The quintessence of project financing is the parcelling out of project and other risks amongst the numerous parties participating in a given project. This apportionment of risk is achieved through the complex array of contractual relations between the various project parties as defined in the contracts concluded between them. The manner in which projects must be structured or how the risks should be allocated amongst the project parties is not cast in stone.
The structure of each project is often shaped by the legal and regulatory framework in the jurisdiction in which it is undertaken. Consequently, the contracts between the various project parties are of fundamental importance because they constitute the instruments in terms of which many of the project risks are distributed amongst the project parties.
There is no such thing as a standard set of project documents. Each project has its own suit of documents specifically fashioned for that particular project. This article describes, with suitable brevity, some of the key documents found in many a project financing structures.
It is not uncommon for first time project sponsors and project stakeholders to be extremely repulsed or off-put upon their initial encounter with Project Finance documents. Admittedly, project finance documents are voluminous, complex, expensive and time-consuming. Nonetheless, not only are these documents critical to successful project financing, they are also essential to the successful construction and operation of the project.
The principal agreement in any project financing is the project agreement. It regulates the relationship, rights and obligations between the public authority and the project company throughout the term of the project. It is also frequently referred to as a concession agreement.
The concession agreement is often the key project document in the majority of projects, especially in Build-Operate-Transfer (“BOT”) projects. It is the document that confers the right to explore, exploit, develop or operate the concession on the project company. In other cases, all that it takes for a project company to be vested with the necessary legal rights to exploit is just a licence. However, in a BOT project, it is usually the case that the project vehicle is granted a concession by the host government with respect to the project.
An assortment of construction contracts are used in project financings, however, most project sponsors and project finance lenders almost always settle for turnkey contracts. In a turnkey contract, a single general contractor assumes all risk of on-time completion of a project which meets guaranteed performance standards. The owner specifies overall performance and reliability standards for the plant, and the turnkey contractor assumes full responsibility for design, construction, supply, installation, testing and commissioning of the plant so as to enable it to meet those specified requirements. Invariably, the most desirable type of construction contracts in project financings are Engineering, Procurement, and Construction Contracts, or EPC Contracts. In terms of EPC Contracts the contractor is enjoined to design, engineer, build and deliver the project for a fixed-price, by a specified date, according to the construction documents, plans, specifications, shop drawings and other support documents.
The offtake agreement is the agreement pursuant to which the off-taker buys all or a substantial portion of the output from the facility and provides the revenue stream supporting a project financing. Offtake Agreements are usually the most important documents in terms of securing approval of a project finance loan. Offtake Agreements are accorded greater weight than most of the project documents because they provide the financial assurances lenders need to validate your cash flow forecasts. All project finance lenders rely on Offtake Agreements for that reason.
On account of the fact that one is trying to place a loan for a project that is not yet in operation, there is no income stream with which to pay debt service. Rather, one can only present project lenders with financial models which are uncertain. Offtake Agreements constitute documentary evidence which substantiate the financial models on which the ability to repay is based. In a nutshell, Offtake Agreements make projects bankable.
Operation and Maintenance Agreements
Operation & Maintenance Agreements (O&M Agreements) are project finance documents which regulate the operations, maintenance and management of completed projects. When the project is completed and commissioned it will then move into the operation stage. The focus of the project shifts from development to operation. The operation of most projects will require an experienced and skilful operator and the performance of the operator in the discharge of its functions will be crucial to the overall success of the project.
Usually, the operator is a third party who specialises in project and facilities operation and management and who will conclude an operating and maintenance agreement on arm’s-length terms with the project company. The objectives of an operating and maintenance agreement frequently include, (i) allocating the risk of operating and maintaining the project to the operator, (ii) ensuring that the project is operated in a manner that maximises the revenue-earning capacity of the project, and (iii) ensuring that the facilities are operated and maintained at levels and according to budgets agreed with the project company and the lenders.
These are agreements between the Project Company and important suppliers of raw materials, feedstock or fuel. Many projects rely on an essential supply of fuel such as coal, oil, gas or wood in order to operate the facility. Both the project company and the lenders will be concerned to ensure that the project has access to a reliable and secure source of raw materials for the entire duration of the project
Supply Agreements contractually facilitate that the volume of supplies to the project can be increased or decreased as necessary, depending on the output being produced by the project and sold to an Offtaker. A Supply Agreement is an indispensable project finance document for projects that produce, refine or distribute fuel, electricity, natural gas and similar commodities or utilities.
Tripartite Agreements are project finance documents required by project lenders to establish a direct relationship between themselves and counterparties to the contract. These agreements are variously referred to as consent deeds, direct agreements or side agreements. The Tripartite Agreement stipulates the circumstances under which the project lender may step in to remedy a default under the project documents. Although the Tripartite Agreement frequently occasions unsavoury negotiating issues, the document is critical to a properly documented project financing.
The Project Loan Agreement establishes the loan terms in project financings and regulates the relationship between the lenders and the project company. By dint of the fact that project financings always include construction of the project, Loan Agreements include construction financing terms which establish how the loan can be drawn based on construction progress, the calculation and imposition of interest and fees based on outstanding loan amounts.
Moreover, given the fact that project financings are limited-recourse or non-recourse, the Loan Agreement spells out dividend restrictions, required project metrics, ratios, and covenants, over and above general conditions precedent as well as basic terms.
This article is by no means exhaustive on the subject. A plethora of other documents which are central to project financing have not been traversed but the writer hopes that the reader has had a viscerally satisfying peek into the role of documentation in project financing.