Construction Project Financial and Contractual Structure An Independent Study Project Spring Semester 2007 Sakib Khan SEAS ’07 Advised by Professor Nicola Chiara

My Goals: Improve understanding of finance mechanisms in place for large scale construction projects Develop understanding of the breadth and depth of contractual agreements in large scale construction projects Gain insight on the ethical implications of contractual structures and international construction projects in developing nation situations

Improve understanding of finance mechanisms in place for large scale construction projects

Develop understanding of the breadth and depth of contractual agreements in large scale construction projects

Gain insight on the ethical implications of contractual structures and international construction projects in developing nation situations

Objectives: Develop descriptive diagram of major relationships between major parties in typical project finance arrangements Present notes on sequence of contracts, legal instruments, and key memos and reports over the stage of project development Identify and think about areas of potential ethical or moral dilemma

Develop descriptive diagram of major relationships between major parties in typical project finance arrangements

Present notes on sequence of contracts, legal instruments, and key memos and reports over the stage of project development

Identify and think about areas of potential ethical or moral dilemma

Source Texts: International Project Finance . Ronald Sullivan. 4th Edition. Huntington, NY: Juris 2004. Principles of Project Finance . E.R. Yescombe. San Diego: Academic Press 2002.

International Project Finance . Ronald Sullivan. 4th Edition. Huntington, NY: Juris 2004.

Principles of Project Finance . E.R. Yescombe. San Diego: Academic Press 2002.

My Grand Diagram

Project Company Investors Equity Lenders Feasibility Study Pledges Local Government Permits Permissions Exceptions Obligations Intent to develop Organized Labor Union deal Engineers Environmental Impact Statement Completion Agreement Purchaser Product Guaranteed Sales Contract General Contractor Contracts Design Debt Profit GC financing Operator Input Supplier Off-taker Not studied: Collateral

Notes on Sequence A sketch of possible key documents over the development of a typical project

Stage 1: Financing the Project

[1] Subscription Agreement Parties: Investors Project Company Obliges Investors to supply equity to the Project Company Subject to exchange regulations and government limitations of foreign investment

Parties: Investors

Project Company

Obliges Investors to supply equity to the Project Company

Subject to exchange regulations and government limitations of foreign investment

[2] Feasibility Study Parties: Investors (by way of I-Bank) Lenders Detailed description of project Information on the investors, similar investments Outline of all agreements and contracts Detail of all costs, to-date and projected Detail on finance structure and attempts

Parties: Investors (by way of I-Bank)

Lenders

Detailed description of project

Information on the investors, similar investments

Outline of all agreements and contracts

Detail of all costs, to-date and projected

Detail on finance structure and attempts

[3] Offering Memorandum Parties: Project Company (by way of I-bank) Lenders Establishes amount to be loaned Describes: Investors’ investments Project completion Management structure Terms of loans Guarantees of insurance Restrictions on sales of assests Limits on working capital ratio, debt service Choice of law Environmental considerations for due deligence

Parties: Project Company (by way of I-bank)

Lenders

Establishes amount to be loaned

Describes:

Investors’ investments

Project completion

Management structure

Terms of loans

Guarantees of insurance

Restrictions on sales of assests

Limits on working capital ratio, debt service

Choice of law

Environmental considerations for due deligence

[4] Commitment Letter Parties: Project Company Lenders Lender outlines commitments necessary to make loan Not legally binding, but typically followed

Parties: Project Company

Lenders

Lender outlines commitments necessary to make loan

Not legally binding, but typically followed

[5] Intercreditor Agreement Parties: Lenders Forum for joint administration between lenders

Parties: Lenders

Forum for joint administration between lenders

[6] Mortgage or Indentured Trust Parties: Project company Lenders Secured with real and personal property, as well as project revenues Places lenders in primary position versus unsecured creditors and investors Indentured trust is like a collective mortgage with trustee and beneficiaries Guarantees by investors may accompany in other forms

