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Running head: Assignment 4

FERNANDO LUZERNO AUGUSTO CARLOS LICHUCHA

Distance Learning Doctorate of Finance
Program

This assignment is submitted in partial fulfilment of the
requirements for 5524S1861 DF Project Finance R2

School of Management
Professor Dr. Igor Gvozdanovic

July 31, 2016

Events of default IV. Describe the following and explain their importance in project finance: I. Of what special significance in project finance are Security agreements? 2 . Discuss d.Assignment 4 Please answer the following questions in the form of a short essay: a. “Project finance covenants are not particularly important for the successes of projects”. Contractor’s bond II. Representations and warranties III. Reserve accounts b. What are the advantages and disadvantages of loan covenants? c.

........................................................................ 4 Representations and warranties..............................................6 “Project finance covenants are not particularly important for the successes of projects”............................................................... Discuss............................... 4 Events of default....................................................... 6 What are the advantages and disadvantages of loan covenants?....................................................................................................................................... 9 3 .............................................................................. 5 Reserve accounts..............................................4 Contractors bonds........ 7 Of what special significance in project finance are Security agreements?.......................................8 References............Assignment 4 Table of contents Describe the following and explain their importance in project finance................................................................................

and if they do not begin (or complete beginning) working on the project. 2006) Contractors bonds provide ways of incentivizing or securing the performance of contractors. (ii) performance bonds guarantee performance by the contractor for a certain proportion (perhaps 5% or 10%) of the contract price. Bid (or tender) bonds aims to prevent fraudulent bids designed solely to deprive competitors the work (Fight. 2006). (iii) advance payment guarantees to enable the contractors to purchase materials and begin working on the contract. 4 . Conversely.Assignment 4 Describe the following and explain their importance in project finance Contractors bonds According to (Fight. the types of bonds are (i) bid (or tender) bonds require the bidder to pay a penalty should they be awarded the contract and decide to withdraw. the contractor wishing to receive full payment may instead offer a guarantee for the equivalent amount of the retention guarantee. So. (iv) retention guarantees provided by the contractor for the project company to retain a specified percentage of the progress payments. (v) maintenance bonds to cover defects which are discovered after completion of construction. that they will have to refund the advance granted. subcontractors and suppliers. in order to repair defects which may not immediately be apparent.

as this governs the ability to enforce the contract against a presumed set of assets. warranty is a complement of a representation and in practice the two terms are used together. where the borrower has 5 . 2006). (iv) cross-default. (ii) failure by the borrower to perform other obligations under the loan agreement. and (ii) to ensure that the contracting party is duly authorized to enter into the transaction (Fight. (iii) any representation or warranty made by the borrower proving to be untrue. Events of default Events of default are those events.e. which. The typical events of default clauses are (i) failure to pay amounts owing to the lender when due. permit the lender to require all amounts outstanding to become immediately payable. Facts required to be true in the future are covenants. The two main conditions underlying the initial representations and warranties are a) to ensure that the legal status of the company exists. 2006) Therefore. the contracting party being asked to represent and ‘warrant’ certain facts (Fight. 2002).Assignment 4 Representations and warranties A representation is a statement by a contracting party to another contracting party only about a past or present fact that is correct on the date when made. (Yescombe. the representations and warranties are a check list of the key elements that lenders need to review in their due diligence to confirm that they are satisfied with the risks of the financing. should they occur. i.

Assignment 4 triggered an event of default or has actually been put into default on any other loan agreement. (iii) breach of representation or warranty. (iv) filing of bankruptcy petition. any project sponsor or any major project participant. (viii) abandonment of the project by the project company. is not paid when due. and (xiii) if any security document. and (v) ´material adverse change’ occurring in the borrower’s financial or operating position (Fight. 2006). or is no longer effective to create a first priority lien on the collateral. or any credit support obligation under a project contract. (x) Failure of the project sponsors to maintain either an agreed-upon ownership interest or voting control of the project company. such as the contractor. stock pledge agreement or mortgage. (xi) if the project company. defaults in a payment obligation in excess of a specified amount. operator. (vii) failing to obtain. (xii) if any party to a credit support document. (v) final judgments rendered against the project company. (ii) breach of covenants. any project sponsor or any major project participant. Events of default specific to project finance transactions and not typically present in commercial lending include (i) non-payment of interest or principal constitutes an event of default. ceases to be in full force.. maintain. off take purchaser or supplier. (vi) final acceptance date. then an event of default occurs. or replace government approvals or permits. (ix) n expropriation. whether a complete taking or an act of ‘creeping expropriation’. renew. Reserve accounts 6 . such as a security agreement. such as the sovereign under a sovereign guarantee.

