Nuts and Bolts of an International Project Financing - Case Study Example

Instruction:- Project finance Lecture outline 2 outline:- total 2000 words. Follow the outline I’ve provided and expand them. Stick to the same organization. Follow my comments. Reading : Class 1 Nuts and Bolts of an International Project Financing. Who’s who in the cast; functional and contractual relationships; identifying project risks and deal issues. Reading Hoffman: (attached) Ch. 1: An Introduction to Project Finance, pp. 4-24; Ch. 2: Project Finance Risks, pp. 27-38; Ch. 5: Project Finance Participants and their Roles, pp. 71-77; and Ch. 6: Project Finance Structures, 78-82. Class 2 Documenting the Deal I. Structure and substance of project documents; due diligence. Reading Hoffman: (attached): Ch. 12: An Overview of Project Documentation, pp. 113-120; Ch. 16: Input Contracts, pp. 188-197; Ch. 17: Project Finance Operation and Maintenance Agreements, pp. 198-208; and Ch. 18: Project Finance Off-take Sales Agreements, pp. 209-219; “Project Finance Techniques” (Chadbourne & Parke, 2004). (attached) Project Finance Class One I. Introduction to Project Finance a. Definition: The financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project. i. Note: In project financing, the debt terms are not based on the sponsor’s credit support or on the value of the assets of the project – project performance is the basis of project finance. b. Nonrecourse project finance i. Defined: A loan where the lending bank is only entitled to repayment from the profits of the project the loan is funding, not from other assets of the borrower. 1. Here, the credit appraisal of the nonrecourse project finance lender is based on the underlying case flow from the revenue. Project sponsor has no direct legal obligation to repay the project debt. c. Limited recourse project finance i. Defined: The project sponsor has limited obligations and responsibilities. d. Tension between the project company and contractor in project financing: i. Contractor must deliver the project at a fixed or predictable price, on a certain date, warranted to perform at agreed levels. 1. Potential problems: difficulty predicting events that could cause delays; increase in prices. 2. Main objectives of Contractor: limit risks of any change in the cost of the project, to ensure there is sufficient contractual excuse for late delivery, and to provide sufficient time to satisfy performance guarantees. e. Other financing types: i. Balance Sheet Finance: Lending decision is based on the overall corporate balance sheet. ii. Asset-Based Finance: Financing is founded on the value of the assets financed. f. Components of Project Finance i. Debt ii. Collateral Security iii. Credit Enhancement: The process of reducing credit risk by requiring collateral, insurance, or other agreements to provide the lender with reassurance that it will be compensated if the borrower defaulted. iv. Equity g. Advantages and Disadvantages h. Project financing in different countries: Business environment in a developing country is different in at least four major respects from the developed world: legislative and regulatory systems, political security, economic security, and centralized infrastructure systems. i. Sources of project finance laws: U.S. laws that regulate international transactions or disputes; laws of foreign countries; public international law; and conflict of law rules that determine which courts/arbitral tribunals will apply to a dispute. II. Project finance risks a. Risk structuring process: Here, risks are identified, analyzed, quantified, mitigated, and allocated so that no individual risk threatens the development, construction or operation of the project in such a way that the project is unable to generate sufficient revenues to repay the project debt, operating expenses, and provide and attractive equity return to investors. i. Types of risks: Development; Design Engineering and Construction; Start-up; Operating Risks. b. Project Finance Participants: i. Sponsor: entity that coordinates the development of the project. ii. Construction Lender: Person concerned with the design engineering and constructions risks (i.e. construction contract) iii. Permanent Lender: Responsibilities include arrangement of sufficient debt to finance the total construction cost of the project. iv. Contractor: Main objective in a project financing is to limit risks of any change in the cost of the project, to provide excuses for late delivery, and to provide sufficient time to satisfy performance guarantees. III. Project Finance Participants a. Project Sponsor: the entity, or a group of entities, interested in the development of the project and that will benefit, economically or otherwise, from the overall development, construction, and operation of the project. b. Project Company: The special-purpose entity that will own, develop, construct, operate, and maintain the project. c. Commercial Lenders: Provide debt financing for projects. Class Two IV. Project Documentation Contracts hold immense importance when it comes to project finance. The importance is so intense and unique that contracts are usually termed as kings when it comes to finance. This importance is even more significant for projects which have limited resources. This is because in such cases both parties are interested in allocation of return (profits) and risk (losses). a. Governing Law and Forum: What law