Tim C' Meaney

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PPP Project Financing
The Role of Direct Agreements in a PPP Project
30th September 2005

• Tim C. Meaney
• DZ BANK AG
• Hong Kong Project Finance

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Agenda
The Role of Direct Agreements in a PPP Project

• What is a Direct Agreement?
• Structural Presentation of a Direct Agreement
• Purposes of Direct Agreements
• Benefits of Direct Agreements
• Who Provides Direct Agreements
• Issues with Direct Agreements
• Conclusions
• Contact Information

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1) What is a Direct Agreement?

• An agreement between individual Project Parties
  each of which is a contracting party with the PPP
  Concession Company (the SPV) and the Senior
  Lenders to the SPV.
• The objective of the Direct Agreements is to
  establish certain legal rights which apply when
  the relevant contract is threatened with
  termination - typically by the action or inaction
  of the SPV.
• The Direct Agreement does not transfer
  obligations to Lenders unless Lenders exercise
  their rights.

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2) Structural Presentation of a Direct Agreement

• PPP Project - Typical Transaction Structure
  (simple form)

Government Authority
Provision of Services
Service Fee Payment
Fixed Time / Fixed Price DC Contract
Sub-contractors
DC Contractor
PPP Project Company (special purpose vehicle or
SPV)
Insurers
Construction Costs
Operation Fee
Services Provider
Sub-contractors
PPP Services
5 - 10
90 -95
Equity
Debt
Investors
LENDERS
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2) Structural Presentation of a Direct Agreement
(cont.)

• PPP Project - Typical Transaction Structure
  (simple form)
• Location of Primary Direct Agreements

Government Authority
Sub-contractors
DC Contractor
PPP Project Company (SPV)
Insurers
Services Provider
Sub-contractors
Equity
Debt
Investors
LENDERS
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3) Purposes of Direct Agreements

• The purpose of a Direct Agreement is to provide
  rights to Lenders which may permit the prevention
  of termination of key project contracts executed
  between the SPV and other Project Parties without
  Senior Lenders having the opportunity to consider
  whether to preserve the contracts by stepping
  in and curing the underlying termination event
  where the SPV has failed or elected not to do so.
• The rationale for Lenders having such rights goes
  back to a fundamental principle in limited
  recourse or project financing

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3) Purposes of Direct Agreements (cont.)

• The Lenders primary source of repayment within a
  limited recourse project financing are funds
  generated by the Project itself and directed
  through the SPV.
• To the extent that the SPV has insufficient funds
  to repay the banks, then these banks may enforce
  and exercise their security interest over the SPV
  assets. The key assets of the SPV are not the
  physical assets but the contractual agreements
  which form the basis of the PPP Project
  arrangements. Hence the need for Direct
  Agreements.

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4) Benefits of Direct Agreements

• The key benefit of a Direct Agreement is in
  providing Lenders with an opportunity to revive
  the Project after a default caused by the SPV
  under the relevant Project Contract which remains
  uncured.
• How is this achieved?
• The Direct Agreement grants Lenders Step In
  Rights i.e. the ability to step in to the shoes
  of the SPV to
• i) Cure the underlying Event of Default
• ii) Manage the Project for the Duration of the
  Step In Period

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4) Benefits of Direct Agreements (cont.)

• Step In is undertaken by a Receiver or a
  Designated Party.
• Step In involves the assumption of joint and
  several liability with the SPV during the Step In
  Period.
• Lenders seek to cap i.e. limit this liability

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5) Who Provides Direct Agreements?

• Direct Agreements can be established with a range
  of contracted Project Parties. For the purposes
  of this Presentation the key parties for Lenders
  with whom the impact of the Direct Agreement will
  be discussed are
• 1) The EPC / DC Contractor
• 2) The OM Contractor
• 3) The Concession Granting Authority (the
  Authority)

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5) Who Provides Direct Agreements? (cont.)

• 1) The EPC / DC Contractor
• The Direct Agreements executed with a EPC or DC
  Contractor is designed to provide Senior Lenders
  with the opportunity to preserve the contract
  with the Contractor following a default /
  termination event occuring under the Contract
  caused by the SPV.
• Lenders will be required to cure the relevant
  event.
• The preservation of the underlying construction
  arrangements is a critical factor for Lenders
  since the SPV has no source of revenue until the
  PPP assets are completed and the service
  provision commenced.

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5) Who Provides Direct Agreements? (cont.)

• A complexity can arise when the Contractor is
  also the (or a) key shareholders of the SPV.
  There may be a hostile relationship following a
  default by the SPV and the Lenders may be forced
  to allow the Contract to be terminated i.e. to
  elect not to exercise rights under the Direct
  Agreement.
• Practically very difficult to replace Contractor
  since the PPP Concession commonly provides a
  Completion Date default provision which may
  prevent the Lenders with limited time to cure the
  underlying default event.

