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International Project Finance, 3rd Edition edited by Dewar, John (14th August 2019)

1 Approaching Legal Issues in a Project Finance Transaction

Phillip Fletcher

From: International Project Finance (3rd Edition)

Edited By: John Dewar

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2015. All Rights Reserved.date: 16 November 2019

Lending and credit — Capital markets

(p. 2) Approaching Legal Issues in a Project Finance Transaction


1.01  Project finance is at its core a form of secured lending. Much of the legal expertise is drawn from the discipline of banking. One who sees the beauty of the perfect covenant, the joy of an all-encompassing event of default, or the elegance of a multi-tiered intercreditor agreement, has the capacity to excel in the field. But the inclination to do so comes from never having outgrown the desire to play with big toys (or for that matter machinery and equipment). The reason for this is that project finance lawyers undertake a greater degree of inquiry into the business of the borrower, and into the construction and operation of the facilities that it will construct, than do lawyers involved in other kinds of lending. Project finance transactions entail lenders extending a large amount of credit to a newly formed, thinly capitalized company whose principal assets at the time of closing are not physical but rather merely contracts, licences, and ambitious plans. Hence the focus on prudent legal analysis.

1.02  The nature of that legal analysis depends very much on the project in question. It is difficult to draw generalities across the full range of industries and countries in which projects are developed and financed. The risks faced by, for example, a deep-sea oil drilling platform in Brazil are quite different to those encountered by a toll road or a metro system in Western Europe. Similarly, one cannot assess the risks faced by a nuclear power plant without a deep understanding of the complex technical and regulatory challenges it will need to address, and extractive industry projects present unique issues due in large part to (p. 3) the significant environmental and social impacts they frequently have on the regions in which they operate and also due to the potential volatility in the markets in which they sell their output. However, there is a broad commonality of legal and commercial issues to be considered across virtually all projects, and the reliability of the approaches customarily used by project finance professionals in analysing those issues has been tested and proven through decades of complex transactions. How those methods are applied to individual transactions may vary, but the issues to be assessed remain consistent across industries, jurisdictions, and financial structures. This chapter, and indeed this text as a whole, considers both those methods and their application in specific contexts.1

1.03  Whatever the efficacy of the legal and commercial due diligence applied to a specific project, unless it reaches financial close, there are no ‘winners’. However, even after the finance documents are signed, the complex relationships among the parties must be sustained through many years of economic, political, and legal change. No matter how comprehensive the legal documentation, virtually every project encounters some form of technical or commercial problem over its life that leads to legal difficulty. Sometimes that difficulty arises because two parties have a legitimate disagreement over the meaning or effect of a few of the words contained within the mountain of documents governing their relationships. In other cases, issues that had not been contemplated at the time of financial close arise with a consequent absence of guidance in the documents as to how to resolve them. Not infrequently, the underlying economics of the project, and the negotiating leverage of the parties, change such that what seemed fair at closing may years later appear to one of the parties as oppressive. In most instances, the parties to a project financing are able readily to resolve such matters, recognizing that their relationships require close cooperation and compromise, but that is not always the case.

1.04  Disputes cannot be avoided on the playground, nor can they be avoided in project finance. When the stakes are high enough, it may be impossible to secure compromise. The frequency with which disputes arise can, however, be limited by a careful initial assessment of the project so that, at a minimum, all parties enter the deal with a common understanding of the rules of the game.

1.05  With the expansion of project finance into new industries and regions, the attendant legal issues have become increasingly complex and the ability to predict where difficulties will arise has become more challenging. Ever-shifting market standards, and the absence of agreed-form project documentation, contribute to the extremely varied nature of project finance transactions. Project finance lawyers must patiently consider the technical, political, and legal risks of each individual project in order to enable parties to reach agreement on how contentious issues should be treated. This process requires familiarity with varied disciplines of law, ranging from civil procedure to contracts, property, trusts, torts, equity, and conflicts of laws, and with a range of financial instruments, such as commercial bank loans, capital markets instruments, multilateral and domestic government-funded loans, guarantees from export credit agencies, and Islamic Sharia’a-compliant instruments.

(p. 4) 1.06  By drawing on this variety of disciplines, a project finance lawyer can help the parties to structure financings that are robust enough to withstand long-term volatility.2 There is a range of threshold legal issues and tasks, common to virtually all projects, which must be addressed if the project finance lawyer is to accomplish his or her role effectively. Among these are:

  1. (1)  identifying the overall legal risks associated with a project;

  2. (2)  assessing the laws and regulations of the host states and of the courts and other institutions that implement them;

  3. (3)  addressing environmental and social considerations;

  4. (4)  choosing the governing law for the finance and project documents;

  5. (5)  drafting and negotiating complex credit agreements; and

  6. (6)  developing security packages across a range of jurisdictions.

