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UNMASKING PROJECT FINANCE: RISK MITIGATION, RISK INDUCEMENT, AND AN INVITATION TO DEVELOPMENT DISASTER?
SHALANDA H. BAKER  I. II. III. ABSTRACT.......................................................................................... 274 INTRODUCTION ................................................................................. 275 LA VENTOSA ..................................................................................... 279 A. The La Venta Projects .............................................................. 281 B. Eurus Wind Farm ...................................................................... 282 C. La Mata-La Ventosa Wind Project ......................................... 283 D. The “Greening” of La Ventosa: Clean energy, Dirty Business ...................................................................................... 284 1. Questionable Acquisition of Indigenous Land ................ 285 2. Disruption of Bird migratory Patterns and Crop Flooding ................................................................................ 287 3. Empty Promises of Employment and Community Development........................................................................ 289 UNDERSTANDING PROJECT FINANCE ............................................ 291 A. Theoretical Underpinnings....................................................... 292 B. Project Finance and Development—The Mexican Example ...................................................................................... 295 C. Structural Components ............................................................. 300 D. External Rationales for Project Finance................................. 305 E. Internal Rationale for Project Finance ................................... 308 PROJECT FINANCE AS A RISK DIFFUSION MECHANISM............... 310 A. High Debt-to-equity Ratio ....................................................... 311 B. Use of Stand-Alone Project Company .................................... 311 C. Non-Recourse Financing .......................................................... 312 D. Risk Shifting in Project Contracts ........................................... 313

IV.

V.

 William H. Hastie Fellow, University of Wisconsin Law School. This article has benefited greatly from feedback and questions received at presentations at the University of Wisconsin Law School, the Earle Mack School of Law, and Vermont Law School. I owe many thanks to andré cummings, Rashmi Dyal-Chand, Carmen G. Gonzalez, Darian Ibrahim, Heinz Klug, Jonathan Lipson, Lahny Silva, and Bill Whitford, who all patiently and willingly commented on earlier drafts of my work. I am particularly grateful for the thoughtful comments and insight of my former colleague, Mitchell Carroll. Finally, I’d like to thank the people of La Ventosa for generously allowing me into their lives to learn about their struggles to maintain their dignity and lifeways. I hope this article sheds light on many of the challenges they face. Any errors contained herein are my own.

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1. Commercial Risks................................................................ 314 2. Political Risks....................................................................... 315 VI. PROJECT FINANCE AS A RISK INDUCEMENT MECHANISM .......... 316 A. Low Initial Capital Outlay—Passing on the Risk of the How ............................................................................................. 317 B. The Special Purpose Entity—Obfuscating the Who ............. 320 C. Non-Recourse Loan—Keep the Income Stream Flowing .... 321 D. Risk Shifting in Project Contracts—Passing the Buck .......... 324 VII. OVERCOMING STRUCTURAL DEFICITS .......................................... 326 A. Eliminate Non-Recourse Loans............................................... 328 B. Lower Debt-to-equity Ratios ................................................... 329 C. Limit Use of Special Purpose Entities .................................... 330 D. Additional Research ................................................................. 332 VIII. CONCLUSION ..................................................................................... 333 I. ABSTRACT

Each year one in every five foreign direct investment dollars in the Global South flows through project finance transactions. These transactions consist of large-scale energy and infrastructure projects, and consistently produce deleterious effects on third parties. Until now, much of the legal scholarship in the infrastructure development field has focused its attention on the complex mechanics of project finance, including understanding the ways in which project promoters utilize project finance to manage commercial and political risks. Much of the human rights and environmental advocacy related to negative development outcomes is limited to seeking ex post facto relief. To date, very few scholars have delved into the intersection between these bodies of scholarship (project finance and human rights), and queried whether project finance transactions, ex ante, have a relationship to the externalities produced in large-scale development projects. This article squarely engages this inquiry, and argues that the risk diffusion mechanisms native to project finance transactions work together to undermine limits on risky behavior on the part of project sponsors and thereby lead to the externalization of risk. To remedy this transactional failure, I recommend that three of the key risk-mitigation features of project finance—(1) non-recourse debt, (2) high debt-toequity ratios, and (3) the use of special purpose entities—be abrogated in order recalibrate the development calculus and force project sponsors to bear more of the risk of their activities. Ultimately, more rigorous, interdisciplinary, examination of project finance is required to understand fully how this pervasive method of financing infrastructure externalizes many of the costs of development; however, this article provides a useful starting point for the discussion.

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UNMASKING PROJECT FINANCE II. INTRODUCTION

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Imagine investing $10 million of equity to create a project company 1 that will engage in the risky business of developing a large-scale infrastructure project in an emerging economy. You will never be held liable for the activities of the subsidiary you create; you will never absorb the environmental, social, and political risks created by the project; and you will never bear the full risk of the project’s failure. Your investment, ten million of the one hundred million total financing required for the project, will yield a thirty percent return, 2 and you will continue to invest in similar projects without any of the economic liabilities of such projects ever appearing on your balance sheet. You have discovered the magic of project finance, 3 a significant source of infrastructure development financing in the Global South. 4 It is a boon: You may engage in some of the riskiest transactions on the planet and, in the process, place only your initial investment at risk. Each year the global financial community 5 spends an estimated $1.7 trillion in foreign direct investment-related projects. 6 Nearly a fourth of this investment goes toward energy and infrastructure development using project finance. 7 Such projects run the gamut, from extractive projects
1. A project company is a stand-alone corporate entity formed specifically for the purpose of building a large-scale infrastructure project. 2. See, e.g., Antonio Estache & John Strong, The Rise, the Fall and . . . the Emerging Recovery of Project Finance in Transport 26, (World Bank Institute: Policy Research, Governance, Regulation, and Finance, Working Paper No. 2385, 2000), available at http://www. wds.worldbank.org/servlet/WDSContentServer/WDSP/IB/2000/08/14/000094946_0007270535479 5/Rendered/PDF/multi_page.pdf (explaining that a thirty percent equity return is standard for transport infrastructure projects). 3. Harvard Business School Professor Benjamin Esty, a leading project finance scholar, defines project finance as “the creation of a legally independent project company financed with non-recourse debt (and equity from one or more sponsors) for the purpose of financing a single purpose, industrial asset.” BENJAMIN C. ESTY, MODERN PROJECT FINANCE 25 (2004). In this article, project finance also captures the class of infrastructure projects that are characterized by private investment, their large scale (over $300 million U.S.), and high debt-to-equity ratios. 4. In this article the term “Global South” encompasses both the geographical designation that refers to those countries that lie south of the Equator and the UNCTAD designation for “developing economies.” In traditional development parlance, this term generally designates “lesser developed” countries. See Adam D. Link, Comment, The Perils of Privatization: International Developments and Reform in Water Distribution, 22 PAC. MCGEORGE GLOBAL BUS. & DEV. L.J. 379, 399 n.6 (2010). 5. Here, my use of the term, global financial community, incorporates the United Nations Conference on Trade and Development treatment of foreign direct investment: Investment initiated and primarily carried out by transnational corporations. See United Nations Conference on Trade and Development, Assessing the Impact of the Current Financial and Economic Crisis On Global FDI Flows vii (2009). 6. UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT, UNCTAD HANDBOOK OF STATISTICS 2010 374, U.N. Doc. TD/STAT.35, U.N. Sales No. B.10.II.D.1 (2010) [Hereinafter UNCTAD]. In this article I refer to the 2008 statistics for foreign direct investment, which captures volumes before the onset of the global downturn in liquidity. 7. In An Overview of Project Finance and Infrastructure Finance—2009, Professor Benjamin Esty and Senior Researcher Aldo Sesia of the Global Research Group estimate that in 2008 global project finance expenditures reached an all-time high of $409 billion. Harvard Business School case 210-061 at 1 (Harvard Business School Publishing, June 30, 2010).

Stating that project finance transactions are complex is somewhat of an understatement. pervades the development landscape despite its complexity. PA. supra note 6. 12. to oil and gas pipelines.]” Steven L. supra note 6. composing approximately one of every five dollars spent on foreign direct investment in the Global South. a method of finance wherein borrowers rely on the income stream from a project in order to provide debt service. What is Bretton Woods. Global Project Finance Review Fourth Quarter 2008. 13. See Estache & Strong. The United Nations Monetary and Financial Conference was convened by the forty-four allied nations at Bretton Woods. See Carl S.htm.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 276 TEXAS JOURNAL OF OIL. supra note 3. 60 BUS. LAW 109. available at http://online. Thereafter. THE ECONOMIC MOTIVATIONS FOR USING PROJECT FINANCE 9 (2002) (“Creating a stand-alone project company takes more time (from 6 to 18 months more) and requires significantly greater transaction costs than financing an asset on an existing balance sheet. an approximation of the percentage of foreign direct investment in the Global South that is attributable to project finance can be made by relying on UNCTAD. in its most recent version. at 5 (discussing complexity and transaction costs of project finance as compared to traditional financing forms). which estimates the 2008 foreign direct investment in developing countries. wind farms.org/Bwf/whatisbw. UNCTAD. however. 10 In the current iteration of the development discourse. and dams.”). See ESTY. 483. In 2008 the Global South saw approximately $630 billion in foreign direct investment projects. 11. By externality. 14. supra note 2. 7. 13 and risk of delivering negative environmental and social externalities. International Project Finance . 11 Project finance. calls for private engagement in public projects typically reserved for state actors. See Sophie Smyth. a rough approximation of the amount of foreign direct investment in the Global South properly attributed to project finance is approximately 18%. World Bank Grants in a Changed World Order: How Do We Referee This New Paradigm. 121 (2004). project finance has emerged as an attractive transactional structure. http://external. J. 9. at 382. and the Thomson Reuters Global Project Finance Review for the fourth quarter of 2008. Bjerre. ESTY. and environmental degradation. 30 U. 12 high transaction costs. New Hampshire after World War II. BENJAMIN C. the International Bank for Reconstruction and Development (known as the World Bank) and the International Monetary Fund were created pursuant to the Bretton Woods Treaty.worldbankimflib. 15 The impacts of infrastructure projects are also well 8. 15. 2011). or about one in every five dollars spent.thomson reuters. GAS. According to Thomson Reuters regional data. See discussion infra Part IV. See Thomson Reuters. UNCTAD estimates that $630 billion in foreign direct investment flowed to the Global South. The extensive documentation coupled with the high level of legal and financial expertise required to complete transactions and constant vigilance with respect to documentation lends itself to significant transaction costs.INPUTFILE. 8 These investments in emerging economies are a part of the larger “development” narrative constructed by industrialized nations. Thus.4 billion went toward project finance developments in the Global South. AND ENERGY LAW [Vol.com/DealsIntelligence/ReviewsAndAnalysis/ArchiveQuarterlyReviews (last visited Feb. Collapsing Corporate Structures: Resolving the Tension Between Form and Substance. 14 The complexity and transaction costs of project finance are well understood and have received a fair amount of scholarly attention. at 2. which began at Bretton Woods 9 and. note 8. 6 and power plants. I mean the “infringement of non-contracting parties’ rights[. approximately $113. INT’L L. which is organized by region and incorporates data from reporting banks in the project finance industry. 10. see also World Bank. Schwarcz. See UNTCAD supra. 495–96 (2008). No single database disaggregates project finance-related foreign direct investment data in the Global South.

12 DUKE J. Michael B. 411 (2002). In this article. Project Finance. & INT’L L.109 (1998). 73 AM. Mitigating Human Rights Risks Under State-Financed and Privatized Infrastructure Projects. A full analysis of the various methodologies deployed in the development context to measure social harm exceeds the scope of this article. See generally Carl S. L. and dams.. but not limited to. 395. 414 n. I argue that the risk diffusion mechanisms native to project finance transactions work together to undermine limits on risky behavior on the part of project sponsors and thereby lead to the externalization of risk. PA. In this article “infrastructure development” refers to the ambit of project finance financed projects. 28 MICH. L. supra note 17. INT’L ECON. . Wendy N. An analysis of the key features of project finance implores an affirmative response. The economic question of how environmental and social externalities are measured against the backdrop of infrastructure production in the development context therefore remains a live issue here. project finance. Kirk Herbertson & David Hunter. J. 16. Think Globally. have investigated the relationship between the specific internal legal form of project finance and the externalization of risk that characterizes the form. 439 (2002). 18. This reality subverts commonly held efficiency Transactions: Selected Issues Under Revised Article 9.3 (1999). the financing and risk mitigation vehicle that. Likosky. 261 n. however. however measured. 17 In this article. 19. to bring economic prosperity to a region. including. GLOBAL LEGAL STUD.J. I begin to explore this inquiry. Although many of the projects may not provide “infrastructure” in the physical sense. (En)act Locally: Promoting Effective National Environmental Regulatory Infrastructures in Developing Nations. 2] UNMASKING PROJECT FINANCE 277 documented and comprise a rich literature. e. 69 (2005). Bjerre. The Social Impact of Project Finance. Matthew F. There are a few exceptions.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. 16 Very few scholars. at 411–12 (seeking to avoid dwelling “almost exclusively on doctrinal and practical questions such as how the transactions work and how they are negotiated” and calling for “fresh and interdisciplinary attention to the negative effects of project finance on non-consenting third parties”). See Bjerre. COMP. RTS. extractive projects such as oil or mining. 12 DUKE J. J. and asks whether certain mechanisms native to the financing form consistently produce deleterious effects on third parties who are not parties to these complex transactions. Smith & Naing Htoo. Duong. & INT’L L.J. Securitization and Consensuality. My analysis instead aims to focus attention on the transactional components of project finance and their specific connection to such externalities. J. the rationale supporting their development is generally the same. toll roads. COMP. L. & DEV. 17. Regional Projects Require Regional Planning: Human Rights Impacts Arising from Infrastructure Projects. 26 U. Energy Security: Security For Whom?. BANKR. 31 CORNELL INT’L L. McCutcheon. Edward D. 11 YALE HUM. See. Lissa Lamkin Broome. J. Emerging Standards for Sustainable Finance of the Energy Sector. provides to sponsors perverse incentives with respect to risk management. J. 175 (2006) (discussing human and environmental impacts of Rio Madeira dam projects in Brazil).J.INPUTFILE. This article answers the call of Carl Bjerre and others 18 who have urged a more exacting review of project finance. 261. & POL’Y 4 (2007) (discussing environmental issues related to energy-related projects). energy production facilities.g. Abby Rubinson. 65 (2003) (discussing human rights risks associated with infrastructure development). such as wind or gas. 7 SUSTAINABLE DEV. This interrogational lens examines the subject. 217 (2008) (discussing human rights impact of natural gas development in Burma). L. my research illustrates. Note. at its structural interior. Partnerships with Monarchs—Two Case Studies: Case Two Partnerships with Monarchs in the Development of Energy Resources: Dissecting an Independent Power Project and Re-Evaluating the Role of Multilateral and Project Financing in the International Energy Sector. INT’L L. in many cases. 10 IND. makes a significant amount of infrastructure development 19 possible and. Note.

The Death of Liability. normatively. 36 GEO. but project finance serves such a critical function in the discursive production of the development narrative that small fixes on a transaction-by-transaction level may be the only realistic solutions. See. I argue that the mechanisms fail to address certain risks inherent at the outset and create an environment where certain risks go unchecked and shift onto those who cannot contractually avoid them. In light of the foregoing assertions. Private Complainants and International Organizations: A Comparative Study of the Independent Inspection Mechanisms in International Financial Institutions. Mexico. I suggest three possible avenues to overcome those deficits: (1) eliminating the non-recourse loan. AND ENERGY LAW [Vol. (2) use of a special purpose entity. The discussion at Part VI begins the process of evaluating each riskdiffusion mechanism vis-à-vis infrastructure development. a reworking or outright rejection of the project finance model would be preferable. See Daniel D. and their underlying rationales. (3) non-recourse loan. GAS. I note that. Bradlow. The technical aspects of each of these selected riskmitigation mechanisms are then addressed in short form. 20 In Part VII. INT’L L. I offer a policy solution to the structural deficits of project finance transactions. 884 (2007) (noting that many law reforms rooted in equality and fairness are viewed as infeasible). 21 This section also highlights areas for further research and advocates for a disruption of the assumption of project finance’s neutrality. more fundamentally.INPUTFILE. this article aims to reinvigorate the academic debate regarding limited liability.g. 22 and presses 20. Following this discussion. 863. are explored. Here. 21. 6 and risk-management principles that are deeply rooted in law and economics and. 3 (1996) (engaging debate on . Heather Hughes. undermines basic notions of social justice and fairness. and (4) project contracts. 403. 55 BUFF. L. (2) lowering the debt-toequity ratios that characterize project finance transactions. J. Part IV provides an historical overview of project finance generally and then discusses the various rationales employed to justify its use. See Lynn LoPucki.. REV.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 278 TEXAS JOURNAL OF OIL. 22. 1. 106 YALE L. Counterintuitive Thoughts on Legal Scholarship and Secured Transactions. and illustrates that the negative externalities relating to project finance emerge even with respect to carbon-limiting projects with stated “green” objectives.J. including potential to alleviate significant project risk for sponsors and developers. and (3) limiting the use of special purpose entities as project companies. Part V explores the following key risk diffusion methods implemented in project finance and their respective rationales: (1) high debt-to-equity ratio. Part III begins with a discussion of wind development currently underway in Oaxaca. 406 (2005) (pointing out that “one group that historically has not been able to hold international organizations accountable is non-state actors who are adversely affected by the actions of an international organization but who have no contractual relationships with it”). e.

. & LEGAL ANTHROPOLOGY REV. See Zach Dyer. 24 and its current situation as the site of an epic struggle between a group of indigenous subsistence farmers and several wind projects developed in the Juchitán region of Oaxaca. Mexico. available at 2006 WLNR 22949361. I reflected on the events of the previous four months. Sam Enriquez. but the state is also known throughout Mexico for its deep cultural significance as the ancestral home to over fourteen indigenous groups who speak no fewer than the same number of unique indigenous languages. and Local “Rights” in a Zapotec Community. 2000 WLNR 2223705. LA VENTOSA As I rode the dusty Oaxacan highway bound for a meeting with indigenous groups in the picturesque mountain town of San Miguel del Puerto to discuss the devastation wrought by several mega-development projects in the region. The capital of the state. a corporate lawyer. Admittedly. 23. Clean Energy Plays Dirty in Oaxaca. and Puebla and Veracruz to the north. available at 2006 WLNR 18295757. 24. A cursory explanation of project finance provides the necessary contextual lens through which the preliminary analysis takes place.INPUTFILE. but I found myself immediately captivated by Oaxaca’s cultural and biological diversity. 26 Oaxaca’s physical beauty is arresting. 24. 21. 26. 23. one must first understand Oaxaca. 25. I begin with a familiar development trope: The disenfranchisement and effective displacement of indigenous people. III. specifically vis-à-vis the complex contractual framework of project finance. NORTH AMERICAN CONGRESS ON LATIN AMERICA. Mar. Lynn Stephen. this was a selfindulgent mission.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. 2000. Oaxaca City. Oaxaca is located in the southern region of Mexico. National. 28 POL. its historical importance for various social justice movements. 27 The region resonates with the vibration of this history. May 14. 2] UNMASKING PROJECT FINANCE 279 colleagues across disciplines to re-engage the inquiry into limiting the liability of private actors in the development context. Unrest Remains. MIAMI HERALD. In 2006 teachers in Oaxaca initiated a pay-related strike that led to the galvanization of the political left and the call for the resignation of the governor of Oaxaca. 2006. Oct. respectively. learn about a new culture and. https://nacla. 133 (2005). ALBUQUERQUE JOURNAL. Oaxaca Teachers’ Strike Gains Momentum (National Public Radio broadcast Aug. 23 on a one-way ticket. 25 To understand the controversy surrounding the wind projects. the second poorest state in Mexico. sits in a valley surrounded by colorful mountains and once served as the the limited liability issue). had landed in the city of Oaxaca. Oaxaca Where Mexico Shows Its Many Faces. 2009. Mexico: Oaxaca Teachers To End Strike. The tension continued for six months and led to at least five deaths in the state. Negotiating Global. 27. however. 2006). sandwiched among the Mexican states of Guerrero and Chiapas to the west and east. Tom Harmon. do a bit of good in the process. My goal? To take a break from my life as a corporate and project finance attorney. perhaps.org/node/5638. I.

