(a)  Where the project company has failed to comply with its obligations under one of the project documents, the counterparty to that project document will be entitled to terminate. This is likely to occur at the same time as the lenders are entitled to enforce their security. As we will see below when we look at security, the ability of the lenders to enforce their security in respect of the project is very important, but in real terms, is piecemeal and may not yield the desired amount of money to repay the loan. The lenders may take the view that they, or a third party appointed by the lenders, could do a better job of running the project than the project company and that, rather than enforcing the security, the lenders would prefer to take on the project as a going concern to remedy the defaults which have led to the right of the counterparty to terminate. The problem is that the lenders have no contractual relationship with the project counterparties under the relevant project document so how can they stop the counterparty terminating?

(b)  This is achieved by “direct agreements” which create direct legal relations between the lenders and each party to the project documents. A direct agreement stipulates that the relevant party to the project document will not exercise its rights of termination or wind-up the project company before the lenders have been given the option of running the project themselves. This option is known as a “step-in” right.

(c)  In simple terms, a direct agreement:

(i)   is a three-way agreement between lenders and the parties to the key project documents;

(ii)  provides step-in rights to lenders and a covenant from the project document counterparty not to terminate or take other adverse action without first notifying the lenders and allowing them time to decide whether they want to step-in. During this period (the “standstill period”) and any step-in period, the project document counterparty will also agree to perform its obligations under the project document; and

(iii) usually permits the granting of security by the project company of its rights under the relevant project document to the lenders.

(d) Direct agreements can have benefits for the counterparty. For instance, most direct agreements will contain a promise from the lenders that if they step in, outstanding amounts due from the project company to the counterparty will be repaid by the lenders.

(e) The direct agreement will often also include restrictions on who the lenders decide to appoint as the nominee, in the case of step-in, or the identity of the transferee if they decide to enforce security and sell the shares in the project company to a third party. These can take the form of pre-emption rights on a sale of the project company shares or a requirement that the nominee or transferee is not a competitor, and has adequate financial and technical capability to undertake the relevant obligations.

Funders direct agreement

(f)         A government will be expected to enter into a direct agreement with the lenders – typically called a funders’ direct agreement.

(g)  The government will be particularly concerned with the following:

(i)  the identity of any transferee to ensure that the infrastructure development they originally contracted for (usually due to an urgent public need) is indeed delivered by a reputable and capable contractor with the relevant technical expertise and financial backing;

(ii) the length of any step in period – the government will want to ensure that the lenders are diligently pursuing steps to remedy the default under the concession agreement in as short a period as possible before they will have the right to terminate the concession agreement and take back the project into public ownership; and

(iii) agreeing what happens after payment of compensation on termination if the lenders have not recovered the full amount of the senior debt. In this scenario, the lenders will want the ability to enforce their security in respect of the remaining amount of senior debt, but the government will also be looking to the project assets to recoup its investment, or to take back the project into public ownership in order to continue construction or remedy defects to get the project back to full performance. The direct agreement can govern the rights of the lenders and government relating to the priority over the project assets in this situation.