Key terms in project finance funding

agreements
https://www.out-law.com/topics/financial-services/project-finance/key-
terms-in-project-finance-funding-agreements/

Accessed 27 April 2017

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.

Drawdown requirements

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.

Repayment formulas

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.

Covenants

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).