Project Financing


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Slides from Abu Dhabi Prroject Financing Conference (2002) on "Negotiating the Terms & Conditions of the Project Debt and Achieving Financial Close"

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  • Project Financing

    1. 1. Negotiating the Terms & Conditions of the Project Debt and Achieving Financial Close Kathleen (Bradley) Chouaï
    2. 2. Negotiating the Terms & Conditions of the Project Debt and Achieving Financial Close <ul><li>The Underwriting Process </li></ul><ul><li>The Term Sheet </li></ul><ul><li>Overview of Project Financing and Security Documentation </li></ul><ul><ul><li>Loan Agreements & Common Terms Agreement </li></ul></ul><ul><ul><li>Disbursement (Accounts) Agreement </li></ul></ul><ul><ul><li>Security Package </li></ul></ul><ul><ul><li>Sponsor Support </li></ul></ul><ul><ul><li>Host Government Support </li></ul></ul><ul><ul><li>Insurances </li></ul></ul><ul><ul><li>Direct Agreements </li></ul></ul><ul><ul><li>Intercreditor Agreement </li></ul></ul>
    3. 3. The Underwriting Process <ul><li>Why give an underwriting commitment? </li></ul><ul><ul><li>award of mandate </li></ul></ul><ul><ul><li>exclusivity </li></ul></ul><ul><ul><li>commitment </li></ul></ul><ul><ul><li>binding obligations </li></ul></ul><ul><ul><ul><li>indemnity </li></ul></ul></ul><ul><ul><ul><li>fee, costs and expenses </li></ul></ul></ul><ul><ul><ul><li>clear market </li></ul></ul></ul><ul><ul><li>conflict of interest </li></ul></ul><ul><ul><li>confidentiality </li></ul></ul>
    4. 4. The Underwriting Process <ul><li>Conditions to underwriting commitment: </li></ul><ul><ul><li>“ subject to contract” </li></ul></ul><ul><ul><li>due diligence </li></ul></ul><ul><ul><li>governmental consents </li></ul></ul><ul><ul><li>no material adverse change </li></ul></ul><ul><ul><li>market flex </li></ul></ul><ul><li>Two important dates </li></ul><ul><ul><li>expiry date for offer </li></ul></ul><ul><ul><li>expiry date of exclusivity </li></ul></ul>
    5. 5. The Underwriting Process <ul><li>Sample MAC clause: </li></ul><ul><li>“ The underwriting commitment set out in this letter is subject to: </li></ul><ul><li>. . . . </li></ul><ul><li>( ) in the opinion of at least [two] of the Underwriters, no material adverse change having occurred (or event which is likely to result in a material adverse change) in any of: </li></ul><ul><ul><li>(a) the business, operations, property, condition (financial or otherwise) or prospects of the Group (i.e., the borrower and its subsidiaries) taken as a whole; </li></ul></ul><ul><ul><li>(b) the commercial bank, loan syndication, financial or capital market conditions generally that, in the opinion of at least [two] of the Underwriters, can reasonably be expected to prejudice the successful syndication of the facility; or </li></ul></ul><ul><ul><li>(c) the political, financial or economic climate of [ country ] which, in the opinion of any two of the Underwriters, can reasonably be expected to prejudice the successful syndication of the Facility.” </li></ul></ul>
    6. 6. The Underwriting Process Two sample market flex clauses: “ Subject to the Facility Amount remaining unchanged, the Arrangers shall be entitled to change the pricing, terms or structure of the Facility if the Arrangers determine that such changes are advisable in order to ensure a successful syndication of the Facility.” “ Given the duration of the underwriting exposure of the Underwriters, the Borrower acknowledges that if, in the opinion of the Arrangers, it appears likely due to market conditions that a target hold level of US$[ ] each is unlikely to be reached through the normal syndication process on the basis of the agreed pricing of the Facility, the right is reserved, after consultation with the Borrower, to adjust the pricing of the Facility. The commitment to lend under the Facility Agreement is subject to the Borrower’s agreement to any adjustment made under this paragraph.”
