March 20, 2016

Our Mini-Theme: Project Finance and Development: Useful Tools for Every Lawyer

Alison R. Manzer

The Project Finance and Development Committee (PFAD) is sponsoring this project finance and development basics and tools for general use mini-theme issue of Business Law Today

The PFAD Committee serves as the Business Law Section’s forum for discussing and disseminating information about the development and financing of industrial, infrastructure, and other projects. This mission statement results in active involvement of the committee, both at its regular meetings and ongoing projects, in looking at the legal substance of finance and development for projects, and also of negotiating and documenting the transactions related to those activities. Committee members include a wide cross section of the parties involved in the project process including sponsors, developers, government, contractors, equipment vendors, providers of operation and maintenance services, banks, export credit agencies, development banks, financial institutions, credit enhancers, and other arrangers and providers of financing. This gives the committee the ability to look at a broad range of projects and the interest of the various parties, involving both the development and financing of those projects. The committee works to develop model documents, materials, and programs to help its members, and others, learn and develop the techniques and best practices that will assist in expediting and adding efficiency to the project development process. 

The PFAD Committee is requesting the opportunity to provide this mini-theme focused on the idea that it is really a non-specialty specialty that is represented in this area of practice. Essentially all lawyers will at some point in their career, whether directly in their professional life or in their personal activities and involvements, touch upon some aspect of project development and financing of that project. The techniques and concepts used in project finance and development practice will be of use to essentially all practitioners when they encounter the opportunity to participate in the development of a project. 

The broad application of project finance and development techniques, procedures, and documentation arises because projects are not just P3, or infrastructure, they are any stand-alone, or able to stand alone, facility consisting of the building and its related equipment and contents, created for public, social, or commercial purposes. Project finance and development concepts cover the inputs necessary for the acquisition, construction, equipping, and operation and maintenance of those facilities. Socially based projects include schools, medical facilities, nursing homes and retirement facilities, churches, and recreation centers. Infrastructure projects include energy, transportation, bridges, highways, pipelines, water, sewer, and other facilities that deliver support for cities and states. Commercial projects include manufacturing plants, refineries, greenhouse facilities, and essentially all of the stand-alone facilities that deliver manufacturing products. Projects also include real estate, housing, shopping centers, commercial buildings, and industrial buildings. Each of these will constitute a project and benefit from the application of project development and finance techniques. 

Project finance is not really a term of art, it is simply the means of fixing the holes in the finance structure, using specialized techniques, to mitigate the risks of acquisition, construction, and operation of the stand-alone project. 

Project finance is corporate commercial financing undertaken using a structured format. The most common definition of project financing is the financing of long-term projects including infrastructure, industrial projects, and public service–based projects, on a nonrecourse or limited-recourse financial structure. The project debt and equity used to finance the project are designed to be paid back from the cash flow generated by the project. Project finance will generally be a loan structure that relies primarily on the project’s cash flow for repayment, the project’s assets, and any related rights and interests will be held as secondary security rather than as the primary source of payment on the financing. The focus is on the project and the assets and revenue of the project. This provides a form of financing that is not dependent upon the balance sheet of the proponent of the project. Most commonly, bankruptcy remote and special purpose vehicles are used to insulate the project risk from other assets of the proponent. 

Project financing is available from a relatively wide source of funds, with generally a senior debt, mezzanine, or subordinated debt, and equity tranches to the overall financing. Project lenders will generally take security over the project assets. This will allow them to take assume control of the project if the proponent encounters difficulties in the undertaking of the project. 

In addition to the nonrecourse basis for project financing, and the focus on revenue to be generated from the project, there are characteristics that will generally be found in a project finance structure. A special purpose entity is generally created for the project to protect the project and its financing from other obligations of the proponent, and to protect the proponent from the potential failure of the project. The project proponent will provide the know-how, contribute assets and equity for the project but this will constitute, most commonly, the sole exposure of the proponent to the project. 

Risk identification, allocation, and mitigation is a key element to the structuring of project finance. Technical, environmental, economic, and political risks are more likely to exist in project development and are of concern to the project finance structure. Project finance techniques have therefore been developed to deal with these anticipated risks. The techniques used include construction assurances, supply assurances, off taken concession agreements, ownership structure, and others that are intended to deter behavior that could increase the perceived risks. While project finance structures incorporate concepts from corporate finance, securitization, derivatives, insurance, secured commercial and corporate lending, they add the techniques intended to deal with the identified risks of a stand-alone project and the construction and operational risks in the development of the project. 

