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Double security? Evaluate the role of direct agreements and assignments of collateral in project financing transactions

The COVID-19 pandemic has turned out to be more than a global health crisis, but also an economic crisis. There is…

The COVID-19 pandemic has turned out to be more than a global health crisis, but also an economic crisis. There is no doubt that while foreclosure was essential, it created uncertainty over the completion of projects and the status of installation agreements, particularly the triggering of default arrangements. The closure of a large number of businesses has affected the ability of businesses to complete projects and generate income, and hence the ability of borrowers to repay their credit facilities, which have been lifted for the purpose of such projects.

A defining feature of project finance is that it is usually limited recourse finance, meaning that lenders only rely on the income from the project itself and its assets to recoup their investment. For this reason, project finance operations present a high risk for lenders, especially for completely new projects. Because of such risk, mainly during the pre-operational phase of a project, a good security package that mitigates the risk as much as possible is essential to protect the interests of lenders.

In addition to finance and safety documents, a project finance transaction also includes project documents such as construction agreements, operation and management agreements, and equipment supply agreements. One of the financial documents generally applicable in project finance transactions are direct agreements regarding significant project documents. Direct agreements are usually made between the lender or, in the case of a syndicate of lenders, the guarantee agent, the borrower and the project document counterparty. Such agreements give the lender (s) / guarantee agent rights to intervene in the event of the borrower’s failure to meet its obligations under the relevant project document. Therefore, before a counterparty can terminate a project document due to borrower default, the lender (s) / guarantee agent will have the opportunity to “step in” and fulfill the obligations of the borrower, thus ensuring the continuity of the agreement and, therefore, the project.

In addition, project finance guarantee packages often include the assignment of project documents by the borrower to the lender (s) / guarantee agents. The assignment of project documents generally takes the form of an assignment in debiti securitatem (security cession) as opposed to a full cession. In terms of collateral assignment, the borrower will assign their personal rights to the project documents to the lender (s) / collateral agent as security for their obligations under the credit facility. While the Borrower will retain ownership of the assigned rights, the Lender (s) / Guarantee Agent will obtain the right to assert these rights against the Project Document Counterparty in the event of an event of default. default under the facility agreement.

The direct agreements and assignments of collateral aim to ensure that despite the borrower’s default, the project can continue in order to reach an operational stage and generate income. Since both direct agreements and assignments of collateral confer on lenders a form of intervention right, it would appear that the conclusion of the two documents constitutes “double collateral”. One question that might arise is why would lenders need both? As stated above, the goal when preparing a security package is to minimize the risk borne by lenders. An assessment of the characteristics of direct agreements and assignments of collateral, as summarized above, will reveal that while the two agreements relate to the rights of lenders to project documents, they offer different protections that are complementary rather than repetitive. While, on the one hand, direct agreements allow lenders to intervene and fulfill the obligations of the borrower in the event of a breach of a project document by the borrower, assignments of collateral, on the other hand , offer lenders the possibility of intervening and enforcing the rights of the borrower against the counterparty in the event of breach of the facility contract by the borrower.

From an enforcement perspective, direct agreements give lenders rights to breach the project document to prevent the counterparty from terminating it if the borrower is unable to remedy a breach. such breach, while an assignment of collateral gives lenders rights to the occurrence of an event of default under the facility contract. Although it has become market practice to draft facility agreements in such a way that breach of a project document will constitute an event of default under the facility agreement, the counterparties to the project documents are not. not parties to the facility agreement and, therefore, the facility agreements do not have a mechanism in place to prevent the counterparty from terminating the affected project document or ceasing to operate in connection with it . Direct agreements and assignments of collateral give lenders a direct relationship with counterparties which allows them to facilitate the continuity of the project.

While including both direct agreements and assignments of collateral in the package of transaction documents may seem repetitive, they each play a different role and provide lenders with more comprehensive security. The two documents complement each other in creating the rights of lenders and combined, they provide lenders with favorable options regarding the project.

This article was first published HERE.

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