This is achieved. or even unanimity. for example.Assignment 4 Reserve accounts ensures that the project entity is protected in the event of any future legislative or regulatory changes by maintaining several accounts with the project trustee such as a reserve account. however. The loan covenants have four key functions which can be also equated to advantages (i) to place some restraint on the danger that a company may become financially distressed. Their purpose is to help the lender ensure that the risk attached to the loan does not unexpectedly deteriorate prior to maturity. or an environmental legislation reserve account (Fight. this may be costly to achieve. (ii) to provide the banker with an early warning if. a debt service reserve account. The disadvantages of loan covenants are a) at some time during the term of a loan a once-relevant covenant may require amendment due to a change in circumstances. 2006). and (iv) they can be used to trigger loan default if necessary (Fight. especially where a company has many bilateral agreements all requiring amendment or a syndicated facility requiring a large majority. by gearing limits. (iii) to limit the extent to which borrowers can take actions which they may be particularly tempted to do when approaching financial distress. What are the advantages and disadvantages of loan covenants? Covenants are undertakings given by a borrower as part of a term loan agreement. a company is beginning to have problems or is significantly changing the nature of its operations. nevertheless. 2006). to agree 7 .

the means and the ways of how the debt will be for sure paid back. Finally. project finance covenants are designed to closely monitor and regulate the activities of the project company and deal with a variety of agency costs between 8 . 2006) unlike asset based transactions. Discuss Project finance covenants are undertakings by the Project Company either to take certain actions ("positive" or "affirmative" covenants). It is through the covenants that the lenders exercise their continuing control over the construction and operation of the project (Yescombe.Assignment 4 amendments. (ii) to give lenders advance warning of any problems that might affect the Project Company. 2002). 2002). (b) contractual restrictions on management activity can turn out to be more costly than the damage they are intended to limit. “Project finance covenants are not particularly important for the successes of projects”. Given these arguments project finance covenants are definitely important for the successes of projects because they deal with the very fundamental philosophy of project finance which is non-recourse structured finance. or not to do certain things ("negative" or "protective" covenants). and (iii) to protect the lenders' security (Yescombe. according to (Fight. The main purposes of the covenants are: (i) to ensure that the project is constructed and operated as agreed with the lenders. (c) setting inappropriate levels for ratio covenants may place unnecessary restrictions on the borrower and may trigger an unwarranted default (Fight. 2006).

Security documents record the required security interest including (i) mortgages or fixed charges over land. 1976) as cited in (Finnerty. buildings and other fixed assets. 2007). Of what special significance in project finance are Security agreements? Security agreements guarantee the lenders the ability to take effective control over the contracts and keep them in place to enforce security through (i) security documents and (ii) security on specific tangible assets (Fight.Assignment 4 shareholders and lenders by negotiating covenant structures that are contained in loan agreements (Jensen and Meckling. throughput or tolling agreements escrow accounts to control cash flows relating to the project. and pledge of shares of project company. (v) assignments of sales contracts. take-or-pay. licenses and joint venture agreements). and production/work in progress. security on specific tangible assets specifically charged will usually include the following (i) the tangible assets used in the 9 . performance bonds. (ii) fixed and/or floating charges over moveable assets. 2006). including charge over dividend rights.g. (iii) assignments of rights under underlying project documents (e. (vi) assignments of long term supply contracts. technical assistance and consultancy agreements. (vii) assignments of project management. (iv) assignments of project insurances and brokers’ undertakings. construction contracts. Whereas.

Finnerty. J. (iii) the license or other operating permits. 10 . Introduction to Project Finance. R. Great Britain: Elsevier.). 2006). Project Financing: Asset-Based Financial Engineering (2nd ed. (2006). References Fight. (2007). A. NY: John Wiley & Sons. New York. (iv) technology and process licences (Fight. Yescombe. (ii) fixed assets. (2002). E.Assignment 4 facilities. Amsterdam: Academic Press. Principles of Project Finance.