Overall Risk Assessment

1.07  Projects inevitably face risk. Although some risks can be structured, contracted, or insured away, projects, as in the case of all commercial endeavours, are exposed to a wide range of potential challenges that can have an adverse impact on their economic performance and even their viability. As most projects will not have been built or even engineered when their financing is implemented, there will inevitably be differing views on the likelihood and potential impact of future adverse events. The ultimate assessment in any project is whether the risk profile of the deal, taken as a whole, is ‘bankable’. This is certainly not a science, and to call it an art is perhaps too kind, but it is a judgment formed by lenders, sponsors, and their respective advisers every time a deal closes.

1.08  An essential aspect of the project finance lawyer’s role in helping the parties reach a ‘bankability’ assessment involves reviewing the project, and in particular its underlying documentation, in order to identify its potential and fundamental risks and to determine if, and how appropriately, those risks have been allocated among the parties. In carrying out this diligence effort, a project finance lawyer must frequently liaise with a myriad of advisers, including, among others, technical advisers in respect of the anticipated performance of the physical plant, market advisers regarding the availability and cost of inputs and the value of future revenue streams, environmental advisers on the social and environmental impact of the project, insurance advisers on the adequacy of the project’s insurance programme, and model auditors to assess the integrity of the financial models. The lawyer also needs to take guidance from the lenders as to their assessment of the credit standing, and ability to perform their obligations, of each party to a material project agreement. The project finance lawyer will work closely with local lawyers in a broad range of relevant jurisdictions, and is often responsible for producing a comprehensive due diligence report that pulls together the key risk assessment and evaluations of each adviser and highlights the potential issues from a documentation perspective.3

(p. 5) 1.09  The project’s underlying economics and risk profile will inevitably lead to a number of assumptions as to how the overall transaction should be structured. The relative economic viability of a project is generally assessed by reference to the projected ratio in each relevant fiscal period (annual or semi-annual) of the project’s net revenues to its debt service obligations, with the focus being on both the average and minimum of such ratios (generally referred to as its debt service coverage ratios). The robustness of the project is also frequently assessed on a more consolidated basis by assessing the ratio of the project’s net cashflows over the remaining maturity of its outstanding loans, discounted on a present value basis, to the outstanding principal amount of those loans (generally referred to as its loan life coverage ratio).

1.10  An assessment of these ratios may dictate how the deal needs to be structured. By way of example, power generation projects are often awarded to sponsors through a competitive tendering process and are thus structured to give rise to the lowest electricity tariffs possible. To achieve this, it is important that the project is funded to the maximum extent possible through debt (being less costly than equity) and that the average maturity of that debt is as long as possible (thereby reducing the debt service burden in any particular year). The financial ratios that result from relatively low tariffs (with a consequently low numerator) and high levels of debt (with a consequently high denominator) will likely be modest, and thus this sort of project will have limited ability to absorb the risk of increased costs or reduced revenues. The parties will, therefore, focus particular attention on the risk allocation effected through the contracts.

1.11  By contrast, a range of other projects may be designed to produce products sold onto global markets where, for well-positioned companies, profit levels may be significant. This is often the case with oil and gas and other natural resource extraction and processing facilities, whose ‘base case’ revenue projections are generally robust enough to sustain the project through periods of revenue volatility or increased costs. Given market uncertainties, the sponsors may be prepared to fund the project with a greater proportion of equity in exchange for contractual flexibility in the management of the business. In these cases, the relevant contracts may be somewhat less comprehensive in addressing all conceivable risks, but the lenders will generally require more robust overall project economics (evidenced through higher projected financial ratios) to mitigate these risks.

Assessing the Host Country

1.12  One of the key variables in the legal analysis of a project, and certainly the one that can neither be structured around nor wished away, is its location.

1.13  As a threshold matter, the political and social stability of the host country will be of concern to all investors and lenders. At the extreme, structuring a deal in a conflict zone may be impracticable, but the scope of political risk encountered by most projects is generally broader and more subtle than simply physical violence. There is a wide variety of publicly available measures of the ease of doing business in specific countries,4 and the credit risk (p. 6) associated with the obligations of most countries is rated by leading commercial rating agencies. If the project’s lenders and investors have particular concerns as to the stability of the host state, they may seek to address that risk through political risk insurance and other mitigants considered in other chapters of this book.

1.14  When the project is located in an impoverished or developing country, multilateral and other public sector lenders, in particular, will focus on the developmental impact of the project. They will seek to confirm that the project benefits a broad spectrum of the host population and not just a limited number of well-positioned investors and government officials. They may require diligence to be undertaken to confirm the absence of any corrupt payments in the award of the project’s licences and concessions.5 They may also seek clarity on how the host government will invest the tax and other revenues derived from the project.6 In addition to ensuring that these public sector lenders’ developmental mandates are adhered to, this sort of inquiry is designed to ensure that the host state will continue to support the project even after the incumbent government is long out of office.

1.15  In whatever jurisdiction the project is located, the laws and regulations of the host state will affect virtually every aspect of the project company’s activities, and its courts and other governmental institutions will have wide discretion in interpreting and implementing that law. In many cases, the project company will itself have to be organized under the laws of the host state, rendering even its control and management subject to local jurisdiction.