    7. 7. The Underwriting Process <ul><li>Types of underwriting </li></ul><ul><ul><li>“ Fully underwritten” </li></ul></ul><ul><ul><li>“ Best efforts” / “best endeavors” </li></ul></ul><ul><ul><li>“ Partially underwritten” </li></ul></ul><ul><li>Legally binding? </li></ul><ul><ul><li>Should it be? </li></ul></ul><ul><ul><li>In complex project financing transactions? </li></ul></ul><ul><ul><li>“ Subject to contract” </li></ul></ul><ul><li>Primary risk for arrangers </li></ul><ul><ul><li>Market reputation </li></ul></ul>
    8. 8. The Term Sheet <ul><li>The purpose of a Term Sheet: </li></ul><ul><ul><li>basis on which mandate is awarded </li></ul></ul><ul><ul><li>details of terms and conditions </li></ul></ul><ul><ul><li>guide to legal counsel </li></ul></ul><ul><ul><li>summary for other parties </li></ul></ul><ul><ul><li>point of reference for future negotiations </li></ul></ul><ul><ul><li>credit committee </li></ul></ul><ul><li>Role in project financings </li></ul><ul><li>Signed or not? </li></ul>
    9. 9. The Term Sheet <ul><li>What does a Term Sheet contain? </li></ul><ul><ul><li>Primary terms and conditions and major points of principle </li></ul></ul><ul><ul><li>Parties </li></ul></ul><ul><ul><li>Major financial terms </li></ul></ul><ul><ul><li>Conditions precedent to financial close </li></ul></ul><ul><ul><li>Drawdown conditions and mechanics </li></ul></ul><ul><ul><li>Changes in circumstances </li></ul></ul><ul><ul><li>Representations, covenants and events of default </li></ul></ul><ul><ul><li>Financial covenants </li></ul></ul><ul><ul><li>Governing law and dispute resolution </li></ul></ul>
    10. 10. Overview of Project Financing and Security Documentation <ul><li>Loan Agreements </li></ul><ul><li>Common Terms Agreement </li></ul><ul><li>Disbursement (or Accounts) Agreement </li></ul><ul><li>Security Documents </li></ul><ul><ul><ul><li>Mortgages and fixed or floating charges </li></ul></ul></ul><ul><ul><ul><li>Assignments of contract rights and insurances </li></ul></ul></ul><ul><ul><ul><li>Control over bank accounts </li></ul></ul></ul><ul><ul><ul><li>Share pledges </li></ul></ul></ul><ul><ul><ul><li>Direct agreements </li></ul></ul></ul><ul><li>Support Documents </li></ul><ul><ul><ul><li>Sponsors </li></ul></ul></ul><ul><ul><ul><li>Host government </li></ul></ul></ul><ul><ul><ul><li>Insurances </li></ul></ul></ul><ul><li>Intercreditor Agreement </li></ul>
    11. 11. Project Financing Documents - Loan Agreements & Common Terms Agreement <ul><li>What is a common terms agreement? </li></ul><ul><ul><li>Sets out terms and conditions common to all lenders </li></ul></ul><ul><ul><li>Supplements loan and other credit agreements </li></ul></ul><ul><li>Important terms and conditions </li></ul><ul><ul><li>Cover ratios </li></ul></ul><ul><ul><li>Drawdown mechanics </li></ul></ul><ul><ul><li>Interest rate adjustment </li></ul></ul><ul><ul><li>Repayment and mandatory prepayment </li></ul></ul><ul><ul><li>Partial prepayment or cancellation </li></ul></ul><ul><ul><li>Representations and warranties </li></ul></ul><ul><ul><li>Financial and project information reporting requirements </li></ul></ul><ul><ul><li>Project supervision </li></ul></ul><ul><ul><li>Covenants </li></ul></ul><ul><ul><li>Events of default </li></ul></ul><ul><ul><li>Project completion </li></ul></ul><ul><ul><li>Financial close </li></ul></ul>
    12. 12. <ul><li>Cover ratios </li></ul><ul><ul><li>forward-looking ratios forecast financial viability of project on a continuing basis (e.g., every 6 months) </li></ul></ul><ul><ul><li>historic ratios test current performance </li></ul></ul><ul><ul><li>importance of “banking case” (the model) </li></ul></ul><ul><ul><li>controlling the forecast assumptions </li></ul></ul><ul><ul><ul><li>economic assumptions </li></ul></ul></ul><ul><ul><ul><li>technical assumptions </li></ul></ul></ul><ul><ul><ul><li>challenges </li></ul></ul></ul>Project Financing Documents - Loan Agreements & Common Terms Agreement