Parties: Project company

Lenders

Secured with real and personal property, as well as project revenues

Places lenders in primary position versus unsecured creditors and investors

Indentured trust is like a collective mortgage with trustee and beneficiaries

Guarantees by investors may accompany in other forms

[7] Security Agreement Parties: Project company Lenders Some jurisdictions do not cover personal property and assets in mortgage Security Agreement allows lender to secure equipment, inventory, etc. Often restricts sale or lease of equipment, encumbering by liens, maintenance of insurance

Parties: Project company

Lenders

Some jurisdictions do not cover personal property and assets in mortgage

Security Agreement allows lender to secure equipment, inventory, etc.

Often restricts sale or lease of equipment, encumbering by liens, maintenance of insurance

Investors Guarantees Parties: Investors Lenders [8] Pledge Agreement Allows for stock of project entity to be pledged to tender Does not really cover equity, but allows lender to take equity holder rights and take charge of company in crisis [9] Stand-by Letter of Credit A bank (not an initial lender) agrees to cover loan payments and default expenses in time of default by project company Typically secured by investors, but also sometime by purchaser

Parties: Investors

Lenders

[8] Pledge Agreement

Allows for stock of project entity to be pledged to tender

Does not really cover equity, but allows lender to take equity holder rights and take charge of company in crisis

[9] Stand-by Letter of Credit

A bank (not an initial lender) agrees to cover loan payments and default expenses in time of default by project company

Typically secured by investors, but also sometime by purchaser

[10] Completion Agreement Parties: Investors Project Company Lenders Investors will make funds available to Project Company sufficient to pay completion costs past funds otherwise available Also can be phrased as: Investors are obligated to make funds available to pay the obligations of the loan agreement Lenders often insist on these agreements

Parties: Investors

Project Company

Lenders

Investors will make funds available to Project Company sufficient to pay completion costs past funds otherwise available

Also can be phrased as: Investors are obligated to make funds available to pay the obligations of the loan agreement

Lenders often insist on these agreements

[11] Sales Contracts Parties: Project Company Purchaser Stabilizes cash flow and reassures lenders and investors Might be “Take or Pay”, where payments are not tied to delivery but are unconditional so as to assure lenders some project revenue Often trustee of debt will receive payments and enforce purchaser obligation

Parties: Project Company

Purchaser

Stabilizes cash flow and reassures lenders and investors

Might be “Take or Pay”, where payments are not tied to delivery but are unconditional so as to assure lenders some project revenue

Often trustee of debt will receive payments and enforce purchaser obligation

Stage 2: Structuring the Project

[12] Retain local counsel Parties: Attorney for the project Local attorney In international projects, local counsel should come on board as soon as possible Locally incorporates legal entities Negotiates with local government Assists with analysis of local tax implications

Parties: Attorney for the project

Local attorney

In international projects, local counsel should come on board as soon as possible

Locally incorporates legal entities

Negotiates with local government

Assists with analysis of local tax implications

[13] Letter of Intent Parties: Unincorporated project group Local Government Non-binding preliminary outline of commitments Investors and Government are willing to make Also known as “Memorandum of Understanding” or “Principles of Agreement” Can be formalized as “Master Agreement” Possibly could be introduced as subject to legislative approval

Parties: Unincorporated project group

Local Government

Non-binding preliminary outline of commitments Investors and Government are willing to make

Also known as “Memorandum of Understanding” or “Principles of Agreement”

Can be formalized as “Master Agreement”

Possibly could be introduced as subject to legislative approval

[14] Incorporation of legal entities Parties: Investors Local Government Fit structure for ideal tax situation Generally: Parent company owns subsidiary which is interposed into host country and then owns project company Investing Parent Company Investing Parent Company Wholly-Owned Subsidiary Wholly-Owned Subsidiary Foreign jurisdiction Project Company

Parties: Investors

Local Government

Fit structure for ideal tax situation

Generally: Parent company owns subsidiary which is interposed into host country and then owns project company

