The Legal Environment
The Parties
The Market
The concept of project finance as the financing of a particular investment, with the proviso that repayment of the financing is made solely through the cash flow generated by the investment, is a relatively new feature in Germany. Accordingly the first project financings implemented in Germany in the late 80's were made subject to English law with English solicitors drawing-up and negotiating the financing documentation, the project agreements, corporate documents and security documents being governed by German law. However, since these first transactions, all of the subsequent projects, such as for example the financing of the AMD plant in Dresden, the financing of the E-plus mobile telephone system as well as a number of other transactions were all made subject to German law, it being understood that the issues addressed in governed project financing documentation governed by German law are, of course, the same as in an agreement governed by US or English law.
The experience of the past years has proven that German law, as a codified law with conflicting interests resolved by rules of statutory law, permits a very lean and also cost-effective documentation whilst providing the same comfort and protection to the parties as English or US law. German law is also suitable to govern project finance in eastern Europe which has a continental civil code tradition. German law firms have acquired the know-how and the expertise to structure and negotiate large and complex project finance transactions in both the German and the English language and in both the shorter codified law format or the more voluminous common law style.
There are neither specific regulations nor specific court precedents addressing particular issues of project financing. This being said, the statutory provisions of German codified law as well as the jurisprudence applicable to financings in general are also applicable to project financings.
Project finance transactions are arranged by the large German commercial banks which, by taking the lead in domestic and international transactions, have acquired expertise and skills of international standard. Until now, the finance put in place for German projects was exclusively bank debt. Most of the project financing loans having been syndicated in the form of 'club-deals' i.e. with a number of banks which were identified as participants in the project from the outset. Whether, as in the United States and England, the German capital market can be tapped for project financing remains to be seen. The rating of projects as a condition to access the capital markets is not a familiar feature in Germany. Assuming that projects will be rated it remains to be seen whether investors will be prepared to rely on such ratings.
It should be mentioned that the project financing of municipal infrastructure projects has been realized in the past through tax-driven structures. There existed a limited market of high net-worth individuals who were prepared to invest for tax reasons in such municipal infrastructure projects.
Financing of projects in Germany may benefit from the participation of special purpose banks which, if the project qualifies under the charter of these banks, will be able to offer preferential terms and conditions. The main special purpose banks are Kreditanstalt für Wiederaufbau (KfW) and Deutsche Ausgleichsbank (DTA). Whilst KfW concentrates on investments in the infrastructure of the New Länder of the Federal Republic, DTA mainly supports environmental as well as regional and sectional structural projects.
The Borrower
As is customary in project financing the borrower is a special purpose vehicle which is responsible for the project. With the 'Gesellschaft mit beschränkter Haftung' (company with limited liability) German law offers a legal entity which is easy to incorporate, cheap to operate and flexible as regards its structure. In certain instances the special purpose company is incorporated in the form a limited partnership in order to benefit for tax reasons from the tax transparency of this vehicle.
As in other jurisdictions the sponsors are usually corporate entities which are active in the relevant market in which the project is to be realized.
In Germany there are various types of direct or indirect subsidies for certain sectors of the industry from which a project financing may benefit. These subsidies are of too great a variety and complexity to be meaningfully described within the context of this overview.
Worth mentioning are, however, specific state aids which were put into place after the reunification of Germany with the purpose of fostering the economic reconstruction of the 'New Länder'. These state aids fall into two categories: subsidies in the form of cash payments or tax relief and subsidies in the form of preferential credits or credit support.
Subsidies in the form of tax relief, to which the beneficiaries have a legal claim if the project satisfies certain conditions, are being phased out.
Subsidies in the form of cash contributions are awarded at the discretion of the administration without the beneficiary having a legal claim. When structuring a project in reliance on such cash subsidies, care should be taken to optimize the project in view of the parameters for such subsidies.
Preferential credits are mainly provided by KfW and DTA as mentioned above.
Credit support is made available by guarantees of the Federal Republic of Germany and of the Land in which the project is realized. The guarantees are granted in the form of a surety (Bürgschaft). Sureties are available in different forms. They normally cover between 65% and 85% of the project loans. Sureties can only be called upon once the banks have exhausted their recourse against the borrower and, if so provided for in the surety, against the collateral furnished by the borrower.
All of the above state aids qualify as a public subsidy as determined in the European Community Treaty and must therefore, as a rule, either generally or individually have been approved by the European Commission, it being understood that the Commission closely examines these state aids.
In contrast to other jurisdictions the domestic market for project financing in Germany is not very deep. This is partly due to the fact that project financing is still a somewhat new feature. The main reasons are, however, particular features of the German market as regards both the parties and the market sector in which projects can be realized.
In today's Germany only a few large companies produce, transport and distribute electrical and other energy. These companies realize their investments by borrowing at preferetial rates against their balance sheet from banks with which they customarily have a close relationship. These companies are, therefore, not interested in project financing structures with their higher lending costs and their more complicated structures.
The few projects which were nevertheless undertaken using a project finance structure relate to investments where a number of parties of different size and/or standing carried out a joint energy generation or transportation project. In such instances, a project finance structure permits the parties involved to clearly delineate and limit their responsibilities for the project to each other. The Stegal-Midal gas pipeline and, more recently, the Rhône-Poulenc power plant in Freiburg are examples for this rationale underlying a project finance structure.