    13. 13. <ul><li>Types of cover ratios </li></ul><ul><ul><li>project life cover ratio - ratio of NPV of projected net revenues over life of project to outstanding bank debt </li></ul></ul><ul><ul><li>loan life cover ratio - ratio of NPV of projected net revenues over loan life to outstanding bank debt </li></ul></ul><ul><ul><li>drawdown cover ratio - ratio of loan life NPV to maximum amount that is likely to be borrowed from lenders ( “peak debt amount”) </li></ul></ul><ul><ul><li>repayment cover ratio - ratio of project or loan life NPV to bank debt actually outstanding </li></ul></ul><ul><ul><li>debt service cover ratio - ratio of actual net revenues over a particular period to debt service obligations during same period </li></ul></ul>Project Financing Documents - Loan Agreements & Common Terms Agreement
    14. 14. Project Financing Documents - Loan Agreements & Common Terms Agreement <ul><li>Use of cover ratios </li></ul><ul><ul><li>determine financial viability of project </li></ul></ul><ul><ul><li>drawstop </li></ul></ul><ul><ul><li>determine amount of repayment or prepayment </li></ul></ul><ul><ul><li>dividend stopper </li></ul></ul><ul><ul><li>test for “project completion” </li></ul></ul><ul><ul><li>event of default </li></ul></ul>
    15. 15. <ul><li>Drawdown mechanics </li></ul><ul><ul><li>drawings only to pay specific project costs (e.g., approved capital expenditure and construction costs, interest during construction etc.) </li></ul></ul><ul><ul><li>drawings only against achievement of specified milestones </li></ul></ul><ul><ul><li>certification by lenders’ technical consultant or independent engineer </li></ul></ul><ul><ul><li>payment direct to contractor </li></ul></ul><ul><ul><li>drawstops may include breach of cover ratio, event of default, material adverse change, etc. </li></ul></ul>Project Financing Documents - Loan Agreements & Common Terms Agreement
    16. 16. Project Financing Documents - Loan Agreements & Common Terms Agreement <ul><li>Interest rate adjustment depending on cover ratios </li></ul><ul><li>Repayment </li></ul><ul><ul><li>minimum instalments keyed to projected cash flows </li></ul></ul><ul><ul><li>determined by reference to loan life cover ratio </li></ul></ul><ul><ul><li>sometimes increased if a cover ratio is not met </li></ul></ul><ul><li>Mandatory prepayment of insurance proceeds </li></ul><ul><li>Partial prepayment or cancellation by borrower </li></ul><ul><ul><li>only if financing in place for project completion to be achieved </li></ul></ul><ul><ul><li>prepayment premium </li></ul></ul>
    17. 17. <ul><li>Representations and warranties </li></ul><ul><ul><li>corporate status and capacity </li></ul></ul><ul><ul><li>due execution of documents </li></ul></ul><ul><ul><li>accuracy of project and financial information (info memo) </li></ul></ul><ul><ul><li>governmental consents </li></ul></ul><ul><ul><li>ownership of project assets </li></ul></ul><ul><ul><li>validity of obligations </li></ul></ul><ul><ul><li>environmental compliance </li></ul></ul><ul><li>Financial and project information reporting requirements </li></ul><ul><ul><li>generally extensive </li></ul></ul><ul><li>Project supervision </li></ul><ul><ul><li>independent engineer </li></ul></ul>Project Financing Documents - Loan Agreements & Common Terms Agreement
    18. 18. <ul><li>Covenants </li></ul><ul><ul><li>Purpose - allow lenders to maintain control over project company </li></ul></ul><ul><ul><li>Key covenants include: </li></ul></ul><ul><ul><ul><li>project contracts </li></ul></ul></ul><ul><ul><ul><li>project plan </li></ul></ul></ul><ul><ul><ul><li>good industry practice </li></ul></ul></ul><ul><ul><ul><li>additional debt </li></ul></ul></ul><ul><ul><ul><li>sole purpose company </li></ul></ul></ul><ul><ul><ul><li>dividends </li></ul></ul></ul><ul><ul><ul><li>disposal of assets </li></ul></ul></ul><ul><ul><ul><li>environmental requirements </li></ul></ul></ul><ul><ul><ul><li>insurances </li></ul></ul></ul>Project Financing Documents - Loan Agreements & Common Terms Agreement
