In the past, infrastructure projects have been undertaken by public works departments which

were funded by funds from tax revenues or proceeds from government bonds. Such
infrastructure projects are costly and are thus out of the reach of private sector of the
developing nation. The Governments of developing nations also find it difficult to fund
public works and have to often perform budget cuts or stall the project midway.

However, in the past two decades, infrastructure projects have been funded and developed by
by private entities by attracting foreign investment. The primary means by which the shift
towards private development in infrastructure has taken place is Project Financing. It
involves a method of private financing where the repayment of the funds borrowed for an
infrastructure project is dependent upon the revenue generated by the project itself.1

The project is sponsored by large investors, both domestic and foreign and they take an
equity stake in the project. 2 The first step in setting up a project financing usually involves
the sponsors forming a project company, which is designed to construct, own, and operate the
project facility.3 This project company is a corporation that is owned and managed by the
sponsors and is designed to borrow funds for the project from the lenders. 4 Since the project
company, and not the sponsor itself, is the entity that is borrowing funds for the project, the
project does not affect the balance sheet or creditworthiness of the sponsor directly. 5 The
lenders loan money to the project company with the assets and cash flow of the project acting
as the security interest for the project loans. 6 The lenders, furthermore, loan this money with
the expectation of a constant cash flow from the project and a continuous operation of the
project.7 To realize these goals, the lenders use contractual agreements with the sponsors of
the project to guard against potential threats.8 The sponsors, in turn, seek guarantees from the
host government that it will provide the necessary assurances to keep the project running
smoothly.9

To understand how project financing works in practice, the Dhabol power project in India is a
good example. A project company by the name of Dhabol Power Corporation was setup
which borrowed money independently from banks, lenders and consortiums. The assets and
cash flow of the Dhabol Power Company formed the security of the company.

Sponsors obtain several commercial advantages by financing a project in this manner. 10 First,
if the project fails to fulfill its loan obligations to the lenders, the only recourse the lenders

1
Nagla Nassar, Project Finance, Public Utilities and Public Concems: A Practitioner's Perspective, 23
FORDHAM Int. LJ 60, 62
2
Ibid
3
Catherine Pedamon, How Is Convergence Best Achieved in International Project Finance?, 24 FORDHAM
INT'L LJ 1272, 1272-73 (2001 ).
4
Ibid
5
David Blumental, Sources of Funds and Risk Management for International Energy Projects, 16 BERKELEY
J. lNT'L L. 267, 270 (1998)
6
Supra Note 1
7
Ibid
8
Ibid
9
Ibid
10
Christopher J. Sozzi, Project Finance and Facilitating Telecommunication Infrastructure Development in
Newly-Industrializing Industries, 12 COMPUTER & HIGH TEcH. LJ. 435,447 (1996).
have is to the assets of the project corporation itself. 11 They have no recourse to any of the
assets on the parent corporation's balance sheet. 12 Second, since the project corporation is
acting as the borrower of funds, the parent corporation's credit rating is unaffected even
though the corporation is investing in a long-term project that is borrowing millions of dollars
in the frequently unstable environment of developing countries.13 Furthermore, financing a
project through project financing can be a vehicle for social and economic development for
developing countries because it is a relatively ·economically efficient way to finance public
works projects that affect the lives of millions of people in the country.14

However, the sponsors are prone to major risks including but not limited to currency risks,
civil unrests in the country where the project is situated, default of payment of guarantees by
the Government, political and legal instability and a complex tax regime.

In the Dhabol Power Porject, the change in the Government of Maharashtra from Congress to
Bhartia Janta Party (BJP) led to BJP stating its intention in its campaign and post campaign
press releases to stop construction of the Dabhol power project and abandon the completed
parts of the facility. 15 The BJP made various claims in support of its action, including that the
project was environmentally unsound, that the electricity rates resulting from the project
would be unaffordable to the population, and that the project was too costly and was awarded
without a competitive bid.16 Although Enron (one of the sponsors) did try to commence
arbitration proceedings in London and legal action in the United States against the state
government, the company was eventually able to terminate these proceedings and renegotiate
the terms of the contract.17

Considering that the projects that are generally financed are of public importance, the risk of
political and legal instability is amplified. A sponsor thus has to be cautious of the projects
that are decided to be financed. To counteract these complex risks, many sponsors and
lenders have begun to negotiate successfully for international arbitration as the method for
dispute resolution with respect to the project agreements.18

11
Supra Note 3
12
Supra Note 5
13
Ibid
14
Supra Note 3
15
Daniel Mazzini, Stable International Contracts in Emerging Markets: An Endangered Species?, 15 B.U.
INT'L LJ. 343 (1997).
16
Ibid
17
Ibid
18
See Christopher Dugue, Dispute Resolution in International Project Finance Transactions, 24 FORDHAM
INT'L LJ. 1064, 1065 (2001).