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The Principles of
Project Finance
Edited by

ROD Morrison

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2 Dos and Donts for

Successful Projects
Anne Baldock
Partner, Allen & Overy

There are many ways to define a successful project but no matter how hard we try, we
cannot get away from the fact that most people, when they speak of a project being
a good project rather than a bad one, are referring to a project that has been built on
time, to budget, had no teething troubles (either technically or revenue generation wise)
during its early years of operation and continues to roll on into the sunset with little
or no intervention from any party other than the operator and the ultimate customer/
purchaser of services. No matter that a project may have operated smoothly for the last
10 years and resulted in higher than expected returns for investors if, during those
crucial construction and commencement of operations months or years it has faltered in
any manner then it will never, repeat never, get to bear the proud badge of a successful
What then can one take from this definition of a successful project that will assist
in bringing only good projects to fruition? Well, maybe one lesson is that not all projects
that falter in the early years are forever doomed to be problematic and loss making, but
surely, the lesson that seems to be screaming at us the loudest is that there is no substitute
in a projects context for good planning, common sense and a sensible, balanced and
healthy aversion to excessive risk. Yes, maybe the true lesson to be learned is the one that
has recently been taught so resoundingly to the banking community as a whole, namely,
there is no such thing as a free lunch.
Too often, even today, investors (both public and private) come to the project finance
market with the aspiration of financing their dream project with, as they see it, large
amounts of (other peoples) funding, whilst spreading the unpalatable risks associated
with their venture to others. Any investor coming to the table with this mindset must,
and will, be disabused of their notions fairly swiftly but the lingering dregs of this mindset
can and will make negotiating any project finance deal tortuous and lengthy and will
certainly not assist in attempting to keep the project to a set timetable!
My advice to those that hold the above view of project financing as a tool is do not
even attempt to undertake your venture using project financing. Most assets that are to
be project financed will be long term assets. Their viability will only become apparent
over the long term. Equity investors in projects should not believe that they are going to
get rich quickly. What they are undertaking is a long term investment that will bear fruit
and reap rewards over the medium to long term.

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The Principles of Project Finance

Bank investors in project finance transactions are, on the other hand, not likely to
ever get rich albeit they will make a comfortable living! They are making a much smaller
return over a much shorter period. They will seek to protect that small return by every
means they can possibly think of and then some this is not unreasonable (or perhaps
in some cases it is) but it is just a fact of project finance life. If a sponsor truly has faith
in his project he should be looking to protect his investment and to retain his project,
not to nickel and dime the lenders out of the protection they feel is necessary to protect
their return. If a healthy respect for the differences in approach between equity and debt
can be maintained at all times then many of the often tortuous negotiations can often
be short circuited.
A reasonable stance at the negotiating table not only assists in keeping projects to
time but also helps to forge a relationship with others around the table. A relationship
that will continue for a long time and which will be invaluable if rocky times ensue. It is
worth spending the time, up front, analysing your project, stress testing it and looking
hard at all the little shocks that will come at it throughout its life (certainly its early
life). To the extent that you are able to do this wearing multiple stakeholder hats and
anticipating each particular stakeholders requirements, then so much the better. You
should then be prepared to share that knowledge (good and bad) with others and to seek
a sensible way through the mire that is a Greenfield Project. Remember, if you wont take
a particular risk then the chances are, nobody else will. However, if you havent even
thought about a particular risk and that risk is brought to the table by others, then its a
dead cert that nobody else will take it. In order to argue convincingly that others should
share a risk then you have to be able, hand on heart, to say that you would be prepared
to take that risk yourself.
What then can each of the parties to a project financing transaction do to put
themselves in the space that is most likely to lead to a successful project? I set out below
some of my thoughts (as an observer and legal putter together of projects for over 20
years. I am sure that there are a number of other issues that I will have forgotten, I am
sure that there will be many reading this who will say no, shes wrong, we can be much
tougher than that and get away with it. I am sure that there are circumstances where
they will be right. However, what I offer here are some observations as an interested but
non-partisan bystander who generally stands-by right in the middle of the structuring
and negotiating action.

