I REASONS FOR AND CHALLENGES OF MULTI-SOURCE FINANCING
Multi-source financing, as used in this chapter, means financing furnished to a project from more than one source (loans from different categories of lending institution (commercial banks, export credit agencies, multilateral institutions, bonds, pension fund investments, infrastructure funds, etc.), or multiple groups of lenders of the same category). The term is not intended to address traditional bank syndication, which presents some similar issues but not nearly the breadth of concerns presented by a multi-source project financing. Multi-source financings involve many challenges for a borrower but, at the same time, may provide significant benefits (politically, economically and from an operational perspective).
A project may obtain financing from multiple sources for a variety of reasons. These include, among others, the need for more debt than any one source is willing to finance, the ability to obtain cheaper debt from a broader range of debt sources, and the opportunity to obtain the political and economic benefits of export credit agency and multilateral financing (which may be particularly helpful in jurisdictions in which traditional lenders may not wish to venture, but may not provide 100 per cent of the required funding or may impose certain restrictions on where a project may source its materials). In addition, obtaining funding from multiple sources spreads the inherent risks of a project (both for the lenders and the project itself) through debt of different tenors, pricing and other characteristics. Furthermore, different types of funding may only be available at certain stages of a project (for example, during the construction or operational phases) and there may be a need to obtain mezzanine debt to fill out the capital structure in the event of a gap between available senior debt and the amount of equity the project sponsors desire or are able to furnish.
In contrast to a basic financing arrangement with one lender, or multiple lenders in a syndicate with a single lead arranger and agent, a multi-source financing typically involves multiple groups or types of lenders, with their own separate financing agreements with the project, including their own separate funding mechanics, representations, covenants and events of default. To avoid a battle over the project collateral, and a scramble to exercise remedies in the event of a default, which is not ultimately in the interests of any of the lenders (given that project cash flow is the primary source of debt service), the lender groups (or agents acting on behalf of the various lender groups) typically enter into a common collateral agreement. While these bear resemblance to lender inter-creditor or subordination agreements in non-project financings (and may go by that same name), they address a wider set of issues. In addition, in contrast to a typical lender inter-creditor agreement, the borrower is generally a party to the common collateral agreement, in which it agrees to grant security for the benefit of all lenders. These common collateral agreements are the subject of the remainder of this chapter.
One of the most important roles of a common collateral agreement is to provide a common security package for the benefit of all participating lenders. Instead of each lender group entering into its own separate set of security agreements (mortgages, pledges, assignments, security interests, etc.), the borrower (and often related parties holding project assets – such as shareholders with shareholdings in the project company, project marketing companies and the like), grant to one or more collateral agents or collateral trustees a single security package for the benefit of all lenders or all lender groups. This avoids conflicting terms of security, and ensures that the lenders have the benefit of a uniform security package (although the common collateral agreement may nevertheless provide that one group of lenders has priority over, or is subordinate to, another group, as discussed further below). Such an arrangement also substantially reduces the burden of financing on the project sponsors, who otherwise would be forced to negotiate security packages with multiple lender groups (and, potentially, obtain multiple consents to security arrangements from various counterparties, including the host government).
Common collateral agreements provide for the perfection of the common security on behalf of all lenders, and specify who bears responsibility for undertaking the required perfection and any associated costs. While the obligation to perfect security and cover any associated costs usually is documented to fall on the borrower, lenders obviously have a keen interest to ensure that this is done correctly so often may take the lead when it comes to perfection. Collateral may not be varied or released without approval of the appropriate vote of the lenders (see further discussion below).
Typically, common collateral agreements will also provide for the execution of a single set of direct agreements with key project counterparties (the host government, the offtaker, the engineering, procurement and construction contractor, etc.) which benefit all lenders. It may be impractical to try to obtain multiple, different direct agreements from these counterparties for each lender group (although it is not uncommon for such counterparties to each try to negotiate their particular direct agreement). In any case, it is important for lenders to try, as far as possible, to maintain a consistent form of direct agreement.
In short, common collateral agreements seek to replicate, to the extent possible, the security package that would be obtained by a single lender group, but for the benefit of all.
III PRIORITIES AND SUBORDINATION
The relative priority of each lender's debt, rights to security and rights to receive the proceeds of enforcement must be addressed, and the rights of senior versus subordinated lenders with respect to each must be enumerated. Are all secured loans treated on a pari passu basis, or are some senior to others (generally based upon commercial discussions among the borrower and lender groups and reflected in debt pricing)? In the latter case, the common collateral agreement will specifically define the quantum of debt that is senior, with senior status often limited to the principal amount outstanding from time to time, not to exceed the original commitments, plus interest, fees and costs, and perhaps an additional commitment allowance, minus payments. The subordinated lenders will not want to be subordinate to an indefinite amount of debt that can be increased without their consent. Common collateral agreements also protect subordinate lenders by including provisions that require all lenders to approve any change in the financing that may impact the timing or priority of their repayment.
