4.1 The Role of Legal Advisors in Project Finance Deals
4.1.2 Project Financing Development Stages and Impacts on the Role of Legal Advisors
Our task now is to describe what lawyers do in order to structure a project. The first observation is that the various lawyers involved in structuring a project perform 66 C H A P T E R u 4 The Role of Advisors in a Project Finance Deal
different tasks according to the project’s development and, of course, depending on which client has retained them to work on the project.
It is probably advisable to follow a strictly chronological approach, as was used in the previous chapter when discussing project life cycle. We describe below the development stages of a project finance deal, classifying legal activities in each stage and for each of the parties concerned.
1. Forming the group of sponsors 2. Preparing the project documents 3. Defining the project financing
4. Maintaining the project financing during the building phase and in the follow- ing operating period
These distinct stages will now be reviewed one by one, in order to understand what legal advisors do in each particular stage. Readers can consult Table 4-1 for an overview of what lawyers do in each stage indicated and which parties are involved.
4.1.2.1 Forming the Group of Sponsors
It is very infrequent that a project finance venture be undertaken by a single party, for the reasons explained in previous chapters. Seen from a strictly cor-
TABLE 4-1 Stages in Structuring Project Finance Deals and the Roles of Lawyers
Stage Activity Required Lawyers Involved
1. Forming the group of sponsors Organizing the project company Sponsors’ lawyers Articles of incorporation for the
project company
Sponsors’ lawyers Agreements between sponsors
(joint ventures or whatever)
Sponsors’ lawyers Check on bankability of the
venture on a without or limited recourse basis
Sponsors’ lawyers Project company lawyers 2. Industrial development of the project Project documents Project company lawyers
Sponsors’ lawyers (when the spons- ors are a counterpart of the
project company)
Arrangers’ lawyers (bankability analysis)
Due diligence report Arrangers’ lawyers
Legal opinions Sponsors’ lawyers
Arrangers’ lawyers 3. Project financing Mandate letter and financing term sheet Arrangers’ lawyers
Project company lawyers
Finance documents Arrangers’ lawyers
Project company lawyers Assistance during syndication phase Arrangers’ lawyers 4. Maintenance of project
financing
Periodic contacts with agent bank and sponsors
Sponsors’ lawyers Arrangers’ lawyers
The Role of Legal Advisors in Project Finance Deals 67
porate standpoint, it can be said that the initial stage of a project is more or less similar to a joint venture. The distinctive feature of a joint venture in relation to project finance is the need to ensure right from the early stages that the initiative has the necessary characteristics to be financed without or with limited recourse.
The worst outcome for a venture of this nature is to discover, perhaps after many months’ work, that the system doesn’t consider it to be bankable, in which case sponsors are either forced to abandon the project or to finance it using their own resources.
In this preliminary phase and based on initial indications as to the nature and peculiarities of the deal (which lawyers receive directly from either sponsors or their advisors), the sponsors’ legal advisors organize the project company, preparing the articles of incorporation and negotiating the necessary agreements between sponsors (normally incorporated in the shareholders’ agreement, but they can also involve more detailed, complex contractual structures). These agreements will regulate rela- tions between sponsors and distribution of project risks. It will be remembered, furthermore, that part of the project funding must be put up by sponsors, who, for this purpose, can be called on to sign agreements as regards their equity contribution in financing the project.
Because a number of sponsors are probably involved, normally each of them is assisted by a different legal advisor, given that at this stage each sponsor has two objectives (so necessary compromises between sponsors may not be easy to reach):
(1) to create the best possible legal basis for developing the project so that future contractual partners (lenders but also the project company’s suppliers and pur- chasers of goods or services) see it as a solid and cohesive venture, but also (2) to obtain the best result for itself in financial and contractual terms when structuring the project as a joint venture. This objective is not easily attained, for sometimes an advantage for one sponsor will be a disadvantage for another or perhaps all other potential partners. Nonetheless, this critical aspect cannot be overlooked (although it often is neglected by inexpert legal advisors or those inexperienced in project finance).
This means that once the preorganization phase between sponsors of the project company is complete, one legal advisor (normally, but not always, the main sponsor’s lawyer) or sometimes a different legal firm is assigned the role of legal representative for the project company itself.
Sometimes in the initial stage a project is developed by a single sponsor who later (either by choice or out of necessity) invites other parties to participate as cosponsors.
This can be achieved either by negotiation with a single party selected beforehand as a result of direct contacts or by means of a competitive bid. In the latter case the main concern of the sponsor organizing the bid (or embarking on negotiations) is the confidentiality of information that inevitably must be made available to the counter- party for negotiation purposes. Instead the counterparty instructs its lawyers to review the venture and its legal and contractual implications. This requires a due diligence investigation similar, from many standpoints, to that conducted for com- pany acquisition purposes, but with two specific differences.
1. Unlike a corporate acquisition, it is an exercise conducted entirely on paper:
The project, by definition, doesn’t yet exist, and so the only aspects that can be verified are whether its development and resulting revenue are reasonable and likely to be achieved.
