You've pored over hundreds of pages and negotiated clauses for months, signed all of the (never-ending stream of) documents, satisfied all of the conditions precedent and celebrated the closing of the financing. The loan has been utilised, and the monies disbursed as agreed under the painstakingly created funds flow. Life is good. The deal is done. Now just to make sure that the lenders get financial and operational reports on a regular basis, along with a compliance certificate at the agreed times. Right?
However, as most of you will know, there is much more to it than that, but we have found that even the most sophisticated investor can find themselves inadvertently breaching the terms of the financing documents because the extent of the reach of these can be further than is often appreciated. With that in mind, we have set out some top tips for investors with debt-financed projects, a short checklist of things to bear in mind during the tenor of any loan.
1. Document filing and record-keeping
It sounds basic, but you will be surprised at the number of people that don't have a full suite of the documentation that they have signed up to, or produced to lenders for a financing. Aside from needing to be able to refer to these to ensure you are clear on your rights and obligations under them, having a suite of previously negotiated documents can save you time and money for any future refinancings. Being able to produce an evidently bankable form to a new lender can reduce approval times and fees incurred on drafting something from scratch.
Top tip: Ensure that (a) counterparties are obliged to provide you with full copies of all documentation entered into, whether at acquisition stage or financing, and (b) those are kept in an ordered and accessible manner for future reference.
2. Counterparty replacement
A lot of focus during the analysis of whether a project is bankable will be on the underlying project agreements and arrangements. What are the cashflows? Where is the potential for cash-leakage? Is the liquidated damages regime sufficient? Is an appropriate insurance package in place? It can often feel – once these documents have been reviewed and signed off as part of the due diligence process – that as long as the terms of those are replicated going forward then, if such project agreements or arrangements expire, putting in place something comparable should be fine.
And you would be right. In most cases, the lenders want the status quo maintained. But that is not to give you free rein as to when or with whom you wish to enter into arrangements. For any change in counterparty, the lenders will want to be comforted that the sophistication of any replacement counterparty is the same or better than the deal they financed, and therefore there will usually be detailed requirements surrounding any such replacement, and even then lender sign-off might be required.
Top tip: Make sure you have ascertained the requirements for replacement project counterparties and project documents before taking any action to do so.
The financing documents will require an operating budget for the next period to be approved by the lenders on a regular basis, as well as a report as to how the project has performed against the budget for the previous period. There will likely be exceptions to sticking to the budget, allowing operating expenditure to increase in the case of emergencies, for example. If you have successfully negotiated a flex in the budget, you will have a percentage by which you can exceed the agreed budget (although please check whether this is in aggregate or per line item).
However, deviations from the budget (plus flex) will most likely result in a breach of a general covenant to comply with the budget and/or the accounts provisions detailing which monies can be transferred out for the purposes of paying operating expenditure (which will be linked to those actually approved by the lender, via the budget or otherwise).
Top tip: Do not incur any unbudgeted operating expenditure without ensuring that this is either permitted by the terms of the financing documents or the lenders have approved such expenditure (in writing).
Linked to the previous tip, but with regards to all payments made by a project company, the financing documents will have stringent requirements regarding payments into and out of the accounts held by such project company which must be adhered to, as in most cases a failure to comply with these will be a default – even payments of budgeted items can result in a breach if not made out of the correct account.
Top tip: The procedures for each account should be read carefully – for example, an account designated an "operating account" does not necessarily (a) have revenues paid into it, (b) permit payments to come out unrestricted or (c) house distribution payments.
5. Distribution criteria
Speaking of distributions, these can be restricted for reasons unrelated to the cashflows (and financial performance of the project). An event of default would usually mean a prohibition on distributions (and even potentially a cash sweep after a certain amount of time), however this can occur in respect of a default under an underlying project document, the insolvency of a contract counterparty, or a misrepresentation under any of the transaction documents. These don't necessarily immediately (or at all) impact on cash forecasts (and therefore projected distributions with reference purely to an expected balance sheet). However, the event of default within the project will mean that the lenders will want to retain as much value in their security net as possible until the relevant default has been remedied or waived, meaning cash will be locked in. Solid financial performance does not therefore necessarily equal distributions at the end of the period.
Top tip: Make sure you know how and when (and under what conditions) distributions can be made to ensure you can manage shareholder expectations.
6. And last (but not least), event of default
In respect of a project financing, no lender wants to waltz in at the first sign of a default and whisk the project away from the borrower. However, the triggers, thresholds and controls within the financing documents give the lender a seat at the table to discuss the resolution of any event of default, and given the limited recourse nature of the financing a lender will want to do so to protect their investment. The path out of any event of default can include (among other things): (a) waiver fees, (b) new cash sweeps and/or (c) an increase in margin. The path can be smoothed by a good (and early) flow of information to the lender as soon as a default has occurred (or is anticipated). Lenders want the project to work, but they need to be confident that you are the ones that are going to make this happen.
Top tip: Keep the lenders fully informed of any defaults occurring in respect of an asset in order to facilitate an amicable resolution of any breaches under the financing documents.