The nature of project finance necessitates that contractual agreements form the basis of limited recourse financing upon which funding for the project is raised. Some of the project contracts are developed or sourced from the sponsor group while others originate from the host government's ceding authority, debt and equity investors, and export credit agencies (ECAs), unilateral, and multilateral agencies. Many contracts are tailor made to fit specific project needs and peculiarities, but our interest is on common project finance contracts which are the pillars supporting financing structures and include:
1. The shareholder agreement, between the sponsor(s) and the project company, defines the terms of participation and ownership interest in the project, the rights and obligations, and the roles and responsibilities of the signatories. Usually, this
contractual agreement is preceded by a separate sponsor partnership agreement specifying their initial and subsequent equity and debt investments in the project company.
2. The concession agreement, also known as the implementation agreement, is a contract between the government and the project company that grants it the right to build and operate the project. It states the concession period, project company roles and responsibilities, eventual transfer of ownership, and project performance.
Concession agreements include licensing, joint venture contracts, production sharing agreements, build, operate, and transfer of ownership (BOT) and public–private
partnership (PPP) agreements, and offtake agreements. Concession agreements comply with host country laws and regulations and these contractual agreements usually include:
a. The objectives, expectations, and support to the project by the host government b. Completion and termination dates
c. The obligations of the concessionaire
d. Direct lender agreements with the host government
e. Security rights in the project company f. Force majeure clauses
g. Liquidated damages and dispute resolution
h. Changes in law and waiver of sovereign immunity
3. The construction agreement—one of the key contracts—spells out the scope of the project, the terms and conditions of a fixed price, date certain turnkey engineering, procurement, and construction (EPC) contract, and the responsibilities of the
contractor and the other project stakeholders. It covers items such as contractor responsibility for design flaws, extensions, and tests to determine completion of
construction, payment procedures, and price changes. It also deals with issues such as contractor performance bond, performance guarantees, force majeure, and liquidated damages in the event of construction delays, security retainers, and dispute resolution measures.
4. The intercreditor agreement is a contractual agreement between project lenders that defines their position relative to each other and the project company, and what happens when problems arise, such as bankruptcy or default. It also spells out their lien positions and security interests and the rights and obligations of the parties
involved and may include buy out provisions giving a lender the option to buy another lender's debt.
5. The sponsor guarantees is a form of credit support normally required by project senior lenders to reduce their risk in the project along with providing additional equity funding and cash infusions to handle cash flow shortfalls, secured interests over the project company's assets, guarantees related to project performance, and insurance against project risks
6. The insurance contracts can vary according to individual project risks and have a significant impact on risk mitigation and project negotiations and are covered in more detail in Chapter 10. Insurance contracts may include the following:
a. Transportation insurance of materials and equipment to the project site b. Insurance of project assets before, during, and after construction
c. Construction and erection of all risk insurance that covers project assets and operations during construction
d. Third party liability insurance that provides third party claims' coverage against omissions of the project company, contractors and subcontractors during
construction and operation
e. Consequential loss insurance for startup delays and business interruption
f. Political risk insurance that includes partial risk guarantees, credit guarantees, and ECA or a multilateral agency guarantees
Political risk insurance provides coverage for revocation of permits and licenses, adverse regulatory changes, changes in tax and business laws, expropriation, currency
inconvertibility, political violence and war, breach of contract, disruption of access to project company facilities, and asset transfer risks.
7. The hedging contracts are financial instrument contracts used in project finance to minimize interest rate and exchange rate risk with swaps when the parties agree to exchange floating rate to fixed rate loans and floating exchange rates to fixed exchange rates.
8. The loan agreement is an agreement between the project company and the lenders that provides loans for the project. The main parts of loan agreements include:
a. The terms of the loan disbursement and repayment terms b. Conditions precedent
c. Positive and negative covenants d. Representations and warrantees e. Remedies in the event of default
Additional project finance documentation involves an agreement on waterfall accounts, such as proceeds accounts, operating accounts, major maintenance reserve account, and debt payment and debt service accounts (Khan and Parra, 2003).
9. The equity support agreement, where the lenders shift completion and
abandonment risks to the project sponsors by requiring equity commitments in the 20–40% range and in some cases even higher.
10. The capital injection agreement deals with a future sponsor's working capital contributions to cover cost overruns.
11. The offtake agreement is contract for the entire concession period that specifies the amounts the offtaker will purchase at a specific price adjusted for inflation. There are several types of offtake agreements for specific projects and financing
requirements, the common ones being:
a. Take or pay contracts where the purchaser pays for the project company's output even if they do not take it
b. Take and pay contracts where the purchaser takes the project company's output and pays for it when the project company provides that output
From the project company and the lenders' perspective, the take or pay offtake contract is more advantageous because the project company's revenue is independent from the
production of output. Other offtake agreements include:
a. Contracts for differences, when the project output is sold in the open market but the offtaker pays if the price goes below the agreed level and vice versa if the price goes above the agreed level
b. Long term sales contracts of the project company's output
c. Throughput contracts used in pipeline projects where the user commits to carry at least a certain volume of a product and pays a minimum price
d. Input processing contracts used in waste incineration projects and sewage plants to agree to certain levels of inputs
Although project contracts form the basis for project financings, many of the problems encountered with them and project failures have to do with the terms and enforceability of offtake agreements.
12. The supplier agreement is a contract for the duration of the concession period between the project company and the supplier of the key production inputs and it is intended to ensure uninterrupted supply of key production inputs to the project company to meet its output requirements. It specifies the duration of the contract, conditions for price changes, and force majeure clauses. The supplier agreements in project finance are of the supply or pay, or put or pay type under which the supplier pays the entire cost of procuring alternative supply.
13. The operations and maintenance agreement defines the roles and
responsibilities, the length of the agreement, performance expectations, and payments to the O&M company. This contract also includes incentives and penalties for the
O&M company for meeting performance expectations.
Many of the risks associated with project finance deals are mitigated through the contracts mentioned above. However, the risks the debt investors bear beyond those contracts are mitigated with various project finance agreements, such as:
1. Each separate facility agreement, that is every debt and equity agreement entered to 2. The accounts agreement
3. Each security agreement
4. The equity support agreement
5. Each direct agreement, i.e., every lender's direct agreement with the host government 6. The drawdown request schedule
7. Each hedging agreement
In addition to the main project contracts, there are other contractual agreements and project documentation developed as part of the legal team's effort. They include ceding authority collateral agreements, project company performance bonds, collateral
guarantees, bond and private placement financing documentation, and the project prospectus or information memorandum. Notice however, that there are a number of risks that cannot be mitigated through contracts and agreements such as
misrepresentations, rigged procurement processes, corruption, and many others.
An important project finance document that is based on the feasibility study and the due diligence reports is the project prospectus or the information memorandum, which is prepared by the project team led by the legal group to market the project to potential debt and equity investors. It is a summary report of the project feasibility analyses and
evaluations, the findings of the due diligence, and the project company's business plan to demonstrate the profitable value creation of the project.