When the Government announced its policy on public private partnerships in December last year (“PF2”), the policy included an intention to act as a minority co-investor in PF2 projects, and to require a funding competition for the provision of third party equity for PF2 projects.
Treasury has now issued a consultation document in relation to equity aspects of PF2 projects, including proposed template form documentation comprising a shareholders agreement (“SHA”), articles of association (“AoA”) and a loan stock instrument (“Instrument”) which would be adopted for PF2 projects. In launching the consultation, Lord Deighton, commercial secretary to the Treasury, stated:
“Taking a share of equity in these projects means a greater voice for the public sector, stronger partnerships with the private sector and increased disclosure to the taxpayer. It will also make us better clients. This is an important step forward and we must continue this momentum.”
The consultation runs to 21 August 2013, and can be accessed at gov.uk.
Set out below are the major points raised by the documentation.
1. Equity investment procedure
The Government will determine on a case by case basis whether there should be public sector investment in PF2 projects – with this being an option, but not an obligation to invest. This will be specified in the relevant procurement documentation. If this applies, bids will need to be made on a fully funded basis – with Government being able to require this to be scaled down. It is expected that this will always be a minority stake (set by Treasury in conjunction with the Authority) – with no obligation to provide further funding over and above that agreed at financial close of the project.
At the same time, the Government will determine if an equity funding competition is required. This is envisaged to be a single stage process, run by the preferred bidder, and with the preferred bidder selecting the winner on an open and transparent basis. Neither Treasury nor the Authority that sponsors the project would be part of the selection process, but both would have access to the evaluation criteria and selection decision.
Sponsors will be able to seek informal guidance from the Treasury team on specific issues (we expect that this would include on the template documentation) during the procurement process.
Where there is a funding competition, the overall capital structure and shareholder debt terms will be set by the preferred bidder – as the Government’s stake will need to comply with State Aid requirements, it is likely that where Government is to be a shareholder, an equity funding competition will be required.
2. Investment appraisal process
The consultation envisages that Treasury would carry out a two stage “due diligence” process on each project, with the aim of minimising the work and cost to their team:
- as part of each bid, the bidder would provide key prescribed information, including on the allocation of risk between the project company, the supply chain, and insurances (which even where detailed documentation has not been prepared should have been priced). A description of material proposed changes from the template PF2 equity documentation will also be required;
- prior to financial close, the Treasury team will carry out a review of the equity documentation (and agreements between shareholders and senior lenders) and of the financial model (with some sensitivity scenarios). The Treasury team will also require a detailed legal due diligence memorandum of the allocation of project risks (from the project’s lawyers), with advanced drafts of the project and finance documents.
At financial close, the Treasury team will require reliance letters from the project’s lawyers and model auditors and (unless the project has its own technical and insurance advisors) from the lenders’ technical and insurance advisors. Reliance letters will need to be addressed to all investors (including any third party equity investor).
3. Template SHA
The SHA has been prepared on the basis of there being 3 shareholders – the developer, Treasury (via a wholly-owned company) and a third party equity provider. There would be a conventional two level holding company (“HoldCo”)/project company (“SPV”) structure, and the shareholder subordinated debt would be issued by way of unsecured loan notes by the project company to the shareholders.
