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Risk Identification, Mitigation and Key Documents in Infrastructure Projects. Presentation by Mohit Saraf Partner Luthra & Luthra Law Offices May 01, 2002. Overview. Financing Risk Identification Risk Identification & Mitigation Financing Documents
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Risk Identification, Mitigation and Key Documents in Infrastructure Projects. Presentation by Mohit Saraf Partner Luthra & Luthra Law Offices May 01, 2002
Overview • Financing • Risk Identification • Risk Identification & Mitigation • Financing Documents • Risk Allocation in the Credit Agreement • Security Documents • Insurance • Conclusion L&L/HUDCO Luthra & Luthra
Financing • Project Financing vs. Balance Sheet Financing vs. Asset Financing • Project Financing • Source of Finance • Commercial Banks • Financial Institutions • ECAs & Multilaterals • Capital Market L&L/HUDCO Luthra & Luthra
Finance Risks MarketRisks Lenders Promoters Supplier – Credit Agreement – Security Documents SupplyAgreement Shareholder’s Agreements Offtaker OfftakeAgreement Project company Insurances Insurers – Concession Agreement – Consents Operating and MaintenanceAgreement ConstructionContract Government Contractor Operator Construction & Operation Risks L&L/HUDCO Luthra & Luthra
Risk Identification • Completion Risk • Technological Risk • Supply Risk • Market Risk • Financial Risk • Political Risk • Environmental Risk • Force Majeure Risk L&L/HUDCO Luthra & Luthra
Risk Identification & Mitigation - General • Hate surprises; will not accept risks which are either incapable of proper assessment or which are potentially open-ended in their effect • No change in law risk • No discriminatory taxation • Minimise “risk-dumping” on project company • No liability for consequential loss • Contracts must survive enforcement of Banks’ security • Application of pre-completion revenues to capital expenditure L&L/HUDCO Luthra & Luthra
Risk Identification & Mitigation - Consents • Consents must last for duration of project • Regulators should not be able to vary the terms of consents unduly • Consents should inure to project and not just to project company • Government Support Agreements L&L/HUDCO Luthra & Luthra
Risk Identification & Mitigation -Promoters • All equity contributions to be provided up-front • Promoters to provide cover for cost overruns • Promoters to provide cover for gaps in undertakings including insurance. L&L/HUDCO Luthra & Luthra
Risk Identification & Mitigation -Concession Agreement • Terms of concession fixed for life of project • No unduly onerous terms on project company • Extension of term for force majeure • Compensation for termination must repay debt • Concession should survive enforcement of security • Transferability of concession on security enforcement L&L/HUDCO Luthra & Luthra
Risk Identification & Mitigation -Construction Contract • Turnkey fixed price contract • Fixed completion date • Force majeure, price increases and completion must back to back with concession agreement • Adequate liquidated damages for late completion • Performance Guarantees L&L/HUDCO Luthra & Luthra
Risk Identification & Mitigation -Operation & Maintenance Contract • Proper incentives to run project properly and profitably - including penalties for failure to meet targets • Ability to remove operator for poor performance L&L/HUDCO Luthra & Luthra
Risk Identification & Mitigation - Supply Contract • Security of supply and remedy for interruptions • Take or Pay obligation L&L/HUDCO Luthra & Luthra
Risk Identification & Mitigation - Offtake Agreement • Full pass-through of capital and variable costs • Foreign exchange protection • Take or Pay obligation • Credit enhancement including Government Guarantees L&L/HUDCO Luthra & Luthra
Financing Documents • Loan Agreement • Inter-Creditor Agreement amongst the Lenders • Indenture of Mortgage • Deed of Hypothecation • Agreement for Pledge of Shares • Security Agency Agreement • Trust and Retention Account Agreement • Sponsor Support Agreement L&L/HUDCO Luthra & Luthra
Financing Documents(Contd…) • Equity & Subordinate Debt Agreement • Undertakings for Overrun/shortfall/non-disposal of shareholdings • Loan Agreements/Subscription Agreement • Declaration and Undertaking • Consents and Agreements • Any such other documents as the Lenders may feel it necessary L&L/HUDCO Luthra & Luthra
Risk allocation in the Credit Agreement 1 • Drawdown mechanism • Staged drawdown • Contingency reserve (Promoter Cost Over-Run Guarantee) • Currency risk • Repayment profile • Match repayments to anticipated income • Dedicated Percentage – linked to financial covenantse.g. repayment cover ratio • Margin • Increase on termination of construction phase • Reference to financial performance L&L/HUDCO Luthra & Luthra
Risk allocation in the Credit Agreement 2 • Undertakings • Comply with terms of project contracts • Project company will diligently pursue its rights under the project contracts • Not to amend the terms of the project documents • Carry out the project in accordance with good industry practice • Not to abandon the project • Restriction on the companies’ ability to pay dividends • Coverage Ratio L&L/HUDCO Luthra & Luthra
Risk Allocation in the Credit Agreement 3 • Events of Default • Usual events of default (non-payment, breach of covenants, insolvency events) • Failure to achieve completion by a long stop date • Cessation of production (e.g. force majeure) for a “sustained” period • Abandonment of the project • Nationalisation of project facilities • Change in law affecting project’s economics • Sponsors’ failure to provide equity • Non-availability of insurances • Purpose of Events of Default L&L/HUDCO Luthra & Luthra
Security Documents 1Purpose of Security Documents • Offensive nature • Defensive nature • Control the Operation of project assets to generate cash and repay project debt The Banks will want to be able to take control of and/or to sell the entire undertaking constituting the Project following an Event of Default. That means all the assets plus the ability of the Project to continue as a going concern. L&L/HUDCO Luthra & Luthra
Security Documents 2Assets to be secured Tangibles • Land • Plant and machinery • Stock and materials (floating charge) Intangibles • Shareholdings – useful (but take care) • Rights and contracts (debts and other rights) – especially important in Project Finance L&L/HUDCO Luthra & Luthra
Security Documents 3Alternative security arrangements • Collateral warranties from Project parties • Direct Agreements • Direct contractual relationship • Ability to step-in following Event of Default – plus a cure period to allow sponsors to cure • Ability to step-in prior to termination of the agreement following default by the project company • Very heavily negotiated L&L/HUDCO Luthra & Luthra
Security Documents 4Some things to look out for • Lender liability • Shadow directorship • Must sell assets at a “proper” price • Environmental liability • Possibility of high costs of security in some jurisdictions L&L/HUDCO Luthra & Luthra
Insurance • Bank’s interest • Ensure adequate insurance • Ensure its interest in insurances is adequately protected • Adequate insurance • Undertaking to provide required coverage, specified risks, limits and deductions (Also a condition precedent) • Undertaking relating to quality of insurances (identity of insurer and terms to be approved by the Bank) • Self help remedy • Adequate protection of Bank’s interest in insurances • Assignment of proceeds and notice of assignment • Loss payable clause • Banks receive their own insurance contract (co-assured • “Cut-through” clauses for re-insurers L&L/HUDCO Luthra & Luthra
Conclusion • A risk is any event or circumstance which may adversely affect the project company’s ability to pay interest and to repay principal on the contractual payment dates • Bank will accept risk so long as it is quantified and understood • The “margin” is not high compared to what the other parties are receiving L&L/HUDCO Luthra & Luthra