The common collateral agreement will also specify whether repayment of the subordinate debt is to be deferred until all senior debt is repaid or is subordinated only in a default or bankruptcy scenario. In a default scenario, there will likely be a time limit on the suspension of payment of the subordinated debt following the default, unless the senior lenders have by that date accelerated the loans or taken other enforcement action. The subordinated lenders do not want to be forced into an indefinite suspension of payments by a minor default.
Subordinated debt payments will be limited to those owing under the financing documents, without the right to receive voluntary prepayments in a non-default scenario (other than where the senior debt has already been fully repaid). Separate provisions generally address prepayment of debt using the proceeds of enforcement of collateral, such as a sale of the collateral or typical mandatory prepayment scenarios (e.g., receipt of property damage insurance proceeds that will not be used for rebuilding).
The common collateral agreement will typically cover the right of the senior lenders to be paid in full in a bankruptcy prior to any payment on the subordinated debt. Beyond this basic issue, common collateral agreements often include waivers by the subordinated lenders of various rights in a bankruptcy, such as any right to challenge the validity of the senior credit documents or the senior lenders' rights to collateral (this waiver may be reciprocal, by both the senior and subordinated lenders) and any right to seek court authority to lift the bankruptcy stay and exercise security rights. It may also expressly limit the right of the subordinated lenders to offer debtor-in-possession financing (i.e., financing to the debtor while under bankruptcy protection) to pre-agreed circumstances, or prohibit it entirely, as debtor-in-possession financing can have priority over the senior lenders' debt in some legal systems. The common collateral agreement may also include pre-approval by the subordinated lenders for debtor-in-possession financing by the senior lenders (including the subordination of the subordinated debt to such a financing), use of cash collateral by or with approval of the senior lenders and similar consents. The senior lenders may seek to control the vote of the subordinated creditors on any plan of reorganisation for the debtor, though this is likely to be resisted. The subordinated lenders may seek to reserve any rights that they would have in a bankruptcy as unsecured creditors, apart from their subordinated lien rights, but the acceptability of such a carve-out from the limitations that would otherwise apply will depend upon the nature of those unsecured creditor rights under the particular legal system.
Whether occurring in a bankruptcy scenario or otherwise, payments improperly received by a subordinated lender to which the senior lenders are entitled under the terms of the common collateral agreement are deemed to be held in trust for the benefit of the senior lenders and must be turned over to them.
IV GENERAL LENDER RIGHTS
Certain other questions of rights among the lenders must also be addressed by the common collateral agreement.
The common collateral agreement will specify any restrictions the groups impose on the right of any group to take actions under its separate financing agreements. For example, can a group:
- take additional collateral in which the other groups do not participate?
- shorten the maturity of its loans?
- amend or waive its positive and negative covenants for the borrower?
- alter its events of default and default remedies?
The lender groups will additionally address how decisions are made on matters of common interest, particularly decisions regarding enforcement of their security. Enforcement decisions may include whether to enforce the security in the first place and, if so, when to enforce and the proposed manner of such enforcement. Such a decision typically requires a vote of the lenders, with a pass mark threshold established in the common collateral agreement. Different pass marks may apply in different scenarios, and may require a specified approval level within each lending group, or among all lending groups as a whole, or both. Typically, in a bankruptcy scenario, any lending group may require that the collateral agent enforce the security. Upon a borrower payment default, a majority in interest (by commitment or debt outstanding) may be able to call for enforcement action. The threshold for a 'majority in interest' may vary from deal to deal. Enforcement action in the event of a covenant default may require a higher pass mark, as the lenders generally do not want to take enforcement actions if the project is still operating efficiently, if cash is still flowing and the borrower is satisfying any applicable financial covenant tests. In such circumstances, subordinate debt holders may not be permitted to seek an enforcement action, perhaps until some deferral period has passed and the matter has not yet been resolved. It is not unusual to see a 'step-down' mechanism where the lender approval threshold required to take enforcement action steps down or reduces, over time. The theory is that, if the breach is relatively minor, or the impact on lenders relatively insignificant (for example, only one lending group is affected), then although those lenders may ultimately have the right to trigger enforcement action, they will have to wait a considerable amount of time before they are entitled to exercise that right.
Less commercial matters are also addressed, such as the appointment and removal of the collateral agent and its release from liability for actions taken in the performance of its duties (other than willful misconduct, fraud, etc.). The common collateral agreement will require that any person acquiring an interest in one of the loans join as a party.
