In a typical project financing, important project counterparties, such as the power purchaser; fuel supplier; landlord; or Engineering, Procurement, Construction (EPC) contractor, are asked to sign a consent and agreement with the project’s lenders. These agreements often address weighty commercial issues. Understanding the inherent tensions in these agreements and having the tools available to manage them can be invaluable for achieving satisfactory resolution.
Common Project Consent Issues
Extended cure periods, standstill obligations and a broad ability to assign the project entity’s assets in a foreclosure scenario are the most common subjects addressed in project consents. The consent also should clearly describe which of the project entity’s obligations must be satisfied in order for the project counterparty to continue performing or recognise a third party transferee. When determining an acceptable cure period, the project counterparty should consider that it may be required to continue performing under the project agreement, even though the payments it receives may be irregular or incomplete during the cure period.
Lenders regularly refuse to assume liabilities for the project other than past-due scheduled contract payments and liabilities incurred after the lender exercises its enforcement remedies. Therefore, the project counterparty’s only recourse for payment of liabilities incurred before the lenders step in may be to seek recourse against the defaulted project, which may then be in bankruptcy. There are variants on how to allocate this risk, and that allocation generally occurs in the consent.
Assignment restrictions are prominent and detailed in project agreements, as most project counterparties insist on controlling the identity of their business partners. Depending on the circumstances, counterparties may insist on retaining consent rights over transfers or require a potential transferee to satisfy requirements of minimum creditworthiness, operational competence or competitive status. Of the three most common requirements imposed on transferees, competitor restrictions might be the most difficult, especially in projects that are unique because of their location, technology, fuel supply or other attributes. Competitor restrictions are most common in “inside the fence” type projects where the project counterparty wants to protect against competitors operating “in its backyard”. However, not wanting to unnecessarily limit the pool of potential purchasers should there be a foreclosure, lenders insist upon a specific objective definition of competitor. Their appetite for competitor restrictions will be inversely proportionate to the number of likely purchasers of the project. In any case, defining “competitor” can be very challenging, particularly in today’s markets where acquisitions and disposals have become commonplace.
In the eyes of the lenders, the counterparty’s desire to control its business partners presents an uncomfortable limitation on the lenders’ attempts to be in a position to obtain the highest price for the project assets in a foreclosure or other liquidation scenario. Lenders want everyone involved in the project to view a foreclosure as an undesirable method of last resort, as they are likely to receive only a fraction of the total fair market value of the project. Therefore, at the project financing stage, the counterparties must engage in a discussion with the lenders about the assignability of the project and their particular concerns about marketability of the project in a distressed sale scenario. Furthermore, lenders typically try to protect themselves against the sponsor of a troubled project gaining an opportunity to benefit from, or unduly affect, decisions on how the lenders can recover their lost investment.
Sponsors with Dual Roles as Key Third Parties
The landlord, EPC contractor, customer or other project counterparty with a key contractual relationship with the project always has legitimate commercial issues to protect. This is no different when the project sponsor is also the project counterparty. But the project sponsor that serves in this dual role presents both a benefit and a challenge to the lenders. On the positive side, a sponsor will naturally be more strongly incentivised than a disinterested counterparty to exercise patience, relax its commercial goals and otherwise extend itself if these efforts will support the project. On the other hand, the sponsor is in the unique position of affecting the project and could allow its commercial considerations to influence the decisions it makes on behalf of the project. The lenders’ goal should be to use the consent to strike the appropriate balance between the sponsor’s legitimate commercial interests as a project counterparty and the interests of the project.
Most sponsor-counterparties are successful in obtaining cure periods and standstill provisions that are within the norm for project consents. However, by virtue of the sponsor’s relationship with the project, they are commonly on the higher side of the range. Sponsor-counterparties tend to experience difficulty obtaining shorter cure periods, for example, because the lenders want to incentivise the sponsor to use available avenues to cure the project company’s default rather than relying on punitive tools.
As discussed above, the parties may be unable to arrive at mutually acceptable definitions of competitor or operational competence that the transferee must satisfy. This challenge in relation to transferability can be overcome by granting the sponsorcounterparty purchase or early termination rights.
Lenders accepting purchase rights typically require that they apply to a buyout of the entire project, rather than the specific contract, because the project assets are worth much more as a whole than separately. Of the purchase structures, lenders tend to favour a right of first offer (where the lender can propose a purchase price to the sponsor-counterparty even without having received an outside offer) rather than right of first refusal (which contemplates an outside offer). The right of first offer is favoured because it enables the lender to conduct an auction more freely, or enter into negotiations with a third party, without the looming risk that the sponsor-counterparty may step in after the sale has been negotiated, as is the case with the right of first refusal. A sponsor-counterparty that wants to prevent competitive or other sensitive information about its contracts or the project from becoming widely available also might prefer the right of first offer.
An early termination right would allow the sponsor-counterparty to terminate the key project contracts that it does not want to be transferred, while allowing the lender to retain and transfer to outsiders other project contracts and assets that may have independent value. However, the main challenges with the selective termination right are that from a practical perspective, most project assets are worth far less independently than they are as a package, and calculating a price for the terminated contracts can pose a significant challenge.
Although typically addressed in the later stages of the financing process and relegated to less experienced business persons and lawyers, consents often contain important issues that, especially in the case of the sponsor-counterparty, should be addressed with considered respect for the underlying commercial issues. A project company that carefully strategises and guides the consent process is likely to be rewarded with a smooth financial closing rather than one that is contentious and extended.