1.16  Among the legal issues arising under the domestic law of the host state that need to be assessed are:

  1. (1)  corporate governance;

  2. (2)  industrial regulation;

  3. (3)  environmental, land use, and other licensing regimes;

  4. (4)  currency transfer and convertibility;

  5. (5)  taxation;

  6. (6)  customs and immigration law;

  7. (7)  reliability of local laws and courts; and

  8. (8)  the impact of potential changes in law.

Corporate governance

1.17  If a project company is organized under local law, which is frequently a requirement of host governments, the investors and lenders will need to assess the governance flexibility (p. 7) afforded to them by that law. Of key relevance to investors is to ensure that the ability of the company to distribute profits to shareholders is not unduly constrained by corporate law and local accounting practices. If it is, they may find it preferable to fund the company with debt instruments rather than equity.

1.18  Among the other issues to be considered are whether shareholders benefit from limitations on their individual liability for the obligations of the project company, whether the rights of minority shareholders will be respected, and whether agreed voting, share transfer restrictions, or pre-emption rights, and the like, set out in an agreement among the shareholders will be given effect under local law. It will also be important to the investors that their appointed directors retain the right to direct the company and its management on key issues. This is of particular concern where international investors are in joint venture with local investors or an entity affiliated with the host government.

Industrial regulation

1.19  Many projects operate in regulated industries. The vast majority of countries, whatever their level of economic and political development, impose regulatory oversight on their public utilities (power, water, and telecommunications), transportation, and other infrastructure sectors.7 Many also view their resource extraction industries to be of material importance and extend regulation to them as well. Regulation can encompass a licensing regime, under which permission to operate is granted to specified companies or classes of companies. Licences or concessions (being in effect a more complicated licence, often including undertakings by both the host state and the concession holder) may be granted on an application basis, following individual negotiations, or on the basis of a competitive tender involving pre-qualified bidders. Regulation may (and often does) extend further to specify the manner in which a project company is to operate and, in many cases, the price it may charge for its services or output.

1.20  Regulation is thus not unusual, but the manner in which it is imposed can vary significantly. For most projects, the analysis of the regulatory environment encompasses two inquiries: (i) what rights are granted to, and what obligations are imposed on, the project company; and (ii) what risk there is that the regulatory regime will change over time to the detriment of the project company or its investors and lenders.

1.21  Where the regulatory regime is established as a matter of statutory law, project finance lawyers must review the relevant legislation and regulations carefully, in close consultation with local lawyers. Where those laws are comprehensive and clear, certainty as to the scope of the regulatory regime can be achieved, but there will remain the risk that the regime may evolve over time; it is an accepted prerogative of sovereign states to change their domestic laws.

1.22  In circumstances where there is an absence of regulation of general application, or where there is significant uncertainty as to the stability of the regulatory regime, it may be appropriate for the host state to enter into direct undertakings with the project company and, (p. 8) in some cases, its principal investors, to set out specific investor protections. The scope of these will vary significantly depending on the extent of investor and lender concern as to the reliability of the host state’s investment regime.8 The nature of the governmental commitment may vary from providing legally binding undertakings, a breach of which may entitle the investor or lender to specific damages, to mere ‘comfort letters’, which may afford little, if any, certainty of remedy, but at least provide an indication of the government’s present intent.

1.23  The host government might also seek reciprocal undertakings from the project company, including commitments to provide adequate service during the term of the agreement; observe relevant safety and environmental standards; sell its output at reasonable prices; and, particularly where the project company is under an obligation to transfer its assets to the host state at the conclusion of the concession period, carry out prudent maintenance and repairs so that at the end of the term the government or state-owned entity will acquire a fully operational project. There may be specific penalties or termination rights arising by reason of breach of these undertakings. These agreements also often include a recognition of the role of lenders, including express notice, cure, and ‘step-in’ rights.

1.24  The commitments of host governments are often implemented into national law through some form of enabling legislation, allowing greater certainty that the relevant undertakings will take precedence over competing, and often inconsistent, laws and regulations. In other cases they are entered into in the form of bilateral contracts that may, again, take precedence over competing legislation. In both cases, it is important to ensure that they were validly entered into and were within the legal competence of the granting authority. Although on its face there is much to suggest that a bespoke, bilateral contract is more likely to be certain and reliable than unilateral legislation of general application, this may not always be the case.


1.25  The construction and operation of a project generally requires the project company to secure a broad range of permits and consents. The subject matter of these ranges from environmental and social considerations, to land use, to health and safety, to, as already noted, industrial regulation.

1.26  The analysis of the risk arising from the need to secure permits turns, in the first instance, on identifying the consents that will be required and ensuring that they have been issued or will be issued in the ordinary course without undue expense, delay, or conditionality and that the project can be constructed and operated in compliance with those permits. The risk of permit revocation or modification is also important, as well as a determination as to whether a secured lender, or its transferee, would be entitled to the benefit of the permits were the lender to exercise its remedies under the security documents. In many instances, the granting authority will wish to retain discretion to assess the identity and competence of the transferee, and unless the granting authority provides guidance as to what criteria it will apply in making that assessment, the lenders may be left with a degree of uncertainty.