    19. 19. <ul><li>Events of Default </li></ul><ul><ul><li>Purpose is control rather than acceleration </li></ul></ul><ul><ul><li>Typical events, e.g., non-payment, covenant breach, cross-default, insolvency, etc. </li></ul></ul><ul><ul><li>Project-related events of default </li></ul></ul><ul><ul><ul><li>failure to achieve project completion by long-stop date </li></ul></ul></ul><ul><ul><ul><li>destruction of all or material part of plant </li></ul></ul></ul><ul><ul><ul><li>cessation of production for sustained period ( force majeure ) </li></ul></ul></ul><ul><ul><ul><li>revocation or prejudicial variation of concession or other material consents </li></ul></ul></ul><ul><ul><ul><li>change in law which adversely affects project economics </li></ul></ul></ul><ul><ul><ul><li>creeping expropriations or regulatory changes </li></ul></ul></ul><ul><ul><ul><li>abandonment of project </li></ul></ul></ul><ul><ul><ul><li>defaults under major project contracts </li></ul></ul></ul><ul><ul><ul><li>cross-default on major project parties </li></ul></ul></ul><ul><ul><ul><li>non-availability (at commercial rates) of required insurance cover </li></ul></ul></ul><ul><ul><ul><li>ECA cover no longer being in full force and effect </li></ul></ul></ul><ul><ul><ul><li>breach of a lower cover ratio </li></ul></ul></ul>Project Financing Documents - Loan Agreements & Common Terms Agreement
    20. 20. Project Financing Documents - Loan Agreements & Common Terms Agreement <ul><li>“ Project Completion” </li></ul><ul><ul><li>physical completion as certified by independent engineer </li></ul></ul><ul><ul><li>financial tests </li></ul></ul><ul><ul><li>bringdown of representations and warranties (including no default) </li></ul></ul><ul><ul><li>governmental consents </li></ul></ul><ul><ul><li>legal opinions </li></ul></ul><ul><ul><li>payment of all fees and expenses </li></ul></ul><ul><ul><li>no material adverse change </li></ul></ul><ul><li>Importance of project completion </li></ul><ul><ul><li>sponsor support may fall away or reduce substantially </li></ul></ul><ul><ul><li>interest rate margin may reduce or increase </li></ul></ul><ul><ul><li>sponsor begins to receive dividends </li></ul></ul><ul><ul><li>liquidated damages for delay no longer run </li></ul></ul><ul><ul><li>risk in project facilities passes from contractor to project company </li></ul></ul><ul><ul><li>defects period starts </li></ul></ul><ul><ul><li>release of performance bond </li></ul></ul><ul><ul><li>release of all or part of retention amount </li></ul></ul>
    21. 21. <ul><li>Financial close </li></ul><ul><ul><li>all project contracts have become unconditional </li></ul></ul><ul><ul><li>all conditions precedent to project credit agreements have been satisfied or waived </li></ul></ul>Project Financing Documents - Loan Agreements & Common Terms Agreement
    22. 22. <ul><li>Types of project accounts </li></ul><ul><ul><li>disbursement account </li></ul></ul><ul><ul><ul><li>receives loan proceeds and equity contributions </li></ul></ul></ul><ul><ul><ul><li>withdrawals subject to borrower (and sometimes IE) certification </li></ul></ul></ul><ul><ul><ul><li>withdrawals only to pay project expenditures already incurred and sometimes projected expenditures </li></ul></ul></ul><ul><ul><li>proceeds account </li></ul></ul><ul><ul><ul><li>receives proceeds of sale of project product </li></ul></ul></ul><ul><ul><ul><li>debited in accordance with “waterfall” (see below) </li></ul></ul></ul><ul><ul><li>compensation account </li></ul></ul><ul><ul><ul><li>receives insurance proceeds and other compulsory acquisition payments </li></ul></ul></ul><ul><ul><ul><li>application of proceeds - mandatory prepayment or repair? </li></ul></ul></ul><ul><ul><li>debt service reserve account </li></ul></ul><ul><ul><ul><li>reserve to meet debt service if other funds not available </li></ul></ul></ul><ul><ul><ul><li>often for payments due over next 6-12 months </li></ul></ul></ul><ul><ul><li>maintenance reserve account </li></ul></ul><ul><ul><ul><li>for future maintenance expenditures </li></ul></ul></ul>Project Financing Documents - Disbursement (Accounts) Agreement
