New Equator Principles need to be reflected in loan agreements. Lenders and project sponsors should also protect themselves against increasing use of trade sanctions by governments to enforce foreign policy goals.
The Equator Principles are a set of rules to which development financing institutions, export credit agencies and many
large banks have committed to follow when deciding whether
to lend. The lenders have agreed not to lend to projects that
damage the environment or cause social turmoil. The principles
have been recently updated.
The Equator Principles Association launched the third version of
the Equator Principles — called EPIII — in June 2013. While EPIII
became effective on June 4, 2013, a transition period was introduced covering the remainder of the year.
Therefore, EPIII became mandatory for projects financed by
financial institutions where the mandates were signed on or
after January 1, 2014.
It is timely to consider how to incorporate the requirements
of EPIII into loan documentation as the finance documentation
for the first projects that are subject to EPIII is currently under
negotiation. The Equator Principles Association updated its
guidance in March on how to implement the Equator Principles
in loan documentation.
EPIII has brought within the scope of the Equator Principles,
project-related corporate loans and bridge loans in addition to
project finance advisory services and project finance that were
already covered. The project capital costs have to be more than
US$10 million to be covered. EPIII has also put new emphasis on
climate change, increased emphasis on human rights,
expanded the reporting requirements of the financial institutions making covered loans and enhanced the covenants that
are required in loan documentation. When considering incorporating the Equator Principles into
loan documentation, it is not usually enough merely to require
the borrower to comply with, or not violate, the Equator
Principles. This is because the Equator Principles are not a
charter specifically directed at borrowers or sponsors but rather
are a set of principles directed at lenders.
Therefore, the key is to take the Equator Principles and
convert them into environmental and social compliance provisions that can then be incorporated into the loan
A project will first need to be categorized by the lender
during its due diligence process according to the degree of environmental and social risk the project presents. This categorization of the project will determine the requirements that the lender is likely to impose on the project. These
will depend on the category.
Thus, lenders will have to assess the environmental and
social risks and require the sponsor to put in place a system for
managing such risks for category A and B projects. The sponsor
will have to prepare an environmental and social management
plan and also have a plan to address any environmental and
social issues that do not comply with the relevant standards. An
independent consultant will have to be hired to assess the adequacy of these plans. This is compulsory for category A projects
and may also be requested for some B projects. The lenders will
have to set up complaint and grievance procedures for local
communities affected by the project. They must also consult
with affected local communities. This is compulsory for category A projects and may also be
requested for some B projects. Finally, the sponsor must turn in
regular compliance reports to the lenders.
In order for a lender to ensure that the project to which it will
be lending will comply with the Equator Principles, the above
requirements will need to be tailored to the specific project
based on the activity being undertaken by the project.
Financial institutions and sponsors can at times be ambivalent about the details of implementation of the Equator
Principles after the loan has been funded, and such ambivalence can translate into provisions in the loan documentation
that do not serve their intended purpose.
For instance, having representations and covenants simply to
the effect that the borrower must comply with the Equator
Principles betrays a lack of understanding of the regime set up
by the Equator Principles Association.
Implementation of Equator Principles in loan documentation
should typically be structured in the following manner. The borrower should represent that there are no environmental or social claims or potential such claims against the
project that might have a material adverse effect on the implementation or operation of the project.
There should be several standard “conditions precedent” to
the initial disbursement of debt. No draw should be allowed
until the borrower has obtained all necessary environmental
and social permits (and provided opinions as to the completion of this requirement). The borrower should have appointed the
necessary technical consultants to undertake an agreed scope
of work. The borrower should also have delivered all reports,
assessments and plans relating to the environmental and social
impact of the project.
Conditions precedent may also be required for each future
disbursement. Such conditions would typically require confirmation that the project continues to be in compliance with any
applicable (at that stage) environmental and social requirements and that all actions required by any environmental and
social management plan have been completed as required.
The borrower should be required to report to the lenders on
environmental and social matters at regular intervals (usually
on an annual basis during the operation phase and more frequently during construction). These reports will include preclosing reports, progress reports during construction and
Any environmental and social claims, environmental contamination, health and safety violations, protests or grievances
by the local community and project employees and any other
environmental and social issues should also be reported to the
lenders as they occur.
The borrower may also be
required to make public reports
on certain issues (for example,
emissions reports where the
project emits more than
100,000 tons of CO2 equivalent
The borrower should be
required to covenant to comply
with the environmental and
social requirements (including
the environmental and social
management plan), deliver
progress reports documenting
and certifying compliance with
these requirements, allow access to the lenders and their representatives to assess compliance, conduct any decommissioning
in accordance with a predetermined decommissioning plan and
respond to complaints about construction, permitting and
operation of the project. The borrower may also be required to
agree not to amend the environmental and social management
plan materially without lender consent.
While some lenders may insist on including events of default specific to environmental and Equator Principle compliance,
such inclusions should not be required if the conditions precedent, representations and covenants outlined above have
already been included. The loan documentation will already
provide for lender rights of termination, subject to varying
periods of remedy allowed to the borrower, upon the breach of
such representations and covenants.
