FIDIC MDB HARMONISED CONSTRUCTION CONTRACT CONFERENCE Session 10

FIDIC MDB HARMONISED CONSTRUCTION CONTRACT CONFERENCE Session 10: Client Perspective Borrowers, private clients, finance issues Jacques Bouillon Partner, White & Case LLP 26 June 2012

Introduction to Project Financings Contractual Scheme of a Project Finance FIDIC MDB HARMONISED CONSRUCTION CONTRACT CONFERENCE Session 10: Client Perspective Borrowers, private clients, finance issues (26 June 2012) White & Case

Role of the Construction Contract in a BOT- Concession Scheme within a Project Finance Structure Ø In a typical scheme a special purpose vehicle (the “SPV”) has the rights and obligations under a concession or a BOT agreement (the “Concession-BOT Contract”) with a public body (the “Grantor”) to design-finance-build and operate an infrastructure (1); Ø The SPV finances the construction of the facilities through loans from banks (4) or the capital markets as well as through equity investments from its shareholders (5); Ø Due to the non-recourse nature of these loans, Lenders looks principally to the cash-flow generated by the operation of the project (6) - and not from the shareholders - as the source of funds from which their loans will be repaid; Ø To satisfy the SPV’s obligation to the Grantor to design and build the infrastructure, the SPV will enter into a construction contract (the “EPC Contract”) (2) with a contractor (the “Contractor”); under such a contract, the Contractor will be required to design-build test and commission the project on a turnkey basis for a fixed lump sum price and within a fixed time for completion, guaranteeing a specific quality or level of performance for the completed works; Ø The terms of the EPC Contract will be as far as possible “back-to-back” with the Concession-Bot Contract and thus any construction risk placed on the SPV by the Concession-BOT Contract will, through the construction, flow down to the Contractor; Ø The price paid to the Contractor is usually the largest capital expenditure incurred by the SPV …. and the EPC Contract is usually, the most likely source of significant cost overruns. FIDIC MDB HARMONISED CONSRUCTION CONTRACT CONFERENCE Session 10: Client Perspective Borrowers, private clients, finance issues (26 June 2012) White & Case

Lenders, Shareholders and Grantor’s expectations – Consequences on the construction Contract Ø Shareholders seek to raise money for the implementation of a project Ø Shareholders expecting a return on equity will want to protect their expected returns by placing construction risk on the Contractor; Ø Shareholders also know the more risk they can transfer to the Contractor, the less direct or indirect support they are likely to be asked to provide to the project by Lenders to cover such risk (8); Ø Any Lender will want to satisfy itself as to the expertise and experience of the Contractor and check the terms and risk allocation under the EPC Contract before committing itself into financing; Ø The EPC Contract will result in the piece of infrastructure that will be relied upon by the Grantor during the term of the concession period and will be handed over to the Grantor at the end of the period; Ø All these factors will put pressure on the Contractor to accept an increasing amount of responsibility and construction risk. Ø Lenders may be less concerned about having the SPV pay a higher construction contract price in order to induce the Contractor to accept as much construction risks as possible; the Shareholders (in particular those not affiliated with the Contractor) will generally view a higher price as reducing their equity return and will be much more sensitive to contract pricing; FIDIC MDB HARMONISED CONSRUCTION CONTRACT CONFERENCE Session 10: Client Perspective Borrowers, private clients, finance issues (26 June 2012) White & Case