(p. 9) Currency transfer and convertibility

1.27  A project will either earn its revenue in local currency or that of an internationally recognized currency, such as dollars. Projects that produce an output, such as electric power, that is consumed locally, will more likely be paid in the currency of the host state. Those that produce an output that is likely to be exported will more likely be paid in dollars.

1.28  Where the project incurs debt denominated in dollars, particularly where the lenders are overseas, it will have to remit dollars offshore to meet its debt service. In order to do so, it may have to convert local currency to dollars and transfer those dollars offshore. Host states may, however, seek to impose currency controls to regulate those flows, particularly in times where a state’s balance of payments is in deficit, placing pressure on the value of its local currency. Sponsors and lenders will want to assess the risk not only of currency exchange rate fluctuations, but also of the imposition of transfer or conversion restrictions.


1.29  Virtually all projects are subject to some form of taxation, and the tax regime will generally have a significant impact on the project’s economics. Most sponsors assess their return on investment on an after-tax basis, and thus consider clarity and certainty of the tax regime to be a key consideration.

1.30  In assessing the tax treatment of the project company in its host state, the following matters are usually considered.

Corporate taxes

1.31  The project company is likely to be subject to corporate taxes, often calculated on the basis of the profits arising to it. Occasionally, however, the tax may be calculated by reference to other factors, such as the value of the project company’s assets. In some cases, as an inducement to attract foreign investment, the host government may afford the project company with a tax ‘holiday’ or rate concessions for at least a specified period.

1.32  Where corporate taxes are calculated by reference to profits, the project company will need to be able to deduct expenditure from the payments it receives so that it is liable to tax on its residual profit only. A significant proportion of the project company’s expenditure is likely to be interest payments, which as a general rule would usually be deductible. Where the project company is highly leveraged, however, there may be restrictions on the deductibility of interest payments under thin capitalization and transfer pricing rules.

1.33  As an additional category of deductible expenditure, the project company may be able to claim depreciation allowances, generally over a period of time, for certain forms of capital outlay—for example, some or all of the cost of the relevant project’s plant and machinery.

Withholding tax

1.34  As a general principle, the laws of the host state may require the project company to withhold tax on interest and dividend payments it makes to overseas lenders and shareholders, but relief from the withholding may be available under an applicable double taxation treaty. Where withholding tax is due on interest payments a project company makes (p. 10) to its lenders, the project company will usually be required to gross up those payments and compensate the lenders for the withholding.

Other taxes

1.35  The project company may be required to account for value added or sales taxes on supplies of goods and services it makes. In some cases, it may be obliged to pay royalties to the host government calculated on the gross or net value of its sales. Stamp taxes, registration taxes, and notaries fees may also be payable on certain transaction documents. Where such taxes and fees are imposed on lending and security documents, the amount payable will often depend upon the amount borrowed or secured. In such circumstances, lenders may be asked to under-secure their loans so as to reduce the cost of the relevant tax or fee, something that many lenders do not generally welcome.

1.36  Subject to relief under an applicable double taxation treaty, certain jurisdictions impose taxes on overseas residents who dispose of shares in a company which is incorporated in that jurisdiction. This may be relevant to equity investors in the project company.

Customs and immigration law

1.37  Whenever goods or individuals cross a border, they become subject to the laws of both the country they are leaving and the country they are entering. For projects, the concern is generally focused on the ability of the project to import into the host state key goods and equipment and to employ qualified expatriate managers, engineers, and labour. Customs restrictions may be limited to an import duty, but in some cases may extend to an absolute prohibition on imports. Immigration law may permit some limited employment of expatriates, but may also require the training and employment of local nationals. In some cases, the project company is able to negotiate exceptions to both import and immigration restrictions, but these may be subject to conditions. The other concern that may arise is that the project’s revenues may be adversely affected if the target export markets impose customs duties or import restrictions on the project’s production or if the host state restricts exports.

Reliability of local law and courts

1.38  Countries with well-developed laws and an established and independent judiciary are often more attractive jurisdictions for investment than countries with little clarity as to their laws or certainty as to their application.

1.39  Countries that achieved independence—and thus a distinct body of law—only recently, or who are unable to afford the cost of an extensive court system, may be at a disadvantage in attracting foreign investment. Emerging economies, in particular, may seek to address this through regional integration and the harmonization of disparate legal systems as a means of attracting foreign direct investment, eliminating barriers to cross-border trade, and providing a platform to improve their chances of competing more effectively on the world stage. Integration is perhaps best developed in Europe through the European Union (EU) and European Economic Area (EEA) and is gaining momentum in other regions such as the Middle East through the Gulf Cooperation Council (GCC) and in Eastern Africa through the East African Community (EAC). However, arguably the most ambitious legal harmonization outside of Europe is the ‘Organisation pour l’Harmonisation du Droit des Affaires en Afrique’, better known through its French acronym ‘OHADA’. The (p. 11) OHADA Treaty is not new. In fact, it is in its third decade, having been brought into force on 17 October 1993 in Port Louis, Mauritius. However, its laws have only been in effect from 1998, and it is only recently that investors have begun to take this legal harmonization seriously.