68 C H A P T E R u 4 The Role of Advisors in a Project Finance Deal
2. The overriding factor to check is the venture’s bankability with or without limited recourse. The advisors asked to make an initial assessment of this essential condition are the lawyers.
4.1.2.2 Industrial Development of the Project—The Project Documents
The choice of project counsel (who, technically speaking, is the legal advisor of the project company, which appoints a law firm by granting a formal power of attorney) is a joint decision taken by the sponsors. As already mentioned, some- times this is the law firm preferred by the main sponsor, who may be the one making the largest investment in the project (and therefore in the project company) or the one who more than any other characterizes and/or conditions the project itself. (For instance, it could be the sponsor that has the underlying technology for the project.)
So project counsel is the lawyer for the project. In the event of conflict of interest among sponsors, the aim of project counsel is to remain neutral (clearly an embarrassing situation) and to act in the best interests of the project, that is (subjectively), of the project company. This is by no means just a theoretical situation, especially when other fundamental players in structuring the financ- ing—the arrangers—enter the scene. Suppose, for example, that the arrangers are not entirely convinced that the contractor for turnkey construction work is reliable and that the company in question is one of the sponsors or belongs to the same group. The arrangers will ask for greater coverage (amitigation, another of the key words used in relation to project finance) for this risk. Who pays the bill, the sponsor concerned or all sponsors? The answer, if there is one, lies in the agree- ments between sponsors mentioned in the previous section; otherwise this opens a legal and negotiation parenthesis in the project development that is part of the previous stage in terms of structure, though not in terms of time. This, in turn, leads to a further consideration: Because of unforeseen issues arising during definition of the relevant project finance agreements, the agreements between sponsors can and/
or must change. In extreme cases, this may even lead to a change in the original group of sponsors. In practice, this has happened in the past on a number of occasions.
When speaking of industrial development of the project, this in fact refers to making the necessary preparations to begin construction work but not construction itself. This is because the necessary financing is not yet available; in fact, work will begin when structuring the deal, as described in these pages, is complete.
Typically this development stage concerns the project documents: In this stage the project company sets up contracts and obtains permits and other legal papers required to realize the necessary works and to operate in accordance with the aims of the project. At this stage, the project company lawyers usually perform the task of drawing up a complete list of these documents and finalizing and/or obtaining them.
Following is a list of possible project documents, drawn up without reference to any specific deal.
Concessions from the Public Administration: This is a necessary element when public works or works of public interest subject to a government concession are realized using a project finance approach. As seen in Chapter 1 when speaking of the involvement of private capital in public works, this factor comes up frequently but not always in project finance. However, it is found in the UK,
The Role of Legal Advisors in Project Finance Deals 69
particularly in the case of PFIs realized as part of that government’s PPP approach.2
Permits to Realize Project Works: Again these are not documents produced by the project company, although they are required to be able to realize the project. Their existence and validity is a necessary condition for launching the project, and so they are the subject of specific clauses in the credit agreement, which will normally contain an attachment listing the permits required to realize the project works. Town planning and building permits are particularly important, as are those relative to the environmental impact of the project itself.
Contracts for Use of Third-Party Assets or Rights: These are documents by means of which the project is assured tangible rights (for instance, the ownership of or right of access to the area where the project will be realized) or intangible rights (like those allowing the use of a given technology) necessary for its realization. Sometimes these rights are granted by the public administration, and so the relevant document assumes an importance (also) from the standpoint of administrative law.
Rights Relevant to the Area Where the Project Works Will Be Developed: The project company must ensure it has the necessary rights (normally rights of ownership or a building lease) as regards the site where the project will be realized.
A legal complication concerning these rights comes up in BOT-based contracts, in which the works will be transferred to the public administration after a certain period. Such rights represent a considerable technical and legal complication in projects in which the nature of legal property rights as regards the project are more difficult to define, for example, projects such as the exploitation of oil fields under the North Sea (whether in territorial waters or otherwise) and the Channel Tunnel.
Contract for Realization of the Project Works and Relevant Subcontracts: This is the document that contains clauses regulating the area of the project subject to most risk and is probably the most important document project company lawyers have to prepare. It should be noted that one possible scenario that could significantly affect negotiation of this contract is whether the performing company is or is not linked to one of the sponsors.
Operation and Maintenance (O&M) Management Contracts and Technical Consultancy Contracts: Often this is covered by the O&M contract described in Chapters 1 and 3 and is the other essential project contract concerning the operating stage. Specific projects may have special characteristics that mean project company operation management is covered by several contracts. Again in this case, it is not infrequent that one of the sponsors is also the supplier of project management services. Also this contract is initially ‘‘managed’’ by the project company lawyers.
Bonds and Guarantees for Project Contracts: These are guarantees (bonds) from banks or financially sound third parties (normally the parent company or holding company of one of the parties to the project contract), the purpose of which is to render the responsibility of a given party bankable, usually as regards damages or
2. Data for the EU market prepared by the European Investment Bank show that PFI projects received support from the bank between 1990 and the end of 2003 amounting to around 15 billion euros, of which 25%
went to the UK. These transactions were mainly in the form of a design, build, finance, and operate (DBFO) scheme that didn’t produce a negative impact on national deficits or debt. See EIB,Evaluation of PPP Projects Financed by the EIB, March 2005.