The Public Sector

My first set of observations/advice is made in respect of the public sector. I start here
mainly because many of those entering into project finance transactions from the public
sector side are doing so for the first time. They feel uncomfortable in their PF shoes.
They feel like the new boy starting in the fifth form of a rough comprehensive school
with a whole posse of sixth form private sector bullies who know exactly where all the
classrooms are and what the protocol for the school day is. Often, the project director is
only undertaking the project using PF techniques because it is currently the politically
chosen manner of doing things, a manner which may well change overnight, and he
has nothing to gain by making decisions that are not strictly within the brief he has

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Dos and Donts for Successful Projects


been handed. What then can public authorities do to try to assist in ensuring that they
procure, let and manage successful projects?

Number 1, Rule of law

The absolute number one requirement for successful projects is that they are undertaken
in a stable and sustainable environment where the contracts and the relevant governing
laws do what they say on the tin.
In this regard, it is not just the contractual framework that is important. Clearly, the
rights and obligations of the parties should be set out unambiguously and it is important
that difficult nettles are grasped at the outset and not fudged in an effort to reach some
false deadline for signing of documentation. However, the best contracts in the world
are worth nothing unless those rights are supported by robust, stable and equitable laws
which are enforced in a consistent and non-partisan manner by the relevant courts.
Better one contract where the project sponsors earn a little too much than to send
shockwaves through the entire market or stifle much-needed investment in a sector
by retrospectively amending contracts or imposing later tax regimes or regulatory
frameworks to try to counter such over-payment. Any ad-hoc attempts to adjust the
rights of the parties can lead to severe market unrest and a loss of confidence by other
project providers. If authorities are nervous of the private sector beginning to earn superprofits then far better to deal with this issue up-front by setting a limit on the amount
capable of being earned, taking an equity stake in the venture to share in the up-side or
inserting a re-balancing clause of the type enshrined in statute in Spain than to try to
fix the issue ex-post-facto.
At a time when one of the most precious resources globally is financial investment,
the need to retain the confidence of potential investors and the need to make the doing
of business in ones home country simple and straightforward is paramount. Outrage
in the Australian mining sector where additional taxation is being imposed by central
government is being mirrored by oil and gas exploration companies operating in the
North Sea. Such spats of anger should be listened to. At a time when the economic position
of so many countries is making it harder and harder to decide to invest, governments
(including those in established western democracies) will need to think long and hard
and take steps to ensure that the market view of stability and rule of law are maintained.

Number 2, Good advice

Get Good Advice, not just from those firms that specialise in giving advice to public
authorities or understand fully the finances and legal constraints placed upon public
bodies but from firms (financial, legal and technical) that are expert in the wider projects
and financial markets. These people are able to advise not just on what the outcome of the
current project or a particular action may be on the project in hand but can take a wider
view and advise on the consequences for other projects or the public bodys business
more generally. They can also act as minders to the public sector, having knowledge
of how similar projects have been undertaken elsewhere and whether the stance being
taken by one of the protagonists on this particular project is a stance that is generally held
in the market and/or what steps have been taken to mitigate or get around such a stance
or any particular risk in other situations.

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The Principles of Project Finance

In this respect, taking soundings from the market and interacting with potentially
interested bidders, financiers and financial investors ahead of time is a useful tip. The
UK Government learned this in a rather painful manner when their original attempt to
procure bids for the design, build, maintenance and financing of prisons within the UK as
private prisons financed through the PFI programme had to be withdrawn when funders
refused point blank to accept the risk of occupancy levels being used as the marker for
setting payment regimes. One cannot help but feel that this reluctance should hardly have
been a surprise to government. The banking market was grappling with new concepts
(PFI) in a new sector (prisons) where prison occupancy and prison sentencing policy
is clearly dictated and controlled by the government payer. Credit to the government
that these projects were eventually successfully resurrected and completed as availability
payment projects which went on to form the basis for all of the early PFI accommodation
projects undertaken by the UK government and to form the bedrock of the hugely
successful programme of PFI/PPP projects undertaken by the UK. A pity perhaps that the
lessons learned have not been highlighted to others in an effort to avoid repeats in other
Further examples of the advice received by government perhaps being a little too
public sector focussed are the UK NHS Lift Projects. The scheme (which took some 1824
months in gestation) was intended to ensure that a single procurement would suffice
to select the service provider that would be responsible for multiple projects to provide
local health care, doctors surgeries, dispensaries, clinics, etc to a particular local area. The
procurement strategy was faultless. However, the government had failed to anticipate the
manner in which multiple projects by the same consortium would effectively be financed
and the original structure required major surgery during procurement of the first projects
to ensure that the required pipeline could be met.