1.40  The OHADA Treaty regime establishes the supremacy and the direct effect of OHADA uniform laws. That it is ambitious is therefore obvious. Whether it is the trigger for any increase in foreign direct investment remains to be seen. However, it is at least not unattractive that a sponsor in Guinea can expect to encounter the same business laws in Benin and seek justice in the same appellate courts. This does not guarantee legal certainty, but at least it brings with it a degree of legal familiarity that can only be good for business confidence.9

1.41  Legal certainty will be of concern to all parties, but lenders will focus particular concern on whether local law recognizes the rights of secured creditors and whether their claims will be respected were the project company to become insolvent. Not all countries have express insolvency regimes, and the ones that do vary significantly as to the rights and preferences that they afford to secured lenders.

Changes in law

1.42  Project finance loans are generally repaid over years if not decades. Notwithstanding the initial certainty that may be achieved in assessing the host country’s laws, these may (and in fact are likely to) change during the life of the project. Public policy evolves in virtually every country as their governments change; where regime change is frequent and policy objectives vary widely, those changes can be volatile. For example, tax rates can be subject to substantial increase as governments manage the competing demands of their spending aspirations and of their budgetary constraints. Governments have tended in recent years to impose increased environmental compliance requirements on companies subject to their jurisdiction in order to comply with new treaty and similar obligations. As their economies develop, host governments are often able to extract more favourable terms from new investors, and agreements reached at an earlier time may begin to appear unreasonable over time. This has been particularly the case in various extractive industries, where the value of the underlying commodity (be it oil, gas, or metals) has increased substantially from when the original terms were agreed, leading to a perception of wind-fall profits on the part of the foreign investor.10 Host governments may in these circumstances be tempted to try to bring older, less favourable, terms in line with current market standards.

1.43  In some instances, the risk of changes in law and policy can be addressed through the underlying concession agreement, where the host government may agree to freeze the application of laws to the project company or to provide compensation if those laws change. In other cases, the project’s offtakers may be prepared to compensate the project company through tariff adjustments to cover increased costs arising from changes in law. At an extreme, changes in law can result in actual or ‘creeping’ expropriation. In some cases, investors can rely on the protections afforded by bilateral investment treaties entered into by (p. 12) their home jurisdictions and the host state. In other cases, it may simply be prudent for the investors to agree to accept a change in terms, even if adverse to them, to reflect current market and political realities.

Environmental and Social Considerations

1.44  The construction and operation of a project invariably have environmental and social impacts on the locality of the project. Managing these impacts may help assure the long-term acceptance of the project by affected parties. Lenders will generally require, at a minimum, the project company to undertake to comply with all environmental and social laws and regulations binding on it. They will also likely require the development of, and compliance with, an agreed environmental and social risk management plan. This is to insulate the project company, and the lenders, from legal risk, but also to preserve the lenders’ reputation as responsible parties.

1.45  Even in the absence of environmental legislation in a particular jurisdiction, national or multinational credit institutions financing a project may require compliance with World Bank or similar standards. The International Finance Corporation, for example, has implemented detailed standards defining a borrower’s environmental and social responsibilities in managing its project. Areas of focus include: labour and working conditions; pollution prevention and abatement; community health, safety, and security; biodiversity conservation and sustainable natural resource management; and protection of indigenous peoples and cultural heritage. Standards such as these seek to achieve comprehensive mitigation of environmental impacts and management of the project’s impact on local populations.

1.46  A large range of other financial institutions have adopted a voluntary set of guidelines, known as the Equator Principles, that call for such organizations to require compliance with guidelines similar to those of multinational lenders. As a result, virtually every large-scale project seeking access to the financial markets must evidence a high level of environmental and social compliance.11

Governing Law Considerations

1.47  Contracts are often quite clear in describing the terms of a transaction, but the manner in which contracts will be interpreted or enforced may differ significantly from those terms. The relevant considerations involve an analysis of: (i) the choice of law to govern the contracts; (ii) the enforceability of contracts under that law; and (iii) the choice of forum for resolving disputes arising from the transaction, including whether judgments or awards from that forum will be enforced in each relevant jurisdiction.

(p. 13) Choice of law

1.48  The knowledge that the transaction is governed by the law of a familiar jurisdiction can be a source of significant comfort to investors and lenders. Choice of law questions inevitably arise in the context of negotiating finance documents and frequently involve an election between English law and New York law.12 Because the law of each of these jurisdictions relevant to the enforceability of customary finance documents is broadly similar, any preference between the two is perhaps not as substantive as it might appear. Each has well-publicized case law precedents that provide clarity as to how the law will likely be applied in specific circumstances. However, lenders may nonetheless have strong views based on familiarity with customary forms and terminology or based on a preference for submission to the courts of one or the other jurisdiction. It is worth noting that both English and New York courts will accept (subject to limited exceptions) jurisdiction to hear disputes governed by English or New York law, respectively, even where there is little connection to either jurisdiction other than the election of the parties.13

1.49  In relation to a range of commercial contracts, the choice of law can have particular significance. For example, parties may find attractive the ability under Article 2 of the Uniform Commercial Code as in effect in the State of New York to leave open for resolution by agreement among the parties (or absent agreement between them, through resolution by a court) key price terms in contracts for the sale of goods and certain commodities. English law, by contrast, may (subject to various exceptions) find that the contract fails for uncertainty in such circumstances.

