Author(s): Rekha Panchal

Project Finance as the technique of financing any development idea is rapidly increasing in developing countries due to their drive to gain industrial development and improve infrastructural amenities. The infrastructural projects or projects relating to energy industry are usually funded by the government through public funds since historical times due to the mammoth size of initial capital investment required. The governments introduce private parties into big infrastructural projects by public-private partnership (PPP) arrangements considering long-run maintenance of the projects and investing the public funds into other projects. Other incentives for the government can be inter alia to introduce new technology, privatization of some sectors for policy reasons and efficiency in operations of the infrastructural systems.

The project finance is a complex process involving various parties, stages, process and legal and financial implications involved in the process. Further, considering the bounds of current publication we will outline the other aspects of this work in subsequent volumes of our publication. This article will accentuate the brief account of what is public finance and understanding of the parties involved.

The project finance is defined as “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."

The project financing is called limited recourse or non-recourse as the major volume of financing is derived predominantly out of revenues generated by the project itself not from any form of share capital. The viability of the project is deliberated upon in pre-development stage which includes concerns such as the title of ownership of assets, revenue generation estimates, profit generation and utility, etc during the planning and financial due diligence. However the concerns in project financing starts with reconciling the interest of various parties involved in the financing. The parties to the project financing are varied and independent having different interests in the project. In pre-development phase parties need to evaluate the financial viability and technical feasibility. General understanding of each party’s objective behind engaging into such financing is pertinent to establish prudent negotiations. The parties and their general role along with the some probable objective are listed below:

1. Host government

The government of country where project proposed is planned to be based and which will be issuing all the relevant permits, authorization, licenses and subsidies, if any, for the project. The host government is usually contracting authority by entering into project agreement and /or carries out bidding process to allocate the project to private party and thereafter may either handover the project for development as well as later maintenance. The host government may allow private party to develop the project, either conjunctively or otherwise, or take under public ownership after the development of project once the return on its investment has been received by the private party or decide to regain ownership in case of failure by the private sector to deliver the project. The host government’s involvement in the project may also be limited to granting consents for project, to granting various tax concessions and / or being partner in the project. The private party financing the project allows host government to allocate resources in other areas of expenditures. The host government can be party to various agreements for the project concerning supply of electricity, water or any other raw materials and imports required.

2. Project Company

This is also called special purpose vehicle (hereinafter referred to as SPV). This company is created with sole purpose of project. It can be corporation established for this purpose or limited partnership usually a PPP. This company is often created in host country where project is intended to be carried out. SPV is the center of all agreement and project financing. SPV is owned and managed by its sponsors/shareholders. The SPV is used to finance the large project without putting a corporation at risk or isolate parent company from project-related risk by shifting it on other investors. SPV in project financing allows shareholders to keep project liabilities “off-balance sheet”. Such off-balance sheet structure needs review of applicable laws to understand its applicability in host country of project and incorporation of SPV. The host government and SPV enter into project agreement to defining degree of participation by host government and further laying down rights and obligations during the term of the agreement for concession agreement. The host government and SPV may enter into different agreements for different phases. The host government would enter into property purchase or product purchase agreements with SPV after the project completion.

3.Sponsors

The sponsors are equity shareholders and /or owners of the project. The main objective is to earn profits either by simple high investment returns called as financial sponsors or by selling the products of parent company usually falling under the category of industrial sponsors as the project is associated to their business activity. However, there can be different factors based on which the sponsors enter into project financing which includes sharing the risk in undertaking the project and carry out project off-balance sheet, enter into new activity by means of diversification and such other corporate strategic plans. The sponsors may be single party or consortium. There can be public sponsors such as municipalities, agencies or corporations whose objective is public welfare or utility. Since sponsors are equity holders they bear the maximum risk of the project they also earn the huge share of the profits is the project is successful. Sponsors enter into management and shareholders agreements or service agreements with the SPV.

4. Lenders

The lenders are primarily large commercial banks, national or international. Considering the large scale of investments there is often a syndicate formed of the group of lenders. This includes investment banks, bondholders or multilateral agencies. The lenders in the project financing only have recourse to the assets of the project at hand. The nature of security depends on the negotiations and loan agreements signed between SPV and lenders. The lenders may also create right against parties other than SPV and sponsors such as off-take purchasers for assurance of purchase of the agreed quantity of purchase, construction companies/contractors to complete the construction as per required standards and performance criteria by giving completion guarantees as agreed. These rights must be expressly stated in agreements between the parties directly. Comprehensive security structure needs to be planned based on the review of laws such as ownership of real property laws as project property are the only assets available, bankruptcy laws and any other financial laws as they may hamper the enforceability of security rights of lenders. Further lenders must note that there are often reversion rights available with the host government to prevent wearing down and suspending of any public utility services thereby giving host government right to regain ownership over the project works or developments of the project. Since the lenders are in syndicate the lenders may appoint an agent to represent their interests.

Multilateral credit agencies such as World Bank, Asian Development Bank, International Finance Corporation, so on and so forth can ensure protection against regional risks to commercial banks such as political risks. Export credit agencies may also lend money to promote that industry.

Other parties

Purchasers: As per the off-take agreement the purchaser will be obligated to purchase the products of the project in advance usually found in energy industry products.

Contractors: The projects will require contractors for various purposes and thereby enter into various different agreements with parties as contractors for construction works vide construction agreements ensuring timely completion and liabilities in terms of liquidated damages for delay. Construction contractors enter into design and perform operations and maintenance (P&M) vide P&M agreement between SPV and operators and engineering, procurement and construction (EPC) contracts for designated works.

Suppliers: The supplier is important to party to project in terms of technical support and financial estimates as price implications impact entire project works. The supply agreement can be for any requirements during the project such as raw materials. The agreement may be, in a sense, off-take purchase agreement for the SPV. The supply agreements need various price considerations bearing implications on project revenue at different phases. The agreements relating to oil and gas sales usually called gas sales agreement are also supplied agreements from SPV point of view. The factual analysis of depletion of such natural resources needs scrutiny while negotiating the agreement. The practice of selling of portfolio of reserves is also undertaken in the UK, however, a lesser followed practice in developing countries.

The SPV along with other parties needs legal and financial advisors for reconciliation of interest of parties and negotiations with several parties by keeping in mind the main objective of the SPV while taking up the project whether it is simply financial investment to earn profit or to work in line with corporate strategic plans of business development and associations. The stages in the project financing and risk factors in projects financing from the standpoint of different parties need elaborate assessment and will be addressed in the subsequent publication.

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