    23. 23. <ul><li>“ Cascade” or “waterfall” for payments out of proceeds account </li></ul><ul><ul><li>prior to default </li></ul></ul><ul><ul><ul><li>1st, to pre-agreed operating costs </li></ul></ul></ul><ul><ul><ul><li>2nd, to debt service in an agreed order </li></ul></ul></ul><ul><ul><ul><li>3rd, to funding reserve accounts to agreed levels </li></ul></ul></ul><ul><ul><ul><li>last, to project company for payment of dividends and/or debt service on subordinated loans </li></ul></ul></ul><ul><ul><li>on a potential event of default, accounts are frozen </li></ul></ul><ul><ul><li>on an actual event of default, proceeds are payable to lenders and other creditors </li></ul></ul>Project Financing Documents - Disbursement (Accounts) Agreements
    24. 24. <ul><li>What is the purpose of taking security in a project financing? </li></ul><ul><ul><li>valuable asset? </li></ul></ul><ul><ul><li>defensive </li></ul></ul><ul><ul><li>control </li></ul></ul><ul><li>Assets over which security is taken </li></ul><ul><ul><li>everything there is, and then some! </li></ul></ul><ul><ul><li>onshore/offshore </li></ul></ul><ul><ul><li>land, buildings and other fixtures </li></ul></ul><ul><ul><li>tangible assets used in project (e.g., plant and machinery, vehicles, pipelines etc.) </li></ul></ul><ul><ul><li>concession rights, licenses and other operating permits </li></ul></ul><ul><ul><li>goods produced by project company </li></ul></ul><ul><ul><li>sales proceeds </li></ul></ul><ul><ul><li>bank accounts </li></ul></ul><ul><ul><li>insurance, requisition and nationalisation proceeds </li></ul></ul><ul><ul><li>technology and process licenses and other intellectual property rights </li></ul></ul><ul><ul><li>performance bonds and completion guarantees </li></ul></ul><ul><ul><li>rights under project documents </li></ul></ul><ul><ul><li>shares in project company </li></ul></ul>Project Financing Documents - The Security Package
    25. 25. <ul><li>Difficulties with taking security </li></ul><ul><ul><li>foreign law </li></ul></ul><ul><ul><li>restrictions on foreigners taking security over land, shares, concession rights </li></ul></ul><ul><ul><li>borrower’s rights in the assets (ownership or something else)? </li></ul></ul><ul><ul><li>fixed or floating </li></ul></ul><ul><ul><li>security over assets not yet in existence </li></ul></ul><ul><ul><li>preferred creditors </li></ul></ul><ul><ul><li>lenders’ liability </li></ul></ul><ul><ul><li>enforcement rights and mechanics </li></ul></ul><ul><ul><li>perfection formalities </li></ul></ul><ul><ul><li>release of security on transfer of loans </li></ul></ul>Project Financing Documents - The Security Package
    26. 26. <ul><li>Types of security </li></ul><ul><ul><li>mortgages or fixed charges over land, buildings and other fixed assets </li></ul></ul><ul><ul><li>fixed and/or floating charges over moveable assets, book debts and production/work in progress </li></ul></ul><ul><ul><li>assignments of rights in underlying project documents </li></ul></ul><ul><ul><li>control over project accounts </li></ul></ul><ul><ul><li>share pledges </li></ul></ul><ul><ul><li>insurance assignments </li></ul></ul>Project Financing Documents - The Security Package
