The debt funders are granted security over the company’s assets. In effect, the sponsor’s liability is limited to their equity contribution or any other obligations they may own in other capacity.
The lenders will analyse the project and undertake considerable legal, technical, financial due diligence on the project. Key considerations include the allocation of risk, the obligations of consortium members, covenants, the capability of subcontractors and the security offered. They lender must at least be satisfied that every participant in the project is sufficiently strong, given the interdependent nature of each player.
The lender will assess the cash flows and the risks attaching to them. Risks should be allocated to the person who is best in the position to bear it. The project company should have as few risks as possible giving its limited nature. If the funders are not satisfied as the ability of the contractors to bear a risk, they will generally not be willing to have it borne by the project company given its limited equity or subordinated debt. The debt funder’s interest must be considered at the bidding stage.
Key considerations include planning, design, construction and completion. Generally no payment will be forthcoming until these are delivered. The capacity and capability of the participating entities to deliver completion is critical.
Operational risk arises in the context of ongoing payments based on continued compliance with the requisite standards and requirements. The lender will need to be satisfied that the payment mechanisms are structured so as to avoid tax withholding or deductions from the payments.
The lender must be satisfied that the cost estimates, capital and operating are realistic and make sufficient provision for contingency. Although, the bank may not directly base to carry the risk of mispricing, the borrowing entity may not have a strong covenant and the funder will wish to be satisfied that the pricing is sufficient to deliver the obligations undertaken.
A funder will wish to ensure that the payment or payments are not subject to the risk of deductions for underperformance. The funder might be concerned at requests for additional services. This may alter the structure of the risk and project.
There may be risks related to changes in the law, legal capacity cost or other critical impediment. This may be a particular issue in jurisdictions which lack reliable application of the law and enforcement. The relevant entity or awarding authority must have sufficient powers and capacities.
The funder must be satisfied with the requisite property rights and with the physical condition of the land in the context of what must be delivered. Issues may arise in relation to residual value, if this is an element of the project that is important. Site conditions including risk of contamination and discovery of antiquities etc. fossils may be significant.
The funder will wish to assess the financial management and technical strength of the sponsors behind the project and key contractors. The consortium must have sufficient key minimum attributes. They must have the technical competence, expertise and resources to perform the project agreement.
The creditworthiness of consortium members will be relevant to the extent that it arises in the context of the recourse available to the funder, reliance on security and completion covenants and other support being granted by them. There may be prohibitions on the key members and sponsors transferring shares in the initial phases or at all.
Certain risks may be insurable and insured. The project should be insured in accordance with normal construction practice by the contractors, subcontractors and /or project company as appropriate. Awarding authorities may wish to be insured in respect of their respective interest.
Funders may wish to have a first call on proceeds to pay their debt. However, there must be a recognition of the interest of the authority in ensuring that the relevant service or the structure is provided, and if damaged is reinstated. There may be accordingly an obligation as to reinstatement provided the project is built substantially in accordance with original specifications and insurance covers the debt servicing during the reinstatement period. There may be circumstances where due to failure of economic tests, the monies must be applied in repayment of loans.
The lenders and funders will be very concerned about circumstances in which the project may be terminated. They will wish to keep the project alive as in the event of termination, the revenues are likely to be destroyed.
The funder may negotiate a right to step in, in the event of default. This may involve appointing a receiver or a substitute entity to perform the services and ultimately sell the project company as a going concern to another entity.
The funder will be concerned with provisions relating to compensation or early payment in the event of early termination. The funder will wish to ensure that the awarding authority does not obtain a windfall gain where it has funded the bulk of costs. Repayment of the outstanding debt may be required.
The funders may wish to transfer their interest under the credit agreement. This will generally be acceptable provided the awarding authority is advised of the identity of the funders. In some sensitive cases, there may be a restriction on transfer.
The security will not generally include effective security over the primary assets. The borrower may have no proprietary rights and such rights as it might have, may or are likely to be terminated on its default. The security is unlikely to be saleable in most cases given its public purpose.
Debt funders will seek to affix its relevant charge over the assets and undertaking of the project company revenues, monies deposited, proceeds of insurance and contractual rights of the company under the agreements. Security is likely to be taken over shares in the company. The funder will wish to maintain the integrity of the project in the event of breakdown. Further control may be ensured through direct agreements with the awarding authority and subcontractors.
The credit agreement will reflect two key phases namely the developing phase to completion and the operating phase. The credit agreement will generally be required to fund the construction phase. It will be paid off over the period of the project from revenues.
The loan credit agreement will be on commercial grounds reflecting with additional features reflecting the PPP element.
The purpose will be tightly prescribed. There may be separate facilities dealing with different aspects such as construction costs. There may be a standby facility dealing with overruns and other financial accommodation by way of a working capital facility.
Funders may wish to ensure monies are put to their intended purposes through a dedicated project account.
Funds are permitted to be applied towards payments due to the construction company, expenses of advisors, fees payable to arrangers, agents etc.
Draw down will be permitted subject to conditions precedent. The general conditions precedent may include those common to most loan agreement such as
- company constitutional documents,
- compliance with authorisations, licenses,
- planning permissions,
- execution of all finance and security documents.
Some documents and conditions more specific to PPP projects may be required such as
- copies of project documentations,
- leases, licenses, relevant agreement,
- evidence of due authorisation,
- legal opinions;
- consents required for design, construction, management and operation;
- reports on title where necessary;
- reports of specialist advisers such as engineers, valuers etc.;
- project budgets;
- base banking case demonstrating sufficient ratio covers for key banking ratios, evidence of minimum capital etc.
Conditions will be applicable to each drawing. Evidence would be that monies are applied towards the requisite use in accordance with the anticipated budget and associated financial model.
Certification will be required that the company has the requisite funds by way of equity, subordinated debt to enable it complete construction and achieve operation.
The repayment schedule and profile will reflect the revenues. Repayments will be tailored to the relevant cash flow. . Payments usually are rolled up during the construction phase. Interest may be rolled up. The minimum repayment will reflect the worst-case scenario. The payments are likely to be over periods that is less than the full use period.
Extensive representations and warranties will be required similar to those in ordinary lending. In addition, project specific covenants will be required including
- validity of project agreements,
- relevant licenses, consents,
- project company having no liabilities
- good title.
Covenants will be extensive. Regular progress reports will be required during construction and during the operational phase relation to performance matters. Information will be required in compliance with respect of obligations and the events causing delay and other impacts upon timing must be reported.
There will be an obligation to ensure no event of default occurs and if it does to give notice. Insurances will be required. Consents etc. must be maintained in being.
The project company is restricted from amending of changing project agreements, authorisation and consents without permission.
Negative covenants against acts which are adverse to the funder will apply e.g.
- restrictions on incurring additional debts
- not giving guarantees security to other
- not disposing of rights under the agreement,
- not incurring capital expenditure other than in accordance with the budget, not changing business etc.
Events of default additional to those found in conventional lending may be provided for e.g. any matter which would threaten the viability of the project such as
- non-completion of construction by a long stop date,
- failure to contribute to equity,
- adverse governmental action,
- breach of ratios etc.
may be events of default. Default will allow the funder to restructure if necessary for default or step in and terminate the agreement,
Inter-creditor agreements may be required where there is more than one funding source. They may deal with mechanisms or procedures for the enforcement of security, acceleration of relevant debt, obligations, step-in rights etc. procedure for agreeing changes. Provision will be made for th application of revenues and the proceeds of enforcement.