Number 3, Listen
Listen to your advisers and be prepared for push back prepare in advance for meetings
and manage your internal client as well as the external project provider.
Much of the time spent by public authorities in negotiating contracts with the private
sector arises as a result of an unwillingness to even try to understand the hopes and
aspirations of the private sector ahead of large-scale set piece all-party meetings. All too
often, the response of the public sector to comments and suggestions made by the private
sector are dismissed without any real consideration and, as a result, when explanations
are given as to why any such suggestion has been made, time is lost whilst such new
concepts have to be run up the chain of command internally after lengthy meetings
have already taken place. If public bodies approach the issues raised by the private sector
more empathetically rather than assuming that every change requested is an effort to do
down or get one over on the authority then far more constructive dialogues may be
undertaken at meetings and internal approvals can be sought ahead of time. Knowledge
of the authoritys wider stance on any particular issues gleaned during these pre-meeting
discussions can also, then, be used to good effect during negotiating meetings rather than
slowing down the process outside.
Good advisers will be able to understand much of what is being asked for and should
be listened to when reviewing commentaries/approaches being adopted. Indeed, to
dispatch ones advisers to request clarification of issues ahead of full party meetings and to

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ask the question, why? can save much time and heartache during the key procurement
phase of any project.
This open approach will also assist in trying to decipher commentaries made by
competing bidders for the same project who choose to adopt a different negotiating style
to requests for responses to information. Many is the time when an authority has selected
the bidder who adopts the stance of everything is broadly acceptable provided we can
discuss a couple of issues with you after we are appointed only to discover further down
the line that those discussions are around exactly the same 105 issues which were the
requested amendments or points in respect of the information raised by other (perhaps
more straightforward) bidders. An understanding and open approach will assist in teasing
out the required information early on, as will the setting of clear parameters around the
type of answers and level of detail required by way of response.
By the same token, public authorities who have a set way of doing their transactions
and who are not prepared to adapt them should not run a process where they state that
they are going to be flexible and take account of bidder requirements where they are not.
Instances of this approach have been rife in the transport sector in the UK and elsewhere
and serve only to frustrate bidders who spend millions of pounds in bidding in earnest
and sharing their concerns, only to have them completely ignored when final bids are

Number 4, Train up
Finally, the advice that I would give to public authorities embarking on project finance or
PPP programmes for the first time is train your people.
In this context, I am not speaking of the project manager during procurement but
rather the people who will have to manage the living, breathing project through to
completion and beyond.
There is always much talk around the fact that good Project Managers in the public
sector just get to the position where they are comfortable in their shoes when they then
get moved on to other departments or promoted to other jobs and the knowledge of
how to get a project completed is lost to the public authority. Whilst it is true that this is
frustrating, this lack of expertise merely delays the project at the early stages whilst new
people get up to speed or makes the process of procuring a project a longer and more
tedious process than it perhaps should be. However, such difficulties pale to insignificance
in comparison to the differences over the life of a project between a successfully managed
and operated project and a dysfunctional one. The issue of lack of expertise at the outset
can easily be managed by, if necessary, hiring competent project manager consultants
whilst the mismanagement of a live project will have a far wider reaching effect than the
one-off procurement.
The training that public sector employees require for successful project management
is training as to the manner in which they should look to enforce the letter of the contract
and the options that might be available to them within the framework of the project
portfolio of the relevant public authority more widely. What matters is that the manager
seeks to obtain best performance from the project provider over the lifetime of the project
rather than just squeezing the contractual provisions available to them until the pips

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The Principles of Project Finance

An operating contractor who is shown some give and take rather than being stung
with maximum penalties for minimum misdemeanours each time they occur will, in the
long run, provide better value. Whilst the penalty regimes and contractual rights set out
between the parties within the hard-fought contractual arrangements have their place
in a well-run project, they should not be taken as holy writ, but should be exercised and
enforced with discretion and sympathy and an eye on value rather than cost.
It should perhaps be remembered that all legally binding contracts ultimately give the
parties a right to sue for breach. Of course, in only a very few cases do the protagonists end
up suing their case in court. Compromises and settlements are by far the more prevalent
outcome. The settlement of an issue that is not fundamental to the performance of the
contract and that that suits both parties even if not catered for by the strict letter of
the contract is surely far more use to an ongoing project than a small (and often smallminded) victory on each minor point. Many is the time that a small missed target on dayto-day maintenance, answered help desk call-outs, etc have been utilised not to deduct
penalty points or deduct payments but to perhaps obtain a fresh lick of paint on tired
woodwork at the same time as maintenance is being carried out nearby or to repair or
redirect a sewer on another project run by the same service provider.
PPP and other project contracts should be viewed as contracts that drive performance
and drive value out of the services provided. They should not be seen as a revenue
generation scheme by the relevant receiving authority.