    27. 27. <ul><li>Types of direct sponsor support include: </li></ul><ul><ul><li>repayment guarantees </li></ul></ul><ul><ul><li>completion (shortfall) guarantees </li></ul></ul><ul><ul><li>cash injection undertakings (e.g., for cost overruns) </li></ul></ul><ul><ul><li>working capital maintenance agreements </li></ul></ul><ul><ul><li>price underpinning (to assure “floor” price for product) </li></ul></ul><ul><ul><li>comfort letters </li></ul></ul><ul><li>Types of indirect sponsor support include: </li></ul><ul><ul><li>take-or-pay, throughput and put-or-pay contracts </li></ul></ul><ul><ul><li>unconditional transportation contracts </li></ul></ul><ul><ul><li>supply maintenance agreements </li></ul></ul><ul><li>Other types of support may include: </li></ul><ul><ul><li>operation and maintenance agreement with one or more project sponsors </li></ul></ul>Project Financing Documents - Sponsor Support
    28. 28. <ul><li>Types of host government support include: </li></ul><ul><ul><li>concessions </li></ul></ul><ul><ul><li>licenses and approvals </li></ul></ul><ul><ul><li>expropriation guarantees </li></ul></ul><ul><ul><li>exchange availability undertakings </li></ul></ul>Project Financing Documents - Host Government Support
    29. 29. <ul><li>Types of insurance support include: </li></ul><ul><ul><li>commercial insurance </li></ul></ul><ul><ul><li>export credit guarantees </li></ul></ul><ul><ul><li>multilateral agency guarantee arrangements </li></ul></ul><ul><ul><li>multilateral “umbrella” </li></ul></ul>Project Financing Documents - Insurances
    30. 30. <ul><li>Who are the parties to a direct agreement? </li></ul><ul><ul><ul><li>project company </li></ul></ul></ul><ul><ul><ul><li>lenders </li></ul></ul></ul><ul><ul><ul><li>parties to project’s key commercial contracts, i.e., </li></ul></ul></ul><ul><ul><ul><ul><li>concession grantor </li></ul></ul></ul></ul><ul><ul><ul><ul><li>design and construction contractors </li></ul></ul></ul></ul><ul><ul><ul><ul><li>offtaker </li></ul></ul></ul></ul><ul><ul><ul><ul><li>supplier </li></ul></ul></ul></ul><ul><ul><ul><ul><li>operator </li></ul></ul></ul></ul><ul><li>What is the value of a direct agreement? </li></ul><ul><ul><ul><li>alternative to terminating project </li></ul></ul></ul><ul><ul><ul><li>positive value - provides for creditors to complete project </li></ul></ul></ul><ul><ul><ul><li>defensive value - prevents other creditors from interfering with project assets </li></ul></ul></ul>Project Financing Documents - Direct Agreements
    31. 31. Project Financing Documents - Direct Agreements <ul><li>Who benefits? </li></ul><ul><ul><li>investors - who stand to lose their investment </li></ul></ul><ul><ul><li>contractors - who stand to lose all benefits from contract </li></ul></ul><ul><ul><li>offtaker - who is entitled to expect supply of product </li></ul></ul><ul><ul><li>concessionaire - who will be able to impose stringent requirements in relation to new project company </li></ul></ul><ul><li>Principal clauses </li></ul><ul><ul><li>notice to third party of lenders’ security </li></ul></ul><ul><ul><li>third party to notify lenders of defaults by project company </li></ul></ul><ul><ul><li>suspend right to terminate </li></ul></ul><ul><ul><li>lenders’ right to “step-in” </li></ul></ul><ul><ul><li>lenders’ right to “step-out” </li></ul></ul><ul><ul><li>“ acceleration step-in” </li></ul></ul><ul><ul><li>other protections </li></ul></ul>
    32. 32. <ul><li>Large financings = multiple funding sources = complex intercreditor issues </li></ul><ul><li>Major issues </li></ul><ul><ul><li>common desire for control </li></ul></ul><ul><ul><li>acceleration rights </li></ul></ul><ul><ul><li>disbursement conditions </li></ul></ul><ul><ul><ul><li>mismatch of currencies </li></ul></ul></ul><ul><ul><ul><li>ECA disbursement requirements (“eligible goods”) </li></ul></ul></ul><ul><ul><ul><li>“ true-up” </li></ul></ul></ul><ul><ul><li>voting rights with respect to waivers and consents </li></ul></ul><ul><ul><ul><li>do ECAs taking only political risk have a right to vote? </li></ul></ul></ul><ul><ul><li>decisions regarding enforcement actions </li></ul></ul><ul><ul><li>security sharing </li></ul></ul><ul><ul><li>subordination </li></ul></ul>Project Financing Documents - Intercreditor Agreements