Globally, the coronavirus (COVID-19) has caused not only a major public health crisis but also major economic uncertainty, as supply chains are brought to a standstill, flights are grounded, borders, businesses and schools are closed, "stay in place" orders are announced and financial markets remain volatile. In the context of an energy project finance transaction, COVID-19-related interruptions to a project's construction or operations can have significant implications for project borrowers, sponsors, project counterparties and financiers.
This Holland & Knight alert outlines some of the issues that may arise under project finance documentation for a typical energy project finance transaction in light of the uncertainties and difficulties arising in this new and challenging environment.
Access to Information
Many clients have asked whether a project borrower is required to provide any information to the lenders or whether lenders have any rights to request additional information of the borrowers now that COVID-19 has created additional concerns about the future of a project. Most loan agreements contain information and notice undertakings of the borrower that will be triggered upon the occurrence of certain events (i.e., defaults under or termination of project contracts; delays in construction; reduction in energy demand or utilization; notice of litigation; and material notices under project contracts). Borrowers will need to consider the COVID-19 outbreak's impact on their project and whether any of these notice or information requirements have been triggered. Many loan agreements also provide lenders with a right to ask for additional information or require meetings with management or site visits. Borrowers will need to assess the reasonableness of the lenders' requests and respond to any such requests within the timeframes set out in the agreements to avoid a default.
Periodic Reporting
Customary project finance loan agreements typically include affirmative covenants that require borrowers to report periodic construction progress and certain financial information throughout the fiscal year. These may include construction progress reports validated by an independent engineer and year-end financial statements audited by the company's auditors. One of the most immediate impacts of COVID-19-related "stay in place" orders and general travel restrictions, is that independent engineers, auditors, other consultants and even project company employees may be unable to provide assistance and the required information in a timely manner. Borrowers will have to consider whether they will require additional time to complete certain information requests or whether to seek a waiver from their lenders.
Borrowing Requests
If the project is in the construction phase and the funds available under the loan agreement have not been fully drawn, the parties will need to consider if any events have occurred that would allow the lenders to refuse to fund (otherwise known as a "draw stop"). Borrowings are usually conditioned on the absence of an event of default (or potential event of default); the accuracy and "bring down" of the representations and warranties in the loan documents (including the absence of a "material adverse change" and solvency); and no delays in construction or anticipated cash or budget shortfalls. In general, borrowers will need to be careful when repeating representations for the purposes of a borrowing request to avoid misrepresentation and triggering a default. Borrowers also have to consider whether any conditions to borrowing include a forward-looking test, such as financial covenant compliance or compliance with approved project budgets or construction schedule. For projects under construction, COVID-19 may present workforce shortages and supply chain disruptions, as well as construction delays from regulatory/permitting agency shutdowns. Delays in construction milestones not only may trigger a default under the loan agreement preventing a borrowing, but may also trigger issues under material project documents (such as power purchase agreements) further complicating a borrower's outlook.
Budget and Liquidity
Many of the COVID-19-related impacts noted above may cause significant delays in construction and increased costs to a project. Increased costs can present two different types of risk to a project borrower. First, many loan agreements require a borrower to present and comply with (i.e., not exceed) an approved construction or operations budget each year. It is customary for some level of contingency to be provided within such budgets to cover unexpected cost overruns and other variables. However, borrowers will need to review any budget restrictions set forth in the loan documentation when approving any emergency expenditures that may be required to mitigate the impacts of COVID-19. In some cases, lenders have rights of approval regarding changes to a project budget, especially if the changes are in excess of a pre-agreed contingency amount. If borrowers do not have the flexibility to exceed budget and incur emergency costs without lender or agent approval, a borrower may need to request a waiver. Second, given the nature of project finance agreements, which typically severely limit the ability of borrowers to incur additional indebtedness, project borrowers may not have the liquidity needed to cover increased costs. Lenders may require additional sponsor support to cover cost overruns or a waiver may be required to allow the project borrower to access bridge or short-term financing to cover such shortfalls.