Joint Venturers and Consortia

Number 1, Know your partners
Unsurprisingly, the best operating consortia are those comprising groups of persons
coming together in a situation where respect, co-operation and understanding of the
needs of the other members is high and the bargaining position of the relevant parties is
equal. Unsurprising, also, is the fact that the stars are very rarely aligned in this manner.
In order to put together a bid, or any project for that matter, in a cohesive and coordinated fashion, it is important that the JV partners inequalities and expectations are
discussed and agreed well ahead of time. Any attempt to hide or fudge the issue will,
inevitably, show up at a later date, in a far more public forum and will potentially discredit
a bid and undermine the confidence of the letting party/financiers to that project.
Issues to be resolved in advance include:

joint and several or several liability;

tax positions of the parties and tax structuring issues;
creditworthiness issues and manner of dealing (upfront equity/bank LCs, etc.);
desire of the parties to finance on or off balance sheet; and
negotiation of/voting on contracts with associated third parties (e.g. construction/
O&M arrangements which are typically sourced out by the associates of the JV

A failure to address such issues and an unwillingness to grasp the nettle but to leave
it to others (e.g. financiers/the public authority/their advisers or worst of all your co-

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venturers) to point up the weaknesses in a JV or contracting structure generally leads

to protracted and unhappy negotiations and sets a project off on a wrong foot with a
mountain of trust and honesty to climb never a good beginning.

Number 2, Know your financiers

Recognize early in the process that the lenders will have specific needs think ahead
and do the preparation work for a project with a clear understanding of those needs to
prevent the need to repeat simple exercises two or three times.
For example, each funder will need to undertake KYC procedures when setting
up the new company, ensure that relevant documents are placed on a web portal that
each can access so that the exercise is only undertaken once by the company. If your
project is looking to utilize funds from international development banks then ensure
that environmental surveys and monitoring procedures that you set up are set up at the
outset in a manner that will mean that they comply with the World-Bank requirements.
A lesser standard will be a false economy in terms of cost and time at the end of the day.
Recognise that if equity is to be injected into the project pro rata with commercial
lenders then credit rating of the equity provider will be a key factor. If a bank LC is
required, start working on obtaining this early on in the project development. Do not
wait until two days prior to financial close when you have finally read the CP schedule to
the borrowing and discovered that you need to negotiate specific forms of LC to comply
with lender requirements or will have to seek unnecessary and complicated waivers for
non-compliant (in terms of strict wording) LCs.
Set up accounting systems and reporting systems on day one in a manner that should
satisfy the lenders and then take the time to read the information sections of the credit
documentation carefully. Far too often those negotiating credit documentation spend
their time arguing over materiality qualifications for covenants and events of default
and skim over the reporting requirements, many of which can be exceedingly onerous
on-going requirements for a project company to fulfil with limited personnel available to
them, and at the same time as trying to manage a construction programme or operational
facility. Remember, the reporting requirements are an on-going cost to the business.
Rarely should lenders need anything which the sponsors do not (or will not) find useful.
If large amounts of excess information and reports are being requested, a frank and open
dialogue should be had to ensure that the banks standard form has not overtaken
common sense on the project.

Number 3, Make the tough decisions early

Tempting though it may be if contracting parties are associated companies, dont try to
make the construction or operating contracts too onerous on the project company. A
construction contract or operating contract that has not been properly negotiated and
prepared (as if between two truly third parties) will not pass muster with financiers who
will seek to renegotiate a clearly one-sided contract often resulting in a far tougher
contract than might otherwise have sufficed.
The washing of a sponsor groups dirty washing in public is never an edifying
experience and again leads to wariness throughout the project which is not conducive to
long-term successful projects.