Trade sanctions can be imposed by various intergovernmental
organizations and states. The United Nations Security Council
can impose sanctions that are binding on all UN members
while the European Union issues sanctions directly effective in
all member states. Individual countries such as the United
Kingdom and United States also impose sanctions that are
usually tougher in terms of scope and restriction than sanctions
imposed by the UN and EU.
While trade sanctions can take a number of forms, the most
relevant types of sanctions for parties in project financing are
financial sanctions. Under certain sanctions regulations, financial institutions are prohibited from making available any funds,
other financial assets or economic resources to sanctioned entities or sanctioned countries. This could include the release of
money in a bank account to an account-holder or extending a
loan or guarantee to a client who is linked to a sanctioned
Breach of financial sanctions may be considered a criminal
offense punishable by imprisonment, a fine or both. A number
of financial institutions have been subject to multi-million
dollar fines and settlements with the US and UK regulators for
In the US, the Office of Foreign Assets Control or “OFAC,”
which is part of the US Department of the Treasury, administers
and enforces financial sanctions. The US Treasury maintains
jurisdiction over all US dollar transactions, and its aims are to
ensure no sanctioned countries, entities or individuals engage
improperly in US dollar-denominated transactions.
OFAC is extremely proactive and diligent in enforcing US
policy and has implemented regulations that have extraterritorial reach to the activities of foreign financial institutions. In
2009, a UK bank agreed to pay a US$350 million penalty in lieu
of US criminal prosecution for processing payment transactions
made by its clients through unaffiliated US banks.
Although the bank was technically not a US entity and none
of its process payment transactions took place within the US, its actions caused its unaffiliated US
correspondent banks to breach OFAC regulations and, therefore, its actions were caught by the US sanctions regime. More
recently, in 2012, another UK bank paid approximately a
US$300 million fine for concealing transactions through the US
financial system primarily on behalf of Iranian and Sudanese
clients by removing information that would have revealed the
payments and otherwise would have been rejected, blocked or
stopped for investigation under OFAC regulations.
Given the challenges of complying with overlapping sanctions regimes, and the potentially significant penalties and personal liability for breaches of regulations, financial institutions
need to be conscious of the complexities of sanctions laws.
It is important in any project financing that lenders are
aware and protected from their funds being used for any sanctioned activities. Borrowers also need to manage risk to ensure
they are not inadvertently prejudiced should another party to
the project finance agreements breach the relevant sanctions
As a matter of policy, lenders will include a series of sanctionsrelated representations coupled with undertakings in the loan
documents so that in the event their funds are used in any type
of sanctioned activity, the lenders will have recourse against
Trade sanctions may be imposed for use of funds directly or
indirectly in a sanctioned activity. This includes dealing with
persons or entities designated on a particular sanctions list or carrying out transactions in sanctioned countries.
Therefore, when negotiating a sanctions representation,
lenders should insist on not only capturing the borrower under
the scope of any representation, but also any party to whom
the facilities can potentially reach.
For this reason, it is not uncommon to see sponsors, shareholders, the EPC contractor, the O&M contractor and guarantors covered by the sanctions representation. While the
borrower will obviously want to limit the inclusion of other
parties, the borrower may be more receptive to having the
scope cover the additional parties if it is able to obtain the same
level of protection from the additional parties under its contractual documentation with such parties.
Lenders will want the borrower to covenant that the sanctions representation will remain true at all times until the loan
is fully repaid.
Typical representations in relation to trade sanctions include
that the borrower and other related parties have not made the
proceeds of the facility available directly or indirectly to any
person or entity that is sanctioned or affiliated with a sanctioned entity and have not made any proceeds of the facility
available for use in a sanctioned country. The borrower may
have to represent that neither it nor any related party is a sanctioned entity or has violated any sanctions and it is not aware
of any claim or investigation against the borrower or an affiliate
by a sanctioning authority.
The lenders should also require negative covenants relating
to sanctions where the borrower and related parties undertake
to refrain from certain actions. There should usually be a prohibition on the borrower and related parties from making any
proceeds of the facility available to any sanctioned person or
for use in a sanctioned country for the purpose of financing
activities in breach of the
If the borrower breaches a
representation or covenant in
the loan agreement, then it
should be entitled to a certain
number of days within which to
remedy the sanctions breach
before the lenders are able to
call an event of default.
Conversely, if the borrower
breaches a negative covenant, then the lenders may insist on no remedy period so that the
lenders have the right to call an immediate event of default.
Should a party other than the borrower breach a sanctions
provision in the loan agreement, then apart from any remedy
period available, the borrower’s only recourse should the lender
call an event of default is to claim against the other party in
breach of the sanctions provision under its contractual framework with that party. This highlights the importance of the borrower properly allocating its risk and ensuring that it is covered
directly for breaches of parties outside its control.
Remedies available to the lenders should the borrower or a
related party breach a sanctions representation or covenant
include calling an event of a default, allowing the lenders to
cancel the loan agreement and facilities under it and claiming
immediate payment of any funds drawn down by the borrower.
Against the backdrop of existing anti-money laundering and
anti-terrorist financing laws, financial institutions must not
overlook the growing area of sanctions law and how to protect
themselves in project financing agreements. From a borrower’s
perspective, the project and finance documentation should
include coverage for breach of the sanctions provisions by other