Key terms in project finance funding agreements
Many of the provisions of the credit agreement for a project finance initiative (PFI) funding arrangement are similar to those found in a conventional syndicated loan agreement. The following provisions are of particular importance:
- purpose clause;
- drawdown requirements;
- repayment formulas;
- representations and warranties;
- covenants; and
- default provisions.
The sheer scale of a typical project financing means that most lending cannot be undertaken by a single lender. Instead, a syndicate of lenders will be formed. In a typical syndication, a number of lenders will be parties to the loan agreement. You may wish to refer to our separate OUT-LAW Introduction to project finance documents [link to: OUT-LAW Guides – Banking – Introduction to project finance documents] for further information. As a reminder, we will refer to the private sector company or partner created for the sole purpose of owning the project as 'Projectco', and the contracting local authority entering into the agreement with Projectco as the 'Authority'.
The purpose clause
It is common for the credit agreement to make available several facilities, or loans, such as:
- a baseline facility, which is required to meet project costs in the construction phase and other permitted expenditure agreed in advance;
- a standby loan facility, which is a facility which can be called upon in certain circumstances, such as where costs are in excess of budgets, as agreed by the lenders;
- an equity bridge facility, which is repayable when the sponsors supply their subordinated debt;
- a change of law facility, which is a facility which can be called upon if certain capital expenditure is needed as a result of a change in the law; and
- a general working capital facility.
The purpose of these funds will be documented carefully in the credit agreement to make sure that their use is restricted to their intended purpose. This will be done by channelling withdrawals or drawdowns through dedicated project accounts from which payments may only be made for certain agreed purposes. These payments can include:
- staggered or stage payments due and owing by Projectco to the construction company under the construction contract;
- the fees and expenses of architects, engineers and other members of the design team;
- fees payable to the agent, arrangers and debt funders in connection with the provision of the banking facilities.
The credit agreement will usually specify a period during which withdrawals and drawdowns can be made subject to the satisfaction of any conditions precedent. A condition precedent is an event that must occur before a contract can be fulfilled, such as supplying certain documents or providing security. See our separate OUT-LAW Guide to conditions precedent [link to: OUT-LAW Guides – Banking – conditions precedent] for more information.
These conditions precedent will be extensive, and will be divided into two categories - conditions precedent to the making of the facility agreement and conditions precedent to each drawing of each loan facility. Such conditions may include:
- a copy of the project agreement; constitutional documents for each borrower and whoever is providing security;
- evidence of all corporate and other authorisations showing that the borrower and whoever is providing security have the power, capacity and authority to enter into the finance documents;
- evidence that all licences and consents required for the project have been obtained.
In addition, legal opinions from the lenders' solicitors will be needed.
The credit agreement will generally recognise two distinct phases in PFI projects - the construction phase and the operation phase.
During the construction phase funds will be drawn down and the need to pay back the debt postponed, either by rolling up interest pending receipt of revenue during the operating phase or by allowing Projectco to make additional drawdowns to finance these interest payments. The availability period for drawings under the credit agreement will end once the project has been completed and becomes fully operational.
Any repayment formula must be structured to reflect the revenues Projectco expects to receive. Usually the formula will require the higher of a minimum repayment and a stipulated percentage of project cashflow for the relevant period to be set off against the loan facility. The minimum payment must ensure that, as a worst case scenario, the repayments will be enough to ensure that the loan is fully paid off within the maximum loan term. The alternative loan repayment formula, a stipulated percentage of cashflow, will generally allow the final repayment to be achieved in a shorter period of time than the term of that facility – for example, up to two or three years ahead of final maturity in a 20 year facility.
Representations and warranties
Extensive representations, obligations and warranties will be required. There will be a number of project-specific representations and warranties required including:
- due authorisation and enforceability of the project agreement and other related project documentation;
- compliance with all laws relating to the implementation of the project and the due issue of all necessary licences, consents and permits;
- the project agreement and all other project documentation must be in full force and effect;
- there must be no litigation involving Projectco and the project assets;
- all project information given to the lenders must be accurate and complete;
- no cross defaults or defaults under the credit agreement should exist;
- Projectco must have no assets or liabilities and must not have traded or incurred any liability or obligation except in connection with the project;
- Projectco must be solvent;
- Projectco must have good title to its assets, free from any encumbrances except for those created under any security documents in favour of the lenders; and
- Projectco must have disclosed all factual information relating to its affairs and the project which could be expected to affect any decision of the debt funders to provide finance – an effective sweep-up clause.
The usual covenants, or promises, both positive and negative, will be required from Projectco. There are certain information covenants specific to the particular project which Projectco will need to supply to the funders. These include progress reports during the construction phase of the project specifying the rate at which construction is proceeding, the current status of the work, a review of how costs are progressing and details of actual or potential cost overrun. Regular progress reports will also be needed during the operational phase specifying availability, occupancy, usage and any performance points incurred - these will be awarded to Projectco during the operational phase of a project and will reflect how well it is performing. The lenders will also want details of any interruptions to the construction or operation of the project and notice of any insurance claims.
Financial covenants will also be needed. These commonly include:
- Project Life Cover Ratio - this compares the net present value of the future revenues of the project against the debt then outstanding;
- Loan Life Cover Ratio - this compares the net present value of the future revenues during the agreed term of the loan with the debt outstanding on the day in question. Accordingly, under this ratio Projectco will not be given the credit for revenues which are forecasted for after the final repayment date of the loan;
- Drawdown Cover Ratio – this compares the projected maximum debt outstanding with the forecast net present value of the project cashflows during the term of the loan;
- Debt Service Cover Ratio - this is usually a historical test which compares the amount by which the net cashflow for a given period, usually 12 months, has gone over the debt service requirement (principal amount plus interest).
Events of default
Credit agreements for a PFI financing will include the usual kinds of events of default which will allow the lenders to cancel the facility, accelerate the loan and exercise their rights under the security documents. The usual events of default - monetary defaults, breaches of representations and warranties and failure to perform other obligations - will be included in a PFI credit agreement.
There will also be some additional events of default which are specific to PFI projects. These include:
- any matters referred to in any project agreement which would threaten the viability of the project, such as construction not having been completed by a specified date;
- failure by the sponsors or other equity investors to contribute equity at the times and proportions agreed with the debt funders;
- government action detrimental to the project, such as a change in the Authority's legal status;
- the insolvency of any other project participant where this may have a material adverse effect on Projectco's ability to observe its obligations under the financing agreement or other project document;
- abandonment of the project;
- any strike, industrial action or acts of terrorism or sabotage which threaten the continuation of the project; and
- breach of any of the project ratios (the financial covenants above).