Chapter 8 The “Unique” Challenges Faced by Project
A. Project Financings—What Are They?
Project financings are “funding structure[s] that rel[y] on future cash flow from a spe- cific development as the primary source of repayment with that development’s assets, rights and interests legally held as collateral security.” 37 Project financings have
37 RICHARD TINSLEY, ADVANCED PROJECT FINANCING — STRUCTURING RISK 2 (2000). See also Anthony B. Kulkin, Real Estate Financing Documentation: Coping with the New Realities, Project Financing for the Real Estate Lawyer , CA20 A.L.I.-A.B.A. 251, 254 (Jan. 4, 1996);
John B. O’Sullivan, Project Financing 1999: Building Infrastructure Projects in Developing Markets , 784 PRACTISING L. INST. 61 (1999); Roger D. Feldman and Scott L. Hoffman, Project Financing 1987: Power Generation, Waste Recovery, and Other Industrial Facilities, Basic Concepts of Project Finance Documentation: Risk Allocation, Drafting, and
historically been recognized as valuable tools for funding the construction of massive public and private works. 38 Examples include toll roads, airports, schools, hospitals, refineries, dams, and traditional and renewable energy power plants. 39 It has even been suggested that project financings are the “primary vehicle for financing cross-border investments throughout the world.” 40
B. Distinguishing Project Financings from Traditional Corporate Bank Lending
Distinguishing project financings from traditional corporate bank lending is important, because some features of project financings that distinguish them from traditional cor- porate financings inform our discussion.
1. Recourse vs. Non-recourse Most of the publicly available literature distinguishes project financings from traditional corporate financings on the basis of recourse. 41 Specifically, traditional corporate bank loans are full recourse to the borrower’s bal- ance sheet. 42 Conversely, loans in project financings, “project loans,” are extended on a limited or nonrecourse basis. 43 Project lenders do not generally have recourse to the project sponsor’s balance sheet for repayment of the project loans, with certain limited exceptions. The proceeds from the project loans will be used to fund the cost of con- structing the project. 44 Typically, that debt will be supported by some quantity of equity investment that is usually sourced or directly provided by the project sponsors. The cash flows generated from sales of the project’s outputs, assuming construction is completed and it becomes operational, will be used to repay the project loans and gen- erate a return for the equity investors. From the project sponsor’s perspective, project financings are a way of sharing project risk with project lenders and other parties. 45
Regulatory Considerations for Power Sales and Fuel Supply Contracts , 297 PRACTISING L. INST. 399, 403 (1987); The Equator Principles, available at http://www.equator-principles.com/prin- ciples.shtml (last visited Mar. 22, 2010) (citations omitted).
38 Nan Zhang, Note, Moving Towards a Competitive Electricity Market? The Dilemma of Project Finance in the Wake of the Asian Financial Crisis , 9 MINN. J. GLOBAL TRADE 715, 716 (2000) ( quoting Mark J. Riedy, Legal and Practical Considerations in Structuring Business Transactions in India for the Conference Entitled: India Power , 3 CARDOZO J. INT’L & COMP. L . 313, 318 (1995)).
39 See TINSLEY, supra note 37.
40 See, e.g. , id.
41 TINSLEY , supra note 37, at 2; see also O’Sullivan supra note 37; Feldman & Hoffman supra note 37; The Equator Principles supra note 37.
42 TINSLEY , supra note 37, at 2.
43 Id.
44 Id. at 1–2.
45 TINSLEY, supra note 37, at 1; see also PETER K. NEVITT & FRANK J. FABOZZI, PROJECT FINANCING
VII (7th ed. 2000).
PROJECT FINANCINGS; RISKS AND MONETIZATION
Project financing is a way of being able to meet customer requirements on the bor- rower side while balancing the demands of the lenders to generate a better risk adjusted return than other investments available in the marketplace. The nonrecourse nature of the project loans also enables the project sponsor to develop multiple projects without risking its balance sheet if any one of the projects under development fails, which means that the project sponsor is able to leverage its equity investments without sacri- ficing its entire balance sheet to support any single project. Project lenders base the extension of credit reflected in the project loans on the present value 46 of the future project cash flows and, subject to certain limited exceptions, agree that they will have recourse only to the project company as collateral, and not to the project sponsor.
Project lenders require project sponsors to invest a meaningful amount of equity in the project company to support the extension of the project loans, and the amount of proj- ect sponsor equity required in the current climate is only increasing. Project sponsors are almost always the principal equity investors in the project company.
2. Collateral Security Interest Package Defensive in Nature The saleable value of the project, especially prior to the operation phase, is not typically a significant basis for the extension of the project loans. 47 Until the project is constructed and operating, the rights of the project lenders to the collateral is not a complete solution to the risk of project default. An uncompleted project will almost always leave the sum of the parts being worth far less than the completed whole. In a default scenario, often the project lenders’ only practical option to recover a meaningful amount of their loan is to step in and complete construction and/or operate (directly or by hiring a third party) the com- pleted project to generate outputs, which can be sold to create the cash flows necessary to make themselves whole. 48 This is one of the features of project financings which distinguishes them from most traditional securitizations, which are premised on cash flows from assets already in existence. The element of risk and uncertainty surround- ing the performance, or even existence, of future cash flows distinguishes project financings from more traditional lending products. Even in the case of whole business securitization and future flow securitizations, which are slightly more exotic than most traditional securitizations, and based partially on cash flows to be generated in the future, the securitization is based on an existing enterprise or business already generat- ing cash, as opposed to lending against cash flows from a to-be-constructed project works. Although project financing and securitization share some similarities they are not precisely identical. 49 Indeed, project financings and securitizations might reason- ably be described as being of the same genus, but members of different species.
46 Id .
47 Nevitt & Fabozzi, supra note 45, at 51–55.
48 See TINSLEY, supra note 37, at 10, 13.
49 For a discussion of project fi nancing securitizations, see Chapter 21.