6 capital of the Zapotec empire. regions that are no strangers to the complexities of Latin America. and its abundance in El Istmo. and Cultures of Racial Hierarchy and Identity in the Americas. oil. 76 TUL. DEP’T OF ENERGY. supra note 26. INT’L L.A.pdf. REV. the region is nicknamed La Ventosa. which features extensive infrastructure projects in Central America. 8 U. & POL’Y 1. This seemingly benign resource. See Posting of Tara Brian. María Eugenia Padua. See. Center for Strategic & International Studies: Sinon Chair’s Blog. 32 moved quickly to identify a strategy that would effectively divide El Istmo into development parcels to serve as individual sites for wind projects. The story begins in Europe and the United States.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 280 TEXAS JOURNAL OF OIL. including the modernization of the railroad in the Isthmus of Tehuantepec). A group of primarily Spanish and French companies. Cottrol.A. AND ENERGY LAW [Vol.S. CLAMOR MAGAZINE. NATIONAL RENEWABLE ENERGY LABORATORY.. Mexico’s Wind Industry Picks Up. 29 When travelling along the Pacific coast through the isthmus region of Oaxaca. it is the windiest region of the world. S.” Ah. and natural gas. Liberalism. of France. Notably. relying on studies that confirmed the economic viability of developing wind projects in El Istmo. or “the windy place. Yet Obstacles Prevent This Breeze From Becoming A Gale.S. 2001 WLNR 9801983 (discussing the impact of Pemex refinery in the Isthmus). the region is poorer than the rest of the state. Mexico’s Latest Assault on the Environment and Indigenous Culture. U.g. 30. however. 32. The companies.org/blog/mexico%E2%80%99s-wind-industry-picks-yet-obstacles-prevent-bree ze-becoming-gale (Oct. . including Spain’s Acciona Energía. the people of the isthmus. 11. one is immediately struck by several distinct features. On the whole. The study conducted by the U. partitioned the La Ventosa 28. and EDF Energies Nouvelles S. 31. 28 (2002) (discussing the Puebla-Panama Plan. 21.000 MW of wind energy. an impoverished sector of the second poorest state in a developing country. http://csis. and by some measures. which boasts an Afro-Mexican population and abundant natural resources such as wind. sparked a controversy that has all of the elements of a classic imperial development drama. 1.INPUTFILE. retain a defiant pride for the culture and abundant natural resources of the region. DAVIS J. e. L. Harmon. WIND ENERGY RESOURCE ATLAS OF OAXACA (2003). 2001. among them a definitive study conducted by the U. Nov.usaid. 31 In fact. the wind. Another Piece in the Puzzle: Plan Puebla Panama. Mexico’s Part in the Neoliberal Project. El Istmo de Tehuantapec (“El Istmo”). GAS. it is home to Mexico’s petrofuel industry and has been identified by the federal government as the future location for various mega-development projects along the coast. 30 The wind in El Istmo also blows constantly.-based National Renewable Energy Laboratory estimates that Mexico has the potential to install and use approximately 40.C. 2010) (noting that the Isthmus of Tehuantepec is “considered one of the best sites for wind development in the world”)..gov/pdf_docs/PNADE741. 29. 28 (2001) (discussing the Afro-Mexican population on the west coast of Oaxaca). See Robert J. The Long Lingering Shadow: Law. los istmeños. http://pdf. National Renewable Energy Laboratory.S. 28 From Oaxaca City one can travel through the Sierra Norte or Sur to the coastal region of Oaxaca.

See Inter-American Development Bank. May 17. Iberdrola Renovables Wins Contract for 103 MW Wind Farm in Mexico (Apr.iadb. La Venta II. The three primary developments highlighted below provide a strong sampling of the way the wind has developed in Oaxaca as a commodity to be captured.000 tons of carbon dioxide. 37.org/cif/sites/climateinvestmentfunds.int/User Management/FileStorage/EVG6YORKTUAC9XMQL0N1F8D3PZS2JH (stating that the project was “commissioned on January 5. 15. http://idbdocs. Press Release. Global Wind Energy Council. and exported.org/wsdocs/get document.unfccc. dollars. 2007”).S. Iberdrola Ingeniería Awarded $2 Billion Contract to Build Combined Power Plant in Venezuela (July 29. 2009). 37 The La Venta projects were developed 33.aspx?docnum=2025671 (last visited May 20. 2009). The 121 wind turbines will be built by Gamesa Eólica.climateinvestmentfunds. 2005. a 2 MW project.org/files/ Current_Information_Ducument_Mexico_Private_Sector_Wind. La Venta II. and 568. 2009) http://www.gwec. Mexico. available at http://www. IDB to Finance Historic Expansion of Wind Power in Mexico. 34 Many of the wind developments have thus far generated intense struggles between the developers and indigenous people living in the area.pdf. The La Venta Projects With strong technical support from the World Bank. 2011). La Venta I.org/NEWS/detail.85 MW project. a 102. One megawatt is equal to 1000 kilowatts. 3. Kim Castleberry. For a sense of scale. Iberdola.S. 36 and La Venta III. The Center for Strategic and International Studies also estimates that “there are at least 28 wind projects in various stages of development in Mexico.35 MW under construction. The project is the first Mexican private wind independent power producer project. 35.es/webibd/corporativa/iberdrola? IDPAG=ENMODULOPRENSA&URLPAG=/gc/prod/en/comunicacion/notasprensa/090729_ NP_02_IING_CCVenezuela. became operational in 1994. a Spanish company.000 people and avoid the emission of 160.iberdrola.cfm?Language =En&artType=PR&artid=6118&id=6118. 34. 36.INPUTFILE.php?id=119 (last visited May 20. http://www. and went on line in January of 2007. UNITED NATIONS FRAMEWORK COMMISSION ON CLIMATE CHANGE. 2011). 2005 WLNR 7943206. an entity owned by the Mexican government. 33 with an estimated overall investment slated to reach over five billion U. an average U. Hurdles Remain. http://www. INTERNATIONAL FINANCE CORPORATION. La Venta III. available at http://cdm. exploited. a 2. 83.iadb. Inter-American Development Bank. Iberdrola Renovables is contracted to provide the construction expertise for the project and promises to supply energy to CFE under a 20-year contract. See Press Release. Iberdrola Engineering and Construction. Environmental and Social Strategy. beginning with a relatively small test project.3 MW project developed by the Mexican Federal Electricity Commission (“CFE”). (Dec. Iberdrola. http://www. Id. The Global Wind Energy Council estimates that Mexico currently has 202.” Center for Strategic and International Studies. called La Venta I.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No.000 acre. CLEAN TECHNOLOGY FUND PROJECT PROPOSAL FOR MEXICO: PRIVATE SECTOR WIND DEVELOPMENT (CURRENT INFORMATION DOCUMENT) 48 (June 29. 2] UNMASKING PROJECT FINANCE 281 region into no fewer than fourteen separate wind projects.net/index.iberdrola. 2011). 20. Press Release. BOULDER DAILY CAMERA. supra note 31. A.es/webibd/corporativa/iberdrola?IDPAG= ENMODULOPRENSA&URLPAG=/gc/prod/en/comunicacion/notasprensa/090304_NP_01_IR parque_Mexico.html (noting that the company previously constructed the La Venta II wind farm). 2009). LA VENTA II 3RD MONITORING REPORT 2 (Feb. was scheduled to go on line in November of 2010.29 MW of wind power generation currently installed.html. 35 The project formed the first part of a series of government-led developments named La Venta I.000 kilowatt-hours of electricity per year. home uses approximately 10. Looking to the Wind for Energy Colorado is in Top 20 for Potential. the Mexican government developed the first wind project in Oaxaca. and is expected to serve 200. with the vast majority of the developments occurring in the Isthmus region of Oaxaca. was constructed by Spanish companies Gamesa Eólica and Iberdrola Renovables. La .

See Inter-American Development Bank. 42 A consortium of ten financial institutions. 41.org/wsdocs/getdocument. available at http://siteresources. The United Nations (“UN”) Clean Development Mechanism program allows a private . 45.org/EXTRENENERGYTK/Resources/51382461238175210723/M exico0Large0S1Development0Project0.000 people. AND ENERGY LAW [Vol. de C. to sixty-five to thirty-five (65/35). nearly eight months before the $525 million project 41 reached financial closing in June of 2010. Mexican companies.worldbank.” the commercial lending arm of the World Bank). Venta III Wind Farm (Mexico).acciona.aspx?docnum=2030700 (last visited Jan. Project Abstract (June 10. http://idb docs. http://www. supra note 43. 44 which means that the initial project developers contributed about 30% to 35% of the project cost.iadb. Ten Entities Finance ACCIONA’s Eurus Windpark in Mexico with USD375m (Nov 6.V. Acciona Energy. developed the largest wind project ever seen in Latin America and the Caribbean. a wholly owned subsidiary of Acciona Energía of Spain. will provide the long-term debt financing for the project. Inter-American Development Bank. 38.pdf.INPUTFILE.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 282 TEXAS JOURNAL OF OIL. through a subsidiary. the International Finance Corporation (the “IFC. Eurus Wind Farm The Eurus wind farm is “by far the largest wind power project ever built in Latin America and the Caribbean. supra note 34. See Press Release. 2010). B. 38 The government-led La Venta projects are noted here because they provided an early template for private investors determining whether to enter the risky environment of developing wind farms in Mexico.” 39 The 250. who. On the clean energy front. See TED KENNEDY CLIMATE CHANGE TEAM.com/ibding/proyectos. through a special purpose limited liability company. See North American Congress on Latin America. See Inter-American Development Bank.P. including the Inter-American Development Bank (the “IDB”).com/news/ten-entities-financeaccionas-eurus-windpark-in-mexico-with-usd375m-. 40. RETOOLKIT CASE STUDY MÉXICO: LARGE SCALE RENEWABLE ENERGY DEVELOPMENT PROJECT.I. supra note 34. 39. Acciona Energy. 40 The project consists of 167 turbines that were installed in November of 2009. See id. the project also includes the sale of United Nations Certified Emissions Reductions (“CERs”) credits 45 in its plan. supra note 40 (discussing estimated project cost of $525 million).5 megawatt (“MW”) project is being developed by Acciona Energía México (AEM). while the lenders provided the remaining amounts. Banks provided approximately $375 million of debt for the $525 million project. 43.do?op= det&id=30&despliega=3.A. supra note 25. Inter-American Development Bank. 44. 2009). By one estimate the Eurus farm will generate enough electricity for a city of 500. Eurus S. and commercial banks. 19. 2011). http://www. 6 to give Mexico the opportunity to gain experience with wind development while maintaining control of the market. 43 Records indicate that the debt-to-equity ratio of the project ranges from seventy to thirty (70/30). GAS. The success of the Mexican government’s projects paved the way for market entry by Acciona Energía of Spain.iberdrolaingenieria. 42. WORLD BANK.

according to a bank official who declined to submit any further documentation related to the transaction. InterAmerican Development Bank. http://cdm. de C. consists of twenty-seven 2. Id.org/ifcext/ media.clipperwind. with a small of amount of funding provided on a recourse basis that is expected to developer to develop an emission-reduction project in a developing country and.5 MW total capacity. 2011). 52 A subordinate lender will provide $15 million U.S. Eléctrica del Valle de México S. 50. About CDM. 51. Press Release. and the U.INPUTFILE.nsf/content/SelectedPressRelease?OpenDocument&UNID=BA4A366AE5794447852577 F9006467BC. 47. a subsidiary of the French power company. 54 The collateral used for the project consisted of project assets. Clipper Windpower Plc is a wind energy technology developer. “the project is a fairly standard project finance structure with typical security on all project related assets. Inter-American Development Bank. 51 The project is being financed in large part by the IDB and the International Finance Corporation (the “IFC”).ifc. See United Nations Framework Convention on Climate Change.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. .html (last visited Mar. La Mata-La Ventosa Wind Project The third project.5 MW wind turbine generators made by Clipper Windpower Plc (“Clipper”) 48 for a total of 67. E-mail from Rachel Robboy.html. depending on the currency used for the calculations. EDF Energies Nouvelles (“EDF”) owns and developed the project. Principal Investment Officer. Renewables.L.unfccc. to author (Jan. generate Certified Emissions Reductions that are then sold on the market. International Finance Corporation. Export-Import Bank. named the La Mata-La Ventosa wind project. 24. 48. 2011. 26. 14. Id. 49 The project reached its financial closing in late 2010 50 and cost an estimated $200 million U. dollars.S. 46 In general.” 47 C. to author (Jan. http://www. The purchasers of the credits are countries that have agreed to reduce carbon dioxide emissions to meet agreed-upon targets. 2009).25. Jan. 53 The debt-to-equity ratio of the project is estimated at between seventy to thirty (70/30) and eighty to twenty (80/20). Id. 2011. 2010. http://www. 46. 54. 15:53 CST) (on file with author). 2] UNMASKING PROJECT FINANCE 283 and it is estimated that the project shall benefit from the sale of credits for a total of 600. based on a set of criteria designated by the UN. who will also provide approximately $81 million U. IFC Helps Finance Mexican WindPower Project to Increase Renewable-Energy Sources (Dec. 2010). dollars of subordinated debt. Ex-Im Bank Approves Debt Financing for Clipper’s Liberty Wind Turbines (Nov. who together will provide 585 million Mexican pesos of debt. 49.int/about/index.000 tons of avoided carbon dioxide emissions per year.S. A special purpose limited liability company. 52.V. de R. Infrastructure Division. and the debt provided was non-recourse as to the assets of the sponsors. Project Finance.com/pr_112609. Press Release. Clipper Windpower. 53. (“EVM”). dollars. E-mail from Jefferson Boyd Easum. 15:21 CST) (on file with author). supra note 34. official. Inter-American Development Bank.S. 13. Id. Its primary offices are located in the United Kingdom and California.

58 Despite such rocky beginnings.” in discussing the private wind development underway in Oaxaca). See Global Wind Energy Council. USA TODAY.html (noting that the closing of Eurus. Inter-American Development Bank.” legal framework allows private wind developers to sell power to commercial and industrial groups in Mexico as off-takers. 6 convert to non-recourse debt quickly. D. Clipper is expected to operate the plant for five years before transferring the plant to enXco. Id. PROJECT FINANCE AND INFRASTRUCTURE FINANCE. the tried and true method of structuring the transactions poses few limitations on sponsors’ abilities to displace key risks upon third parties.usatoday. http:// www. Mexican law forbids the private sale of energy to the public. supra note 33. Cleanenergy Windmills A ‘Dirty Business’ For Farmers in Mexico. http://www.com/about/corporate_structure/ (last visited May 20. The “Greening” of La Ventosa: Clean energy. June 17. or for export to other countries. amended the Electric Energy Public Service Law in 1992 and provides that the private sector may participate in the generation of energy if such production goes to a particular entity or individual. See Hawley. available at http://www. and a third project generated momentum that will allow subsequent investors to rely primarily on commercial banks to provide project financing). AND ENERGY LAW [Vol. supra note 52. GAS. As an initial matter. several wrinkles became apparent. See Presidential Pride?. Construction at the Eurus project was halted at least six times. 60. Dirty Business 60 In the planning process for the foregoing developments. La Mata-La Ventosa.com/Article/2719427/Presidential-pride. supra note 34. 57 In general. and is estimated to receive credits for up to 168.INPUTFILE. 57. Nov. .DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 284 TEXAS JOURNAL OF OIL. 2011). In several wellpublicized instances. Moreover. htm. See also enXco. 59. a subsidiary of EDF. through generation from an independent power producer (IPP). The “auto-abastiemiento” (or self-generation) law. 55 The project is also working to obtain United Nations CERs credits. and the region provides solid partners to purchase the energy produced.enxco. or “autogeneration. 2009. 61. Mexican law forbids the private sale of energy unless such private production is for self-generation for particular entities. such as with Acciona’s Eurus project. “[i]t’s clean energy but dirty business. construction has been halted altogether. with members of the community posting signs indicating that La Venta belongs to the ejido.com/money/industries/energy/environment/2009-06-16-mexico-wind-power_N. the foregoing projects and others in the region have been met with substantial resistance from the local community. 61 The selfgeneration. Corporate Structure. 56 As for management of the project. the successful financial closings of the Eurus and La Ventosa-La Mata projects all but guarantee that private investors will continue to invest in Oaxaca’s profitable wind market.000 tons of avoided carbon dioxide emissions per year. E-mail from Jefferson Boyd Easum. 56. Chris Hawley. or for export to other country. supra note 58 (quoting attorney Claudia Vera of Tepeyac Human Rights Center in Oaxaca who stated. as long as such off-taker also becomes a shareholder in the 55. 58. As a general rule. 2010. 59 The wind always blows in Oaxaca.projectfinancemagazine.

66. 1. Wal-Mart de Mexico S. supra note 37. Cemex announces completion of EURUS wind farm construction. See Corporate Information. principal shareholder of Wal-Mart de Mexico).org/ifcext/spiwebsite1. a subsidiary of the American retail giant. http://www.. de C.asp. 2009. supra note 34. http://www. EDF La Ventosa. Inter-American Development Bank. 69.INPUTFILE. 63 Wal-Mart de México. Inter-American Development Bank. 67 The companies proceeded with the planned developments after meeting the requirements of Mexico’s autogeneration legal framework.aspx?cusip=C484P8980 (last visited May 20. Questionable Acquisition of Indigenous Land The public relations material provided by the IDB describes the landacquisition process as straightforward: The land on which the turbines of both projects are located has been leased from local ejidos.com/Company-Snapshot. and the disruptive effects of the projects. 65. 68 Of course. Nov. and Cemex. a traditional Mexican system of communal land ownership that is widespread in the country’s rural areas.com/qr/mc_pr_112309. and has entered into a twenty-year power purchase agreement to purchase its power from the Eurus wind farm. 66 According to Cemex press releases.ifc.corp orateinformation.. Wal-Mart. 2011) (Wal-Mart Store. 68. See International Finance Corporation. a global supplier of cement and concrete. International Finance Corporation. the private developers worked closely with the Mexican government to determine appropriate buyers of the energy produced.cemex.B. The land subject to the parceling happens to be occupied by indigenous Oaxacans who speak little Spanish and rely on the land for subsistence farming. Inter-American Development Bank.V. http://www. 62 Being entrepreneurial. but certain issues remained with respect to acquiring the land required to build the wind turbines. the Eurus project will provide 25% of the power for its operations. the environment. 64.A. who is aiming to “green” its Mexico operations. supra note 34. 63. the Mexican cement manufacturer. proceeded to enter 62. 67. a company with a complex history of its own. undeterred. Enter Wal-Mart. 64 resolved the power purchaser problem in the La Ventosa-La Mata wind project by utilizing four of its subsidiaries to purchase the electricity generated from the project under fifteen-year power purchase agreements. Inter-American Development Bank.nsf/1ca07340e47a35cd85256efb00700 cee/81ACEB3C99869A77852576BA000E32E3. The indigenous communities in El Istmo speak Zapotec. 23. supra note 34 (noting that Wal-Mart aims to use 100% renewable energy in its Mexico operations). Inc. 65 Cemex. supra note 25 (stating that “not everyone in the . the actual story is more complex. 69 The companies. CEMEX. These projects will generate jobs and a steady flow of income from leases for these communities. 2] UNMASKING PROJECT FINANCE 285 project. supra note 34. See North American Congress on Latin America. is an equity partner in the Eurus project.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. an indigenous language.

info/nota.. 2011. and installation of the wind turbines. Aug. available at http://idbdocs. supra note 52. for twenty-five years. NACLA also states that some farmers have received additional. per hectare. Gonzalez. the privatization process is extensive. 2008. the ejido land ownership structure has undergone significant reform.org/wsdocs/getdocument. See Diego Cevallos. one-time signing bonuses of $650 to entice them to sign.org/articles. supra note 25.iadb. Karen Trejo. the agreements could be viewed as extra-legal. 26. the director of the Tepeyac Center for Human Rights in Oaxaca. 20. J. April 30. E-mail from Jefferson Boyd Easum. 74. There is a genuine legal issue regarding whether the land subject to the various wind project leases was subject to the ejido structure or private ownership. renewable at the option of the lessee. See NORTH AMERICAN CONGRESS ON LATIN AMERICA. amounts paid to other farmers are said to be ten to twenty times less than amounts offered to American farmers for similar uses. construction. 73 In the La Mata-La Ventosa project. MEXICO EURUS WIND PROJECT (ME-L1068) ENVIRONMENTAL AND SOCIAL MANAGEMENT REPORT (ESMR) 2 (Nov. 14. GAS. 2004). Instead.lapress. EVM and EDF relied on affiliates to perform this role. For an in-depth discussion of the ejido structure. collateralized.A. see id. leased. 2009). 70. .V. S. The North American Congress on Latin America (NACLA) states that some of the leases are at rates of less than $50 per month for locals with turbines on their land and less for those without turbines. per hectare. Over the past two decades. which is consistent with other accounts of the land leases in the area. at 23. not the community and the developers. Depending on the characterization of the auto-renew leases. In 1992. 72 Moreover. INTER-AMERICAN DEVELOPMENT BANK. 2004 (on file with author).php?lang=eng&idnews=85. 6 into various long-term land leases with individual farmers that provided for the construction of the turbines and the right to enter the land for the development. 32 U. a contract provided by an indigenous rights organization and in connection with a different project indicates that one developer obtained land at the bargain price of $120 per year. Feb.aspx?docnum=2150998. See id. 70 Although the specific terms of each contract are not public information. 74 region knows Spanish in addition to Zapotec and. because although the 1992 agrarian reform permits a conversion from communal ejido property ownership to private ownership.tierramerica. PA. http://www.-Vicente Sánchez Orozco. at 20. 71 In addition. Wind Parks Take Over Indigenous Lands. and Carmen G. requires an assembly vote of all of the ejido members. and the Mexican Neoliberal Economic Reforms. 108–10. 71.asp?art=5683. and gives members of the ejido right of first refusal for a transfer of interests. according to Javier Balderas. A detailed analysis of this issue is beyond the scope of this article. Deconstructing Comparative Advantage: Environmental Justice. including any necessary infrastructure.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 286 TEXAS JOURNAL OF OIL. See id. Eoliatec del Istmo. de C. LATIN AMERICA PRESS. TIERRAMÉRICA. INT’L L. Farmers and Scientists See Risks in Wind Energy. 73. 72. The Latin American Press interviewed one farmer whose lands were rented to a developer at $15 per year.INPUTFILE. JENNIFER BROWN. the Mexican government initiated land reform that allowed previously inalienable ejidal property to be transferred. the project company was not even the entity that entered into the land leases. http://www. representatives of the Eurus project “‘used local leaders who used their position in the community and understanding of the Zapotec language to get landowners to sign [land] contracts’”). and terminable only at the discretion of the lessee. Some estimates are even lower. EJIDOS AND COMUNIDADES IN OAXACA MEXICO: IMPACT OF THE 1992 REFORMS 1 (Rural Development Institute. the land leases were as between individuals and the project developers. AND ENERGY LAW [Vol. See Contrato de Arrendamiento. although the ejido property ownership structure provides for communal ownership of land and limited alienation. Indigenous Peoples. and sold to private interests.