will govern the contract? i. Follow local laws re: contract formation There are various different laws prevailing around the world when it comes to contracts. Most countries allow foreign laws and regulations to govern contacts being formed in their country. Some however do not permit this practice. UK law or New York commercial law is usually used worldwide in countries which allow their practice. The law of governing country is usually the best option even if it’s not enforceable. This is because local laws are more enforceable as compared to foreign laws. b. Document types: Organizational documents: These include agreements which are related to basis of an organizational activity. These can be partnership agreements, merger agreements and joint venture agreements. Agreements with the host country government: All agreements entered in with host country. Examples include concession, licenses, investment tenure etc. Real property agreements: Documents related with Property, Plant or Equipments. These include documents for both leased and bought machinery. Construction documents: Construction contracts agreed willingly between two parties. Technology documents: These are license agreements, related to technology. Operation and maintenance documents: Agreements pertaining to supply of spare parts and warranties etc. Fuel supply documents: Agreements to supply fuel. Utility documents: Agreements to share or pay for utility expenses. Off-take revenue agreements: Agreements relating to energy related things. Transportation documents: Contracts which include receiving or giving delivery of goods/ services etc. Financing documents: these are contracts usually made with the banks and include loan agreements, payment plans etc. c. Sample provisions Nonrecourse Provisions: This is the classic recourse project financing where any obligation to guarantee the repayment is not imposed to the sponsor if the revenues of the respective project fails to cover the principal and interest. Moreover, no recourse is available against the sponsor or any affiliate for liability to the lender in connection with any breach or default, except to reach project collateral. The lender, therefore, relies solely on the project collateral in enforcing its rights and obligations. Cooperation with financing; this adds to protect the interests of the project sponsors, project documentation must be negotiated in a way that will satisfy the requirements of the lending community. However in most deals, the lenders are not selected before contract finalization. One way to cater with this dilemma is to include a provision with the name ‘financial cooperation clause’ in the project contracts. It is to allow and encourage the parties to execute the project contracts, yet remain cooperative to the reasonable demands of the lenders. As an example where contracting parties agrees to cooperate with Project company in the negotiation and execution of reasonable amendments or additions to this agreement required by Lender as a condition to financial closing for the project debt, provided such amendments or additions does not result in a material adverse changes to Contracting Parties rights hereunder. Completion: This concept is also called commercial operations. The occurrence of completion of contracts can have a triggering affect throughout the collection of contracts used in a project financing. For example, under the construction contracts, completion determines if and when the contract is liable for the liquidated damages arising from construction delays or performance guarantees. So in the case of operating agreements, it determines the date the operator begins its responsibilities for project operations. Completion shall mean the satisfaction of each of the following conditions: a) the project shall have been completed according to schedule of construction contracts. b) the contactor is the one to complete all start up and testing as such terms are defined in the construction contract. c) the terms of the performance guarantee shall satisfy the successful completion or the payment of all liquidated damages required under the construction contract. d) the interconnection facilities shall have been completed tested and approved. These a-d clauses are the general example primarily used in construction contracts. d. Take or Pay Contracts e. When Things Go Wrong (pg. 119) i. Different consequences ii. Contract damages – not appropriate remedy iii. Liquidated damages – preferred remedy iv. Specific Performance – not typical V. Input Contracts a. Contracts that represent the cost of fuel and other inputs to the project company are of particular importance because these contracts affect cash flow. i. Often used: Supply or Pay contract: the supplier agrees to provide goods, such as fuel, or services, such as fuel transportation. If supplier unable to fulfill that obligation, it must generally provide either the goods or services from an alternate source at its expense or pay damages to the project company in securing the goods and services itself. ii. When are supply contracts not needed? When there is wide availability, little price risk, and no transportation problems. Then, spot purchases feasible. b. Types of input contracts i. Risks – Supply, delay, force majeure Force Majeure: force majeure are the events that are outside the reasonable control of the effect party to a contract which are supposed to be avoided