Project financing spans both a construction and operation period, and will have different contractual and structuring requirements in each of the phases. The contractual framework includes engineering, procurement and construction contracts, operations and maintenance agreements and arrangements, land rights agreements, off taken supply agreements, loan and inter-creditor agreements, and credit support documents. The requirements for each of these contributing arrangements for the project finance structure will depend upon the perceived risk of the structure and on the nature of available credit support, lender requirements, industry, and geographic location. 

One key purpose of project finance structuring is to ensure that there is enough money available during the course of construction of a project to pay all of the costs required to get the project completed to a stage of commercialization and use for its intended purpose. The intended purpose of the project must give enough revenue from sale, lease, or other sources of revenue to repay the financing provided during the construction of the project. Traditionally construction projects are financed using a significant amount of equity, usually between 25 and 50 percent of anticipated costs. A construction lender provides interim construction finance on a debt basis – usually 60–75 percent, with the balance provided by subordinated debt or mezzanine, as required. A take-out lender will be identified that will repay the construction financing with longer term loan, and repayment of the term financing is usually made over several years matching the revenue characteristics. 

Project finance and development techniques are not usually used if there are deep pockets with adequate access the necessary funds for the development of the project. However, even in that case, concerns such as balance sheet construction and liability issues can result in the need to consider project finance structures. Often even very large and solvent owners will put a project into a project finance structure, using a special purpose vehicle for liability isolation purposes. If deep pockets are not available and the project proponents do not have the credit available to do the project using traditional sources of funding and techniques, it is easier to do a project finance structure to achieve the financing. 

Most projects, large or small, nonprofit, social, public or commercial, now need structured finance or project finance arrangements; very few projects will fit the traditional construction financing model that was common in prior decades where the project sponsors used their balance sheet and traditional credit. Decreasing interest from investors in financing projects, and increased interest in off balance sheet treatment of the individual project, is driving an increased interest in project finance and development techniques. Project finance will generally be needed and used where the profile of the project does not match traditional debt models, but the project still makes economic sense. 

Considering projects on this basis, almost all lawyers will touch on project finance or development sometime in their practice. The occasion will arise when the lawyer is involved with the acquisition, development through construction, renovations, or expansion of a facility (a building and related equipment and contents) where it cannot simply be financed using the balance sheet of the interested party. When that occurs an understanding of the techniques used in project finance and development will assist in ensuring the project gets done – whether the local church, a skating arena for the community, or a large-scale hydroelectric project, the basic concepts and techniques are the same. 

Project development techniques will provide an understanding of the requirements for acquisition, permitting, reviews including environmental, contracting, technical needs, oversight of budget, specifications, performance, timing, and other support concepts. These will allow the lawyer to actively participate in all of the legal aspects of due diligence and documentation for the acquisition and building of the related project. 

The PFAD Committee considers on a regular basis a broad range of topics and ideas to support project concepts, both as to development and finance. These range from the very basic to the specialist. For the non-specialist there will be ideas from project finance and development techniques that can be used for a broad range of involvements and activities. 

The topics for this mini-theme were chosen to be of interest for a wider audience. The intent of these topics is to try to show the value of some of the specialist concepts that have been developed in the project finance and development world discussed as a broader and more general application that will hopefully be of value to most, if not all, practitioners. 

I would like to encourage you to attend our committee meeting at the Business Law Section Spring Meeting, Montréal, April 7–9, 2016. Registration for and attendance at the Spring Meeting is a valuable membership benefit, and we hope that our committee meeting, and our two continuing legal education sessions, can provide some valuable tools, techniques and precedents for everyone ranging from the young lawyer, general practitioner, corporate counsel, and nonprofit lawyer to project financing specialist. PFAD Committee always has a key mark dinner on the Thursday evening, and we have scheduled our continuing legal education and committee meetings to all occur on Friday, April 9, making attendance easy and convenient. 

I would be happy to provide information about PFAD Committee, membership in the committee, and involvement and leadership opportunities within the committee. The committee is an actively growing committee, with several projects it is looking to undertake, and is encouraging involvement in specific projects and leadership roles. Please feel free to contact me directly at and (416) 869-5469 if you have any questions regarding the PFAD Committee, or would like to step forward and start your active involvement with the committee. 

Hoping that you be in Montréal at the Spring Meeting, please seek me out, I would be delighted to spend some time talking about the PFAD Committee and its activities and opportunities with you.

Alison R. Manzer

Alison R. Manzer
Chair, Project Finance and Development Committee