See Center for Strategic and International Studies. 1159 (2006) (noting that highly . Out of the project’s 800 hectares. He cut his herd from [thirty] cows to [ten]. 78. making it even more difficult to pursue contractual claims against developers. Center for Strategic and International Studies. the subsistence farmers who rely on the land for the production of crops have stated that the turbines have significantly limited the remaining arable portion of their land. NORTH AMERICAN CONGRESS ON LATIN AMERICA.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. 77. supra note 72. 400 was set aside for farming”). 82.200 tons of concrete is needed per tower. Choi & G.INPUTFILE. INTER-AMERICAN DEVELOPMENT BANK. 75 Further. supra note 25 (stating that in the La Venta II development “[c]ommunity members signed contracts with La Venta II on the premise that they would be able to continue farming in the spaces between turbines. El Istmo. at 7–8. there are significant environmental concerns. 1129. supra note 31.N. 80 Even if one assumes that the lease prices negotiated by the project developers adequately compensate farmers for the use of their land. Oaxaca (April 25. 78 Farmers and a group of engineers from the Technical Institute of Tehuantepec have also raised significant concerns regarding the impact the 200 tons of concrete per wind turbine will have on the local watershed. See Draft Complaint of Álvaro Martínez Sánchez. involving a dizzying array of calculations relating to land use and turbine output. 77 2. Contract as Statute. 79. and says part of his land is unusable because of dust and blocked irrigation lines. 79 Such concerns include crop flooding and the eventual depletion of the water table. 81. 2009 WLNR 15694180. they contend. 76. such leases do not contemplate the longterm social and environmental effects of flooding and eventual displacement resulting from the wind farms 81 Such incomplete contracts 82 75. supra note 70. the narrow strip of land linking the Pacific and Atlantic oceans. serves as a critical migratory path for six million birds.” Living Off the Wind. LAW REV. See Stephen J. As one of the windiest places on earth. some of the farmers claim that the documents were not presented in their native language and they never received copies of their documents. C. even as between sophisticated parties with equal bargaining power. including thirty-two endangered species and nine species that are indigenous to the region. June 24. One farmer “now has two roads cutting through his [sixteen] acres of pasture. and gravel roads fifty feet across were built to support generators required for construction. Juez de lo Civil en Juchitán de Zaragoza. supra note 25. 80. Many project finance transactions run the risk of producing incomplete contracts. See Tierramérica. Disruption of Bird Migratory Patterns and Crop Flooding Despite the recognition by the U. supra note 31. 2009. Moreover. of the projects’ potential to provide widespread global benefits by the reduction of carbon emissions. 2008) (on file with author). One account of one wind development project in the Isthmus estimates that 1. 2] UNMASKING PROJECT FINANCE 287 Advocates closer to the land rights issues also state that the developers accessed the leased land through deceptive contracts and by misleading the local communities. 76 In general the transactions were complex. THE ARIZONA REPUBLIC. Mitu Gulati. NORTH AMERICAN CONGRESS ON LATIN AMERICA. 104 MICH.

84. 86. See Cevallos. expansion is concentrated in areas where communities are marginalized on multiple levels and often the developments “are located within communities of indigenous people or farmers who have lived in in [sic] the same remote areas for many centuries”). 87 The IFC material hints at as much.INPUTFILE. & DEV. Indeed. International Finance Corporation. such as here. incomplete contracts could further aggravate the harm suffered by the party in the weaker bargaining position. 83 By contrast.” 85 The IFC further avoids a more fulsome discussion of the environmental impacts of the project by stating that: The Project footprint does not directly impact or touch any protected area/habitat and will physically affect less than 0. EDF La Ventosa. Laplante & Suzanne A. GAS. “limited environmental and social impacts that can be readily addressed through accepted good engineering practices. substation and ancillary facilities (approximately sixteen hectares) and. http://www. e. the space above the wind farms may at times constitute natural habitat critical to migratory species. roads.J. at 10. 69. which could lead to the uprooting of indigenous communities who have resided in the La Ventosa area for hundreds of years. 6 raise serious concerns about the environmental sustainability of these projects. supra note 72.ifc.. See also ESTY.” International Finance Corporation. Environmental and Social Standards. Spears. According to the IFC’s Policy on Social & Environmental Sustainability. Out of the Conflict Zone: The Case for Community Consent Processes in the Extractive Sector. The development is extensive.g. supra note 3. Based on migration patterns. 83. Id. according to the IFC.org/ifcext/sustain ability. might not have a significant impact on the migratory patterns in the region. See. the IFC categorizes the La Mata-La Ventosa project as a Category B project under the IFC’s Environmental and Social Review Procedure 84 because it shall have a small total physical footprint from platforms. risks and impacts to birds and bats are not considered significant. but also in the global ecosystem. Lisa J.nsf/Content/EnvSocStandards (accessed by clicking Policy on Social and Environmental Sustainability). Certainly one project.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 288 TEXAS JOURNAL OF OIL. a Category B project is one “with potential limited adverse social or environmental impacts that are few in number. International Finance Corporation. When the parties to the agreement are of arguably unequal bargaining power and there are serious information asymmetries. supra note 65. 86 This discussion ignores an obvious feature of the wind development currently under way in El Istmo. 87. no fewer than fourteen separate projects are currently identified for potential construction in the region. AND ENERGY LAW [Vol. RTS.5% of total ejido lands in La Mata and La Ventosa. . 85. noting that certain coastal portions of El Istmo and the Sierra Tolistoque mountain range negotiated agreements between sophisticated parties have long been recognized as running the risk of being incomplete). generally sitespecific. the overall development could have far-reaching impacts not only in El Istmo. such as La Mata-La Ventosa. L. but taken as a whole. largely reversible and readily addressed through mitigation measures. supra note 65. 11 YALE HUM. 77 (2008) (noting that in the extractive industry. however given that there are only [twenty-seven] turbines.

90 is even more cavalier.” 89 3.00. This is not insignificant. at 106–08. due to internal and external pressures. 22 GEO. See World Bank.html (last visited May 20. e. supra note 65. INT’L ENVTL. by noting that. INTERNATIONAL FINANCE CORPORATION’S POLICY ON SOCIAL & ENVIRONMENTAL SUSTAINABILITY (April 30. About Us. The residents on whose land these projects will be located are experiencing a profound and fundamental shift in their lifeways.INPUTFILE. raising limited crops for survival. In discussing the La Mata-La Ventosa project. Walking the Talk: The Effectiveness of Environmental Commitments Made by Multilateral Development Banks. supra note 65. Note.” 88 The IFC materials justify the La Mata-La Ventosa project. access roads and the substation are located was formerly agricultural land and/or existing roads. See Rachel Bowen. 2006) http://www.nsf/AttachmentsByTitle/pol_SocEnvSustainability2006/$FILE/SustainabilityPolicy. 91. and historical fabric of communities has been permanently ruptured. the IFC.g.. “according to results of bird monitoring activities carried out in 2007 and 2008. In light of the IFC’s comprehensive guidelines concerning sustainable development. cultural. supra note 70.pagePK:50004410~piPK:36602~theSitePK:29708. Empty Promises of Employment and Community Development On social issues. 90. International FINANCE CORPORATION.” 91 This perspective does not comport with the reality voiced by many istmeños materially affected by the La Mata-La Ventosa project and other projects that mirror its form. These residents have a deep spiritual and cultural attachment to their ancestral home.org/WBSITE/EXTERNAL/EXT ABOUTUS/0. REV. the Project’s site is not located within a high bird traffic zone in either the fall or spring migratory seasons.”). 92. an agency created solely for the elimination of global poverty. See Gonzalez.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. this way of life is in jeopardy. at 11.worldbank. 731.org/ifcext/sustain ability. For many. however. All land where turbines. supra note 73. sharing knowledge. 742–43 (2010). building capacity and forging partnerships in the public and private sectors. International Finance Corporation.ifc. The IDB also notes that the “[p]otential cumulative impacts of those wind farms [adjacent to the Eurus wind farm] on migratory birds. the agency states that the wind project “entails no involuntary physical resettlement and only marginal economic displacement. The spiritual. this attitude is alarming. International Finance Corporation. the commercial lending arm for the World Bank. and is being leased by [EVM] at market rates on a voluntary basis.. With respect to economic development. INTER-AMERICAN DEVELOPMENT BANK. 2] UNMASKING PROJECT FINANCE 289 form part of a bird migration corridor that connects the Atlantic and Pacific Coasts. 2011) (explaining that the mission of the World Bank “is to fight poverty with passion and professionalism for lasting results and to help people help themselves and their environment by providing resources. the stated aims of the La 88. 89. but is consistent with other findings that. 92 and have relied on the land for centuries. and their significance at the species level is currently unknown. . L. http://web. officials at multilateral development institutions tend to minimize the environmental and social affects of projects.pdf.

org/ story/analysis/when-wind-blows-cradle-will-rock. SOLIDARIDAD Y ACCIÓN. Some limited research corroborates much of the anecdotal information provided in the popular press. AND ENERGY LAW [Vol. with respect to the Eurus wind project. 7. COLECTIVOS DE APOYO. RENEWABLE ENERGY REPORT. Cf. Sept. 9:13 AM). supra note 25. NORTH AMERICAN CONGRESS ON LATIN AMERICA. 97. creating “approximately 150 local jobs” during the construction phase. although extensive mainstream media coverage of the indigenous resistance to the wind development is generally laudatory of the development. supra note 83. projected the creation of a mere 150 local jobs during construction and ten permanent full-time employees thereafter. Isthmus of Tehuantepec (July 17. See INTER-AMERICAN DEVELOPMENT BANK. 97 While the exact circumstances of the land leases and social and environmental impacts of the project may never be fully known except through extensive interviews with local indigenous communities and indepth empirical studies. including approximately 200 workers from the La Venta Ejido” (emphasis in original)). April 2007.html. 94. at para. the United States or Europe. not their own. communities resent extractive projects because they derive few of the benefits while bearing most of the costs). 95 as many of the skilled workers used for the projects have been brought in from other parts of Mexico or. at ¶48(iii). 100. supra note 37. the Cradle Will Rock. Trejo. supra note 58. 6 Ventosa-La Mata project include providing a steady stream of income to landowners on whose land the projects will be located. private interests. available at http://www. 98. 99 and a continuation of the dispossession of communal lands.INPUTFILE. supra note 34. as previously noted. 98 it is clear that the residents in the region see this round of development as beneficial to large. GAS. 100 It is uncertain whether the promises foretold by the developers shall ever bear fruit in La Ventosa.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 290 TEXAS JOURNAL OF OIL. supra note 70 (stating that.yachana. at 100–01 (noting that in Peru. 13. 94 The promise of jobs. even the La Mata-La Ventosa project. a Mexican-led development. 2007. supra note 71. with a subsidiary of the largest American retailer as offtaker (or energy buyer). apparently only employs eight people from the local community. supra note 37. Hawley. and ten permanent full-time jobs during the operational phase of the project. INTER-AMERICAN DEVELOPMENT BANK. 96 Further. 2009 WLNR 18585118. and increasing economic activity for the local Port of Salina Cruz. Local Protests Mount at Iberdrola Affiliate Wind Farm.casacollective. appears as yet unfulfilled by the developers. in many cases. 93 The Mexican government also boasts that the new wind projects in Mexico shall generate approximately 10. http://www. . “[t]here are currently about 400 to 500 workers on site. For a full discussion of the numerous benefits claimed to accompany the La Ventosa-La Mata project. In Mexico. See See Ricardo & Diana. see International Finance Corporation. supra note 31. See INTERNATIONAL FINANCE CORPORATION.000 jobs directly and indirectly during the construction phase of the projects. 2009. however. 96. 95. 99. When the Wind Blows. the only that thing that is known with some 93. See Center for Strategic and International Studies. Mark Becker. For example. See also Laplante & Spears. and that around 374 permanent operation and maintenance jobs shall be created as a result of the developments.org/reports/mex07/2007/07/isthmusof-tehuantepec. La Venta II.

it has been troubled since inception. It is compelling – and complex. 2009. Id. http://idbdocs. this fact does not bode well for the local indigenous population.org/wsdocs/getdocument. Human Rights Watch issued an extensive report detailing DPC’s alleged complicity in human rights abuses carried out by state police that were paid to provide security for the company. Note & Comment. 104 Azerbaijan.INPUTFILE. See Kelly Hearn. In 1999. 5. is that the project sponsors relied on project financing for the transactions.aspx?docnum=837877 (last visited May.S. resulting in the large-scale displacement of indigenous people. See id. The situation playing out in La Ventosa replicates itself in all corners of the world and across development industries.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. 2007). 104. THE WASHINGTON TIMES. the people of Peru. 6 NW. supra note 91. See Vivian Lee. 101.-backed President Pressured by Protesters. UNDERSTANDING PROJECT FINANCE On learning of the situation in La Ventosa. EUROMONEY INSTITUTIONAL INVESTOR PLC. July 6. 2005 WLNR 27364850. The Camisea natural gas project is a thirty-year project that is touted by the InterAmerican Development Bank as enabling Peru to become one of the few Latin American countries to meet its internal energy needs and eventually export natural gas outside of the country. Given the damaging effects of the activities to date. See id. U. available at http://www. The complex project received financing through a consortium of banks and sponsors using project finance. Peru Indians’ Demands Seen as Stoked by Chavez U. 359–60 (2008). Camisea Project: Fact Sheet (Feb. the Dabhol Power Corporation (“DPC”). The project also appears to be part of a larger effort on the part of the Peruvian government to open up large swaths of rain forest to private energy and agriculture investment. contracted with the government of Maharashtra state in India to build a $3 billion electricity generating plant. See also Chloe Hayward. J. Id. Turkey. However. intimidation. The project was heavily opposed by environmental activists and communities affected by the development. 5. development of the natural gas in areas inhabited by indigenous groups. I was immediately drawn into the story. and attacks on individuals opposed” to the project. 2005. a joint venture of the Enron Corporation. INT’L HUM. The complaint alleged that the mill would cause damage to the local environment and fisheries relied on by local populations. IV. the transportation of the processed natural gas through over 1200 kilometers of pipeline. 1. General Electric. 2008. Enforcing the Equator Principles: An NGO’s Principled Effort to Stop the Financing of a Paper Pulp Mill in Uruguay.iadb. and the Bechtel Corporation. THE ENRON CORPORATION CORPORATE COMPLICITY IN HUMAN RIGHTS VIOLATIONS (1999). 2011). Unocal Corporation.hrw. and the construction of a processing facility in an environmentally sensitive marine national park. See Bowen. and the distribution of the gas. The project is the subject of intense scrutiny because it requires pipeline construction in sensitive areas of the Andes. a California oil company. . RTS. 354. and is financed by project finance. The project is one of the largest capital investments in Uruguay’s history.org/legacy/reports/1999/ enron/index. at 360–61. the largest in the world. 103 Burma. experiencing a number of pipeline spills and damaging the ecosystem of the surrounding area. Despite much attention paid to promoting the sustainability of the project. acting with an international consortium. Indeed.htm/. We have seen this before. 20. Aug. 102. one of the most intriguing aspects of this story. Mar. It involves the exploration and processing of gas deposits in the Camisea field in Peru. Project Finance: Record Financing for Peruvian LNG Project. at A1. HUMAN RIGHTS WATCH. 102 Argentina. See Latin American Oil & Gas Deal of the Year 2004. In 1992. 103. EUROMONEY. An Argentine NGO has been engaged in a pitched battle against the developer of a paper mill on the Uruguay-Argentina border. 2] UNMASKING PROJECT FINANCE 291 certainty is that these landmark developments provide a blueprint for private investors aiming to invest in the region. 2008 WLNR 27704713 (discussing related liquid natural gas pipeline that will export gas from Camisea field). Id. See Inter-American Development Bank. 101 India. The report also claims that contractors of DPC “engaged in a pattern of harassment. at 737–38. so full of fascinating elements.

Feb. Avoiding Liability for Human Rights Violations in Project Finance. Id. Promised Highest Standards Are Sorely Lacking in Georgia (Feb.uk/BP%20accused %20of%20cover-up%20over%20pipeline%20deal. have borne acute witness to the degradation of their environment. Press 2008). 105. however.org.nsf/Content/Publications_Report_Sustainability2004. but thirty-three complaints to the IFC’s ombudsmen indicate a host of other grievances. 106.aspx?id=71. Press Release. assault. THE SUNDAY TIMES. the European Bank for Reconstruction and Development. exploitation of their natural resources. & BUS. 62 (2010). BP Accused Of Cover-up In Pipeline Deal. 30 NW. 107 and the simplicity of the name obfuscates a world of complexity. which was constructed using project finance.org/ifcext/sustain ability. 6. The Baku-Tblisi-Ceyhan Pipeline. 108 Despite this complexity. financed by the IFC.2 billion. The pipeline. 106 The form has roots dating back to the medieval period. IFC SUSTAINABILITY REPORT 2004 33 (2004). CEE Bankwatch Network. at $1. “traverses 17. project finance effectively relies on an income-generating asset and is self-financing as to debt service—hence the name. Georgia/BTC Pipeline-30/Vale. and other well-documented abuses. and a group of private lenders. BTC Outraged By Oil Company’s Violations. A. 107. IFC. which is the subject of this article. cost over $3. proper assessment of the environment in an area prone to landslides. J. 23. and the use of a special purpose vehicle to conduct the affairs of the project further characterize project finance. including weekends and holidays). supra note 2. For a lengthy discussion of project finance and its variations.ifc. project finance. issues with compensation for land acquisition. according to IFC documents.htm (discussing a document leak which indicated that British Petroleum failed to disclose safety design faults that could lead to an environmentally catastrophic leak in the pipeline). see generally SCOTT L. inter alia.INPUTFILE. 15. 301. 6 Georgia. The consortium allegedly paid the Burma military to provide security for the project.org/cases/case_detail. 306–08 (2001). 22 ENERGY L. 2004) (claiming that pipeline workers are required to work twelve to fourteen hours per day. Kojo Yelpaala. The bank indicates that no physical displacement resulted from the pipeline.6 billion and. Compliance Advisor Ombudsman. 2004. there is an underlying form. INT’L L. at 3–4. . torture. These harms were all facilitated by project finance-based development.ca o-ombudsman. Non-governmental agencies also report serious concerns related to worker rights and the environment.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 292 TEXAS JOURNAL OF OIL. See generally. THE LAW AND BUSINESS OF INTERNATIONAL PROJECT FINANCE (Cambridge Univ.J. Rethinking the Foreign Direct Investment Process and Incentives in PostConflict Transition Countries. Estache & Strong. Theoretical Underpinnings Project finance locates itself in the larger law and development narrative constructed by legal and political science scholars in the Global participated in the development of the Yadana oil field in the Andaman Sea off the southern coast of Burma. and saw friends and family murdered by the Myanmar State. HOFFMAN. Residents of Burma claimed that they “were relocated against their will.700 individual land parcels with a total of 60. 108. AND ENERGY LAW [Vol. GAS. and losses to fishing stocks. was the largest cross-border transaction ever conducted by the Burmese government. rape. subjected to forced labor.” See Eric Marcks. By definition. available at http://www. the basic project finance form is well understood and generally consistent across industries.000 landowners” and reaches from the Caspian Sea to the Mediterranean Sea. High amounts of nonrecourse debt. wholesale disregard for traditional land rights. including. low initial equity contributions. 105 inter alia. Project finance transactions may assume many different configurations. http://www.bakuceyhan. http://www.