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repayment of advances received. In essence these are seen as accessories to the project documents, and the required forms for these guarantees are given in attachment.
In reality these are rather well-known, standard forms in the financial market.
Insurance: Technically speaking, these are project contracts, even if normally advisors specialized in the insurance sector are assigned to prepare them, as is seen in Section 4.3.
The project company must have adequate insurance coverage for risk exposure and is an aspect regulated in an extremely detailed manner in the credit agreement. The insurance element is vital when structuring a project finance deal; however, practices in the insurance field are extremely specialized and are therefore considered the domain of a separate profession. Insurance is handled by consultants and brokers with a considerable degree of separation from the rest of the legal and contractual activity in terms of structuring the project finance deal.
Procurement Contracts for Raw Materials Required for Project Operations: Fuel supply agreements (contracts for the purchase of fuel for projects in the power generation field) are particularly important in this category.
Sales Contracts: These contracts generate the project company’s income. A detailed analysis of the nature and necessary features of these contracts can be found in Chapters 4 and 7.
4.1.2.3 Project Financing—The Finance Documents
The stage when the finance documents are defined (first and foremost, the credit agreement) is clearly central to a project finance deal.
While project contracts are normally prepared by project company lawyers and reviewed (and modified, if necessary) by the arrangers’ lawyers, preparation of the finance documents is usually the responsibility of the arrangers’ lawyers, who then negotiate them with the project company lawyers. So in this case the arrangers’
lawyers lead the process by preparing and managing the documents concerned, whereas the project company lawyers come into the picture afterwards when they receive and review the documents.
At this stage the project is almost entirely in the hands of lawyers. More than any other document, the credit agreement is a contract that requires highly special- ized lawyering. Decisions of a business nature required from the principal actors (arrangers and project company’s sponsors) are the guidelines around which the credit agreement is fashioned. This then becomes the control document for the entire project. In the early stages, a specific project finance deal is above all an industrial idea regulated by a financing contract, which will then provide most of the financial resources to realize the project itself. Bearing this in mind, it indeed makes sense to say that ‘‘on the starting grid’’ project financing is a legal product waiting to become an industrial and financial reality. If not, this concept would be difficult to accept.
The finance documents usually include the following.
. Documents by which the sponsors appoint one or more banks (the arrangers) to organize and grant the financing: These are normally referred to as mandate documentsorcommitment documents. These usually include a letter of appoint- ment (a mandate), in which the arrangers (as we see in Chapter 6, they are referred to asmandated arrangers—MAs—or even mandated lead arrangers—
MLAs; a bit of emphasis at this stage doesn’t do any harm and costs nothing) are appointed to organize the financing, or a letter of commitment, in which the
The Role of Legal Advisors in Project Finance Deals 71
arrangers commit themselves to sign (initially, i.e., before but with a view to syndication) a table summarizing the main financial and legal terms of the deal.
. The credit agreement
. The security documents, which constitute the package of collateral granted in relation to the financing
. The intercreditor agreement, which regulates some or all of the relations between lenders
. Some other ancillary documents relating to the credit agreement, for instance, fee letters that establish the commissions due to the arrangers
. Contracts concerning capital made available to the project company by spon- sors, often known as theequity contribution agreements.
. Other documents concerning financing in the event the credit agreement and equity capital put up by sponsors are not the only sources of project financing
. Hedging agreements to cover the risk of swings in both interest and currency exchange rates
. Direct agreements, which pertain to an area lying between security documents and project contracts
An analysis of the credit agreements and other finance documents refers more to the legal nature of project finance as opposed to describing the role played by legal advisors; this analysis is found in Chapter 7.
4.1.2.4 The Due Diligence Legal Report
This document is a report prepared by the arrangers’ lawyers for their clients giving a summary of the project and its formal and substantial bankability. Its content describes everything concerning the project assembled by the sponsors and project company.
. Nature and characteristics of the project company
. Project contracts
. Administrative concessions and permits
. The general regulatory setting for the project: Depending on the case, arrangers may want a description of other legal aspects concerning the project, for instance, the guarantee system and the administrative and concessionary system
This document normally constitutes one of the many conditions governing the project company’s ability to utilize the financing granted under the credit agreement. This is a consolidated practice, to the point that no project company or sponsor raises any objection to the fact that from a formal standpoint this report is controlled entirely by the arrangers (who must unilaterally state that they are satisfied) and the arrangers’
lawyers. In theory the due diligence legal report ought to be prepared months before the credit agreement is finalized. In practice, however, things are very different: The due diligence legal report is one of the many documents finalized by the lawyers and approved by the arrangers during the last few days before the financial close of the project.
4.1.2.5 Legal Opinions
The legal opinions are contained in yet another summary document used in the final stages of structuring the financing and again constitute a condition for releasing the financing itself.
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