V ENFORCEMENT OF SECURITY
When directed by the pass mark decision of the lenders, the collateral agent is obligated to enforce the lenders' security under the various security instruments executed pursuant to the common collateral agreement. Proceeds of such enforcement will be applied by the collateral agent for the benefit of the various lender groups in accordance with the terms of their relative priorities under the common collateral agreement. Collateral agents are typically very reluctant to act without clear direction from the required lenders (or lending groups) so the common collateral agreement will need to be specific as to what agents may do (or are required to do) without specific lender approval.
VI PROJECT SPONSORS AS LENDERS
A project financing is often undertaken by a project sponsor group of varying creditworthiness, and sponsors with stronger credit frequently find that they could borrow funds at a lower rate through alternative arrangements. To avoid suffering the cost of the more expensive project finance arrangement, these sponsors with stronger credit sometimes join the lender groups as co-lenders, essentially neutralising their cost of the financing by acting both as lenders that receive interest as well as borrowers that pay it.
Introducing a sponsor into the lender group generates certain challenges, particularly with respect to the decision-making mechanism used to undertake enforcement actions. If the sponsor share of funding is large enough, the sponsor could block actions adverse to the project. Even if the sponsor's share is not that large, it can certainly prove an impediment to obtaining the necessary majority for approving such actions. As a result, common collateral arrangements will generally exclude the sponsor-lender from participating in certain types of decisions, enforcement actions being key among these.
Such limitations aside, sponsor-lenders should have the same rights as other lenders, particularly to benefit from the common security package and to participate in decisions relating to the terms of the common security arrangements, changes in lender obligations or priorities, and any releases or waivers of security rights.
VII ADDITIONAL DEBT FOR EXPANSIONS AND MODIFICATIONS
Common collateral agreements are generally established to secure initial construction debt from specific lender groups. Projects are not static, however. Sponsors often are interested in expanding successful projects, adding related bolt-on infrastructure, or undertaking upstream or downstream investments. This interest directly conflicts with the lender interest in containing and managing project risks, by limiting activities of the project company and its ability to incur additional debt.
To balance these conflicting interests, common collateral agreements may specifically address the conditions on which an expansion or related project and the additional debt to fund it may be undertaken.
Expansion projects conducted by the project company or its affiliates that are borrowers or grantors of security in the existing project present the greatest risk to lenders. Common collateral agreements typically require, among other things, that the new expansion not adversely affect the existing project, that overall debt-to-equity and debt service coverage ratios be maintained in acceptable ranges, that the expansion be fully funded (debt and equity), that the terms of the additional or new senior debt be no more beneficial to the borrower than the terms of the existing senior debt, that the additional or new senior debt share in the same collateral (under the existing common collateral agreement, on the same terms), and that the tenor of the new financing not be shorter than the existing financing, to protect those existing senior lenders who are not participating in the additional financing.
Any security on the new infrastructure will most likely be shared with all existing lender groups under the common collateral agreement. However, while the new infrastructure is being constructed, the lenders for that infrastructure as yet have nothing of value to contribute to the common security pool, so will typically not be permitted to participate in the existing common security. Once an expansion project is completed, these lenders will become full participants in the common security arrangement.
Depending on the jurisdiction of the project and the governing law of the security documentation (including the common collateral agreement), lenders will need to consider carefully whether the existing security package that was put in place on day one in respect of the initial financing will stretch to cover any new or increased indebtedness. In jurisdictions where day one security does not automatically cover additional indebtedness, it will be necessary to take and perfect new security to cover it. Any such new security will likely not rank pari passu with the original security. Lenders (whether senior or subordinate) who have provided new or additional financing and that consequently benefit from the second security package will need to be aware of their deferred status.
In contrast, completely new, though related projects (particularly upstream or downstream projects), if conducted by different entities, and not utilising security over the existing project, may be permitted with fewer restrictions. One typical restriction is that no related project be undertaken before the initial project is funded, so that the equity resources and human resources in the sponsors' corporate families are not diverted before the original lenders' collateral is in place. Others include the availability of sufficient debt and equity funds for the related project and confirmation that the related project not adversely affect the existing project. Collateral typically is not shared, so the lenders to the related project will not join the common collateral agreement, though special arrangements may be made with respect to common infrastructure shared by both the existing project and the related project, such as an export terminal.
VIII FIT FOR PURPOSE
As can be discerned from the discussion above, a common collateral agreement is a bespoke document, negotiated for the specific groups of lenders, a specific borrower and a specific project. This discussion has touched on a number of the key concerns in such agreements but has only scratched the surface in addressing the great variety of arrangements that can be found in the project finance world.
1 David F Asmus is a partner and Adam Cowan is counsel at Sidley Austin LLP