5 January 2010
Project finance is the long term financing of a wide range of infrastructure and industrial projects which typically involves a group of investors (known as the sponsors) providing the equity for a project and a group of banks providing the debt financing.
What’s it all about?
Project finance is the long term financing of a wide range of infrastructure and industrial projects which typically involves a group of investors (known as the sponsors) providing the equity for a project and a group of banks providing the debt financing. This form of financing has traditionally been used to develop power stations; wind farms; oil and gas pipelines; petrochemical plants; sports stadia; mines; social (i.e. prisons, hospitals and schools) and economic (i.e. road and rail networks) infrastructure projects. The practice involves simultaneously documenting the financial terms pursuant to which a bank group is prepared to lend, together with the process by which the project will be constructed, operated, maintained and, if relevant, its product sold.
Sponsors typically establish a special purpose company to borrow the funds necessary to develop the project. The debt is secured against the project assets and shares in the special purpose company and repaid using the cash flow generated by the project rather than the assets or creditworthiness of the sponsors. This is known as non-recourse financing as, if the project defaults in the repayment of the debt, there is no recourse to the sponsors (i.e. if the security taken over the project assets does not realise the full value of the debt, the lenders cannot recover the shortfall from the sponsors). The drafting of project documents (construction contracts, operation and maintenance contracts, off-take purchase agreements and sales/supply agreements)will, therefore, not only aim to provide the legal framework for the development of the project but will vitally also look to achieve performance levels that maintain these cash flows so that the project can service its debt.
The working culture
The work can be fast paced but is extremely varied day to day depending on who you are acting for and the stage of the deal. Transactions typically last between six and fifteen months from inception to close, depending on their size, nature and complexity together with the then current state of the markets. Commonly, junior lawyers will assist the senior lawyers in drafting the project documents, finance documents and security documents, liaising with local counsel and the various specialist advisers (including financial, technical, insurance and environmental) and managing the collection/delivery of the conditions precedent to the financing. Conference calls, email correspondence and meetings (both internal and external) all form part of the weekly work pattern.
There are a large number of parties involved in any single project financing (including financial institutions, sponsors, governments, construction contractors, off-takers and specialist advisers) scattered across global locations. With such a diverse range of projects and clients, we benefit from learning more about global business and legal practice in a wide range of jurisdictions. We also have the prospect of travel to some fairly exotic locations.
As with other practice areas, it is vital to have a firm grasp of the law and a commercial understanding of the process involved in bringing a project from conception to completion within the parameters required by your clients. In addition, clients expect their lawyers to have a sound understanding of their commercial goals and the market in which they operate, frequently requesting details of previous deals, recent developments in the industry sector or current practice in specific areas.
The transactional nature of the work demands an ability to work in high pressure environments and to deadlines. You need to be well organised with excellent time management skills. Given the team work and long hours involved at certain points of a financing, it is vital to be able to maintain a sense of humour and a positive approach to working with your colleagues and clients. Effective communication skills are also essential because clients from a commercial background will require you to cut through the jargon and explain legal concepts in simple terms.
The project finance market has traditionally been perceived as less risky than other forms of financing, which is partly because many projects are government-backed with some of the risk assumed by governmental entities, rather than lenders. As a result of recent market events, however, advisers have had to become more inventive and rigorous in their approach to structuring and financing a deal. Given the reduction in liquidity in the markets, large scale project financings are now frequently achieved by way of a combination of commercial debt, export credit agency and multilateral loans, bond offerings and Islamic financing. Lenders are also increasingly imposing more stringent financial terms. These can be seen in a higher pricing of the debt, tighter financial covenant packages, a requirement for the sponsors to invest more equity and an increased emphasis on “early warning indicators” such as ongoing reporting requirements, delivery of financial statements and involvement in the borrower’s budgeting process.
The good news is that the project financing market is definitely still alive and growing. In the past six months our London team has seen the conclusion of the landmark Al Dur IWPP (the US$2.1 billion financing of a power and water plant in Bahrain which was the first Middle East power project to include a mix of commercial debt, export credit direct loans, export credit covered loans and Islamic financing; and the first Middle East power project financing to reach financial close since Lehman’s collapse) and the US$6 billion Dolphin Refinancing (the Middle East’s largest cross-border gas project, involving the production and processing of raw gas in Qatar, a sub-sea pipeline to Abu Dhabi and a further connection to Oman), together with the first ever project financing of a cement plant in Syria.
Simon Thomson and Suzanne Szczetnikowicz, associates, Shearman & Sterling