Press 2006). and foreign investment became the overriding goal. 115 In this moment. 113 the tenor shifted away from a focus on capacity building in the public sector and toward neoliberalism. Tamara Lothian & Katharina Pistor. INFRASTRUCTURE. at 6. J. for industry could not be developed without infrastructure—a consistent supply of electricity and the roads to 109. 115. 109 and advanced by the Bretton Woods agencies. there was a belief that “markets were markets. the move toward privatization began as early as the 1970s with Margaret Thatcher.” 116 The concept of “project lending” also gained prominence in development circles. MICHAEL B. The focus in this moment was on capacity building within public agencies and modernization of the legal profession in order to support the dynamics of the “developmental” state.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. Id. AND FUTURE. as Professors Trubek and Santos note. LIKOSKY. LAW. if simplified. . Local Institutions. 112. THE “RULE OF LAW” IN DEVELOPMENT ASSISTANCE: PAST. In The New Law and Economic Development. The First Moment. coupled with an emphasis on the judiciary as a way to limit the role of the state and promote markets. and states must direct limited financial resources to specified investment targets. post-Cold War period. 114. 101. at 5. at 3. 110 Professors David Trubek and Alvaro Santos describe the law and development movement in terms of “moments. lens through which to view the discourse. 116. DAVID M. The development of the law of private property and contract regimes would foster these goals. beginning in the late 1980s. Id. 114 In this moment. 110. and the same legal foundations would be needed and could operate anywhere. 113.INPUTFILE. initiated in the 1960’s. TRUBEK & ALVARO SANTOS. state intervention was seen as limiting the natural progression of development. TRANSNAT’L L. 112 In the so-called Second Moment. 42 COLUM. TRUBEK & SANTOS. Id. AND HUMAN RIGHTS 36 (Cambridge Univ. 111 This moment emphasized the importation of public and regulatory law from more advanced states to “developmental” states in order to manage an increasingly complex legal and economic environment and remove limitations to natural macroeconomic processes. PRESENT. Foreign Investment and Alternative Strategies of Development: Some Views from Practice. 111. 2] UNMASKING PROJECT FINANCE 293 North. FINANCING ENERGY PROJECTS IN DEVELOPING COUNTRIES 51 (1996). 113–14 (2003).” which provides a useful. HOSSEIN RAZAVI. supra note 109. with an inherent suspicion in the abilities of private markets and foreign capital to create sustainable growth. assumed that import substitution in the internal markets of states would facilitate growth. By some accounts. IN THE NEW LAW AND ECONOMIC DEVELOPMENT A CRITICAL APPRAISAL 79 (2006). and continued with President Ronald Reagan in the 1980s. Id.

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allow for the transport of finished products. 117 According to Trubek and Santos, in the Third, and current moment, the neo-liberal development is critiqued and disrupted. In particular, critics point to the limitations of transplanting laws without fully understanding the local institutions in place or the particular cultural context in which such transplantation takes place. 118 Moreover, the overemphasis on economic development and poverty alleviation at the expense of other development goals, such as freedom, is seen as ignoring the human aspects of development. 119 The World Bank has weighed in to critique policies it has supported as well, noting that transplantation of a “formalistic rule of law to developing and/or democratizing countries could actually be counterproductive for economic, institutional, and political development, especially when informal mechanisms would be more effective and efficient.” 120 Other critics push the inquiry further, querying the notion of the linear arc of development as a viable or even desired outcome with respect to “developing” the Third World. 121 Still others take an even more critical view, questioning the very dialectic frame that produced the development discourse. 122 Scholars such as Ruth Gordon and Jon Sylvester argue that the discursive production of the development frame has obfuscated the reality that the rules relating to development were and have always been a Northern construct. 123 The exportation of legal models and privatization mechanisms from North to
117. See Ruth E. Gordon & Jon H. Sylvester, Deconstructing Development, 22 WIS. INT’L L.J. 1, 31 n.126 (2004). 118. See TRUBEK & SANTOS, supra note 109, at 6–7; Lothian & Pistor, supra note 115, at 104. 119. See generally AMARTYA SEN, DEVELOPMENT AS FREEDOM (1999) (recharacterizing development in more human terms). 120. TRUBEK & SANTOS, supra note 109, at 90 (citing World Bank, Legal Institutions of a Global Economy Home Page, http://www1.worldbank.org/publicsector/legal/index.htm). 121. TRUBEK & SANTOS, supra note 109, at 80 (discussing linear development as the presupposition that “all nations [go] through similar states to reach a common end, represented in this kind of thought by the legal, economic, and social structures of the United States and Western Europe”). 122. Joel M. Ngugi, The World Bank and the Ideology of Reform and Development in International Economic Development Discourse, 14 CARDOZO J. INT’L & COMP. L. 313, 320 (2006) (quoting Duncan Kennedy, “the World Bank’s attitudes toward development seen as a whole are ‘the product of the underlying structure of economic forces and relations, which it legitimizes.’ That ‘underlying structure’ is the current system of international economic relations, including the international division of labor, extraction of natural resources, banking and trading systems and supposedly supported by a world of liberal democracies.”). See also Gordon & Sylvester, supra note 117, at 82 (“The post war development discourse established a discursive practice that in turn established the rules of the game. This discourse permits ‘the systematic creation of object, concepts and strategies,’ as it determines who can speak, from what points of view, and with what authority. It establishes the criteria that define expertise and that expertise was deemed to reside in Western systems of thought, values and ways of life.”). 123. See LIKOSKY, supra note 114 at 38; Ngugi, supra note 122, at 328–29; Gordon & Sylvester, supra note 117, at 73. See also Tayyab Mahmud, Postcolonial Imaginaries: Alternative Development or Alternatives to Development?, 9 TRANSNAT’L. L. & CONTEMP. PROBS. 25, 26 (1999) (noting that critiques of development “remain imprisoned within the imaginary of development” and therefore “radical critique must move beyond the discourse of alternative development and begin to imagine alternatives to development.”).

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South takes for granted that those in the Global South actually accept the underlying methodologies and psychologies supporting such importation. 124 This, such scholars argue, is flawed reasoning, and the underlying rules that produced the linear development model should be exposed and evaluated. 125 Project finance locates itself near the nucleus of this rich discourse. The discursive production of the development framework that evolved through the three so-called moments produced the same flawed theoretical understandings of development finance, specifically project finance. Similar to the development discourse, the more pervasive the use of project finance, the less penetrable, as a form, it became. Outsiders assumed that the outcomes resulting from infrastructure development were attributable to other causes—the corruption of transition states in the Global South, market imperfections, and necessary evils in the messy business of creating infrastructure. I suggest that the answer is hidden in plain sight, in the form itself. B. Project Finance and Development—The Mexican Example The situation unfolding in Mexico illustrates the complex relationship between the development narrative and the project finance form. The legal and regulatory frameworks promoted by the World Bank and IDB in Mexico encourage privatization mechanisms such as project finance to situate themselves in a discourse that assumes neutrality of the private law. 126 These interventions promote a form of energy production that removes the indigenous voice from decisions related to ancestral land, and by pushing for increased private engagement in potentially disruptive development, avenues for recourse become exceedingly narrow. Against the backdrop of assumed neutrality of law, project finance serves as a mechanism to advance the subordinating effects of the development discourse, even if such subordination lacks the obvious badges of intent. 127 A brief analysis of the emergence of project finance and its
124. See, e.g., Gordon & Sylvester, supra note 117, at 74 (“The widespread acceptance of development as instinctive or natural has much to do with the power of the West to construct the prism through which the world is perceived.”). 125. See id. at 81–85 (discussing and exposing the discursive production of development concepts). These recent critiques of development are positioned within the ongoing critique of development that existed at the outset of the law and development movement. Early scholars questioned the efficacy of the modernization track and the narrative framing of development and underdevelopment in the Global South. E.g., David M. Trubek & Marc Galanter, Scholars in Self-Estrangement: Some Reflections on the Crisis in Law and Development Studies in the United States, 1974 WISC. L. REV. 1062 (1974). 126. See TRUBEK & SANTOS, supra note 109, at 14 (contrasting the concept of a neutral private law regime with the sphere of public or “regulatory” law, “which is presented [in development thought] as coercive, and an ‘intervention’ in an otherwise level playing field”). 127. The ejido land contracts illustrate this subordinating effect. The contracts themselves are neither fair nor open, but widespread to effectuate the massive acquisition of land for the

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relationship to the development discourse, followed by an overview of the specific interventions deployed in Mexico, illustrates how project finance works hand in hand with the subordinating elements of the development discourse. The roots of modern project finance date back to the 1930s, when early investors in Texas oil fields perfected the project finance form. 128 However, it was not until the 1970s and 1980s that the use of project finance gained popularity. 129 The needs articulated by the law and development movement (e.g., the call for more law and the opening of emerging economies) closely tracked the re-emergence of project finance in the late 1980s and 1990s, during which time project finance emerged as a way for private actors to engage in the risky business of development and realize a robust return on investment. 130 Early seminars relating to understanding project finance acknowledged this unique feature of project finance, and emphasized its utility as a risk mitigation mechanism, especially for project developers who relied on the off-balance sheet features of the form. 131 These early seminars engaged the international finance community squarely during the Second Moment. The laws created during the Second Moment therefore provided an avenue through which private actors could engage in the risky process of infrastructure development, while simultaneously mitigating risk. Project finance served as a useful template; it could be used in multiple development contexts, rarely changing its essential shape. Even now, the focus on market development and private investment still leads the development discourse. 132 Despite the emergent critique of neoliberalism and the Washington Consensus, 133 and the questionable ability of private actors to act for the public benefit, 134 the Bretton Woods
erecting of windmills that will produce energy for corporations. In the name of “green” development, this large-scale land acquisition fundamentally shifts the relationship between indigenous groups and their land and disrupts traditional lifeways. 128. E.R. YESCOMBE, PRINCIPLES OF PROJECT FINANCE 6 (2002). 129. Id. (noting use of project finance in North Sea oil fields in the 1970s). 130. See ESTY, supra note 3, at 29; HOFFMAN, supra note 108, at 8. 131. Roger D. Feldman & Scott L. Hoffman, Project Financing 1987: Power Generation, Waste Recovery, and Other Industrial Facilities, 297 PLI/REAL 399, 415 (1987). 132. See Yelpaala, supra note 107, at 26 (noting World Bank study that points to need for “two types of complementary investments: public and private”). 133. The term “Washington Consensus” refers to the policies of international financial institutions (such as the World Bank and International Monetary Fund), emanating from Washington, D.C., in the 1990’s, which prescribed “prudent macroeconomic policies, outward orientation, and free-market capitalism” for countries identified as “developing countries.” SARAH BABB, BEHIND THE DEVELOPMENT BANKS ix (2009) (quoting JOHN WILLIAMSON, LATIN AMERICAN ADJUSTMENT: HOW MUCH HAS HAPPENED? (John Williamson, ed., Washington, DC: Institute for International Economics 1990)). 134. See Yelpaala, supra note 107, at 52 (stating, “[t]he primary objective of [multinational enterprises] is not economic development. . . . For developing countries in general, the evidence so far seems to suggest that economic development cannot easily be achieved without some deliberate and active state intervention.”).

advancing the subordination of indigenous interests. 22. 136. also plays a role in easing the path for future wind development in Mexico. See INTERNATIONAL FINANCE CORPORATION. Id. 2006). . 5. at paras. 137. The agency is collaborating with the Mexican government to create a regulatory framework to the 2008 Renewable Energy Law. a key funder in each of the La Mata-La Ventosa and Eurus wind projects. working through its “Large Scale Renewable Energy Development Project. 136 The World Bank also assisted the Mexican government in obtaining carbon financing and $25 million in a Global Environment Facility grant for the La Venta III project. In the case of the wind development currently underway in Mexico.INPUTFILE. See id.” 138 The World Bank’s assistance is forward-looking. interconnection. 2] UNMASKING PROJECT FINANCE 297 agencies continue to play a vital role in producing the knowledge essential to effectuate Northern-led development. Comisión Reguladora de Energía (“CRE”). For example. supra note 37. as the agency is working with the Mexican government to conduct a Strategic Environmental Assessment “to facilitate and optimize the planning and siting of future wind farm developments. 138. the World Bank. at para.org/external/projects/main?pagePK=64312881&piPK=64302848&theSiteP K=40941&Projectid=P077717. http://web. and transmission mechanisms and the financial potential of renewable energy projects supported by 135. 140 The IDB will also work with the Mexican government to remove barriers to expanding the development of non-traditional energy forms. 139. World Bank. the Ministry of Environment and Natural Resources.worldbank. Further. at para. Large-scale Renewable Energy Development Project (June 15. the World Bank and IDB have worked closely with the Mexican government to establish an ample opening to encourage private development of wind resources. 135 Such agencies include the Ministry of Energy (“SENER”). the bank developed a system to monitor the avian strike issues associated with the La Venta II project and is working with the Mexican government to “support social and economic development policies to support the ‘ejido’ landowners under Mexico’s traditional system of land tenure. 141 Their efforts will consist primarily of commissioning studies to evaluate the existing power generation. See id. 137 one of the early Mexican test projects for wind energy. the Mexican energy sector regulator. and CFE. 13.” 139 The IDB.” has provided technical assistance to the Mexican governmental agencies that are engaged in the wind development sector. 140. 22. Id. 141. which grants the CRE and SENER powers to create the relevant regulatory framework required to implement the new law. Id.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No.

customs. and creating an attractive market for such developers to engage in the wind development market. as illustrated in the Oaxaca wind projects. and historical connection to the land is forever severed. See id. at 12. 6 public and private funds. AND ENERGY LAW [Vol. 145 and. if accounts from the region are accurate. 53–54. & POL. This framework. “Usos y costumbres” is a term that encompasses a wide range of local tradition. where private land contracts dictate the terms of engagement between indigenous individuals and private entities. at 25-year renewable increments.INPUTFILE. and decision-making in indigenous communities in Oaxaca. Such future developers may elect to supply energy to the CFE as independent power providers. but it simultaneously attenuates the relationship between the state and the landholder. 143 Future projects are also expected to garner carbon credits through the United Nations CER credits framework. By forcing reliance on private land agreements. physical. Woodhouse. 38 N.Y. all facilitated by the technical assistance provided by a Bretton Woods agency and the IDB. Although limited contractual remedies may be available. 145.” Id. 22. supra note 27. 143. at the outset. at para. a private developer produces its own energy for sale to a public utility. See id. 122 (2006).DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 298 TEXAS JOURNAL OF OIL. See Stephen. 144. Project finance is a critical component of this arrangement. . 20. See BROWN. “[t]he autogeneration framework for private wind power developers is effective because it allows private developers to earn tariffs which are higher than those paid to private wind power developers by CFE through the [independent power provider] process. supra note 73. but which are lower than what CFE would charge the industrial consumer directly. the North will serve as the beneficiary of a windfall. will affect generations. As noted by the IFC in materials describing the attractiveness of the Mexican private wind development sector.U. ignores traditional decision-making mechanisms of the ejido. 144 Therefore. The stated goals of such efforts include reducing entry costs and risks for future developers. 11. Erik J. Any large-scale transfer of ejido land would likely be handled through the assembly process. 121. J. to what end? Once the windmills are in place. 142 all of which means the inevitable proliferation of privately-led wind development in El Istmo. creates an instant power differential in which the indigenous landholder immediately divests its rights to terminate leases that. GAS. but they will more than likely participate in the Mexican renewable energy revolution through the more profitable autogeneration framework. at paras. In an independent power provider (“IPP”) scenario. INT’L L. In the name of “sustainable” development and profits. which will provide a significant investment incentive for developers. The Obsolescing Bargain Redux? Foreign Investment in the Electric Power Sector in Developing Countries. the spiritual. the developer affectively undermines 142. it is unlikely that local populations will fully reap the benefit of a resource that resides in abundance at their doorstep. This private contractual process not only operates to sever traditional indigenous connections to land. at para. including the use of an assembly to conduct the major affairs of the community.

may be conceptualized as an effect of. supra note 107.g. 148 Locating such flaws. 147 In these ways the development discourse. creates a “low-level development trap. Professor Yelpaala notes. .” Yelpaala.INPUTFILE. customs. and a condition of subjection to. languages and religions. 150. RTS. 33.ilo. 2011). which “protects and promotes the development of [indigenous] languages. lead to meaningful technology transfer. at 29. 1989. As Professor Kojo Yelpaala notes. James Anaya & Robert A. supra note 109. so the assumption of importation of a neutral legal framework to promote private market development is flawed. 36 (2001) (discussing Inter-American human rights system’s recognition of “indigenous peoples’ rights over their traditional lands and resources”). is a crucial first step to subverting what has become a common financing mechanism for infrastructure development. at 29. Professor Yelpaala discusses the inefficacy of foreign direct investment in the mining context of Sub-Saharan Africa. a disciplinary apparatus. . the international community has moved toward recognition of indigenous rights. 21. See Stephen. 146 These instruments are of little force against private actors.” Yelpaala. 14 HARV.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. [foreign direct investment] is unlikely to generate growth. The non-neutrality of corporate legal frameworks as imported to the Global South has been examined by others. subordinates traditional indigenous rights. 149. and contractually enforced by project finance participants. within the framework of the States in which they live. In 1990 Mexico was the first state to ratify International Labor Organization Indigenous and Tribal Peoples Convention. 169) Concerning Indigenous and Tribal Peoples Convention. 2] UNMASKING PROJECT FINANCE 299 international legal instruments that require the state to respect indigenous lifeways. This might be argued of foreign direct investment in general. This form of foreign direct investment. or create the internal links necessary for the development of certain regions of the world. e. HUM. at 26 (noting that “[p]ost-coloniality. Professor David Trubek notes that law is used to intervene in markets to correct market failures and allocate risk. which recognizes “the aspirations of [indigenous] peoples to exercise control over their own institutions. an institutional modality.org/ilolex/cgi-lex/convde. See. supra note 27 (discussing Article 4 of the Mexican Constitution. and a . Jr. Williams. 148. Moreover.pl?C169 (last visited Feb. ways of life and economic development and to maintain and develop their identities. Mahmud. “left to its own devices. he argues. at 87. however. even in the most basic political sense. noting specifically the “scoop and ship operations” that mine natural resources without refining or developing the resources. TRUBEK & SANTOS. resources. supra note 107. with the latter seen as a discursive structure.. but do provide a high return to the investor. then. available at http://www. J. The Protection of Indigenous Peoples’ Rights Over Lands and Natural Resources Under the Inter-American Human Rights System. adopted June 27. and specific forms of social organization”).” International Labor Organization (No. 147. a closer examination of the transaction forms encouraged by these legal frameworks reveals that the assumptions of neutrality embedded in these forms must also be disrupted. 149 but even if we assume neutrality with respect to the legal framework that encourages private development. See S. the development project.. yield little positive impact on the host country in the form of “technical spill-over effects” or employment opportunities. as discursively produced by the Mexican legal instruments promoted by the World Bank and IDB. . 150 146. but states. Such operations. 1989. uses. What becomes evident in the foregoing illustration is that the fallacy of the development discourse is so tightly woven within the fabric of infrastructure finance that it logically follows that such financing mechanism would also be infected. face more scrutiny in navigating issues affecting indigenous rights. supra note 123.

and even dictatorial regimes are subjected to a level of scrutiny not yet faced by transnational actors in the international community. Shell. at 2. 154 In addition. IDB officials simply responded that the projects contained “standard” project finance features. as equity) in the creation of a special-purpose entity (“SPE”) project company whose sole purpose (in the corporate sense) is to develop the project. Sovereign involvement would significantly alter the analysis. where debt of the project ranges from seventy to ninety percent of the total project cost. and (5) lender reliance on project contracts and assets. The sponsors serve as the project promoters and principal developers for the project. supra note 128. See E-mail from Rachel Robboy. 153 These investors are corporations with recognizable names. supra note 3. a publicprivate partnership). Project finance may also involve a co-investment by a sovereign (e. supra note 47. The shareholder agreement governs the relationship between the joint venture (e. ESTY. . Pemex. GAS. (3) no recourse or limited recourse to the project sponsors for defaults related to the project debt.INPUTFILE. The project company therefore serves as the borrower and contracting party for all transactions related to the project. rather than the sponsor’s assets. A sovereign possesses obligations to its polity. 153. The principal agreement to which the project sponsors are party is the shareholder agreement. the analysis herein is limited to private investments that involve agreements with the sovereign for the provision of services. See Marcks.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 300 TEXAS JOURNAL OF OIL. 151. the sponsors. (2) a high debt-to-equity ratio. 154. (4) lender reliance on cash flows from the project to service the project debt. AND ENERGY LAW C.”). The typical project finance transaction begins with an equity investment by a project sponsor or sponsors into a project company. along with a brief description of the principal project contracts. as security for the project debt. The project company also engages a political risk insurer to insure against political and other hostcountry risks that may arise throughout the course of the project. Structural Components [Vol. at 7–8. 151 Each feature is described in more detail below.. YESCOMBE. supra note 128. such as Texaco.. the number of equity investors ranges from one to three. but in which the sovereign is not an initial co-investor.g. at 34. 6 The key features of a project finance transaction include: (1) an equity investment by project sponsors into a special purpose legal entity formed to build the project. 152 In modern project finance transactions. When questioned about the structural components of each of the La Mata-La Ventosa and Eurus wind projects. YESCOMBE. the debt of the project company does not appear on the balance meta-theory of history whose genealogy is firmly rooted in the colonial encounter. and BP. 152.g. however. at 318–19. supra note 104.