by good skill and judgment, which typically excuses certain negotiated portions of contract performance during its pendency. The effected party is obligated to take all the responsible actions necessary to restore performance as soon as possible. Under the uncontrollable circumstances, generally performance is excused by a party upon the occurrence and during the continuance of a focus majeure, outside a party reasonable control that make the performance impossible for example catastrophic weather events. Change of Law should also be taken into consideration when talking about the Force majeure. Terminations: by seeing the contract from Suppliers point of view, the input method agreement is typically subject to termination for these events: nonpayment of the amounts owed by the project company to the supplier, bankruptcy or acceleration and liquidation of the project company. As from the perspective of Project Company, inputs contract terminations are subject to nonpayment of amounts owed by the supplier to the project company, bankruptcy, acceleration, or liquidation of the supplier, or other action that make supplier seems not intended to perform the contract. ii. Quality and Rejection: Quality is among the vital aspects in the input contracts for example bad fuel quality can raise the operation costs. Besides clear statements and guidelines for the input quality, a setup or procedure is important to be in place like a laboratory or quality check centre to test the quality of inputs required. A determination should be made about which party is to bear the costs and frequency of testing and which party is responsible for the testing. Sample provision: Quality; the input delivered by supplier here under shall be of the quality and shall have the characteristics and specifications set out. Project Company shall have the right to reject any delivery not in conformity with such characteristics and specifications. VI. Project Finance Operation and Maintenance agreements a) Operating Agreements: A project sponsor has two options available i.e. either to operate the project itself without an operating agreement or retain an operator to operate the project for it. Like project finance construction contracts, the operating and maintenance contracts must serve to provide the project sponsor with a facility and have certain agreed upon performance criteria and operator should likewise be responsible for all aspects of project operations and maintenance. Project operation and maintenance agreements typically contains each of the following provisions: a detailed scope of work; a fixed or variable but predictable price for all of the work necessary to operate the project; performance guarantees; liquidation to the damages for failure to satisfy performance guarantees; and a showing of financial credit worthiness of the operator. Mainly in one aspect where operation agreements are not as critical as construction contracts that is if it is needed to replace the operator however its flexibility depends on project to project. b) Important Operation Risks i. Increase in operating costs more than the funds available because of different reasons like construction defects, use of a new technology, and input difficulties like fuel handling. ii. Performance Guarantee: if a project does not operate after completion at guaranteed level, the project company will still need to pay debt service and other contractual obligations. But the revenue will not be able to do so. iii. Force Majeure: Project contracts are interrelated and a breach of contract can lead to another and have a trickledown effect. iv. Raw material supply and utilities: the project company must be assured of a supply of raw materials and other input utilities at an acceptable cost range. Operator are the one responsible to manage these supplies and costs. v. Excuses for the Operator’s non performance: The contractor did it, the owner did it. vi. Coordination: even if the construction work is completed, the operator must coordinate with operation activities with other activities at the site, such as manufacturing company and the project. Without coordination, risk of construction delays and operational costs over run increases. c) Responsibilities i. Operator’s responsibilities include the types of services that will be provided such as operations, maintenance, and repair. Other typical responsibilities are staffing, hiring, training, and purchasing supplies, inventory management, routine inspection, preventive maintenance and schedule over halls. ii. Project company responsibilities are more likely to be the owner of the project and include access to the site, permits, fuel for operations, utilities and waste disposal. Company would like to keep it responsibility part as minimum as possible. d) Remedies for Breach Events of default: party may terminate this contract for default by the other party as provided below. A party shall be considered in default of its obligations under this contract upon the occurrence of an event. Event as example: insolvency of a party. Failure to perform and misrepresentation. VII. Project Finance Off-Take Sales Contracts a. Off-Take Agreements: Agreements that provide the revenue flow to a project; the agreements by which the project company sells its products or services. i. Take or Pay: requires unconditional payment. ii. Take and pay: requires payment only if the product is produced. Read More