[February 26, 2014]

NHAIS EXIT POLICY FOR ROAD PROJECTS NHAI on 29 January, 2014 notified a new exit policy (Exit Policy) for highway developers which allows original consortium members of the Concessionaire (the Project SPV) to exit by way of a substitution mechanism. The earlier NHAI exit policy circular dated July 17, 2013 permitted substitution of only original Project SPV with a new company, instead of a direct exit of consortium members. This note sets out a snapshot of the key aspects of the Exit Policy. 1. Applicability of the Exit Policy

The Exit Policy is applicable to only following national highway projects: (a) On-going 2-laning and 4-laning projects, which have achieved financial closure (but not COD); (b) On-going 6-laning projects, which have achieved financial closure (but completion certificate is not issued); (c) Completed 2 laning, 4-laning and 6-laning BOT projects; (d) All new 2-laning, 4-laning projects and 6-laning PPP projects to be awarded in future on BOT basis. This Exit Policy clearly excludes a large number of recent BOT projects which have not yet achieved financial closure. 2. Pre-condition(s) for Substitution

Financial Distress: The original substitution agreement requires that a financial default should have actually occurred before resorting to substitution. The Exit Policy permits substitution without an actual financial default. In the Exit Policy, the definition of Financial Default is expanded to include a scenario where the following two conditions are fulfilled in the considered opinion of lenders and/or NHAI: (a) Project SPV is likely to face financial distress; and (b) Project SPV is likely to default under the terms of the Concession Agreement. As for the process, the Project SPV would need to make a written representation to the lenders with a request to them to seek NHAI approval for substitution. It appears that this representation would essentially need to demonstrate financial distress requirement. One potential challenge in this respect is that self declaration of financial distress may trigger cross defaults under other agreements of the consortium members/Project SPV, depending on the drafting of events of default, insolvency proceedings, etc., in other agreements. It would be interesting to see if the Exit Policy provides an exit route for developers of projects which are financially viable. Financial distress of the project SPV as a precondition for substitution gives a prima facie impression that the Exit Policy might not apply in relation to viable projects.

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It is however worthwhile exploring whether deterioration in the financial health of consortium members leading to a potential inability to make requisite equity contributions or to continue maintaining any required guarantees or discharging any undertakings which may be required under the financing documents, or the likelihood of attachment and sale of their assets including shares of the Project SPV, can be said to lead to financial distress of the Project SPV and consequent breach of the concession agreement. There is another interesting detail in the Exit Policy. Paragraph 4 of the Exit Policy clarifies that the right of substitution by the lenders representative is not limited to situations listed in the substitution agreement. Thus, it can be argued that the Exit Policy allows the lenders to recommend substitution even in projects where there is neither financial default nor financial distress, if they consider such substitution to be in the interest of the project (please note that the general rule which the lenders need to follow while recommending substitution is set out in para 4(i) of the Exit Policy which says that the lenders representative needs to be satisfied that the proposed substitution will be in the interest of the project). Notwithstanding the language of the Exit Policy which ostensibly vests wide discretion in the lenders to recommend substitution, considering the reluctance with which the exit policy was brought in, the chances of convincing the lenders to exercise wide discretion in this regard might not be very high. It would, therefore, be important for the developer and investor communities to engage with the lenders and explore their willingness for recommending substitution without any financial default or distress in the project. 3. Role of Lenders

The substitution process is to be initiated and led by the project's lenders. Therefore, the Exit Policy, it appears, would be inapplicable to projects where loan obligations have been fully discharged, in which case, promoters of such projects would continue to be subject to lock in provisions of the concession agreement. While this is ironic, given that the objective behind the Exit Policy was to rescue the roads sector and the lenders from the current financial distress, this does not seem to be an oversight. This 'no full exit in zero debt road SPVs' also makes the Exit Policy less than ideal for attracting financial investors into completed projects. Lenders need to assume a central role to implement the substitution under the Exit Policy. The key responsibilities cast on the lenders include determining whether the substitution would be in the interest of the Project, selection (and to some extent certification) of substitute entity (or substitute promoters), equity valuation for substitution and recommendation of substitution to NHAI. It remains to be seen if the lenders would be willing to assume these responsibilities except in cases where failure to do so would jeopardize their own interests. If the lenders show any reluctance or resistance in assuming these responsibilities, the expanded avenues under the Exit Policy for substitution might get negated, practically! 4. Approval from NHAI

The lenders' proposal for substitution is to be submitted to NHAI for its approval. NHAI's discretion to reject the proposal appears to be limited to determining whether the credentials of the substituting entity are satisfactory, which are: 2

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(a) (b)

for operational projects, adequate experience in O&M of completed road projects by itself or through its associates or subsidiaries; and for under-construction projects, requisite financial and technical qualifications for bidding a similar or bigger project;

However, it remains to be seen whether NHAI will limit its approval to this specific question or will analyse the broader question of whether the substitution should take place or not in the first place. 5. Conclusion

If lenders are willing to initiate the substitution process only in cases of acute financial distress, the Exit Policy is unlikely to benefit the investor community as their exit from projects would also be subject to the conditions under the Exit Policy. A financial investor would balk at the prospect of having to self declare financial distress! These are however early days of the Exit Policy, and it remains to be seen if the lenders embrace the idea that substitution can be proposed even where there is no financial distress and how NHAI reacts to any such recommendation. Another hitch is the fact that investors in projects where loan obligations have been discharged, would not be able to take the benefit of the Exit Policy. Given these hurdles around an eventual full exit by a new investor and the ambiguities around feasibility of full exit in financially viable projects, acquisition transactions of the relevant projects are likely to be acquisition of majority stakes (to the extent allowed in the concession agreements), with the original promoters retaining the remaining shareholding. In this context, it would be essential for acquisition documentation to contain robust frameworks for governance and operation of the SPV, sharing of costs, profits, etc.