159 The concession agreement is a major project document that allows the project company to construct and earn revenues from the project in exchange for providing a public service. performance guarantees. Such compensation may involve beneficial tax treatment. at 125–26. and construct the project at a fixed-price. permits. at 12. at 9. and construction contractor (the “EPC Contractor.” HOFFMAN. Otherwise. It is similar to.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. Changes in United States accounting rules that went into effect in 2010 could limit the availability of off-balance sheet financing going forward.g. including debt-to-equity ratio requirements. A subsidiary controlled more than 50 percent by the parent company is consolidated on a line by line basis with the parent.INPUTFILE. 160.. . a waiver of sovereign immunity. 156. http://www. YESCOMBE. the project company enters into a government support agreement 156 or concession agreement concerning the goods the project will provide. 2] UNMASKING PROJECT FINANCE 301 sheet of sponsors with less than a majority stake in the company. the sovereign shall provide to the project company certain compensation.pdf. the equity method of accounting is used whereby the investment in the subsidiary is shown as a one line entry. supra note 128. and consent to arbitration. 162 They are inapplicable in extraction projects (e. 159. at 10. 158 In countries where the private investment in an industry is novel. basis.bis. procurement. the “EPC Contract”). 161. 157. 158. Id. Debt in such circumstances is not reported on the parent company’s financial statements. at 9. at 122. accounting rules in the United States generally require the consolidation of financial statements of a company and certain of its subsidiaries and other entities over which it can exercise control. Id. See BASEL COMMITTEE ON BANKING SUPERVISION. on a fixed dated. which governs the relationship between the project company and the government. 157 and other favorable treatment. Id. the government services agreement will provide the legal framework for the transaction. Id. meaning that the EPC Contractor shall deliver the keys to the fully-constructed. share retention requirements for equity investors. 160 The project company also engages a contractor to design and construct the project. Id.” the underlying contract. provision of work permits. Id. 161 EPC Contracts are preferred by lenders to most infrastructure and energy transactions because of their ability to shift the risk of construction delay to the EPC Contractor. “From the perspective of the project sponsor. fully-operable project by a date certain to the project company. but distinct from. supra note 108.org/publ/joint23. This is usually a private entity. engineer. 162. 126. REPORT ON SPECIAL PURPOSE ENTITIES 2 (2009). oil and mining) or projects that rely on the creation of a network (such as 155. and on a turn-key. The government support agreement essentially provides that in exchange for the building of the project. guaranteed payment rates for project output. 155 At the outset. The EPC Contractor agrees to design. called the engineering. the government services agreement.

166. 171 Other payment methods include the long-term sales contract. which may be a government entity (the “Offtaker”). 169. Id. and sometimes other human resources to train project employees regarding the start up of the facility. Id. which is sometimes also confusingly called a concession agreement (the “Offtake Agreement”).INPUTFILE. AND ENERGY LAW [Vol. securing price guarantees for the fuel input becomes a critical aspect of the overall financial picture of the project. at 70.g. 165. 173 163. the project company must enter into a fuel supply contract (the “Supply Contract”) in order to supply the project with the fuel (e. 173. 169 This principal project document dictates the revenue stream that will be generated by the output of the project. 163 Most large projects also involve an operation and maintenance contract (the “O&M Contract”).DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 302 TEXAS JOURNAL OF OIL. or coal) required to run the facility. 6 telecommunications). Id. Id. The Offtake Agreement contains several features related to pricing. 168 The output contract is arguably the most important document among the project contracts.. 168. 171. 166 If the project requires a fuel input. Id. 164. where the utility agrees to purchase the project’s capacity. oil. at 72. A common feature is the “take or pay” arrangement. 172 the hedging contract. at 116. at 71. gas. such as the project manager. at 117. Under a long-term sales contract the Offtaker agrees to purchase a fixed amount of output at the market price or agreed market index. Id. or pay the project company in lieu of purchasing the project’s output. 170 The parties to this agreement are usually the project company and a utility. Id. 164 The operations and maintenance contractor (“O&M Contractor”) provides key personnel. Id. and may take the form of a power purchase agreement. at 117. 170. at 115. 167. 172. the timeline of the Supply Contract should match the term of the output contract. Id. 165 The O&M Contractor receives incentive payments for efficient operation of a project that exceeds projected operation targets. 167 The input requirements of the project are closely linked to the output requirements and the negotiated rates set forth in the output contract. wherein a contractor agrees to provide general operations and maintenance services to the project to ensure that the project’s operations and management-related fees stay within budget. The process of negotiating the Supply Contract requires an understanding of prevailing fuel rates and projected supply. GAS. 180. In a hedging payment arrangement the project company hedges the price of its commodity by entering into an agreement with an entity to whom it may sell the output if the . Id.

181 however. 180. and not the assets of the sponsor.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. project finance transactions are typically non-recourse. U. Id. In the case of the Mexico wind developments. 176 During the initial. these limited recourse features often dissolve after completion of the initial phase of the project. 182. provide the critical justification for the project’s financing. and pay a minimum price for use of the pipeline. Id. If the price exceeds a certain level. The throughput contract. but could price of the commodity dips below a certain price. supra note 17. With respect to financing. Wal-Mart. the Offtaker will pay the project company the difference. at 78. 175 The Offtake Agreement. Conversely. at 8–9. where debt appears on the project sponsor’s balance sheet. 2] UNMASKING PROJECT FINANCE 303 the contract for differences. Id. the debt-to-equity ratio of project finance transactions is high. meaning there is typically a low initial equity investment and substantial debt required to finance the cost of the project. . but who has the right to purchase the output from the project if the price exceeds a certain price. after which time the project reverts back to a non-recourse project. at 10. at 71. 179. If the market price falls below a certain level. lenders may also request a sponsor guarantee of the project company debt or allow some recourse to the sponsor’s assets (“limited recourse”). if the sponsor owns more than fifty percent of the project company. 181. 177 As in the La Mata-La Ventosa wind project. 174 and the throughput contract. supra note 108. and the United Kingdom. Duong. 178. which means that in the event of a default. accounting rules require the consolidation of the parent’s and SPE’s financial statements. Cemex. 179 This arrangement frees up the sponsor to invest in multiple projects without carrying their respective liabilities. The debt-to-equity ratio varies. Id. The stability of these entities provides significant security to the project sponsors.S. and the pricing mechanisms therein. the lenders’ recourse is only as to the project assets.S. and comfort to the lenders regarding the future income stream of the projects.INPUTFILE. scholars still point to the availability of off-balance sheet financing as a critical incentive to electing the project finance form over standard corporate finance. at 9. Id. at 72. riskier phases of the project development. such as oil. the project debt does not appear on the balance sheet of the project sponsor. or transportation contract. 177. Id. Id. at 8. 175. charges a user for use of a pipeline if such user agrees to use it to transport no less than a certain amount of product. See id. HOFFMAN. 182 Because of the capital requirements of infrastructure projects. 174. the project company will pay the Offtaker the difference. A contract for differences permits a project company to sell output on the market and not to an Offtaker. 178 When the parent does not own more than fifty percent of the project company. 180 There is some indication that reliance on this benefit of project finance transaction is declining in the U. and CFE are the offtakers of the electricity generated by the wind farms. 176.

185. at 10. understanding that the more a project sponsor has at stake in a particular project. Project lenders also obtain collateral security in the form of contract assignments and project revenue in order to step into the shoes of the project company in the event of default and to support the underlying debt obligations of the project.html (last visited May 20. http://web. 190 183. 187. 184. requiring more of an equity commitment in the Global South. 188. whose assets are not placed in jeopardy as a result of the financing. HOFFMAN. or as high as 100% in others. at 87–88 (noting that consent of affected communities would be preferable to mere consultation. and sometimes host governments. determining whose voice should be added to the negotiations can be daunting. 186 Given that the players in Oaxaca wind development are consistent. the debt-to-equity ratios of the Oaxaca projects were lower than anticipated in future projects. Id. which are expected to be financed almost entirely by private debt. such engagement is limited to stateled projects involving the World Bank. 189.org/WBSITE/EXTERNAL/ EXTINSPECTIONPANEL/0. 186. such investors were presumably willing to advance more of an initial cash outlay in early projects—La Venta. See id. See The Inspection Panel. supra note 83. . at 10. the trajectory of a well-financed project. as illustrated by the difficulties faced by wind developers in El Istmo. 11. 189 For highly controversial projects. Id.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 304 TEXAS JOURNAL OF OIL. 2011).worldbank. 184 In general.INPUTFILE. GAS.00. Notably absent from the transaction are members of the community that hosts the project. 188 In the private development context. supra note 108. where the developers simply hear community concerns). such engagement is typically limited in its ability to affect. supra note 108. supra note 59. the more likely it is that such sponsor will be committed to see the project through. About Us. 183 Ratios between 80-90% are common. at 78–83 (discussing the ways in which community stakeholders are brought into the development process. which is largely at the discretion of developers). 187 This is standard and largely seen as an advantage to sponsors. Although the World Bank Inspection Panel aims to integrate the voices of individuals affected by large-scale development into discussions regarding a project. such community involvement is at the discretion of the developers. 190. with lenders. engaging the community is critical to prevent construction delay or disruption to plant operations. on any meaningful level. Project Finance and Infrastructure Finance.menuPK:64129249~pagePK:64132081~piPK:64132052~theSiteP K:380794. Eurus. Moreover. HOFFMAN. 6 be as low as 75% in some cases. at 8. 185 Because wind had never been privately developed in Oaxaca. AND ENERGY LAW [Vol. and La Mata-La Ventosa—in anticipation of higher debt-to-equity ratios in future projects.. the lenders set forth the equity requirements. but for outsiders to a region. Laplante & Spears.

which is sometimes critiqued as providing a reverse subsidy that flows from a developing country to a corporation that resides in a developed economy. I begin by examining the external rationales. developers. at 42 (noting that structural adjustment programs often created investment climates in the Global South favorable for private interests). is that the market is better positioned to bear the costs of development and. The more nuanced argument proffered by the development community. Practically speaking. LIKOSKY. and Development Common Sense. Project developers benefit from this arrangement. See LIKOSKY. and host governments rely on several rationales to support its continued popularity. Project finance. is a relatively “efficient” way to bring public works projects to fruition. supra note 107. in TRUBEK & SANTOS. at 130. The “Rule of Law. See Yelpaala. David Kennedy. 2] UNMASKING PROJECT FINANCE 305 This highly complex transactional structure brings with it substantial transaction costs. 194. D. post-conflict and transition states following the linear modernization track emerged from the 1960s and 1970s saddled with debt and unable to finance large. however.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. As illustrated by Mexico’s efforts to provide a legal framework that is attractive to wind development.INPUTFILE. at 38. noting that several studies have questioned “the efficacy of tax and other fiscal incentives for attracting [foreign direct investment (FDI)]” and that one such study “questioned the theoretical foundations of tax incentive policies and concluded that not only were tax and other fiscal incentives ineffective instruments for attracting . 193 Evaluating the efficiency argument provides a useful starting point. lenders. See also HOFFMAN. 193. host countries buy into this rationale by providing incentives for various types of development and making investment more attractive. Such rationales can be viewed from both outside and within the transaction form. supra note 108. 191 This created quite a conundrum. 192. supra note 109. and the other a bit more nuanced. at 27. supra note 117.” Political Choices. 192 The proposed solution? Private financing of public infrastructure projects. supra note 114. development proponents argue. seen as risky investments by private enterprises. supra note 114. at 17. but to no surprise. 194 because the host government is unlikely to resist the 191. Gordon & Sylvester. including the World Bank and other multilateral lenders. one practical. the same parties involved in the lending and structural adjustment programs that led to many of the sovereign debt problems emerged with solutions to the liquidity crisis facing states in the Global South. in support of private infrastructure development. at 39 (noting that the shift to privatization was strategic and involved substantial participation by international institutions). the professional expertise provided by international developers allows for more efficient project development. in the case of infrastructure. expensive infrastructure projects. External Rationales for Project Finance The rationale underlying the discursive shift from public to private financing of infrastructure consists of two main points.

See id. e. REV. See. 197. Moreover. The energy produced is clean. Looking deeper.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 306 TEXAS JOURNAL OF OIL. 198 This is certainly the argument promoted in Oaxaca. . 197 they are probative of a less-definite balance of costs and benefits.C. project finance.g. INT’L & COMP. at 17 (discussing emergence of private sector and general acceptance by host governments that “the private sector is often better able to develop. as seen in certain Amazonian regions. but they also provided a form of perverse reverse subsidies from impoverished and weak recipient states to affluent capital exporting countries. On its face. In doing so.g. however.. (discussing limitations on host governments’ ability to obtain financing for infrastructure projects). such integration could result in the widespread devastation of previously pristine environments and the traumatic disruption of the community in which such projects are located. Dinesh D. 195 In theory. The private development of infrastructure allows host governments to move away from the prominent role of project developer and bridge capital shortfalls. Also included in the efficiency rationale is the suggestion that project finance allows the economic integration of developed and developing economies because a number of the projects involve the exploration of commodities that are exported to developed countries. provides the path of least resistance. the social and environmental externalities emerge. host governments also benefit by importing capital that would otherwise be unavailable to furnish public goods. the wind is virtually free. construct. GAS. 355. Gonzalez. the theory provides. 26 B. and perhaps a net gain. Banan. AND ENERGY LAW [Vol.. 198. See supra note 101 (discussing the Camisea development). Once again. the development in Oaxaca appears to be a win-win situation. as a tool to aid the shift from public to privatelyled development. and operate large-scale infrastructure projects. the argument purports to distribute comprehensively the costs and benefits of the project. the country as a whole is benefited by the efficiency of development experts. save land rental fees. 6 activities of the project developers. supra note 108. International Arbitration and Project Finance in Developing Countries: Blurring the Public/Private Distinction. supra note 73 at 136–37 (noting that the theory of comparative advantage does not take into account the powerful spiritual and cultural connection indigenous peoples have to their land). L.” 195. 199. 359–60 (2003). If project finance is the chosen FDI. Although our Northern lens prevents full understanding and quantification of the true social costs of the project. HOFFMAN. 196 In the end. See. host governments are also able to shift development risks away from public entities and toward private actors and thus avoid many of the negative reputational and political outcomes associated with state-led development. Oaxaca provides a useful illustration. 199 In this context.”). 196. however.INPUTFILE. and the corporations purchasing the energy are no longer relying on carbon-dioxide-producing elements to power certain portions of their operations. This “efficiency” argument does not fully account for all of the harm that accompanies project development. e.

203 Michael B. L. Hoffman notes. In addition.g. the sovereign is among the group bearing the risk of development. . (forthcoming 2011) (“Failure to regulate the power.. REV.. e. See generally. 203. 85 ST. 200 and private actors may be blamed for any resulting negative externalities. Law. 204 noting that the penumbra of project finance creates a gray area of activity wherein actors are difficult to identify. This is evident in Oaxaca. in which they serve as landlords. REV. leaving the project company with insufficient financial responsibility for taking excessive risks. Moreover. these shifted risks are further shifted by private developers onto third parties through the contractual mechanisms discussed in Part V. 202. supra note 114. 2] UNMASKING PROJECT FINANCE 307 method of delivering infrastructure. REV.” Id. but in the end. the Inter-American Development bank and IFC each declined to provide this author with detailed information regarding the Eurus wind project. . In many cases. Anderson. See. 6 HUM. Reimagining Human Rights Law: Toward Global Regulation of Transnational Corporations. What’s in a Name? Transnational Corporations As Bystanders Under International Law. JOHN’S L. See. were not provided. 88 DENV.L. . Jena Martin Amerson. Infrastructure and Human Rights. 202 Human rights advocates have also identified the private nature of project contracts as significantly limiting with respect to achieving accountability for various atrocities that occur in the development context. 201 Underlying the cost and efficiency rationales is a subtle. Likosky alludes to this difficulty in his work. LIKOSKY.”). CONTRACTS CONFIDENTIAL: ENDING SECRET DEALS IN THE EXTRACTIVE INDUSTRIES (2009) (including a comprehensive review of host country contracts with corporations in the extractive industries and arguing for greater transparency). and further erode the country’s financial health. The end result is a circular game of finger pointing. the sovereign still avoids holding the bag. where adversely affected persons are left without a clear avenue for redress. PETER ROSENBLUM & SUSAN MAPLES. but for now.INPUTFILE. any risk it bears is ultimately borne by the people. Currently a growing body of scholarship attempts to create a human rights framework around such transnational corporate behavior. U.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. the elusive quality of private behavior in the public context continues to evade meaningful review. impose significant costs on the host country’s taxpayers. . David Kinley & Rachel Chambers. 450 (2006) (discussing the need for uniform and enforceable international standards for transnational corporations). supra note 102 (discussing Dabhol case). The UN Human Rights Norms for Corporations: The Private Implications of Public International Law. at 44–45. where farmers allege that access to their own land leases. supra note 108. See HOFFMAN. rationale. the largest wind 200. wealth. host government guarantees “can undermine the benefits of private sector involvement . (forthcoming 2011) (using “bystander” framework to discuss transnational actors’ assumed role under international law). at 75 (noting that. 447. 201. Project finance is unique in its ability to allow corporate actors to engage in the foregoing risky and profit-maximizing public-goods producing behavior under the full protective guise of private activity. Rachel J. and influence of transnational corporations is a weakness in human rights law that should be remedied. but related.”). e. 204.g. RTS. the lack of transparency with respect to such contracts prevents sovereigns from negotiating market terms with respect to their individual extractive projects. “the risk structure of a project can allocate too much risk to the host country. In addition.