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The Principles of Project Finance

Although each project is individual to the needs of the parties and the associated
geographies/market needs, there is a clear risk allocation in projects within each relevant
sector which is broadly accepted within that sector. Sometimes, the differences between
sectors have no logical reason to exist beyond market precedent. However, it is important
that parties know what the generally accepted allocation is and highlight to other
participants in the project where the risk allocation in this particular case differs from
that norm. If this is done, together with a clear explanation as to why such an approach
has been adopted then such a stance will be far more likely to gain acceptance and
speedy resolution than where such issues have been negotiated behind closed doors and
presented to others as a fait accompli.
Sponsors should also clarify up-front the type and amount of completion support is
required. Too often, this all important element is fudged at heads of terms and term sheet
stages only to become the make or break point at the eleventh hour of negotiation when
all parties have expended too much time and effort into the process to be capable of either
backing out or backing down. Issues such as amount, principal or interest only, default
payment versus on-going payments, required completion tests (timing, parameters,
etc.) should be worked out in detail up-front in order to prevent major hiccoughs at a
later stage. I have just recently been working on a project that has been shelved after 18
months of work as a result of a fundamental misunderstanding of the nature and amount
of completions support being offered.

Number 4, Think about the future

When entering into a long-term financed position, parties should always have one eye on
the future and on how the project itself and also the project economics can be improved.
In this regard, thought should be given to whether or not a differential margin
should be required pre- and post- operations and/or whether the credit facility is easily refinanceable once the riskier (and therefore inherently more expensive) part of the project
has passed.
In this regard, the hedging arrangements put in on place day one will potentially
have a large impact on the economics of a refinancing case and the ability to negotiate
flexible hedging arrangements with embedded break provisions may (although initially
more expensive to procure) prove to be a better long-term economic investment.
This is an issue not just for the private sector sponsors of a project. The UK
government has often lamented the fact in public that its PPP sector has not evolved
into a conglomeration of companies holding many and various PPP assets and taking a
corporate holistic view across its portfolio, but has rather retained the structure of many
small single-purpose project vehicles undertaking their own small projects.
This seems an odd lament indeed when the documentation which has been fought
over and defended to the hilt, often against all rational instincts of those actually carrying
out the projects, provides such barriers to any other structure ever being adopted. The
requirement for 100 per cent interest rate hedging, the requirement for all re-financings
and change-of-control arrangements to obtain prior approval, the need for major
contractor changes to be approved, etc. all seem to lead inexorably to fossilization of
the project and an inability, or at least a major disincentive, for the private sector to drive
further values and structures out of the projects what a pity that such innovation and
creativity have been stifled at the altar of standardization.

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All Parties
Dont say no, ask Why?
Too many parties to a transaction will argue for a position in negotiations because that
is the way the original document presented to the parties was drafted. Such documents
have often been drafted with no thought or only limited understanding as to the current
project needs and with the desire to protect a particular position in a particular manner.
What must be remembered is that the manner in which a particular issue is dealt with in
any document is almost certainly not the only way in which a particular position can be
protected or a particular outcome achieved.
There are, of course, times when a tough stance in documentation will need to be
taken and maintained. We have all at some stage banged our heads against the stone wall
that is the development banks standard form or ingrained policy. However, in the main,
a rigid position is not required and a partys desired aims and goals can often be achieved
in a manner which is far more palatable to the other side and which, in the context of
a long-term partnership arrangement, is probably far better suited to the task in hand.
Taking the time to understand why provisions have been presented in a certain
manner will usually assist parties to take their eyes off the page of negotiations and
concentrate on the consequences of their actions and the desired outcomes for the parties
and the project.

It is always difficult to predict at the outset which projects will be successful or even
what success will look like. To give a famous example, work on the Clifton Suspension
Bridge (one of Brunels best known civil engineering projects in the UK) was started in
1831, but then suspended due to riots which drove away investors, leaving no money for
the project, and construction ceased. Work recommenced in 1862 (after a concerted fundraising effort by colleagues of the, by then late Brunel, and admirers at the Institution
of Civil Engineers who felt it would be a fitting memorial. The project was completed in
1864, five years after Brunels death and 34 years after its commencement. The Clifton
Suspension Bridge still stands today, and over 4m vehicles traverse it every year. Who is
to say that this was not a successful project?
But by most peoples reckoning a successful project still remains a project that is
built in the time anticipated, that is completed at the cost which was anticipated, that
operates smoothly to provide services to the end-user at an affordable price and which
provides a sufficient return for the contractor, operator, supplier, sponsor and other
project stakeholders. One can only hope that some of the words written above will assist
those desiring to undertake successful projects to ensure that this highly improbable and
illusive confluence of events occurs.

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