Structures and Agreements for Project Company and Investors Structures: Limited Liability Company Joint-Venture Partnership Agreements: [15] Shareholders Agreement [15] Joint Venture Agreement [15] Partnership Agreement

Structures:

Limited Liability Company

Joint-Venture

Partnership

Agreements:

[15] Shareholders Agreement

[15] Joint Venture Agreement

[15] Partnership Agreement

Stage 3: Government Agreements, Concessions and Obligations

[16] Government’s Obligations Parties: Project Company Local Government Often the Government has incentive to help the project develop Project Company can negotiate with the Government the obligation to provide infrastructure, including: Roads, rail links, ports Utilities Housing and schools

Parties: Project Company

Local Government

Often the Government has incentive to help the project develop

Project Company can negotiate with the Government the obligation to provide infrastructure, including:

Roads, rail links, ports

Utilities

Housing and schools

[17] Exchange Control Consents and/or Exemptions Parties: Project Company Local government To tap the international capital market, Government permission is needed to allow capital to flow in and out of the host country Project Company counsel works closely with Local Attorney to determine the restrictions on foreign borrowed capital and draft consents or exemptions as necessary

Parties: Project Company

Local government

To tap the international capital market, Government permission is needed to allow capital to flow in and out of the host country

Project Company counsel works closely with Local Attorney to determine the restrictions on foreign borrowed capital and draft consents or exemptions as necessary

[18] Project Company’s Obligation to Construct Parties: Project Company Local Government If the Government is obliged to help with the project, the Project Company is obliged to construct the project Key point to exert bargaining power over Government Set no firm completion date secure right to expand minimize duties and taxes avoid Government influence on pricing

Parties: Project Company

Local Government

If the Government is obliged to help with the project, the Project Company is obliged to construct the project

Key point to exert bargaining power over Government

Set no firm completion date

secure right to expand

minimize duties and taxes

avoid Government influence on pricing

[18] Project Company’s Obligation to Construct (cont’d) Project details: What is completion? Expansion rights? Right to import raw, construction, and operations materials? Pricing? Royalties? (for natural resource exploitation) Sales restrictions in local market? Export licensing Term of agreement Determine governing law Dispute resolution method Better to use arbitration than Government’s judges

Project details:

What is completion?

Expansion rights?

Right to import raw, construction, and operations materials?

Pricing?

Royalties? (for natural resource exploitation)

Sales restrictions in local market?

Export licensing

Term of agreement

Determine governing law

Dispute resolution method

Better to use arbitration than Government’s judges

PC’s Protection from Government Parties: Project Company Local Government [19] Non-Discrimination Agreement Disallows Government from discriminating against Project Company [20] No Changes Agreement Attempts to bind future Governments to the Agreement Neither carry much practical weight

Parties: Project Company

Local Government

[19] Non-Discrimination Agreement

Disallows Government from discriminating against Project Company

[20] No Changes Agreement

Attempts to bind future Governments to the Agreement

Neither carry much practical weight

Utilities Purchase Agreements Parties: Project Company Local Government Utilities Companies (if not national) [21] Power Purchase Agreement [22] Water Purchase Agreement [23] Waste Disposal Agreement

Parties: Project Company

Local Government

Utilities Companies (if not national)

[21] Power Purchase Agreement

[22] Water Purchase Agreement

[23] Waste Disposal Agreement

Transportation Access Agreements Parties: Project Company Local Government [24] Agreement to Build Port/Harbor Facilities Waterworkers’ unions “extremely militant” [25] Shipping Agreement Use of shipping lanes limited solely to national lines? Or free access? Exemptions? [26] Railroad Siding Agreement

Parties: Project Company

Local Government

[24] Agreement to Build Port/Harbor Facilities

Waterworkers’ unions “extremely militant”

[25] Shipping Agreement

Use of shipping lanes limited solely to national lines? Or free access?

Exemptions?