E-mail from Fuphan Chou. supra note 114. . that “‘so much of the activity of the political economy now occurs in a zone which is truly intermediate between its public and private sectors’. 206. and representatives of international organizations] blurs the distinction between public and private commercial actors. . Yet. 209 In addition. Thus. when it comes to human rights. at 24 (quoting CLAIRE CUTLER. the mercatocracy [transnational merchants. accountability is a significant challenge. 209. its perceived profitability and 205. to author (Jan.’” (quoting M Freedland in Law.”). the corporate sponsor may not invest in a foreign country unless the profit margin is extremely high . from a risk-management perspective. activities. 6 (1998)). International Finance Corporation. Project finance can be viewed as a revenue-generating mechanism. See also id. supra note 47. provides an avenue for developers to engage in infrastructure transactions that. at 80 (“Without the type of financing structure that helps buffer the corporate sponsor against investment risks. the internal rationales provide more compelling evidence for the proliferation of the form. PRIVATE POWER AND GLOBAL AUTHORITY: TRANSNATIONAL MERCHANT LAW IN THE GLOBAL POLITICAL ECONOMY 5 (2003): “As a complex mix of public and private authority. New Regimes?. Public Services. Likosky notes. The project finances itself. See Duong. privatization occurs ‘between the realms of public and private law. Thus. 13. not the assets of the sponsors.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 308 TEXAS JOURNAL OF OIL. government officials. AND ENERGY LAW [Vol. 2011. moreover. Inside the transaction form. the project will generate proceeds to pay down the underlying project debt and eventually provide sponsors with an attractive return. and law. GAS.”). as a form. however.INPUTFILE. and shall be the subject of a future project. project finance fundamentally serves as a risk-allocation structure. 205 In this development context. 207 If the project succeeds. which comprise the core of the project finance form and which may have harmful effects on third parties. 206 E. 16:37 CST) (on file with author). at 42 (noting that “[t]he particular mixes of state and non-state actors involved in transnational [public private partnerships] are diverse. and Citizenship – New Domains. 208. Internal Rationale for Project Finance Full consideration of the efficiency rationales espoused by project finance proponents suggests that external rationales provide the most support for deploying project finance. in PUBLIC SERVICES AND CITIZENSHIP IN EUROPEAN UNION LAW: PUBLIC AND LABOUR LAW PERSPECTIVES 1. LIKOSKY supra note 114. Investors continue to see this as a viable option because if the project fails. Professor Benjamin Esty notes that “[o]ne of the primary reasons why managers say they use project finance is to achieve better risk mitigation and improved risk allocation. supra note 17. the prevailing literature states. E-mail from Rachel Robboy. private international lawyers and other professionals and their associations. the lender looks primarily to the revenue stream created by a stand-alone project for repayment and to the assets of that project as collateral”). The name suggests as much. This underlying incentive for employing the project finance mechanism is no less worthy of discussion and exploration. . 207. at 251 (noting that project finance-based finance does not depend on the credit support of project sponsors. project finance. “in project finance. See RAZAVI. 6 project ever developed in the Americas. accordingly. nongovernmental organizations and community groups find themselves targeting varied public-private actor configurations. 208 This provides useful cover for parties conducting project finance transactions because it allows such actors to justify their risk-mitigating activities. would otherwise be cost prohibitive. the banks typically only seek recourse through the project’s assets.”). .

supra note 3.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. which further cheapens the value of debt as compared to equity. supra note 108. The risks inherent in infrastructure development do not go away on initiation of a development project. See HOFFMAN. 217. . no two deals are alike. at 9 n. Established. 216 Finally. well-capitalized corporations often select a project finance structure to assist in undertaking large debt commitments with a minimum of risk.). self-regulated. in project finance. 210 The long-term debt received by the project affects neither the balance sheet nor assets of the project sponsors. See Marcks. supra note 104. The intriguing question is which aspects of risk management cannot be replicated in a corporate setting. at 356. 213 With respect to internal economics. Project financiers are famously creative. increasing the overall return). 214 The finance structure of a project finance deal rewards equity investors for taking on more project debt (at the special purpose entity level). described more fully in Part III. Each rationale is addressed in turn. Rather. 216.INPUTFILE. Banan. See id. mechanism that relies on its own highly negotiated terms to deliver the goods.9. supra note 198. at 8.g. at 78 (noting that project finance transactional structures are “virtually unlimited by the creativity and flexibility of bankers and lawyers. HOFFMAN. 212. at 15 (illustrating that in low leverage scenarios. etc. at 7 (“each deal has its own unique characteristics”). “[p]roject financing is used by companies that desire any or all of several objectives. Id. 214. supra note 128. making it difficult. supra note 108. 213. such risk is distributed throughout the structure through various contractual mechanisms.. states. author of a comprehensive treatise on project finance.) and to allocate project risk could be replicated in a corporate financed transaction. to correlate negative outcomes to their original source and thus lead to an externalization of these inherent risks. and as Scott Hoffman. 212 These mechanisms diffuse risk as to the sponsors and developers. whereas in a high leverage situation profits are divided against a lower equity number. 215. See HOFFMAN. ESTY. 2] UNMASKING PROJECT FINANCE 309 self-governing features all provide attractive incentives to rely on this method of finance. See discussion infra at Part VI. at 320. project finance is profitable when compared with low leverage transactions. Infrastructure and energy projects carry certain risks. at 15. 210. These benefits are well known. if not impossible. and project finance is designed to mitigate the risks to project sponsors without affecting their creditworthiness.”). 215 Interest is also tax deductible. offtake agreements. supra note 108. fixed-price construction contracts.” (Emphasis added. given that lenders generally accept lower returns than equity investors. and while the basic components of a project finance transaction are fairly standardized. 211.” 211 This creates an interesting paradox. profits are divided by a greater amount of equity. See YESCOMBE. project finance is a self-contained. 217 The advantage of this framework is that developers may push the most of the same techniques used to mitigate project risk (e.

supra note 115. noting that the primary critiques emerging out of second generation corporate social responsibility initiatives acknowledge that “[c]onsultation as a model of engagement with affected communities cannot address the underlying root causes of community opposition because it ‘do[es] not involve sharing or transferring decision-making authority to those who will be directly affected . 219. . receptiveness of the foreign market to the product to be exported. more important is a party’s leverage. at 6 (noting that “it is the best and most experienced negotiator that ends up bearing the least amount of risk. .”). at 109 (noting that in a discussion with a project finance attorney. 222. given that the transactions involve mostly private parties. 6 transactional boundaries to maximize revenue. 223 The instability of the legal regimes in the Global South was also viewed as a liability to early investors. V.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 310 TEXAS JOURNAL OF OIL. investors could control the terms of their investment through reliance on private contract. and is rarely an empowering form of public engagement.org/publication/development-without-conflict). Risks inherent in the development project were therefore handled within the project structure. rather than vis-à-vis a corporate legal schema that distributes risks. such attorney stated that “[n]o fixed set of legal entitlements could guarantee the economic conditions for the project’s success or the goodwill or the social acceptance required for both the project and the country to move forward. however. contractual mechanism 218. replete with the requisite checks and balances. 222 Instead. 221. . 220 More troubling.wri. GAS. 218 Also. the legal framework of the host state is less outcome determinative. Laplante & Spears. at 368. As such. The foregoing reflects a fundamental shift from reliance on a public forum to manage and distribute risks to a private. supra note 198. In emerging markets. 220. AND ENERGY LAW [Vol.INPUTFILE. creativity is critical to managing unknown risks. See Estache & Strong. Id. See id. access to raw materials. 219 This can create tension between the host government and the project developers. Development Without Conflict: The Business Case for Community Consent 7 (2007). the parties imported a form with the ability to create a quasi-governmental. 221 This disenfranchisement is not the subject of this article. http://www. at 83. and geographical location of the host country with respect to other markets were believed more important to investors.”). but is closely connected to the most well-understood aspect of project finance—its ability to diffuse risk. requires only an exchange of information . but through project finance. especially with respect to waiving sovereign immunity and submitting to an arbitration tribunal. PROJECT FINANCE AS A RISK DIFFUSION MECHANISM Early proponents of project finance as a mechanism for foreign direct investment believed that no single external legal framework was outcome determinative with respect to the decision to invest.’” (quoting World Resources Inst. but private. legal framework. See Lothian & Pistor. is the inability of parties likely to be affected by the transaction to penetrate the form in any meaningful way to affect its terms. See Banan. supra note 83. supra note 2. 223.. . .

at 75. at 436–37 (noting that project finance occupies a space somewhere in the middle of the consensuality spectrum. while a higher risk project might involve upwards of 40% initial equity investment. supra note 16. 228 The rationale is straightforward. 226 Although a failure to develop the project would mean a loss of the equity investment. subsequently. such losses pale in comparison to losses suffered when a project is financed almost exclusively from a project promoter’s coffers. 229 SPEs allow prolific project sponsors to obtain financing for numerous projects without such debt appearing on the balance sheet 224. supra note 3.]”). project sponsors are experienced developers with consistent and expert global engagement in project finance transactions. supra note 104. A. 227 B.g. 2] UNMASKING PROJECT FINANCE 311 for such tasks.INPUTFILE. while offering such equity investors the opportunity to enjoy the benefits of a successful project. away from investors. See Duong. The high debt-to-equity ratio shifts the risk of project failure to debtholders—sophisticated multilateral lenders. the lenders or the host government may dictate the amount of equity contribution. 18 TRANSNAT’L LAW 139. 227. in contrast to corporate financing. project finance provides sponsors with the unique benefit of limiting risk exposure to the initial equity investment in the project. participation in large-scale projects. it has effectively excluded the public from meaningful.. 224 The features highlighted below indicate the specific ways in which project finance provides a unique shield to distribute risk within the form and. supra note 17. 225. e. supra note 83. at 67 (noting that many of the parties involved in project finance are repeat actors. Part Two—Building Up to a Drawdown: International Project Finance and Privatization—Expert Presentations on Lessons to Be Learned. 228. While the private management of risks has yielded substantial rewards for developers. at 3. Laplante & Spears. See Bjerre. Likosky. In the vast majority of cases. See Marcks. See ESTY. at 83 (noting that many efforts to include community consultation in the development process were seen as “risk mitigation strategies” that offered few meaningful opportunities for community participation). Sponsors may spread the financial risk by sharing the initial equity contribution with other parties. 225 As previously stated. 229. consensual. 226. engaged in a variety of transactions across the world). See. at 321 (noting that sponsors limit liability through formation of a project company. High Debt-to-equity Ratio As discussed. Katharine C. 145 (2004). A project identified as having strong potential cash flows might be structured with a debt-to-equity ratio of 90% to 100%.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. where the consensuality is unclear). . supra note 17. Use of Stand-Alone Project Company Special purpose entities (“SPE’s”) provide a key element of project finance transactions. Baragona. and that “sponsors that want to mitigate the human rights risk would be advised to incorporate their project company[.

and maintenance are handled through the SPE. All financing.S. As Professor Duong discusses. where the corporation incorporated special purpose entities (SPEs) to conduct illicit activities. See Marcks. at 78–79. lenders evaluate the economic viability of the project to determine whether the key feature of project finance. As previously discussed. Professor Duong further notes that the changes to the Securities Exchange Act of 1934 incorporated by the Sarbanes Oxley Act of 2002 were meant to catch egregious cases such as Enron. now requires public companies to disclose all “material off-balance sheet transactions. the passage of the Sarbanes Oxley Act of 2002 might limit the use of off-balance sheet transactions if off-balance sheet project finance transactions are deemed to be within the meaning of Section 401(a) of the Act. supra note 17. at 321. HOFFMAN. 232 Nonrecourse financing thus provides project sponsors with the flexibility to invest in multiple. 230 These entities also allow the sponsor to minimize exposure to risk.” See id. which means that in the event of default the lender’s recourse is only to the assets of the project itself. 231. at 86. Non-Recourse Financing The availability of non-recourse financing provides project sponsors a key incentive in project financing. supra note 108. supra note 104. not the assets of the project sponsor. may enjoy legitimate ‘off-balance sheet’ accounting treatment. loans are extended on a nonrecourse basis.” Id. “off-balance sheet arrangements” include “Variable Interest Entities” (defined by FASB Interpretation No. development. operation. ownership. § 78m(j) (2011)). she notes. which by virtue of its NonRecourse Financing structure. which. 233 In awarding financing. at 78 (quoting 15 U. risky projects without any such project affecting its balance sheet.INPUTFILE. . adding a new Section 13(j) to the Securities Exchange Act of 1934. 233. Such financing does not appear on the sponsor’s financial statements unless the sponsor and financial auditors view the investment as material to the sponsor’s overall financial picture. This parent-subsidiary structure also protects the SPE by preventing contamination of the SPE’s financial status by the sponsor’s other liabilities. the selffinancing aspect of the transaction. AND ENERGY LAW [Vol. according to Securities and Exchange Commission guidance. In addition.” Id. Duong. 6 of the project sponsor or affecting the sponsor’s ability to obtain its own financing or engage in other development projects. Lenders therefore scrutinize deal documents to determine whether risks have been adequately transferred to third parties or 230. at 79.C. 46) as contractual. SPEs are bankruptcy remote entities.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 312 TEXAS JOURNAL OF OIL. obligations. and other relationships of the issuer with unconsolidated entities. GAS. which means that a parent’s bankruptcy will not affect the SPEs operations. at 77–78. including environmental and human rights risks associated with the project. 231 C. or other pecuniary interests in an entity that change with changes in the entity’s net asset value. will indeed be realized throughout the life of the loan. 232. arrangements. and such cases are “completely distinguishable from legitimate SPEs set up in accordance with a host country’s legal requirements for the specific purpose of conducting a [foreign direct investment] overseas. in the classic form of project finance transactions. because the sponsor does not participate directly in the project.

at 76. 237. supra note 114. Id. Risk Shifting in Project Contracts To borrow a property law analogy. 236 Under most loan documents. 237 The collateral. at 320. supra note 104. According to a program officer. 235 These fiercely negotiated contractual arrangements give lenders the comfort required to extend loans on a nonrecourse basis. the assets of the sponsor). lenders react to “untreated or uncovered risk of loss” by turning down requests for financing or by requesting additional collateral support for the loan. the project itself. The other recourse available to the lender is to obtain possession of and operate the project.INPUTFILE. the trend in project finance remains closely linked to non-recourse financing. 239.g. in most cases. at 75–76. . 236. consists of any project contracts and the physical assets of the project.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. Id. 240 Under general contractual principles. See id. the project contains limited recourse debt that will quickly convert to nonrecourse debt during the course of the project. thus increasing the likelihood that the asset will generate income to service the outstanding debt. This allows the lender to maintain the operation of the project. While some empirical studies point to a trend toward limited recourse financing to provide lenders with additional collateral in the event of a default (e. Id. Id. at 7. risks are shifted to parties best able to bear 234. E-mail from Jefferson Boyd Easum. project finance transactions are composed of a bundle of risks. the agent of the lending syndicate has the right to step into the shoes of the project company and protect its most valuable asset. The La Mata-La Ventosa wind project contains this feature. As such. 2] UNMASKING PROJECT FINANCE 313 assumed by project participants that are best able to absorb the risk. supra note 108. 240. supra note 52. LIKOSKY. See HOFFMAN. 238. “contracts form the framework for project viability and control the allocation of risks. thereby further isolating the sponsors’ assets from the activities of the project. 235. As Scott Hoffman notes. at 27. 238 D.. during project negotiations. significant energy goes into developing a cross collateralization framework that allows the lender to take over the project if the project company defaults on its loan. at 20. in the event of default. allowing for some encumbrance on the balance sheet of the sponsor.” 239 Contract serves as a critical risk mitigation mechanism within the overall risk mitigation mechanism of project finance. Marcks. at 75. 234 As Professor Wendy Duong notes in her case study regarding a power project in Vietnam. The resulting contractual framework for cross-border project finance transactions is one of the most complex and extensive of any type of financial arrangement. In some instances the loan is extended on a limited recourse basis.

243 Scholars and practitioners engaged in project finance routinely identify two primary categories of risks with respect to infrastructure development: (1) commercial. supra note 242. lower prices for the project output.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 314 TEXAS JOURNAL OF OIL. AND ENERGY LAW [Vol. at 82. Commercial Risks The key commercial risks are risk of construction delay and operational risk. such as weak demand for output. 244. and is the most frequently referenced commercial risk. GAS. 6 them. Duong. As such. such as environmental damage or regulatory interference. 243. John G. The project company pays the EPC Contractor a premium to absorb the risk associated with a delay. supra note 17 at 82. 241. If these risks are not covered via risk shifting. bearing any costs associated with delay. and (d) operating risks. The project company passes along any construction-delay risks to the EPC Contractor as reflected in the financial terms of the fixed-price.INPUTFILE. 1996 COLUM. which include risks relating to the day-to-day operations of a project. which include identifying the party best situated to assume the risk and translating such risk into a premium paid by the party shifting the risk. 84. and changes in the exchange rate and inflation. The following sections outline the key mechanisms utilized to diffuse the two primary categories of risk commonly associated with infrastructure development. . risks. at 42. BUS. multiple causes may produce various risks within the project. 242. and (2) political risks such as government expropriation. currency inconvertibility. The party best able to absorb the risk of delay is the EPC Contractor. risk shifting becomes a key component of the project negotiations. 1. Mauel. 244 The foregoing risks are typically evaluated and incorporated into highly negotiated transaction documents. Mauel. L. REV. 241 Usually this means that the parties who control the causal mechanism responsible for bringing the risk to fruition as a harm or loss also bear the contractual burden of the risk. The EPC Contractor then completes the construction. which generally take the form of delays and cost overruns. EPC Contract. and therefore the project company must disaggregate and isolate individual risks and their associated causation in order to distribute them through the project documents. Construction delay is the death knell of a project finance transaction reliant on the income generated by the project under construction. (b) fuel supply risks. 37. turn-key. including price increases and supply shortfalls. 242 In a complex infrastructure development transaction. the project developer will bear both the risks and associated costs. (c) market risks. or economic. 41 (1996). Duong. Common Contractual Risk Allocations in International Power Projects. and war. supra note 17. including (a) construction risks.

at 87. To create stability within the transaction. at 3. In each of the foregoing cases. 246. the project company has several options. See Duong. When the project company or operations and maintenance contractor receives the keys to the project. 248 If availability of currency poses a threat. 2] UNMASKING PROJECT FINANCE 315 and thereby shifts the risk of delay to the contractor and away from the project company.S. 247. and is therefore well situated to control factors that may lead to performance difficulties at the plant. as the dominant currency for the transaction. 2. Project companies have become quite adept at obtaining political risk insurance 246 to cover the risk of government expropriation of a project or political unrest. supra note 2. See Duong. In the build-operate-transfer (“BOT”) form of project finance the private developer builds the project and operates the project for fixed amount of time to provide for debt service and the required investment return prior to transferring the project to a public entity. the party absorbing the risk is paid a premium for accepting it. dollar. at 75. and war. save the honoring of various warranty obligations. such as the U. a comprehensive discussion of its ability to induce risky behavior exceeds the scope of this article. the Offtaker and project company may agree to use a certain exchange rate throughout the course of the transaction to avoid significant variations in the revenue generated by the project and to provide comfort to lenders regarding the project’s ability to service the debt. Political Risks Political risks generally fall into three categories: expropriation.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. currency inconvertibility. supra note 17. It may designate a purportedly stable currency. the project company shifts operation risks to the O&M Contractor via the terms of the O&M Contract. . supra note 17. because they are structured to provide for the eventual public take over of the project. 245 Performance difficulties in the project fall into the category of operation risk. 248. Accordingly. the project company establishes an offshore account with a certain amount of the required currency and requires that the Offtaker maintain the currency at certain 245. Both the buildown-operate-transfer (“BOOT”) and build-operate-transfer (“BOT”) models also effectively displace expropriation risks associated with risky development projects. Political risk insurance is a crucial component of modern project finance transactions. The party to whom such risks are shifted is the O&M Contractor.INPUTFILE. the EPC Contractor may walk way from the project. 247 To avoid currency-related risks. however. See Estache & Strong. The O&M Contractor oversees the daily operations of the plant.

AND ENERGY LAW [Vol. Public financing was 249. supra note 17. “one reason public infrastructure was formerly provided by either ‘government-owned enterprises . they combine to create an environment where certain risks are passed on to third parties. GAS. . 20 INT’L J. and contractual risk shifting are standard features of project finance transactions. as Professor Lissa Lamkin Broome reminds us. Broome. 107. supra note 16. it subverts the dominant law and economics framework that underpins contractual risk management and the market efficiency principles promoted in the development discourse. VI. as illustrated in Part IV. Likosky. supra note 16. Indeed. supra note 17. What is not discussed is that these risks are also handled structurally via the project finance form. at 443 (quoting Darrin Grimsey & Mervyn K. Lewis. however. Evaluating the Risks of Public Private Partnerships for Infrastructure Projects. SPE’s. or by privately owned utilities subject to rate of return regulation. With few exceptions. however. non-recourse financing. Moreover.INPUTFILE. all accompanied by explicit risk-shifting rationales that primarily fall into economic and political risk categories. supra note 17. the parties ultimately bearing such risks are not parties to the transaction structure. as well as to externalize effectively the negative outcomes that typically accompany large-scale projects.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 316 TEXAS JOURNAL OF OIL.’ was because of the existence of ‘[e]xternalities whereby benefits and costs are conferred upon those not a party to the transaction. This cuts against the assumption that project finance provides a neutral framework to finance infrastructure. PROJECT MGT. Broome. . 6 levels within the account until the project debt is paid. in the past. Notable exceptions include and Bjerre. 250. it actively undermines social justice. Even more fundamentally.’” 251 In other words. PROJECT FINANCE AS A RISK INDUCEMENT MECHANISM High debt-to-equity ratios. 249 These risk mitigation tools allow the project company to better manage the most precious commodity at stake in a project finance transaction: the revenue stream. 250 absent from the literature is a robust discussion of the risk of social and environmental externalities that exist at the outset of a project and the corresponding risk mitigation techniques that are employed by project developers to displace such risks. at 222. is a unique feature of modern-day infrastructure development that prominently features non-state actors. Project sponsors’ utilization of the project finance framework to shift risks away from themselves. 108 (2002)). 251. . Moreover. the unique effects of large-scale public infrastructure projects were explicitly acknowledged in the finance form. and therefore receive neither premium nor compensation for bearing them. See Smith & Htoo.

