We have already discussed the benefits of PPP transactions for governments (see section 1.7 above). Using project finance has its drawbacks for the various parties:

(a)        Project investors/project company

PPP and project finance transactions are all about allocating risks, with the aim that the project company passes down most of the risks to other project parties. However, the project investors and/or project company may still be required to share some risks if they have not been allocated elsewhere e.g. the project investors may be required to provide a completion guarantee to mitigate the risks of using unproven technology.

Project financing is expensive. For example, funding costs are higher than traditional corporate financing and fees are payable to the funders and their advisers. Costs can spiral, for example, bid costs and the costs of legal advisers. The project company will be obliged to pay all lender costs.

One of the features of project financing referred to above is the amount of control the funders exert over the project company and its assets. Lenders achieve this in the finance documents by including many various representations and undertakings (often a complex “controls matrix” will be included which governs the amount of discretion the project company is able to exercise in relation to project decision-making). This makes it incredibly hard for the project company to manage the project on its own terms. All but the simplest decisions will require input from the funders which adds a level of time and cost to managing the project that doesn’t occur with more traditional financing methods.

(b)        Funders

The funders are at an information disadvantage. Although they attempt to exert a high degree of control over the assets and the project company through the provisions of the finance documents, they are dependent on the project company complying with these provisions and providing them with regular and detailed information.

The lenders want to exert control but this control gives rise to its own issues:

(i)         do the lenders have the capacity and ability to answer frequent requests for consent or instructions from the project company on potentially technical issues relating the project? This can be mitigated by the employment of the lenders’ technical adviser to assist on technical matters and, perhaps, the recognition that one or two experienced project finance banks will take the lead on assessing information provided by the borrower;

(ii)        is there a risk that the lenders will be held liable in respect of claims against the project, for example, environmental damage, or that they might be considered to be “shadow directors” with liability for the project company’s actions? This can be mitigated to some extent in the drafting of the finance documents with indemnities provided by the project company to the funders for any claims against them and a careful tightrope being walked by the lenders in their control over the project company, particularly where the project is in distress.

These types of projects are high risk for lenders, albeit managed by appropriate risk allocation and mitigation. Large sums of money are lent on the basis of projected outcomes in respect of the project over a very long tenor. Even with risk mitigation and allocation, there is the possibility of unforeseen change in the project economics which could result in non-payment of the debt.

Although the lenders will have taken extensive security over the project assets, achieving a valuable sale of these assets on enforcement in order to repay the debt is extremely difficult. See further section 5.7 below.

(c)        Government

The government will expect to deal only with the project company but will need to build lender involvement into project company response times. The project company is likely to need to seek consent or instructions from the lenders for most decision-making under the concession agreement. This can mean that variations etc. take longer than expected.

The government may come under pressure from funding institutions, particularly international commercial banks and multilateral development banks, to act in a certain way regarding the project. It will need to consider the response of these entities when dealing with the project, particularly in times of project distress.

The government is likely to be required to provide some form of government support for the project e.g. direct support by way of grants or subsidies or changes to tax treatment of the project company.

For all parties the time and complexity involved in project financing can significantly delay the project.