Economics Essays

Finance Essays: Legal Aspects Of Project Finance

An Introductory Note for Commercial Lenders

Extracts: What is “Project Finance”?

This question is capable of a number of widely differing answers, depending on the standpoint of the person defining it. A broad and very encompassing definition given by one authoritative text author will, however, appear preferred for most purposes:

“… project finance is financing the development or exploitation of a right, natural resource or other asset where the bulk of the financing is not to be provided by any form of share capital and is to be repaid principally out of revenues produced by the project in question.”

Although project finance as a distinct discipline is gaining prominence, the concept of a commercial lender looking principally to the cash flow generated by a specific project to service debt has a long history dating back to Athens of the 5th Century BC.

In the 1980s project finance featured primarily worldwide in mine developments, mineral processing plants, oil & gas field developments, and pipelines.

In the United States, project finance was also during this period applied to public sector infrastructure, where states and municipalities raised debt against revenues derived from a particular source as an alternative to borrowing against their “full faith and credit”.

Privatisation (the voluntary withdrawal of the state from economic activities it used to control and manage) and deregulation around the world over the last two decades has, however, given the latest boost to project finance; ….

Lenders’ Objectives –

The law applicable to project finance is essentially general law, equally applicable to both international infrastructure projects as to, for instance, a domestic property development financing. The nature of the project to be financed would undoubtedly dictate the nature of the parties involved.

Part of the challenge of any project financing is to reconcile the often times differing objectives of the various interested parties…

Lenders to a project company who are not commercial banks may, of course, have other or differing objectives. For example, the export credit agencies in a particular country will support a project in order to promote that country’s industry and they may not, as a result, have as great a profit motive.

Bondholders will share the commercial banks’ objectives but will tend to be less interventionist….

Shareholders in a project company who lend it money may view their loans as quasi-equity … and will usually accept a subordinate position to other lenders.

Lenders’ Security –

These security types may be “offensive” (securities which allow enforcement by disposal of specified project assets to repay debt) or “defensive” (securities which protect senior securities from actions by junior or unsecured creditors).

A well-negotiated security package should contain arrangements relating to:

· physical assets
· the legal rights and revenue stream of the project
· share pledges

There are, of course, alternatives to project financing of even the largest projects, including the good old fixed and floating charge bank loans.

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