Direct agreements and step-in rights in the Netherlands: coordination is key

From BESS projects and solar parks to more traditional real estate development financings, when the performance of the underlying asset matters to the borrower, it matters to the financier. Lenders therefore want assurance that they can protect both the value of the assets and the revenues they generate. Where that value depends on arrangements with third parties, financiers expect to be able to exercise appropriate influence over those agreements.

In practice, financiers require step-in rights to be able to take over the most important agreements entered into by the borrower in connection with the assets to prevent devaluation of the assets when the borrower is in (financial) distress. While Dutch legal literature seems to focus on renewable energy projects and the step-in rights in connection therewith, we also frequently see step-in or similar rights being required in more traditional real estate development financings.

For real estate development financings, the most relevant agreements are those with contractors and architects: the parties required to finish the development. For renewable financings, the operation & maintenance agreements, power purchase agreements, rights of superficies or, as applicable, lease(hold) agreements are the most common agreements where step-in rights may be required. These step in rights are normally included in 'direct agreements' (although the name used for the document varies), and sometimes directly in the relevant underlying agreements by way of third party stipulation.

The content of the direct agreement varies slightly depending on the type of underlying agreement, but is normally not limited to step-in rights. For example, the following types of clauses are commonly included in direct agreements or similar arrangements between the borrower, the lender and the borrower’s counterparty:

1. Limitations on changes to the underlying agreement without prior written consent from the financier, including but not limited to changes to the budgeted costs, payment conditions and scope of the agreement;
2. Information rights: an active information obligation for defaults and disputes;
3. Guarantee of punctual performance of the obligations under the agreement, and in case of a development contract, a completion guarantee (subject to receipt of payment of undisputed invoices);
4. Step in right, including a step-in decision period during which period the counterparty must perform its obligations in accordance with the underlying contract, while the financier decides whether it wants to use its step-in right. The step-in decision period starts upon the occurrence of certain events, such as an event of default under the finance documents or borrower insolvency;
5. Payment arrangements in connection with the invoices to be paid by the financier or the step-in entity appointed by it (such as VAT responsibility); and
6. A waiver by the counterparty of rights of retention, retention of title, rights of recovery and all similar rights in connection with amounts due under the relevant contract, including an undertaking to make sure that all sub-contractors waive the same rights.

Although these measures seem far-reaching, parties that are regularly involved in these types of projects (such as major contractors or O&M service providers) are generally familiar with the concept and the requirements of financiers. That said, these agreements normally do give rise to a range of discussion points, not unlikely to cause delays if not addressed at an early stage in the process. Common discussion points we face in transactions include:

• The conditions of waivers of rights of retention and similar rights;
• Responsibility for VAT on invoices;
• The length of the step-in period and payment obligations during that period;
• The question who bears responsibility for additional work not covered by the lender approved budget during the step-in period, and more in general under what conditions work should continue during the step-in period.

These issues can often be avoided or resolved at an early stage through clear explanations, timely engagement and support from advisers. Although the provisions of direct agreements are primarily relevant to the third party counterparty and the financier, the coordinating function of the borrower and its advisers must not be underestimated.

Contract parties tend to be less cooperative if the arrangements with the financier appear to come out of nowhere after an extensive negotiation process, as this can, whether fair or not, be perceived as a form of 're‑negotiation'. By informing counterparties at the outset of the contractual relationship about the likely requirements of a potential financier (even if that financier is not yet identified), clearly explaining the purpose of the document and walking them through the requests they can expect, many questions can be pre‑empted and the process can be made more efficient.

As the advisers of the financier usually prepare the direct agreements, the financier can also contribute to a smooth process by ensuring that its requirements are clear from the outset and, where possible, already provide a standard agreement to make sure the borrower can reach out to the third party counterparties rather sooner than later.

Although in practice we frequently draft and negotiate direct agreements, we have not yet encountered a situation where these rights were actually exercised, as the parties involved typically come to the table well before that stage is reached. While this offers no guarantees, it is a widely used argument to give the third party counterparty sufficient comfort to proceed with signing a direct agreement.

If you have any questions on this topic, or would like to know more about its legal implications, please feel free to contact one of our specialists.