Force Majeure
It is expected that many project companies will receive notices from or deliver notices to their material project counterparties claiming force majeurein response to the pandemic and government-mandated quarantines and shut downs. "Force majeure events" are generally defined as those events that are unforeseeable and outside the reasonable control of the party seeking to have its obligations excused as a result of circumstances other than that party's negligence or willful misconduct. These provisions in most construction, equipment supply and power purchase agreements are highly negotiated and whether the parties may avail themselves of force majeure will depend on a close read of the contractual language. In the United States, case law is scant on the extent to which pandemics and government-mandated quarantines constitute valid grounds to suspend performance under energy-related contracts. As a general matter, force majeure is not customarily included in financing documents to excuse a borrower's financial obligations to lenders thereunder. However, if force majeureis invoked under material project contracts to excuse performance or completion delays thereunder, a borrower should review its loan documentation to confirm whether force majeure also operates to excuse what would otherwise be a default by the borrower for project-related delays under the loan documentation.
Events of Default
There are a number of events of default that could be triggered as a result of the COVID-19 pandemic. Many of these events may also extend to the material project counterparties, including the construction contractors, operator, main equipment suppliers and off-takers. Certain events of default that may be triggered by the current environment may include:
Non-payment and Insolvency: If a project is in the operational phase, principal and interest payments are likely to be due every three or six months. Lenders may worry that cash flows for many operating projects may be impacted negatively by COVID-19. Typically, a lender cannot call a payment default until a borrower actually misses a payment of debt service. However, given the issues raised by COVID-19, some lenders may make additional information requests of their borrowers to outline cash forecasts so that they can monitor the health of the project (as described above). Relatedly, in light of the dramatic effects COVID-19 has had on the energy markets, borrowers may not be able to represent that they are "solvent" (as defined in the loan agreement) and may have to seek bankruptcy protections.
Financial Covenants: Project finance documents include financial covenants to assess the ability of the project company to cover its debt service, often on a backward-looking and forward-looking basis. Financial covenants help lenders identify the financial health of a project and any early signs of trouble. The COVID-19 outbreak may cause a reduction in energy demand, which could have a negative impact on a project's revenues depending on the terms of their power purchase or off-take agreements. Reduction in cash flow is likely to negatively affect a borrower's compliance with financial covenants triggering a default.
Project Delays: As discussed elsewhere, loan agreements typically include an event of default for the failure to achieve construction completion by a certain date. Given the expected delays in equipment deliveries and the inability to mobilize workforces, construction delays may be inevitable triggering a default.
Defaults Under Material Project Contracts: Loan agreements typically include events of default for matters relating to material project documents, including but not limited to, breaches by contract counterparties, abandonment of work and/or termination or repudiation of project documents. If such actions are not expressly excused by force majeure pursuant to the terms of the loan agreement and such actions would have a material adverse effect, lenders may be entitled to call a default.
Material Adverse Effect: Many borrowers and lenders have asked whether the COVID-19 pandemic and its effects on the global marketplace has triggered "material adverse change" or "material adverse effect" provisions in loan agreements. "Material adverse effect" provisions require fact- and situation-specific analysis. Case law around what constitutes a "material adverse effect" is mostly acquisition-related, but a material adverse effect generally will comprise a downturn in the specific business of the borrower, that has occurred and/or is expected to continue for a substantial period of time. Identifying a "material adverse effect" will require the parties to carefully consider the drafting of the relevant provisions and surrounding circumstances (industry, geography, etc.).
Government Actions: In cross-border project financings, loan agreements may also include events of default related to moratoriums of governmental payments under power purchase agreements, expropriation or nationalization of assets and foreign currency controls. As governments around the globe struggle to contain the unprecedented economic fallout of COVID-19, dramatic steps may be taken in certain jurisdictions that may affect the energy industry at large and project borrowers and their assets in particular.
Conclusion
It is recommended that project borrowers review their finance agreements to ensure that they continue to comply with their obligations thereunder and interact with their material project counterparties (such as insurers, government agencies, contractors, O&M operators and suppliers) to identify potential issues and agree on how to deal with them. Time may be of the essence. Borrowers are encouraged to get ahead of possible issues and be mindful of how and when to communicate the same to their lenders.
DISCLAIMER: Please note that the situation surrounding COVID-19 is evolving and that the subject matter discussed in these publications may change on a daily basis.