1.50  In some circumstances, there is no real choice of law. Conflict of law principles, such as the doctrine of lex situs (i.e. the rule that the law applicable to proprietary aspects of an asset is the law of the jurisdiction where the asset is located), may dictate which law is to be applied in relation to certain contracts. For instance, under English conflicts of law rules, ownership of land is determined under the law of the jurisdiction where the land is located, so a contract transferring title to land in (say) France that is invalid because it does not satisfy a particular requirement of domestic French law, will not be valid even if the contract is expressed to be governed by English law and would have been perfectly valid if the land had been in England. Likewise, many governments may require the use of domestic law to govern contracts with national agencies, and in many cases may require that those contracts be written in the domestic language.

(p. 14) Enforceability

1.51  Not all contracts are enforceable in accordance with their terms. There may be mandatory provisions of law that override the terms of the contract. Many countries have civil or similar codes whose provisions will apply to a contract notwithstanding its terms.14 Legal uncertainty may be pronounced when the country in which the project is located has no tradition of reported case law (making it more difficult to establish how the rules are applied by the domestic courts in practice) or where domestic law prohibits fundamental aspects of the transaction (for instance, Sharia’a principles preventing the enforcement of interest payments). In some cases, mandatory provisions of law will be applied by the courts even if not applicable under the express law stated to govern the contract. Thus, parties need to assess not only the terms of the relevant agreements, but also their consistency with applicable law.


1.52  The selection of a forum for any disputes heard in connection with the project has important implications, such as:

  1. (1)  Will the forum be neutral in its decision-making?

  2. (2)  What law will the chosen forum apply and will the outcome differ as a result?

  3. (3)  Which evidential or procedural rules will apply in the forum?

  4. (4)  Will judgments or awards be enforced in the home jurisdiction of the borrower or the other project parties?15

1.53  One important factor, when considering the choice of forum, is whether the dispute should be litigated or arbitrated. There are advantages to using the courts, particularly in jurisdictions such as England and New York, where long histories of case law precedent, established procedural laws, and unbiased judicial oversight provide comfort for sponsors and lenders that their claims will be duly upheld. In many jurisdictions, courts can compel parties to disclose facts or documents and may, in some circumstances, be able to order interim relief, such as an injunction. Further, as arbitration is a product of contract, only parties that have consented to arbitration through the contract can be compelled to proceed in that forum. Litigation may thus be necessary in a multi-party dispute in order to join an interested party that is not party to the original contract.

1.54  On the other hand, the speed and privacy of an arbitral process is a benefit, and a specially designated arbitrator may be better equipped to address complex technical issues than a more generalist judge. The parties may view an arbitral forum in a neutral foreign venue as providing certainty of an efficient and reasonable result. Moreover, an arbitral award may, in some cases, be more likely to be recognized and enforced in the relevant party’s home jurisdiction without review on the merits than a foreign court judgment. International treaty arrangements, such as the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention), and regional treaty arrangements, such as the Convention on the Enforcement of Judgments, Disputes, and Judicial Summonses in the Arab Gulf Co-operation Council States (the GCC Convention), call for member states to give effect to arbitral awards made in other member states. Nonetheless, (p. 15) there are often sufficient exceptions to even treaty-based rules to leave open the possibility that the award may be re-opened on enforcement.

1.55  As a practical matter, lenders prefer to use the courts, as they typically view arbitration as a less attractive option for disputes under finance documents. This is in part due to the perceived tendency of arbitrators to arrive at compromise positions (so-called rough justice), although lenders may wish to reserve the option of arbitration to address technical issues or where arbitration may have procedural benefits in relation to enforcement of awards. Commercial contracts, on the other hand, far more frequently contemplate arbitration.

Sovereign immunity

1.56  The host government and its instrumentalities may be immune from being brought before the courts of either the host state or of other sovereign countries. In addition, they may be immune from enforcement of judgments, so that even if a court or arbitral panel were to rule against them, it may not be possible to execute that judgment against their assets. This immunity is widely acknowledged as a matter of international law, but there may be exceptions to its application. For example, a state entity acting in a commercial capacity may not benefit from immunity in all circumstances, and it may be possible for a state entity to waive its rights to immunity. The courts of various countries have sought in recent years to subject to their jurisdiction sovereigns for violation of international norms of conduct, but the scope of these decisions remains somewhat narrow and controversial.

Credit Documentation

1.57  Once the overall risk of the project has been properly profiled, the parties will need to reach agreement on the most appropriate financial structure for the deal. There are some very obvious rules at play: lower risk projects tend to have greater flexibility in their funding sources than projects facing greater risk and are thus able to secure less stringent financing terms; projects with a larger capital cost will need to integrate a broader range of lenders into their finance plan than smaller projects, with the consequent need to satisfy a broader range of credit requirements.

