85–86, 185–186 Operator, 16 Purchasers and users, 16, 154–155 Special project vehicle, 13–14 Sponsors, 12–13, 67–82 PARTNERSHIPS, 73, 74, 97–98 PAYMENT TRUST (See “Project Account Agreement”) PERFORMANCE LIQUIDATED DAMAGES, 135 PERMITS AND LICENSES, 22, 31 PHASES OF A PROJECT (see “Stages of a Project”) PLEDGE OF SHARE ISSUE, 318–319 POLITICAL RISK INSURANCE, 224, 230–231, 233 POWER PURCHASE AGREEMENT, 164, 373 PREFERRED CREDITOR STATUS, 229, 310–314 PROCUREMENT General, 50–54 Bidding for concessions, 59–63 Bidding rules, 54–55 Competitive bidding, 52–54 Due diligence, 409–410 Legal issues, 57–58 Role of finance, 62–63 Site acquisition, 63–64 Stages of bidding, 57–58 Unsolicited bids, 61–62 World Bank procurement review, 53–54 PRODUCTION PAYMENT FINANCING, 90 PROGRESS PAYMENTS, 137 PROJECT ACCOUNT AGREEMENTS General, 10 Operation period account, 303 482 Primary account, 303–306 Purpose, 303 Sub-accounts Compensation, 305 Debt prepayment, 304 Debt service reserve, 304 Operating cost, 304 Tax payment, 304 PROJECT COMPANY (see “Special Project Vehicle”) PROJECT DOCUMENTS Concession, 115–125 Construction contract, 127–139 Coordination of project documents, 103–104 Integrated nature of project documents, 102–103 Offtake/User agreement, 153–168 Operation and Maintenance Agreement, 148–152 Supply Agreement, 146–148 PROJECT PREPARATION General, 20–22 Funding project preparation, 174 PROJECT RISKS General, 8, 38–40 Identification, 40 Methods of risk classification, 38–39 Mitigation, 39, Appendix 1, 399 Risk matrix, 39, Appendix 1, 399 PROJECT SIDE LEGAL WORK, 34 PUBLIC PRIVATE PARTNERSHIPS (PPP’s) General, 96–97 As due diligence issue, 46 Definition, 96, 356 Financing PPP’s, 360–362 Reasons for use, 357–358 Types, 358–360 REINSURANCE, 225–226 483 RELIEF EVENTS Commercial impracticality, 107 Fait du prince, 106 Force majeure, 105 Frustration of contract, 108–109 Hardship, 106 Impossibility of performance, 107 Imprevision, 106 Material adverse change, 106 Material adverse state action, 106 Undue burden, 107 RENEGOTIATION CLAUSES Automatic adjustment, 324 Automatic review, 324 Specific renegotiation clause, 324 REPRESENTATIONS AND WARRANTIES, 280, 283, 456–457 RESERVE BASED FINANCING General, 89–90, 393 Production payments, 90 Production sharing, 89 RESETTLEMENT ISSUES, 44, Appendix 2, 413 RESTRUCTURING Examples of restructurings, 331–334 Key variables, 328 Organizational and institutional aspects, 327 Political and social aspects, 329 Potential problem areas, 329–330 Prerequisites for restructuring, 326–37 Process, 325 Role of lawyers, 330–331 Standstill agreement, 326 RETAINAGE, 137 RETENTION BONDS, 137, 220 REVENUE STREAM, 4, 7, 85–86, 103 484 RISK (See “Project Risks”) RISK MATRIX, Appendix 1, 399 SECURITIZATION, 3, 97 SECURITY Collateral account agreement, 301–302 Direct Agreement, 242–244 Due diligence issues, 239–242 Enforcement, 241 Host country laws, 238–239 Process for obtaining, 240 Purpose of security, 237–238 Security in concession rights, 124 Typical security package, 244–245 SET-OFF RIGHTS, 289 SHAREHOLDER AGREEMENT, 77–82 SHARIAH BASED FINANCE (See “Islamic finance”) SITE ACQUISITION, 63–64 SOURCES OF FINANCE Bilateral institutions, 193, 201 Capital markets, 195–196 Carbon finance, 202–203 Commercial banks, 194–195 Evaluation criteria, Appendix 5, 439 Export credit agencies, 199–201 Impact of Basel III regulations, 206–209 Infrastructure funds, 193, 196 Islamic finance, 204–206 Multilateral development banks, 193, 197–199, 203 Project participants, 193 Sponsors, 193, 201 SOVEREIGN BORROWING, 4–6 SOVEREIGN IMMUNITY