2] UNMASKING PROJECT FINANCE 317 preferred because of a host government’s unique ability to mitigate negative externalities and absorb the risks associated therewith.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. to bear the risk of a project’s failure resulting from the externalities it produces. The high debt-to-equity ratios that characterize project finance transactions are typically labeled as economic risk diffusion mechanisms. we examine the four key risk diffusion mechanisms already outlined to gain a deeper understanding of how risk could be induced. Although there could be other mechanisms within the project finance form that mask and displace risk. project sponsors are incentivized to commit as few funds as possible in order to reduce the amount of their capital that is in jeopardy throughout the course of the project. but are disproportionately borne by third parties who are not parties to the transaction. but they go further. project finance is attractive to investors because it permits investors to invest relatively little at the outset. Low Initial Capital Outlay—Passing on the Risk of the How As previously discussed. and leave more cash available to fund other projects. Lenders recognize the relationship between the commitment to the success of a project and equity outlay. ultimately forcing communities. 252 Because they do not have to bear the risk of their activities. The investor’s primary concern in this arrangement is realizing a return on his investment. who have. the risk diffusion mechanisms could actually operate to induce risky behavior on the part of project sponsors. The how concern is passed on the lenders. rather than sponsors. A classic project finance transaction permits an investor to contribute its limited equity and then take a relatively passive role throughout the lifetime of the project. purports adequately to distribute all known risks on those parties best able to absorb them. very little interest. they 252. other than reputational risk. . The following discussion illustrates that certain additional risks— namely the social and environmental externalities associated with infrastructure development—are in fact never fully borne by the project sponsors. this mechanism could be viewed as something more—a social and environmental risk diffusion mechanism. however. Project finance subverts this explicit acknowledgement. in seeing that a project limits its social harm. This liability limiting carries significant weight in the project finance development context. where the rules of the transaction are created by a complex contractual framework that lacks transparency and the potential harm to third parties touches on intimate aspects of such parties’ lives. Therefore. but ultimately shifts unaccounted-for negative externalities onto third parties. The investor is less concerned with how the project manifests itself because even if the project fails the investor’s relative contribution is 10% to 30% of the overall project cost. A. If equity investors had more at stake. arguably.INPUTFILE.

See LIKOSKY. available at http://www.pdf.equator-principles. The Equator Principles. and therefore might more actively participate in the mitigation of negative externalities associated with the project. Without this incentive.pdf (noting that “[f]or a number of years banks working in the project finance sector had been seeking ways to manage the environmental and social risks associated with [project finance]” and that the group jointly developed a framework for addressing such risks). See THE EQUATOR PRINCIPLES. 258. are unable to affect the management of projects. the risk of externalities inevitably becomes a community burden. when failures occur. 256. See Bowen.com/documents/About_the_Equator_Principles.INPUTFILE. GAS. Indeed. If lenders. 258 This evidence raises a significant concern regarding the management of social and environmental risks associated with project finance. See THE EQUATOR PRINCIPLES. ten short guidelines related to the social and environmental oversight of projects financed using project finance. and sponsors. 26 (2004). where the Equator Principles figured prominently in the project finance transaction.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 318 TEXAS JOURNAL OF OIL. THE “EQUATOR PRINCIPLES” A FINANCIAL INDUSTRY BENCHMARK FOR DETERMINING. See Robert F. at 737–38. 257 also suggests that these lender-based efforts at shoring up risks may have failed. Thomas. 256 and actual evidence in the Camisea pipeline development in Peru. 254. investors—the actual owners and promoters of a project—assume a passive role that relegates the concern of the how to a lender problem. the project lacks an internal backstop to limit the externalization of these risks. The Equator Principles and Project Finance: Sustainability in Practice?.com/documents/Equator_Principles. never bear the risk of the project’s activities. 254 Lenders who sign on to the Equator Principles agree to incorporate the principals into bank policies. however. The principles have been critiqued as vague and unenforceable. ABOUT THE EQUATOR PRINCIPLES. available at http://www. 253 aim to create a lender standard with respect to project lending. and that such risks are common features of project finance transactions. supra note 114. . Risk on the ground level of the project therefore goes unchecked. illustrate this effect. Lawrence & William L. with little skin in the game. adopted in 2003 by a group of nine international banks and the IFC. AND MANAGING SOCIAL AND ENVIRONMENTAL RISK IN PROJECT FINANCING. The Equator Principles. as evidenced by the serious environmental and social externalities 253. 6 could be more likely to take an interest in the how of a project’s manifestation. With the how of a project squarely a lender concern.equatorprinciples. RESOURCES & ENV’T 20. 255. ASSESSING. AND ENERGY LAW [Vol. 255 and presumably work to enforce the standards in the projects they finance. supra. 19 NAT. See id. note 91. 257. suppliers of 70% to 90% of a project’s debt and parties to highly negotiated loan agreements containing covenants that require the project company to manage social and environmental risks. at 119. They are based on an implicit recognition that project finance participants do not properly manage environmental and social risks.

at 25. supra note 13. See HOFFMAN. 260. and minimize effects on third parties. safeguard the project. 261.”). the equity contribution does not exist in a vacuum. Lenders understand this dynamic. 259 Changing the capital structure could impact this outcome. which is why they aim to balance the needs of the investor with the needs of the project by sometimes requiring lender consent prior to a change of control of project ownership. This explains the intricate contractual maneuvering among the lenders. and host governments throughout the project structure. however. the equity investors avoid a significant aspect of managing large-scale infrastructure risk. harm to waterways. at 327 (“If the project sponsors were to sell all or a substantial portion of their investment in the project company. Sponsors may be concerned about their investments. ESTY. . such investors are more likely to act rationally in the face of risk. Therefore. Estache & Strong. See id. Without a proper check on this aspect of project finance. The risk of the how therefore ultimately falls on the backs of third parties who will never realize a financial return. Without this incentive. It could be argued that the sponsor’s equity investment faces the most risk at the beginning of the project. and damage to ecosystems).INPUTFILE. the parties with more control over project design and management. but the project finance capital structure takes the overall burden of project failure off of sponsors. the externalities are absorbed at a communal level. the project sponsors have the least at stake. 260 Host governments also recognize this dynamic. investors assume a passive role that relegates the concern of the how to a lender problem. this reasoning provides. a standard equity contribution relative to the overall cost of a project is minimal. when vulnerable projects are more likely to fail and produce externalities. however. and in some cases they require certain debt-to-equity ratios. and therefore might more actively participate in the mitigation of negative externalities associated with the project.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. some of the risk of the social and environmental harms could be retained by project sponsors. First. It represents one component in a highly negotiated mechanism that diffuses and displaces 259. supra note 108. sponsors would be more likely to take an interest in the how of a project’s manifestation. but it fails in two respects. All parties understand that in terms of relative capital. 2] UNMASKING PROJECT FINANCE 319 produced in the Camisea case. prior to the commercial operation date. sponsors. Arguably. 261 Second. This argument has some merit. supra note 2. it is possible that they would be more likely to abandon a project or not otherwise support it if financial or other problems arise. at 15. By giving the equity investors a bigger stake in the project at the outset. at 738 (noting pipeline spills.

6 risk. LoPucki. If the project fails. GAS. The SPE. supra note 17. When that happens. Professor LoPucki analogizes corporate liability to a poker game. Liability will die. Taken as a whole. the lenders take over the project and the SPE simply goes away. 262 Professor Lynn LoPucki discusses the movement away from liability and accountability in society towards something more amorphous in which corporate actors are never held liable for their actions. or incentive to engage in sustainable business practices. and require the SPE to contract with financial institutions. at 71. the project sponsors do not feel the full impact of project failure. AND ENERGY LAW [Vol.” 263 He analogizes further. at 104 (explaining that project failures do not reach the project promoter’s assets. 263. B. supra note 22. the SPE absorbs all of the risks of the project before contracting them away. liability is very close to dead. Large-scale infrastructure projects may cost billions of dollars. and citizens of the “Third World” also feel the impact because they must pay the project debt without the benefit of the infrastructure). 265. impact the public in significant ways. Such chips are taken in order to satisfy liability. Id. and the impacts are deeply felt throughout the communities in which such projects are developed. but in making this argument. players who are judgment proof— can keep playing the game and are eligible to win. contribute chips to the pot. in which the players. Save a loss of their initial equity investment. and that in the event of failure. construction companies. but even “players who don’t put any chips in the pot—that is. Id. Even if a SPE commits a foul throughout the course of development. and power purchasers. 264. the mechanism also yields externalities. and are permitted to continue engaging in development activities through other special purpose vehicles. See HOFFMAN. It is an extreme view. reputation. lacks substance. where the SPE limits a project developer’s “chips” in the development game. See Duong. The sole purpose of the project finance SPE is to develop the project. the citizens of the capital exporting company feel the impact of the losses when loans are defaulted. 266 Moreover. the fundamental nature of the game will change. however.INPUTFILE. sans penalties. economic actors.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 320 TEXAS JOURNAL OF OIL. 266. at 3. 265 The scope of infrastructure projects is broad. I turn now to the remaining components of the form. the same principles of remoteness that characterize securitization make it difficult for affected third parties to reach the actors better able to prevent externalities from occurring—the 262.” 264 In project finance transactions. The Special Purpose Entity—Obfuscating the Who In The Death of Liability. supra note 108. . suppliers. stating that “[s]oon no one will have significant chips in the pot.

the who is the EPC Contractor. On a basic level. It is simultaneously elusive. at 12 (“Reputation plays a very limited role in project finance. Turning a Blind Eye: Wall Street Finance of Predatory Lending.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. project losses are not borne by the SPE. At the sponsor level. McCoy. See Duong. reputations do not exist because most projects are greenfield entities.. . pervasive. and who lack access to a SPE-tortfeasor’s assets due to the allassets liens that are standard in project finance transactions. See ESTY. The risk of real damage therefore falls on third parties who never agreed to the project or the structure thereof.g. the project company must make the case to lenders that the project will produce enough income to service the 267. or in the case of the La Mata-La Ventosa project and the land leases entered in connection therewith. supra note 17. The absence of a who that may be engaged makes access to justice difficult. 268. and yet. The project sponsors therefore shift the risk onto an entity that. At the project level. e. Instead the community is left in the wake of any project damage. Engel & Patricia A.INPUTFILE. 268 Recall that the project finance SPE owns nothing other than its contracts and the project assets. 1706 PLI/CORP 307. Often. Non-Recourse Loan—Keep the Income Stream Flowing With respect to the actual financing of the transaction. at 78. See. 313 (2008) (noting that thinly-capitalized loan-originators have “reduced reputational risk. the SPE. reputation effects are nullified by the nonrecourse nature of project loans. with claims against a virtually judgmentproof entity that is a mere vessel of its contracts and liabilities. and operate with low capital” and participated in the subprime market by capitalizing on their ability to shift risk). This reputational behavioral paradigm is also evident in the securitization market that fueled much of the systemic failures related to the global financial crisis. supra note 13. In failing. The SPE further diffuses risk as to the project sponsors because the project may fail. With language barriers and no access to the land contracts that are the subject of dispute.”). if not impossible. reputation is only a factor for sponsors that repeatedly enter the project finance market. ultimately invisible. Kathleen C. 2] UNMASKING PROJECT FINANCE 321 project sponsors. The Isthmus is the site of no fewer than fourteen separate development projects. C. in substance. related entities that exist far down the corporate food chain from the project sponsor. the project may result in significant losses to the environment or the social fabric of a community. if the project fails. but any failures related to the project do not affect sponsors financially 267 or reputationally. The La Ventosa projects demonstrate some of the difficulties faced by those seeking redress for land and environmental harms caused by the development. resembles the air. local residents must first determine the who behind these various developments. The project finance form contributes to this obfuscation. through the non-recourse loan funding process. who has negotiated a price to deliver the project by a date certain. navigation of this web of entities is daunting at best. but given that the SPE was formed solely for the development of an isolated project.

270. AND ENERGY LAW [Vol. In this process. 270 Indeed. See id. Duong. where lenders received standard collateral packages. credit. As previously discussed. the risk of failure is substantially borne by the lenders and third party tort claimants. 272. or balance sheet. 6 project debt and obviate the need for providing additional collateral to support the loan. the project company is incentivized to maximize the project’s revenue. at 106 (noting that project lenders want the project company to structure transactions to avoid disputes regarding a failure to construct the project correctly). supra note 17. This treatment was consistent in the Oaxaca transactions. As a result. GAS. To a project sponsor.S. . See E-mail from Rachel Robboy. supra note 52. but they are financed in large part by the project debt. at 83 (noting that risks to the revenue stream must be contractually allocated). The non-recourse loan is the reward for effective risk diffusion. See Duong. 272 Admittedly. but with non-recourse financing. such assets are not cheap.” 271 The implications of this type of financing are troubling. Both the project sponsor and project company have a real incentive to complete the project and generate a revenue stream for debt service.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 322 TEXAS JOURNAL OF OIL.-trained business executive or lawyer. See YESCOMBE. E-mail from Jefferson Boyd Easum. the project company must demonstrate that it has adequately shifted any risk of disrupting the income stream away from itself and onto a third party or other project participant better able to absorb such risk. the security agreement of the transaction will treat the project assets and contracts as collateral. at 80 (noting that “[u]nless Non-Recourse. project sponsors would be reluctant to invest in risky infrastructure projects of the Global South absent a high profit margin. In essence. Off-BalanceSheet Project Financing is available. but in fact bears no burden for such revenue maximization. the corporate investor is reluctant to take on high-risk FDI transactions in faraway lands or on foreign territories with political and legal concepts alien to the U. therefore.”) 271. ‘Third World’ development project in question will leave no effect [on a project sponsor’s] assets.INPUTFILE. As Professor Wendy Duong notes. the project company must show that the project itself is virtually risk-free with respect to delivering a fully constructed facility that is capable of consistently generating revenue. 269 The project company may not obtain financing without proving to the lender that it has adequately distributed the risks of the project throughout the transactional structure. Scholars note that without the incentive of off-balance sheet financing. supra note 17. the reverberations of a project failure ring hollow. sponsors work exceedingly hard to structure deals that rely on the purest form of classical non-recourse financing. “[t]he end result is evident—the high-risk. The risk of failure does little to affect the sponsors’ bottom line. simultaneously leaving little collateral for thirdparty tort claims. supra note 47. Such loan does not appear on the sponsor’s balance sheet or affect its assets. supra note 128. at 77–78. but success could mean a 269.

eventually. but residents remain affected by the turbines. What then. and lenders—reap the benefits. the project company goes away. As long as the project produces a revenue-stream. In actuality the project company also loses no real skin in the game. it absorbs none. If a wind project fails or substantially harms the community. it has nothing else at stake.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. Such risks do not lapse. 2] UNMASKING PROJECT FINANCE 323 substantial payout. The community absorbs the harmful effects of the development. This displacement of risk is promoted by the project finance structure. and is left with an asset-poor SPE against whom to direct latent tort claims. which isolates the assets of the project promoter. but are absorbed by the community in which the development is housed. the SPE. the project sponsor has no assets at stake and the project company. it generates electricity that will be sold to a private company. where affected parties are able to limit or halt the development. Once a resident “agrees” to permit a windmill on his or her property. is the project company’s objective in delivering the project? Generating a revenue stream that pays down the debt and eventually allows the sponsors to cash out of the project. the parties—sponsors. with few viable options. and their affect on the residents’ ability to maintain their lifeways. The non-recourse feature of project finance further promotes a devilmay-care attitude with respect to accountability for such risk shifting. The water table is changed by the cement that supports the turbines. even though such harms are outside of the community’s control. the land is disrupted. This community. The community. Other than what it creates as a result of the project.INPUTFILE. A portion of the property is affected by the soil unearthed by the digging for the turbines. This dynamic permits the project company to ignore certain social and environmental risks at the outset of the development because. effectively. If a wind project succeeds. any assets at stake were paid for by non-recourse debt. the sponsors will receive a return on their investment from any residual proceeds. eventually walks away through a liquidation of its assets. This outcome subverts risk-shifting . and leaves third parties. Even in a worst-case scenario. Indigenous communities rely upon the land used for the various wind projects to support a subsistence way of life. The wind development in El Istmo bears this out. bears these burdens with none of the lucrative benefits that await the sponsors. as is such resident’s connection thereto. such as the rural farmers in Oaxaca. cannot walk away. their impact on the environment. the project company. however. The proceeds of the sale will flow to the project company to service the project debt and. a group of tort-claimants without access to the sponsor’s deep pockets and with no ability to control development outcomes. places a comprehensive lien on the project’s assets through non-recourse lending. because its sole purpose is the development of the project.

Amnesty International notes that.amnesty. supra note 107. Yelpaala. 1272.uncitral. and turns the notion of neutrality of the financing form on its head.org/en/library/asset/POL34/012/2005/en/76f5b921-d4bf-11dd-8a23d58a49c0d652/pol340122005en. Project finance. Sophisticated players. CONTRACTING OUT OF HUMAN RIGHTS: THE CHAD-CAMEROON PIPELINE PROJECT 22 (2005). given that the predominant neoliberal philosophy puts the interests of the firm ahead of non-party stakeholders. These risks are sometimes labeled generically. and who benefits the most from the financial reward of the project. the agreements are declared to prevail. at 1294. Mitu Gulati. Yelpaala. rely on their own boilerplate documents to provide most of the transactional template. at 105. at 77. the extensive documentation of project finance transactions provides the legal framework for the deal. the structure of project finance transactions produces tangible effects for third parties. Efforts at standardizing project finance transactions appear limited to individual state statutes. supra note 256. “it is not uncommon for the project documentation to form the principal legal framework for the transaction).” 273 D. “[t]he use of Project Financing as the corporate sponsor’s risk-allocation mechanism is fatally flawed because it ultimately protects the corporate sponsor. supra note 114.INPUTFILE. See Pédamon. ultimately to be borne by parties that are conspicuously absent from the negotiating 273. See also LIKOSKY. one of the largest projects affecting the African continent. at 21 (noting that given the environment for project finance transactions. the party who is in the best position to assess future risks of loss. This method of finance is not neutral. Duong.J. 276. Choi & G. where national laws and regulations conflict with the terms of the agreement itself.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 324 TEXAS JOURNAL OF OIL. Risk Shifting in Project Contracts—Passing the Buck In the development context. See also Lawrence & Thomas. The United Nations has also set forth extensive legislative guidelines for project finance. 275. 274 This creates a precarious situation for third parties.” AMNESTY INTERNATIONAL. “political risks. 1277 (2001). available at http://www. at 33–34. supra note 82. See GENERALLY UNITED NATIONS COMMISSION ON INTERNATIONAL TRADE LAW. 6 principles. the sheer number of parties participating in a project finance transaction incentivizes the project sponsor to conceal risks and create a moral hazard. all to the detriment of those whom the project is supposed to serve. to put it simply. GAS. supra note 107. 276 I have already discussed the mechanisms available to project companies to distribute known political and economic risks and noted that very rarely does the prevailing literature acknowledge that social and environmental risks also exist at the outset of a project and are therefore also distributed. as Professor Duong notes. See Catherine Pédamon. 277. 24 FORDHAM INT’L L.org/pdf/ english/texts/procurem/pfip/guide/pfip-e. “[a]ccording to the [project] agreements. How is Convergence Best Achieved in International Project Finance?. LEGISLATIVE GUIDE ON PRIVATELY FINANCED INFRASTRUCTURE PROJECTS (2001). at 1130 (arguing that boilerplate contractual language should be viewed as statutes). is the law. supra note 108. . available at www. at 156–57 (noting that globalization is held in place by a system of legal rights that promotes capital accumulation to the detriment of millions of people). In the case of the Chad-Cameroon pipeline. at 100. Stephen J.pdf. supra note 17. however.pdf. Indeed. 274. AND ENERGY LAW [Vol. 275 Further. See HOFFMAN.” 277 and are masked throughout the transaction structure. supra.

at 741 (discussing failure of Inter-American Development Bank to enforce social and environmental standards in the Camisea project). The O&M Contractor’s motivations are similarly aligned to the EPC Contractor. who manages the day-to-day operations of the project.”). it too has little economic incentive to mitigate externalities by incurring additional costs (e. It also incentivizes a party with significant control over project. See Bowen supra note 91. developing and implementing an extensive plan to prevent and manage externalities). which would likely lead to a disruption in the revenue stream and a delay in paying the creditors. The risk of externalities therefore slips through the contractual gaps of the transaction and becomes a thirdparty concern. . the O&M Contractor would most certainly owe liquidated damages to the project company. The EPC Contractor.. 280. the transactional structure simply permits it. The parties best positioned to manage social and environmental risks might also lack real incentives to do so. at 22. supra note 256.INPUTFILE. however. such adherence would increase the economic burdens borne by the project.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. is in the best position to control negative outcomes concerning the construction of the project. This does not suggest that such risk-shifting is accompanied by intent. private lenders have little incentive or ability to encourage project companies to adhere to strict human rights standards. at 29 (discussing the separate incorporation feature of project finance. 279 From a practical perspective. they will more readily admit to this concern in private conversations. ESTY. 278 From an economic perspective. Despite the recent movement toward increasing the specter of accountability on the part of lenders. project companies lack economic incentives to do so. Let me begin at the debt level. In addition. it is delivered to the O&M Contractor. and could put the borrower in a default situation. noting that such feature “shields risk averse managers in sponsoring firms from bad outcomes at the project level more effectively than corporate finance” and that while “managers do not often publicly admit to using project finance for this reason. since the EPC Contractor is paid a premium to avert construction-related delays. supra note 13. Absent lender enforcement of strict guidelines relating to human rights or the environment. reduce the revenue stream available to pay down project debt. This structural aspect of project finance requires singlemindedness on the part of the O&M Contractor.g. Cf. 2] UNMASKING PROJECT FINANCE 325 table. lenders are not the parties best situated to manage social and environmental externalities of large-scale projects. the O&M Contractor. to 278. The O&M Contractor’s primary goal is to maximize efficiency of the project’s output and to avoid penalties related to delivering a second-rate product. Lawrence & Thomas. A delay in producing the output could mean a delay in selling the output. as the contractor on the ground responsible for building the project. 279. 280 When the project is fully constructed.