1.58  Project finance credit documentation is generally replete with conditions precedent to lending, as well as representations, undertakings, and remedies designed to allow lenders to manage the underlying risks of the transaction. As those risks vary significantly across transactions, so does the manner in which they are addressed in credit agreements.

1.59  Perhaps the most significant area in which project finance transactions tend to differ from other types of lending arrangements is in relation to the extent to which the lenders seek to control the borrower’s cashflow. The project’s revenues are generally required to be paid into a secured account and are applied in an agreed priority, commonly referred to as a ‘waterfall’, first to pay operating costs and then debt service and then to fund agreed reserves. The residual cash flow after funding those costs and reserves may be available to be distributed to the equity investors, but generally subject to specified legal and economic conditions.

(p. 16) 1.60  Although most lenders value the comfort provided by relying on precedent transactions, particularly given the guidance they provide as to what will be accepted in the syndication markets, there is no broad consensus on what model of credit document should be used in the industry. Neither the Loan Market Association (LMA) in London, nor the Loan Syndications and Trading Association (LSTA) in New York, the two leading inter-bank associations charged with developing standard credit documents, has sought to prescribe standard documentation for project finance transactions.

1.61  Various categories of lenders have specific and unique requirements. For example, export credit agencies may in most circumstances only lend if and to the extent that their funding is expressly applied to finance exports from their home jurisdiction. Capital markets debt can only be accessed if the project company satisfies the requirements of rating agencies and the disclosure and other requirements of listing authorities or other security regulators. Sharia’a-compliant transactions must be structured to avoid any of the prohibitions imposed by Islam, including most notably the prohibition on the charging of interest on loans. These disparate and specific requirements must often be blended into a unified set of documents governing the overall transaction.16 The more complex the finance plan, the more time and thought may need to be committed to ensuring that the various categories of lenders are able to agree how to regulate their collective conduct through prescriptive voting and other intercreditor arrangements.

Security Packages

1.62  Project financings are in essence complex secured lending transactions. The willingness of lenders to extend long-term credit to a project may depend on the degree of comfort they take in the viability of the underlying security ‘package’.

1.63  The structuring of security packages across jurisdictions and diverse assets can present numerous and unique challenges.17 The purpose of a lender’s collateral package is to enable it to deprive the borrower of the pledged assets when the loan is in default (commonly referred to as an ‘offensive’ objective) and to provide the lender with the means to defeat claims that the borrower’s other creditors may seek to assert against its assets (commonly known as a ‘defensive’ objective). Whether a security interest has been validly created and whether it has priority over competing interests are questions of law. As noted earlier, under English conflicts of law rules, proprietary aspects of an asset are determined by reference to the location of the asset on the basis of the doctrine of lex situs. The validity and priority of the security is thus, in most instances, governed by the law in which the charged assets are, or are deemed to be, located. Whilst the bulk of a project company’s assets will for these purposes be located in the jurisdiction where its physical plant lies, its bank accounts, contractual rights, and receivables may be (or be deemed to be) located elsewhere, as may its shares, which will, in most instances, be the jurisdiction of its incorporation.

(p. 17) 1.64  Difficulties arise when dealing with security in jurisdictions where clear procedures for creation or perfection of security (such as registration or filing) are absent or where the enforceability of step-in rights granted to the lenders is uncertain. This may arise in, for example, Saudi Arabia, where the application of Sharia’a principles may adversely affect the perfection and/or enforceability of common forms of security. Similarly, lack of clarity as to which country has jurisdiction may adversely affect the certainty of security sought to be taken over satellites in space or cables laid under the sea. Lack of clarity may also arise where the domestic law lacks uniformity. In many countries, the government agency responsible for the registration of security interests varies with the type of asset (e.g. security interests over land use rights may be registered with the local land bureau, and equipment may be registered with the commerce and industry bureau). The substantive and procedural requirements for creation and perfection of security interests may be far from uniform as a result of differing local government agency practices.

1.65  In other cases, the cost of filing or registering security may be significant. Sponsors may argue that the practical value of security does not warrant the expense, particularly in jurisdictions where the practical value of security may be limited by the lack of certainty in the applicable law. In some cases, it may be possible to negotiate reductions in or exemptions from such costs in the underlying concession agreement or enabling legislation.

1.66  The efficacy of security interests may be overridden by the relevant insolvency regime, whether this is a court-supervised ‘debtor-in-possession’ regime (as in the US) or one whose primary objective is the liquidation of the insolvent debtor. Whether the court or administrator (or the equivalent) is bound by a grant of security must thus be assessed in light of the applicable insolvency law (or, where the charged assets are located in a number of jurisdictions, the insolvency laws of all those jurisdictions). However, many jurisdictions simply do not have an insolvency law to apply at all, leaving uncertainty as to how security may, as a practical matter, be enforced.