[26] Railroad Siding Agreement

Tax Agreements and Exemptions Parties: Project Company Local Government [27] Tax Agreement for Expatrioted Employees Allows for foreign employees to pay lower taxes than natives of same tax standing [28] Project Tax Arrangement Fix a method of tax calculation for all project revenue Exemptions from specific taxes, customs duties, interest on foreign loans Creation of tax holidays Keeping accounts in foreign currency

Parties: Project Company

Local Government

[27] Tax Agreement for Expatrioted Employees

Allows for foreign employees to pay lower taxes than natives of same tax standing

[28] Project Tax Arrangement

Fix a method of tax calculation for all project revenue

Exemptions from specific taxes, customs duties, interest on foreign loans

Creation of tax holidays

Keeping accounts in foreign currency

Labor Related Agreements Parties: Project Company Local Government Organized Labor Employment and Training of Indigenous Workers Can Government provide training? Does Government restrict labor pool? Labor deals with necessary unions

Parties: Project Company

Local Government

Organized Labor

Employment and Training of Indigenous Workers

Can Government provide training?

Does Government restrict labor pool?

Labor deals with necessary unions

Political Risk Insurance Parties: Project Company Insurer Only issued when intergovernmental agreement exists between host and sponsor countries Insures against: Expropriation Political violence Inconvertibility of currency

Parties: Project Company

Insurer

Only issued when intergovernmental agreement exists between host and sponsor countries

Insures against:

Expropriation

Political violence

Inconvertibility of currency

Stage 4: Design and Construction

[29] Retain Design Professional Parties: Project Company Engineers (or Architects) Pretty standard

Parties: Project Company

Engineers (or Architects)

Pretty standard

[30] Environmental Impact Statement Parties: Engineers Government Detailed description of project Required permitting information Analysis of environmental impacts to: Hazardous Materials Earth, Air, Water, and Shoreline Vegetation and Animals Natural Resources Preservation and Recreation Housing, Transportation and Public Services Noise, Aesthetics, and Glare

Parties: Engineers

Government

Detailed description of project

Required permitting information

Analysis of environmental impacts to:

Hazardous Materials

Earth, Air, Water, and Shoreline

Vegetation and Animals

Natural Resources

Preservation and Recreation

Housing, Transportation and Public Services

Noise, Aesthetics, and Glare

Site Acquisition, Zoning and Engineering [31] Site purchase or lease agreement [32] Re-zoning application [33] Locally-signed drawings [34] Building permits

[31] Site purchase or lease agreement

[32] Re-zoning application

[33] Locally-signed drawings

[34] Building permits

[35] Retain General Contractor Parties: Project Company Contractor Contract terms: Gross Maximum Price Fixed Price Cost Plus Cost Plus with Guaranteed Maximum Price and Incentive Based Fee Contractor Financing BOT, DBO, DBFO Bank guarantees promissory notes are saleable Waived right to off-set during dispute with contractor

Parties: Project Company

Contractor

Contract terms:

Gross Maximum Price

Fixed Price

Cost Plus

Cost Plus with Guaranteed Maximum Price and Incentive Based Fee

Contractor Financing

BOT, DBO, DBFO

Bank guarantees promissory notes are saleable

Waived right to off-set during dispute with contractor

Moral Issues Application to third world context is essentially a colonial enterprise Ideal structure for manufacturing and natural resources projects, which are exploitative Also ideal for electric power generation plants, which are empowering Author has some troubling early passages Classifies dock-workers unions, in general, as “militant” Looks to leverage third world governments into unfavorable positions with regards to completion date, expansion, taxes, duties, etc.

Application to third world context is essentially a colonial enterprise

Ideal structure for manufacturing and natural resources projects, which are exploitative

Also ideal for electric power generation plants, which are empowering

Author has some troubling early passages

Classifies dock-workers unions, in general, as “militant”

Looks to leverage third world governments into unfavorable positions with regards to completion date, expansion, taxes, duties, etc.