Key areas include:
- a single board structure at HoldCo and SPV levels (see further comments in relation to the AoA), with Treasury being able to nominate an observer to the HoldCo and SPV boards (in consultation with the sponsoring authority) whether or not it holds shares (the observer may be excluded from parts of meetings by a majority vote of the directors)
- proposed reserved rights for shareholders and the board (set out at Annex 1) – requiring the approval of all material shareholders (holding over 15% of the shares in HoldCo) or a director appointed by each material shareholders. These are relatively standard
- step aside provisions for the conduct of disputes under contracts with shareholder group members
- the SHA envisages that if the SPV required working capital (for example if the SPV were developing a number of projects at different stages), this would be provided by the sponsor alone (and not Treasury/the third party equity provider)
- specific obligations to supply key information to the Treasury (whether or not it is a shareholder) – including in relation to the HoldCo and SPV financial position and key project performance indicators, the IRR for shareholders, defaults, distributions and shareholder debt payments, the beneficial ownership of shares and shareholder debt and tax residence of owners, and terms of any proposed disposals of shares and shareholder debt
- reasonably standard rights to other information and confidentiality obligations – subject to customary Freedom of Information Act 2000 exceptions
- permitted transfer rights and a deemed transfer notice process for shareholder defaults (see further comments in relation to the AoA). In addition to the usual pre-emptive purchase arrangement for transfer notices issued on shareholder default, there is an unusual sale agent procedure that applies where the non defaulting shareholders do not purchase all the defaulting shareholder’s shares and subordinated debt, under which an independent sales agent is appointed to run an auction sale. If at the end of that sale process the defaulting shareholder’s shares and subordinated debt have not been sold, the non defaulting shareholders may either purchase the shares and debt for the par value of the shares, or require that the HoldCo is wound up (it is not clear what would then happen to the SPV – its shares would (subject to the senior lenders’ security) be assets to be realised by the liquidator)
- the events of default for which the compulsory transfer process applies include the customary shareholder insolvency/breach of transfer restrictions provisions – but also extend to material breach of the SHA and (more unusually) a disposal by a shareholder of its business/assets to an “Unsuitable Third Party”, changing its business such that it becomes an “Unsuitable Third Party”, and suffering sequestration/expropriation of its business or assets by a public body or governmental authority
- the “Unsuitable Third Party” definition is to be adapted to reflect the nature of the relevant PF2 project (to reflect the usual Government areas of concern), but will also include persons whose tax returns submitted after September 2012 have been found to be incorrect as a result of a successful challenge by HMCRC under tax abuse principles or the failure of a tax avoidance scheme •any disputes would be subject to escalation between the shareholders – and if unresolved would result in a deadlock.
- A third party expert procedure would then apply – which would only be binding if the shareholders agree to this. Otherwise the courts would have jurisdiction. It is not clear what would happen to the SPV’s business while that deadlock was subsisting – the position is usually that the business should continue to be run as far as possible in accordance with its then current business plan
4. Template AoA
The AoA would incorporate the Model Articles prescribed by the Companies Act 2006, with a number of bespoke provisions for PF2 projects.
Key areas include:
- each shareholder to be entitled to appoint one shareholder for every 15% of the share capital held by it (up to 3) – with one vote per director and the possibility to have an independent chairman (with no right to vote). The chairman would otherwise be a shareholder director, appointed by rotation between the shareholders
- permitted transfer rights. There will be a very wide transfer right by Treasury in favour of the “HMT Group” – which extends to any UK government department or public body, any of their subsidiaries, and any fund managed by them or in which they have an interest (however small). The other shareholders have permitted transfer rights to group members and within investment funds. If a group member leaves its group, there is a requirement to transfer back to the original transferee – but this does not apply to the Treasury shares
- a right of first refusal process for other transfers of shares (using the price agreed between the seller and the HoldCo board, or if this can’t be agreed the seller’s proposed sale price), and a compulsory transfer process for shareholder insolvency/breach of transfer restrictions (using the price agreed between the relevant shareholder and the HoldCo board, or if this can’t be agreed, a fair market valuation with no discount)
5. Template Instrument
The Instrument is pretty standard for PFI projects – notable features include:
- stapling of the loan stock with transfers of shares (so that a similar proportion of loan stock needs to be transferred with shares (the stapling requirement are set out in the Instrument and SAH, but not the AoA))
- no ability for the SPV to redeem the loan stock early (and in particular no “spens” formula)
- events of default to include termination of the Project Agreement and acceleration of the Senior Debt
- the usual requirement for an extraordinary resolution of the noteholders to approve certain matters – however this is set at 100% of those voting which is a little inflexible