Process Management

1.67  Closing a project finance transaction is often as much about process management as it is legal analysis and drafting. The project finance lawyer is required not only to analyse the project’s risks and assess the negotiating leverage of each party, but also to organize the documentation process and ensure that each of the parties understands fully the issues in question. With projects often being located in remote parts of the world, and with sponsors and lenders often being based in a broad range of countries and time zones, the challenge of organizing a financing can be significant. Managing the logistics of complex negotiations across the globe requires a mastery of both languages and communications technology. Fortunately, technology is advancing at a pace that allows ever more ambitious financings to be undertaken. Web-based document ‘deal rooms’ allow parties to access current drafts of reports, documents, and update communications at their discretion. Although in many respects English is the dominant language of project finance, it is a significant hindrance to closing deals if the project finance lawyers are not conversant in at least some of the native languages of the key project participants.

1.68  Of key importance is the ability of the lead project finance lawyer to communicate with local counsel in a broad range of jurisdictions. Local lawyers who have trained at (p. 18) international firms will often be adept at conveying legal issues in terms that are readily understood by their international counterparts. However, the role of guides in the nature of this book cannot be understated in ensuring that all of the lawyers on all sides of the deal have a common view as to the key legal issues that must be considered by the parties.


1  For analysis of the implementation of project financing techniques in the key industrial and infrastructure sectors, please see Chapter 14.

2  For a discussion of the approach generally to negotiating project finance transactions, see P. Fletcher, ‘Rules for Negotiating Project Finance Deals’, International Financial Law Review, November 2005.

3  For a more detailed description of the risk identification and allocation process, see Chapter 4.

4  The World Bank website publishes rankings of economies based on their ease of doing business, currently from 1–190. See <http://www.doingbusiness.org/economyrankings>. A high ranking on the ease of doing business index means the regulatory environment is more conducive to the starting and operation of a local firm. This index averages the country’s percentile rankings on ten topics, made up of a variety of indicators, giving equal weight to each topic. The rankings for all economies are currently benchmarked to May 2018.

5  There is a wide range of international conventions and national statutes to combat corruption. For example, the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions established legally binding standards to criminalize bribery of foreign public officials in international business transactions and provides for a number of related measures that make this effective. See <http://www.oecd.org/corruption/oecdantibriberyconvention.htm>.

6  The Extractive Industries Transparency Initiative (EITI) is a coalition of governments, companies, and others which set global standards for transparency in the oil, gas, and mining sectors that is focused on, among other things, ensuring transparency in the host state’s use of revenues derived from major projects. See <http://eiti.org/>.

7  For a discussion of how lenders to the early independent power projects in the United States assessed regulatory risk, see P. Fletcher and J. Worenklein, ‘Regulatory Considerations in the Project Financing of an Independent Power Production Facility’ 8(4) Journal of Energy and Natural Resources Law (1990).

8  For a discussion of the scope and nature of host government undertakings, see P. Fletcher and J. Welch, ‘State Support in International Project Finance’, Butterworth’s Journal of International Banking and Financial Law, September 1993.

9  See also paras 13.140 et seq.

10  See Conflict and Coexistence in the Extractive Industries, Chatham House Report, November 2013 (Paul Stevens, Jaakko Kooroshy, Glada Lahn, and Bernice Lee).

11  The Equator Principles is a risk management framework, adopted by financial institutions, for determining, assessing, and managing environmental and social risk in projects and is primarily intended to provide a minimum standard for due diligence to support responsible risk decision-making. The Equator Principles website provides a more complete discussion of the framework: <http://www.equator-principles.com/index.php/ep3>. See also paras 4.80 et seq.

12  For a discussion of material differences between New York and English law governed finance documentation, see S. Mehta and L. Hanrahan, ‘Intercreditors’, IFLR Leverage Finance Quarterly, December 2013; S. Mehta and L. Hanrahan, ‘Super seniors and first outs compared’, International Financial Law Review, August 2013; S. Mehta and L. Hanrahan, ‘Transatlantic decision-making’, IFLR Leverage Finance Quarterly, May 2013; S. Mehta, ‘Finance without borders’, International Financial Law Review Cross-Border Financing Report 2013, October 2013; R. Gray, S. Mehta, and D. East, ‘Debt Repurchases: Easier with the LMA’, International Financial Law Review, March 2010; R. Gray, S. Mehta, and D. East, ‘Similar Objectives, Subtle Differences’, International Financial Law Review, December 2009/January 2010; R. Gray, S. Mehta, and D. East, ‘US and UK Compared: Fundamental Differences Remain between the Markets’, International Financial Law Review, October 2009; R. Gray and S. Mehta, ‘The Market Disruption Clause’, International Financial Law Review, December 2008/January 2009.

13  In respect of New York law, see New York General Obligations Law, sections 5-1401 (Choice of Law) and 5-1402 (Choice of Forum).

14  For analysis of the application of civil law to project financings, see Chapter 13.

15  For a more detailed description of dispute settlement procedures, see Chapter 16.

16  For a description of a transaction that blended debt sourced from export credit agencies, domestic development finance agencies, commercial banks, Islamic institutions, and capital markets instruments into a single financing, see P. Fletcher, J. Dewar, A. Pendleton, M. Hussain and V. Cox, ‘Sadara—Redefining the Possible’, 2013 Middle East Market Review, published by Project Finance International (September).

17  For a more detailed description of security packages generally, see Chapter 12.