Project Financings Are Non-Recourse
Project finance is either non-recourse or very limited recourse as to individual shareholders, including the project sponsors. Non-recourse financing means the borrowers have no personal liability in the event of monetary default. Project companies are generally limited liability special purpose entities, so any recourse the lender may have will be limited to the project assets if the project defaults on the debt.
The project is owned by a special purpose entity which is formed for the express purpose of owning the project. The project company has no credit or assets so lenders don’t evaluate the project company when underwriting the project. Because project loans are non-recourse and the borrowers have no assets to satisfy deficiencies in the event of project default, underwriting is focused entirely on the viability of the project.
Project Financings Are Off-Balance Sheet
Project finance is off-balance-sheet financing. In project finance transactions, the project company that owns the project is a stand-alone company known as a special purpose entity. Because there are numerous participants and stakeholders in the project and ownership of the projected is a Special Purpose Entity, the ownership interest of the project sponsor or other project participant is a sufficiently minority subsidiary interest. As such the balance sheet of the project company is not consolidated onto the balance sheets of the project sponsors or shareholders.
The off-balance-sheet element of project finance is attractive to project sponsors because project loans do not negatively impact the sponsor’s balance sheet, nor does it impact their available borrowing capacity. Government entities also find the off-balance-sheet feature of project finance attractive because project debt and liabilities don’t impact their balance-sheets, relieving pressure on an increasingly stressed fiscal space.
Project Financings Special Purpose Entities
Project ownership is ordinarily held in a single-asset, Special Purpose Vehicle (SPV) with a limited life (sometimes referred to as Special Purpose Vehicle or Special Purpose Company) formed for the express purpose of owning a project pursuant to a Project Finance transaction by the project sponsors. They own only the underlying deal itself. In many cases, the clearly defined conclusion of the project is the transfer of the SPV. 1. Injection of share capital, 2. voting requirements, 3. dividend policy, 4. management of the SPV, 5. dosposal and pre-emption rights.
Loan Agreement
Project finance documents that establish the loan terms in project financings and govern the relationship between the lenders and the project company are the Loan Agreement. Because project financings always include construction of the project, Loan Agreements include construction financing terms that establish how the loan can be drawn based on construction progress, the calculation and imposition of interest and fees based on outstanding loan amounts, and the usual provisions found in a corporate or real estate loan agreement.
The Loan Agreement in project finance contains specialty clauses that contractually address the specific requirements of the project and project finance documents. In addition, because project financings are limited-recourse or non-recourse as to the borrower, relying on the project alone as the sole source of loan repayment, the Loan Agreement sets forth dividend restrictions, required project metrics, ratios, and covenants, in addition to general conditions precedent as well as basic terms.