At the outset of a transaction, the lenders will want to design a security package which will ensure to the greatest extent that all monies advanced will be recovered (together with interest and any other costs incurred).

(a)        Why do lenders take security?

(i)         “Aggressive” nature of security

Where a borrower defaults, the lenders can take possession of the secured assets and sell them to repay the debt. This is the traditional view of security and the main reason for taking security in many types of transaction. However, in a project finance context it is not the main reason for taking security. Think about a road project – the project assets will include the road (once built) but there is not much value in a half-built road, or a ready market to purchase it (especially given any potential restrictions on the identity of the project company e.g. the requirement for it to be a local entity). The project company may have other assets e.g. land moving equipment, but these may be leased or not worth very much compared to the amount of senior debt outstanding.

(ii)       “Defensive” nature of security

If the lenders take security over an asset, this reduces the risk of other creditors obtaining an interest in project assets or bringing disruptive action, such as insolvency proceedings, as they would rank behind the secured lender in any such action. This is a principal motive for security in a project finance transaction as, often, and especially during the construction phase, the value of the assets will be less than the outstanding debt.

(iii)      Management and control

Security may (depending on the jurisdiction) entitle the lenders to:

(A)       take ownership of the project company and manage the project;

(B)       give the lenders the opportunity to negotiate with contractual counterparties in the event of a default in order to restructure the project or seek support e.g. from the government; and/or

(C)       appoint an insolvency practitioner to the project company which gives the lenders greater control over the insolvency proceedings.

(b)        Types of security

The security package on a project finance transaction will depend on a number of factors: the nature of the project assets (e.g. whether the asset is tangible or intangible; moveable or immoveable) and location of the project assets – is the asset located “onshore” (i.e. situated in, or governed by, the law of the jurisdiction where the project is located) or “offshore” (all other assets)?

Security granted by the project company will typically cover:

In addition, the lenders will expect to receive security over:

(i)         the shares in the project company in order to exercise the management purpose of the security mentioned above; and

(ii)        any shareholder loans – in order to discharge the shareholder debt on enforcement to more easily effect a sale of the project company on enforcement.

This security will be granted either by a holding company or the project investors depending on the structure of the project. As mentioned above, it is not uncommon to include a holding company between the project company and the project investors for tax structuring purposes or because the project investors are restricted by the terms of their own corporate borrowing from granting security.

(c)        Project investors’ support

In some limited circumstances the project investors might give some form of support in addition to the required equity contribution (see section 5.3(a) and (b) above). This may be some form of completion or cost overrun guarantee and it will depend on the nature of the project, the jurisdiction and the amount of risk of completion being delayed. They are typically used on projects which utilise untested technology.

The support may be backed by a bank letter of credit, a guarantee of the project investors or it may be an increased equity contribution if standby or cost overrun facilities are required.