In concessions, 121 485 SPECIAL PROJECT VEHICLE (SPV) General, Bankruptcy remoteness, 71–72 Governance, 82–84 Structuring the SPV Basic considerations, 69–71 Options for legal form, 72–74 SPONSORS, 12–13, 26–28, 69–72, 193, 201 STABILIZATION (OR CHANGE IN LAW) CLAUSE, 119 STAFFING A PROJECT FINANCING Lawyers, 30–34 Non-lawyers, 29 STAGES OF A PROJECT FINANCING Completion testing/start-up, 23–24 Construction, 22–23 Operating, 24–25 Pre-construction Feasibility, 19–20 Pre-feasibility, 18 Preparatory, 20–22 STANDSTILL AGREEMENT, 326, 333 STEP-IN RIGHTS Concession, 121, 123, 433–434 Other project documents, 242–244 STRUCTURED FINANCE, 3–4 STRUCTURING A PROJECT FINANCING Basic considerations Accounting, 70 Bankruptcy remoteness, 71–72 Control and management, 71 Limited liability, 70 Sponsor objectives, 68–69 Tax, 69–70 Basic techniques and structures Advance payment, 90 486 Charterparty contract, 93, 158–159, 167 Construction trust financing, 93 Contractual credit support, 86–88, 157–161 Deficiency agreements, 88 Hybrid financing, 94 Lease financing, 91–93 Production payment, 90 Project accounts/cash flow control, 95, 302–306 Public-private partnerships, 96, 356–360 Reserve based financing, 89–90 Chain of investment, 76–77 Lender concerns, 85–86 Overall project, 85–98 Process, 67–68, 85 Relations among owners Checklist, 80–82 Financial issues, 78–79 Management and control, 79–80 Special project vehicle, 72–76 SUBORDINATED DEBT, 184–185, 201 SUPPLY AGREEMENT, 146–148 SURETY BONDS, General, 220–222 Advance payment bonds, 137 Bid bonds, 220 Performance bonds, 138, 220 Retention bonds, 220 Warranty bonds, 220 SYNDICATED LOANS Administration, 300–306 Closing, 276, 298 Common terms agreement, 275–276, 297–298, Appendix 7, 455 Function, 270 Funding, 277–278 Key clauses (See “Loan Agreement (Specific Clauses)”) Legal opinions, 299 Mandate letter, 271 487 Process, 271–276 Structure, 279–282 Syndicate formation, 274 Term sheet, 273 Types, Revolving, 270–271 Swingline, 271 Term, 270–271 Working capital, 271 TAKE-OR-PAY CONTRACT, 157–158 TAX ISSUES General, 69 Chain of ownership, 76 Checklist of issues, Appendix 3, 415 Form of the SPV, 69, 73–76 Lease transactions, 91–93 TECHNIQUES AND STRUCTURES Advance payment, 90 Charterparty contract, 93 Construction trust, 93 Contractual credit support, 86–88 Deficiency agreements, 88 Equity funding methods, 97–98 Hybrid financing, 94 Lease financing, 91–93 Production payment, 90 Project accounts/cash flow control, 95, 302–306 Public-private partnerships, 96, 356–360 Reserve based financing, 89–90 TERMINATION COMPENSATION Concession, 120–121,124, 434 TERM SHEET, 273 THROUGHPUT-AND-DEFICIENCY AGREEMENT, 158, 165 TOLLING AGREEMENT, 158, 165–166 TURNKEY CONTRACT, 128 488 UMBRELLA CLAUSE, 348–349 UNCITRAL, 341 UNILATERAL TERMINATION RIGHTS, 120, 437 UNINCORPORATED JOINT VENTURE, 73, 75–76, 78 UNSOLICITED BIDS, 61–62 WARRANTIES, 138, 221 WATERFALL ACCOUNT, 305 WEATHER DERIVATIVES, 253 YIELDCOS, 97–98 ... of the main legal issues that arise at various stages of a financing A WHAT IS INTERNATIONAL PROJECT FINANCE? Project finance is a special method of raising funds for projects—primarily in the... PART I INTRODUCTORY Chapter Overview of International Project Finance A What Is International Project Finance? A Type of Structured Finance Comparison with Corporate and Sovereign Finance B Basic... INTERNATIONAL PROJECT FINANCE IN A NUTSHELL SECOND EDITION PART I INTRODUCTORY CHAPTER OVERVIEW OF INTERNATIONAL PROJECT FINANCE This chapter provides an overview of an international project finance transaction