In anticipating forthcoming EC regulations, the federal government has started to deregulate the energy market. In view of the existing strong players in this market and long established monopolistic structures, it will still take some time until the deregulated energy market becomes so transparent and liquid that it will permit the reliable cash flow forecasts necessary for project financings and thereby become attractive to new independent energy producers, such as the merchant power plants in the United States and the United Kingdom.
Road Transport
Traditionally, roads in Germany were built with public funds and their use was free. In order to meet the substantial infrastructure needs of German reunification, since 1990 roads were pre-financed with loans from the private sector. The government went one step further and in 1994 introduced a law permitting user paid toll structures.
In 1997 the Federal Ministry of Transport published a list of projects which it considered suitable for toll structures. Recognizing that most of these projects would probably not generate enough cash flow to justify a true project finance structure, the ministry indicated that public funds may need to be made available to make these projects viable.
However, due to the persistent shortage of public funds only two projects have so far advanced. Furthermore in contrast to the former Christian-Democrat/Liberal government which favoured private financing of public infrastructure projects, the Social Democrat/Green government in place since last autumn takes a rather restrictive view as regards such financing. However, in view of the fact that there are no cash-rich sponsors to realize road transport infrastructure projects as well as in view of the continuing shortage of public funds project financing of toll structures which are supported by reasonable public subsidies should have a future in Germany.
Rail Transport
The investments to be made for the improvement and extension of local public transport facilities are huge. However, local public mass transport is and will remain heavily subsidized and is exposed to political intervention. Therefore, whilst private financing is available for this transport sector in the form of financial leases for rolling stock, there appears to be no sound commercial grounds for project finance of local transport schemes in the foreseeable future.
As regards long distance rail transport, the second phase of the German rail privatization has broken down the German railway group into individual subsidiaries which operate partial services such as, for example, the operation of the tracks. The first private operators by obtaining access to the tracks in exchange for payment of an access charge, have set-up passenger or goods transport services with their own rolling stock. These operations are, however, still rather small and also substantially subsidized. It remains to be seen whether such operations will grow to a size and profitability that would justify a project finance.
Air Transport
The past years have seen efforts to privatize airport construction and operation. With respect to Düsseldorf airport, the consortium which will acquire a 50% share in the airport and operate it has already been determined. The privatization of the Berlin airports is completed with the proviso that the private owners will close down two of the existing airports and increase the capacity of the third airport. It is envisaged that the substantial costs for the increase of the third airport will be financed by a project finance structure. The owners of other airports such as Hamburg and Frankfurt are considering privatization. Future investments in these airports may also be financed through project financing structures.
Infrastructure Utilities
Municipal utility services such as water supply, waste water treatment and waste disposal, but also local power plants, were, like roads, traditionally operated as a public service and financed with public funds. However, in the 1980s, municipalities started to turn to private investors for the financing of their aforementioned facilities. The structures used to raise this finance are of a project finance type and have become quite popular.
The financing of a public utility is normally structured around a special purpose vehicle ('SPV') established as a limited partnership. The limited partnership shares are placed mostly with individual investors which seek tax breaks achieved through initial tax losses incurred by the SPV as a result of the initially high depreciation and interest expenses.
Financing involves principally the equity of the SPV and debt. Sophisticated debt/equity ratio optimization schemes have been developed by the arrangers of the projects to optimize the tax benefits. These schemes are, as a rule, negotiated with and agreed upon by the competent tax authorities, because only if certain criteria under applicable tax laws and regulations are met would the investors be deemed to be 'co-owner/entrepreneurs' and their tax losses would thus become deductible from other income. Part of the benefit of the private financing derived from the investor tax breaks is passed on to the municipality, thus achieving overall cheaper financing for the project.
In the concession agreement the municipality/public entity undertakes to pay the capital costs independent from the actual performance and operation of the facility, plus a volume-related price. After repayment of the debt, the public entity acquires the facility at a fixed price which makes the investors whole. This usually involves put or call options which have to be structured in such a way as not to jeopardize the 'economic and beneficial ownership' of the facility by the SPV. Complicated legal considerations apply to walking this fine line.
The exploration for and exploitation of raw material of all kinds is traditionally a field of project finance. To the extent that raw material is exploited in substantial quantities in Germany, its extraction is either highly subsidized, such as coal, or, like lignite, operated by cash-rich companies such as the large energy producers. In both instances project finance is, therefore, not an issue.
The German state-owned telecommunications system was privatized in 1996. Simultaneously with privatization, the telecommunication market is being deregulated. An ever increasing number of companies are investing in this deregulated market and its various opportunities. Most projects are realized with strong sponsors which, at least for the time being, raise the necessary debt by lending against their balance sheet. Only the E-plus mobile telephone network, which was realized by several sponsors, was project financed in order to delineate the risks of the participating sponsors. Other projects may follow.
For further information on this topic please contact Ulrich Mannsfeldt at Freshfields Bruckhaus Deringer by telephone (+49 69 27 30 80) or by fax (+49 69 23 26 64) or by e-mail ([email protected]).
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