One of the main functions of the World Bank, a financial institution mandated with fostering the reconstruction and development of sovereign nations after the Second World War, is to extend loans to the governments (and government-owned entities) of such sovereign nations. Acting through the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA), the World Bank plays a critical role often operating as a lender of last resort for developing countries in need of financing for important infrastructure projects. In doing so, the World Bank does not require any security from its borrowers and instead relies on the credit of the sovereign as a matter of policy. This act of good faith, however, needs to be balanced by the need of the World Bank to protect the World Bank’s interests, in particular, the priority of its debt claims in respect of the claims of other third party creditors.
Accordingly, the World Bank requires any member state that is borrowing from (or guaranteeing loans from) the IBRD to sign up its General Conditions for Loans, which include a negative pledge clause that is set out in section 6.02 of such conditions (the NPC). The NPC seeks to prevent other foreign currency creditors of a member state from receiving security from the relevant borrower or guarantor in priority to the World Bank, by providing that any lien securing an external debt by a member state (whether as borrower or guarantor) “which will or might result in a priority for the benefit of such creditor in the allocation, realization or distribution of foreign exchange […] shall […] equally and rateably secure” amounts payable by that member state to the World Bank.
The NPC extends not just to security that may be granted in respect of assets owned directly by the relevant member state government, but also to assets of any entity that is owned or controlled by, or operating for the account or benefit of that member state.
Because of its broad scope, the formulation of the NPC presents a potential challenge to any foreign investor that wishes to lend on a secured basis to a project that is owned or controlled by a member state with IBRD debt.
The IBRD’s General Conditions do not include a definition of “ownership” or “control”, for purposes of determining whether the assets of an entity that may be considered to be owned or controlled by a member state do in fact fall within the scope of the NPC. The lack of certainty as to whether a particular project or project assets may be subject to the NPC, and the wide potential interpretation as to its purview, could affect the decision by a potential investor to invest in a project financing, or affect the manner in which such an investment is made.
While the IBRD is able to waive the application of the NPC in respect of particular transactions, it has only done so on rare occasions.
Since its introduction, there have been a number of calls for reform of the NPC by industry participants and academics. Such proposals have tended to focus on a few key changes to the NPC: firstly, to provide clarification as to the entities to whom the pledge would apply; secondly, to adopt a formal, narrow interpretation of the term “control” and “ownership”, thereby providing for easier identification of assets subject to the negative pledge; and thirdly, to amend the NPC to permit limited recourse project financings to be subject to customary security packages (e.g., security over the project company shares, key assets and project revenues). The World Bank has itself in the past considered1 the benefits, particularly to states transitioning to a market-oriented economy, of permitting such limited recourse financings, subject to certain conditions, including that the borrower is a special purpose vehicle and is ‘private’ in character (e.g., publicly owned but established for commercial purposes).
It has been observed that such reforms could have the potential to facilitate further foreign direct investment to projects in countries that are seeking such investment to improve their infrastructure; particularly in the case of commercial lenders that typically will expect a robust security structure as a feature of a project financing . In the meantime, it is important for member states and state-controlled sponsors to ensure that, where relevant, the NPC is considered in any financing of a project in which they are involved.