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5) Who Provides Direct Agreements? (cont.)

• For certain PPP Projects there may also be a
  desire to establish Direct Agreements with key
  EPC / DC Sub-Contractors. Primary focus here
  would be key equipment suppliers. This may also
  be slightly more critical where the SPV
  shareholder and the EPC Contractor are related
  parties.

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5) Who Provides Direct Agreements? (cont.)

• 2) The OM Contractor
• The OM Contract Direct Agreement provides
  Lenders with a right (but not an obligation) to
  cure an Event of Default.
• OM is critical in the context of PPP since PPP
  at its heart involves the provision of
  services.
• OM Contractor should provide notice of
  termination to Lenders. Otherwise ineffective.
  The same applies to the EPC / DC Direct
  Agreement.
• The OM Direct Agreement will permit the Lenders
  to Step In to the Contract between the SPV and
  the OM Contractor.

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5) Who Provides Direct Agreements? (cont.)

• 3) The Concession Granting Authority (the
  Authority)
• Commonly a Direct Agreement or Tripartite
  Agreement. Tripartite Agreement to the extent
  that the SPV also is a counterparty to the
  Agreement.
• The Authority Direct Agreement is the key Direct
  Agreement in the contract of a PPP Project. The
  SPV has no source of revenue other than that
  receivable under the Concession Agreement. As
  such the need for preservation of the Contract is
  critical.
• The importance of the Authority Direct Agreement
  is influenced by the consequences of the
  underlying SPV Default Termination regime within
  the Concession

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5) Who Provides Direct Agreements? (cont.)

• If termination of the Concession by the Authority
  for SPV Default results in transfer of the assets
  to the Authority and a termination sum being
  payable to ensure repayment of debt, then Lenders
  are in a position of some comfort.
• If termination of the Concession by the
  Authority results in no transfer of the assets to
  the Authority and no payment of a termination sum
  to the Lenders, then the impact and importance of
  this Direct Agreement is substantially heightened.

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5) Who Provides Direct Agreements? (cont.)

• In the latter case, Lenders will wish to ensure
  that the Authority Direct Agreement provides a
  sufficient basis for a preservation or revival of
  the PPP Project. This may involve
• Foreclosure on the Project Assets
• Appointment of a Receiver
• Termination of the Construction Contract and
  appointment of a replacement contractor
• Termination of the OM Contract and appointment
  of a replacement contractor
• Rescheduling of the Project Debt
• The exercise of the above remedies should not
  provide additional termination rights to the
  Authority

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5) Who Provides Direct Agreements? (cont.)

• Target of the Lenders under a Direct Agreement is
  to minimize the interference and disruption to
  the Project and to consider the steps which are
  to be taken to preserve the Project and the
  underlying Concession.

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6) Issues with Direct Agreements

• Importance of achieveing a balanced Direct
  Agreement
• Imbalanced Direct Agreement will limit the
  effectiveness of the Step In arrangements and
  limit the ability to preserve the Project.
• The following comments focus on the Authority
  Direct Agreement / Tripartite Agreement.
• Identified issues
• Tripartite Agreement should not be the only
  remedy for Lenders
• Election Periods and Cure Periods should be
  reasonable

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6) Issues with Direct Agreements (cont.)

• Transfer of liability should be defined and
  reasonable e.g. Lenders representative should
  only be liable for identified defaults causing
  the termination event and Step In plus
  obligations during Step In Period.
• Unreasonable Step In Criteria should be avoided.
• Direct Agreements should not in themselves create
  Lender obligations unless the election to Step In
  is taken.

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7) Conclusions

• In considering the formulation of Authority
  Direct Agreement (which an appear as a bid
  document) it is vital for the Authority to
  receive appropriately experienced advice. This
  is a general comment regarding the proposed bid
  documentation.
• Inexperienced advice leads to unbalanced
  documentation which could render the underlying
  transaction unbankable in its current form.
• Poor bid documents unnecessarily delay the
  closing process may add cost and create an
  unhelpful atmosphere during negotiations.

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7) Conclusions (cont.)

• The Authority Direct Agreement is not the only
  source of remedy for Lenders. The financing
  agreements must also be acknowledged.
• The Direct Agreement will remain an essential
  ingredient to the PPP (and other) infrastructure
  financing arrangements and as such should be
  given due consideration.

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Contact Information
For further information please contact
Mr. Tim C. Meaney Head of Project Finance DZ
BANK AG Deutsche Zentral-Genossenschaftsbank Hong
Kong Branch 9th Floor, Tower II, Admiralty
Centre 18 Harcourt Road, Hong Kong Direct Tel.
852 2864-3990 Direct Fax [phone] Email
tim.meaney_at_dzbank.de Website www.hongkong.dzbank.
de