GAS. were established “to level the playing field. .g. A useful illustration of this point is the establishment of the Equator Principles. the incentive is to streamline the process to allow for construction and eventual commercial operations. social development. But my financial risk is diffused throughout the finance structure to facilitate a higher return on my investment. AND ENERGY LAW [Vol.” To affected third parties. Arguably. they might suggest. which are often difficult to measure. An extreme example of this occurring is the Dabhol case. Understanding the relationship between the costs (e. this framework is of little effect today. acting within full view of lenders. supra note 256. project developers. the true costs of project finance-based development are difficult to quantify. We both win.” Lawrence & Thomas.. and establish a minimum standard to which the major project financing lenders would adhere. the 281. You absorb the environmental and social risks. externalities produced) and benefits of this transaction model is beyond the scope of this article. 283. The problems remain: The are mere externalities to lucrative wind developments. 6 externalize certain of the risks by avoiding the costs of their management. with and without it. push the limits of risk to maximize profits. 283 VII. project finance bundles and diffuses risks throughout projects and passes such risks on to third parties who are not parties to the transaction. as some have pointed out. Your environmental and social risks are passed on to the community. Principles of economic efficiency. and the subject of a future project.INPUTFILE. the land. OVERCOMING STRUCTURAL DEFICITS As the foregoing discussion illustrates. Taking the Oaxaca private wind projects for example. 282. This is an empirical question. I absorb the financial risk. and bird migration issues certainly arose throughout the course of development. but the transactions reached financial closing. 282 The project finance form incentivizes actors to push this ceiling. host country. In doing so. which. As noted at supra note 16. At every level of the project structure. you must make it easy for me to get the deal done. in fact incentivize all actors to hew closely to the highest of environmental and social standards to increase the likelihood of the project’s success and the eventual payment of each party to the transaction. See supra note 102. 281 Project participants might counter the suggestion that the contractual mechanisms that characterize project finance transactions allow the risk of social and environmental externalities to slip through the cracks by arguing that the opposite is true. Any deviation from this goal is inefficient. This argument would be more convincing if the success of projects did not so closely rely on the rapid production of an income stream to flow through the project to all project participants. want this investment. at 22. the project finance mechanism permits project sponsors to approach host governments with the following implicit bargain: “If you. in which a contractor of the project developer allegedly harassed and intimidated those opposed to the project.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 326 TEXAS JOURNAL OF OIL. This suggests that there may be a ceiling of externalities beyond which point projects fail. but raises an interesting question regarding whether the benefits of project finance form ever outweigh its costs.

.” Id. & INT’L L. but you. In his discussion of the danger of utilizing limited liability companies in the project finance context. 287. The Limited Liability Company: Lessons for Corporate Law. the legal framework produced by the form intentionally creates an environment where risk is actively bundled and diffused. 285 Professor Wallenstein is correct. and therefore not financially viable. Rational actors would not opt for the complexity and high transaction costs of the project finance framework unless such structure provided an added benefit. 449. as opposed to shopping malls.” Jonathan R. 451 (2002). . 2] UNMASKING PROJECT FINANCE 327 project sponsor enters the development scene stating: “We will bring investment to you. 287 As this article illustrates. Macey. Third parties may consent or object to business activities occurring in society. while the costs associated with projects that turn out badly are largely borne by creditors and ‘innocent’ tort victims. 433. The problems associated with development follow all financing forms. L. 285. ESTY. In critiquing Professor Carl Bjerre’s discussion of third-party consensuality to project finance transactions. Macey notes that “limited liability allows investors to pursue extremely risky projects and to profit from the pursuit of a ‘heads I win. Professor Stephen Wallenstein argues that: From the perspective of third parties. COMP. This is not a unique problem of project financing. and your people. [and] much of this new risktaking will be suboptimal from a societal perspective. Moreover. at 449 (emphasis added). Professor Jonathan R. Stephen Wallenstein. at 27 (suggesting that the risk management can be value enhancing in project finance). project finance provides an added economic benefit in that sponsors may diffuse the risks associated with infrastructure development while avoiding absorption of the externalities 284.” 284 The legal framework created by project finance facilitates this attenuation of risk. there must be something imbedded in the project finance form that makes it more attractive. supra note 108. this investment is too risky. as Professor Macey points out. 448 (1995).DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. 286 Therefore.Q. What Professor Wallenstein neglects in his discussion is that project finance is extreme in its treatment of risk. [it] must entail significant countervailing benefits to offset the incremental transaction costs and time. there is nothing unique to building power and transportation projects in emerging markets. 73 WASH. tails you lose’ strategy of project finance. Otherwise. Indeed. industrial complexes or office building in the United States. through conventional corporate financing. . supra note 13. must bear the risk of externalities associated with the project. at 2 (noting that for project finance “to be rational. because the people making the decisions to pursue these risky activities are not going to bear the full costs of the damages they impose others. Situating Project Finance and Securitization in Context.”). at 100 (stating that the social effects of project finance infrastructure projects “are more accurately labeled as political risk and should in no way be viewed as unique to project finance.INPUTFILE. . Id. The members divide the spoils of risky or dangerous projects that turn out well. See also HOFFMAN. 12 DUKE J. and indeed these same negative effects can occur as a result of a securitization. U.”). but the government regulates them all. 286. economic theory would “predict that the emergence of the limited liability company will raise the level of risk-taking beyond its previous levels .

DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 328 TEXAS JOURNAL OF OIL. 289. A. HOFFMAN. Moreover. Using the same rationale. or lender liens on certain of the sponsors’ assets. transactional nature. supra note 17. This could lead to more careful development. 288 but are of a fundamental. a wholesale rejection of project finance is unlikely. We can. See RAZAVI. 290. this was the dominant mechanism used to finance energy projects. Thus. supra note 108. Such problems are not problems of a political or democratic nature. sponsors will be more engaged and more likely to care about the how of a project. however. “lenders (in particular commercial banks) took comfort in knowing that repayment of loans came from the parent entity and was backed by the entity’s entire balance sheet. however. Hossein Razavi of the World Bank notes. one might be tempted to do away with project finance altogether. 6 produced.” 291 Modern-day large-scale infrastructure projects could follow this model. Opponents to this approach could argue that including such encumbrances on a sponsor’s balance sheet might make sponsors less likely to engage in risky infrastructure development projects and thereby reduce the amount of capital available in riskier development contexts. at 251. at 100. Duong. 290 As Dr. best resolved by modifications to the form itself. one could counter that by putting more of a sponsor’s assets at risk in risky environments. while it is true that third parties are no more present at the bargaining table in a project finance transaction than a corporate finance transaction. the sponsor will be prudent in minding the store. however. 289 Until the 1980s. at 75. sponsors might take more care in selecting projects. 291. given the current infrastructure landscape and the prevalence of the form. Cf. Id. AND ENERGY LAW [Vol. a lender typically has recourse to all of a project sponsor’s assets and revenues. Faced with a form that contains these structural flaws. examine the impact of small changes on a case-by-case basis and urge for host government adoption of laws that modify some or all of the risk mitigation features of this type of foreign direct investment. We begin with the abrogation of the non-recourse financing mechanism. and force the sponsor to bear more of the risk of development rather than shift risk to a SPE that exists solely for the purpose of developing the project. GAS. Collateral could take the form of sponsor to lender guarantees that live throughout a project’s lifetime. the logic being that if lenders require more upstream collateral. this absence is exacerbated by the externalization of risk that characterizes the form.INPUTFILE. supra note 114. Eliminate Non-Recourse Loans Under a traditional corporate finance rubric. . If a 288.

Putting more of a sponsor’s initial investment at risk could change this dynamic. A higher equity outlay would increase the likelihood that the sponsor would remain engaged in the project a meaningful way throughout the lifetime of the project. are adequately covered. it lacks the incentive 293 or expertise to ensure that negative social and environmental risks.. Recourse financing would force the project sponsor to absorb more of the social and environmental risks of the project. supra note 256. from environmental issues or social unrest arising from the project) that could result from disruption on the ground might push a sponsor to think more fully through the potential implications of a project and be more prudent in assuring proper management of the project through the SPE. a project sponsor whose assets are on the line might be more deliberate in mitigating the potential negative effects of a project or decide to forgo the development altogether. The risk of negative externalities does not go away. as equity. and not managerial. 744 (noting that with the Camisea pipeline project in Peru. . 293. This arrangement also allows the sponsor to fade into the background with respect to project oversight. at 740.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. Lower Debt-to-equity Ratios High debt-to-equity ratios permit sponsors to shift the majority of the financial burden of a project to the lenders.g. B.INPUTFILE. Since the sponsor. This type of hesitation would greatly serve the communities in which such potentially harmful projects are located. Since the lenders’ oversight of the project is primarily financial. with its deep pockets on the line. See Lawrence & Thomas. at 26 (noting that lenders lack incentives to monitor environmental performance in various areas of projects). is in the best position to control such risk. they rely on the project company to hedge such operational risks. especially those that do not affect the project’s revenue stream. whose main objective is ensuring that the project is contractually prepared to deliver the debt service in a timely fashion. Understanding that it does not have the shield of nonrecourse financing to separate its assets from any potential defaults (e. 292 However.]”and the bank “left a lot of day-to-day monitoring to the project sponsors[. supra note 91. See Bowen. but rather it is borne by third parties. when a lender evaluates a facility’s operations. the sponsor. gets paid last in the 292.]” all of which resulted in significant harm to the environment and local community). and this makes sense. the Inter-American Development Bank relied “too much on the project sponsor to provide for a community monitoring system that did not meet the [bank’s] standards[. With a relatively small investment at stake. the concern that a project may cause displacement or environmental harm falls on the lenders. 2] UNMASKING PROJECT FINANCE 329 large-scale project carries with it the known potential to create devastating social and environmental harms.

with more at stake it might have more of an interest in ensuring that the business is operated in a way that guarantees that it realizes its return. all of the risks of a project flow to other parties—the lenders 294 and third parties—who lack meaningful control over a project’s management and who stand to gain relatively little if a project succeeds. . 295. In the process. at 3 (noting that direct project ownership would prevent opportunistic behavior). If the transactional structure is collapsed. the SPE also allows the project sponsor to avoid feeling the full impact of losses associated with a project’s failure. as previously discussed. To the contrary. not only would the liabilities of a project appear on the balance sheet as part of the sponsor’s bottom line. at 17 (noting that sponsors’ limited exposure in project finance transactions results in lender assumption of a part of project risks). but it would also create more of an opportunity for the sponsor to engage in the activities of the project throughout the project’s lifetime. the sponsor is permitted to make its initial investment. allows the party with the most to gain from a project finance transaction—the sponsor—to sacrifice a mere pittance in comparison to what it stands to receive if a project is successful. The current form of project finance. in a more active managerial role. supra note 2.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 330 TEXAS JOURNAL OF OIL. and more appropriately.INPUTFILE. the sponsor absorbs very little of the risk associated with a project. C. 295 Such engagement could have a positive ripple effect both with respect to business practices and the project’s relationship to the local community. GAS. thereby mitigating any harmful effects the project may have on the community in which it is located. Skeptics may argue that this type of financial convention would subvert commonly held risk management principles. By changing the deal structure. Without such an incentive. the SPE is typically seen as a tool to enhance financial outcomes. however. the sponsor makes a long-term commitment to the project’s success. Limit Use of Special Purpose Entities With respect to direct project participants. bearing more of the risk associated therewith. Reworking equity contribution amounts would alleviate this imbalance and allow the sponsor to realize a return on its investment while simultaneously. and then cross its fingers with the hope that it eventually realizes a return. In this scenario. would pay attention to a project’s effects on the local community and environment. 6 line of creditors. The incentive to stay the course also makes it more likely that the sponsor. AND ENERGY LAW [Vol. supra note 3. See Estache & Strong. See ESTY. absent additional equity requirements imposed by a host government or lenders. the true face of the project is unmasked and the sponsor is more likely to be seen as the face 294. By collapsing the project structure.

at 122–23. 1. Schwarcz. Under this proposal. leaving the sponsors’ assets available to third-party tort claims. the lenders have liens on all of the project assets. The Inherent Irrationality of Judgment Proofing. 52 STAN. at 112–13 (discussing the rationale for piercing the corporate veil and noting that where “limited liability is absolute. including externalities. at 121 (assuming that “externalities should be allowed to defeat contract enforcement only where [a] minimum threshold is met and the externalities cause the contracting in question to become economically inefficient. or environmental standards). REV. 298 Opponents to collapsing the structure of project finance transactions could argue that the economic benefits accompanying the prior form would be altogether lost. everyone loses. supra note 3. Professor Schwarcz goes on to explain that two types of efficiency are generally referenced in the law and economics literature: Pareto efficiency. from an economic perspective. Cf. among them the potential . all parties suffer. ESTY. 297 Tort claimants in Oaxaca could benefit from this arrangement. and it therefore follows that the sponsors might be more inclined to adopt more sustainable business practices that engage the community in the decision-making process. and therefore investing in risky infrastructure projects would become unfeasible. Steven L. 301 In the Oaxaca 296. Schwarcz.” rather than shift all responsibility to a project company that is unsupported in any meaningful way by the sponsor’s deep pockets. 297. See. and Kaldor-Hicks efficiency. but the potential of the SPE to render the sponsor judgment proof looms large in any project finance transaction. See Schwarcz. 1395 (1997) (discussing perils full priority pose to tort claimants). including the third parties most affected by the positive and negative externalities of infrastructure development.INPUTFILE. where the contracting puts contracting parties in a better position and does not make any parties worse off. 299. and assuming a nonrecourse finance model. Therefore. e. at 881 (posing a hypothetical UCC amendment that would allow third-party tort claimants to obtain a security interest in a project finance debtor’s property “during a period of time in which [such debtor] was also violating” prescribed human rights.”). at 211–12 (describing a framework for evaluating the impact of development). This framework resembles the carve out advocated by Professor Elizabeth Warren during the discussions regarding the revision of Article 9 of the Uniform Commercial Code (“UCC”). See Schwarcz. supra note 14. supra note 14. See. Elizabeth Warren. they might conclude. where “the aggregate benefit exceeds the aggregate harm.g. e.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. at 110 (noting that “[w]hen economically beneficial transactions are prevented. As it stands. supra note 21. 1373. The sponsor is also more likely to “pay for what it breaks.. 300. as the aggregate harm. 2] UNMASKING PROJECT FINANCE 331 responsible for any benefits or harms of the project. a parent can form a subsidiary with minimal capitalization for the purpose of engaging in risky activities[.. Off-balance sheet financing is one of the key rationales supporting the use of SPE’s in project development. 296 This carries reputational weight.”).”). See. See also Hughes. 300 and that such costs undermine the purported efficiency of the project finance model. 31–32 (1999) (discussing transactions between related entities and noting that “[n]onarm’s length transactions are more likely than arm’s length transactions to be entered into for judgment proofing. e. the lenders would maintain their security interest in the project assets. L. REV. 299 This economic argument fails to acknowledge the social costs that never fully figure into developers’ calculations relating to development.. The Oaxaca projects would likely fail under each model. 82 CORNELL L. Making Policy With Imperfect Information: The Article 9 Full Priority Debates.” Id. labor.g. 301.]” which exceeds what is deemed socially acceptable). supra note 14.g. 298.

. 304.g. . towering windmills are permanently placed on communal land. ultimately. but they are a step in the right direction. the project company). 303 but this article argues for deconstructing the form and examining the merits of the respective elements thereof. 6 privately developed wind project examples. under the modified form. In exchange for this “beneficial” development. Removing the cover of the SPE simply brings liability a bit closer to home and forces the developer to consider fully the social costs of its activities. in various environments. that the mechanism is so flawed that it should be altogether eliminated. the project sponsor absorbs more of the risk of the negative externalities that will be produced by the project. as a specific infrastructure development financing form. at 2 (noting that “project companies are founded on a series of legal contracts.”). the who of the project is brought into sharper relief. Changing the corporate structure of project finance transactions could bring costs and benefits more into balance.INPUTFILE. the water table is affected. rather than an amorphous entity that is merely the sum of its contracts (e.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 332 TEXAS JOURNAL OF OIL. the complex web of agreements that is standard to project finance transactions would not go away. the land is disrupted. supra note 114 at 170 (arguing for the creation of a human rights unit under the United Nations to “handle human rights issues arising in the context of [transnational public-private partnerships]”). AND ENERGY LAW [Vol. 303. the causes of externalities would be more readily traceable to the sponsor. GAS. arguably exceeds the corporate and “green” benefits of the projects. Additional Research Others have theorized the potential impact of making changes outside the financing form in order to effect real change for those affected by large-scale projects financed by project finance. See. it could be argued. The three suggestions enumerated herein barely begin to address the risk-shifting properties of project finance.g. I decline to make that claim here. and the social and environmental externalities that result. 304 We cannot rely on the argument that the social benefits of development outweigh the harms displacement of indigenous communities and potential environmental harm. Extensive empirical research is needed to understand the impact of project finance.. supra note 3. but suspect that structural and market fixes may fail to redistribute the costs and benefits of this form of infrastructure finance and that a more profound intervention may be required. See ESTY. D. the community never stood to gain in the first place. More inquiries into project finance methodologies and externalities may reveal. 302. This article aims to begin the discussion and begin to expose the links among the structural deficits of project finance. LIKOSKY. Although. all of the energy produced is being transported to large corporations. and large. risk diffusion. 302 When the SPE disappears as a vehicle that carries all of a project’s risks. Without the SPE. e. and the likelihood that affected parties may effectively seek redress for harms caused by a project also increases. and how the permutations of the form manifest different results. Therefore.

In particular. have so much at stake throughout the lifetime of the project that they need effective ways to distribute risk to parties best able to absorb it. such developers actually have very little at stake in a project finance transaction and in fact shift many key project risks on to parties least able to absorb them. this claim is specious at best. This article begins to expose many of the structural deficits native to the most commonly used mechanism for infrastructure development finance and disrupts the assumed neutrality that accompanies its form. fall on the shoulders of third parties. Assuming neutrality with respect to the form 305. As this article demonstrates. and indicate that the widespread use of project finance in the Global South creates significant cause for concern. Macey. project finance.. See.INPUTFILE. project finance is so adept at risk diffusion that environmental and social risks more appropriately borne by project sponsors and project decision makers ultimately. These structural deficits create a development environment where risk is shifted away from project developers and externalities are borne disproportionately by third parties who are not parties to the project finance transaction. wreak havoc in the development context by creating perverse incentives for development.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM No. Indeed. This discourse further suggests that the use of contractual mechanisms is efficient: They will effectively distribute risks throughout an efficient framework that allocates rewards to the parties that are best positioned to control and absorb such risks. 2] UNMASKING PROJECT FINANCE 333 caused by the form. The current outcomes related to the pervasive use of project finance challenge these principles. We must do more. at 449 (arguing that the social benefits generated by limited liability outweigh the social costs). . e. Some argue that project developers.g. as parties responsible for creating a large-scale infrastructure projects. however. the expert players who routinely engage in development behave rationally in order to maximize returns. and its risk allocation framework. Moreover. VIII. 305 For indigenous communities impacted by development. supra note 284. and consistently. CONCLUSION The discourse surrounding infrastructure development finance suggests that the only way to engage project sponsors in risky infrastructure development projects in the Global South is by deploying financing mechanisms that adequately allocate risk. Thus. we must seek to answer the question of whether there are particular structural mechanisms that can close the gap and prevent the interstitial matter—the risk of social and environmental externalities— from regularly seeping through the tightly negotiated form and onto third parties.

and severs the causal link between the form and the risks ultimately dispersed onto third parties. environmental. The body of scholarship that examines these relationships is woefully sparse in the infrastructure finance. development. . Academics across these disciplines should therefore work together to understand the structural deficits inherent in infrastructure development finance and strive to rewrite. perhaps radically. and human rights disciplines. this deeply flawed paradigm.INPUTFILE. 6 obfuscates the harm that often arises from large-scale infrastructure projects. AND ENERGY LAW [Vol.DOCX (DO NOT DELETE) 6/20/2011 11:23 AM 334 TEXAS JOURNAL OF OIL. GAS.

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