Focus on the EPC Contract within a Project Financing Framework To evaluate the bankability of a project, the Lenders need to be able to assess with a certain accuracy the residual risk borne by the SPV (the borrower) in fine, i. e. the risk not borne by either the Grantor through the Concession-BOT Contract or by the co-contracting party through the EPC Contract or the O&M Contractor under the O&M Contract (3). Thus, to tend to such certainty in a project financing, the construction contract is: a. Usually a turnkey contract : i. a design and build contract ; ii. fully equipped facility delivered, ready for operation at the “turn of a key” (the “EPC contract”); iii. lump sum price; iv. strict construction timetable (damages provisions): longstop date; v. must be bankable – contractor with a good credit risk or supported by a creditworthy guarantor. b. A turnkey contract with specific technical aspects : i. strict definition of the transparency principle with the Concession-BOT Contract (back-to-back); ii. accurate treatment of the guarantees; iii. insurances; iv. payments; v. Lenders’ rights (step-in rights). FIDIC MDB HARMONISED CONSRUCTION CONTRACT CONFERENCE Session 10: Client Perspective Borrowers, private clients, finance issues (26 June 2012) White & Case

Which FIDIC Standard Forms to Tailor? Ø As a consequence, the Silver Book, which was originally intended for use in privately funded projects such as a turnkey subcontract in private-public partnerships (PPP), seems to be a more suitable basis to tailor a standard form of D&B contract within a project financing framework, notably for the following reasons: ü EPC/Turnkey contract ü Lump sum price ü Allocation of risks: more risks borne by the Contractor which avoids uncertainty of risks borne by the SPV Ø The Pink Book (MDB Harmonised Edition), even if including specific clauses adapted to Multilateral Development Banks, seems less suitable, notably as it is not drafted for turnkey projects and the SPV is in charge of the design (whereas, in the Silver Book as well as in a project financing scheme, the Contractor is). FIDIC MDB HARMONISED CONSRUCTION CONTRACT CONFERENCE Session 10: Client Perspective Borrowers, private clients, finance issues (26 June 2012) White & Case

The Back-to-Back Principle: Definition of the back-to-back principle Ø Complete transparency between (i) the duties and obligations of the SPV under the Concession-BOT Contract and (ii) the duties and obligations of the Contractor under the EPC Contract regarding the design and construction aspects (same mechanism as the one contemplated in the FIDIC book Conditions of Subcontract for Construction). Ø The back-to-back principle serves the bankability of a project as it ensures that, except for those which cannot be passed through because of law restrictions, all the project risks “pass through” the SPV directly to the most suitable co-contracting party to bear it (in the case of construction risks, to the Contractor). Ø Strict definition of the transparency principle: a. Only « if and when » ; b. Claim mechanism: due proportion with payment devolved primarily to the Lenders (the “Due Proportion”); c. Documentation hierarchy: (i) Concession-BOT Contract and (ii) Contractor Direct Agreement both prevail on the EPC Contract in case of contradiction. FIDIC MDB HARMONISED CONSRUCTION CONTRACT CONFERENCE Session 10: Client Perspective Borrowers, private clients, finance issues (26 June 2012) White & Case

The Back-to-Back Principle: Consequences The back-to-back principle reflects on all the D&B Contract, notably: Ø Payment of any sum due by the Grantor to the SPV for the construction phase under the Concession-BOT Contract like subsidies (if any) or indemnities; Ø Back-to-back guarantees: bank guarantees (e. g. : performance guarantee) may be ordered directly by the Contractor to the benefit of the Grantor to avoid a two-level guarantee unnecessarily expensive; Ø Back-to-back penalties: capped and specific (e. g. : delays, construction phase) allowing a more accurate assessment of the maximum risk incurred by the SPV (to reflect it on the Contractor); Ø Force majeure, unforeseen events, change of law (same grounds to claim additional time and additional money to complete the works than those provided for under the Concession-BOT Contract); Ø Administrative procedures; Ø Termination grounds: grounds of general interest, force majeure, unforeseen event, breach by a party, breach by one party leading to the termination of the Concession-BOT Contract; Ø Termination indemnities: the SPV will indemnify the Contractor only up to the amount it received from the Grantor, within the limits of the Due Proportion and only once the SPV has actually receive the payments from the Grantor. FIDIC MDB HARMONISED CONSRUCTION CONTRACT CONFERENCE Session 10: Client Perspective Borrowers, private clients, finance issues (26 June 2012) White & Case

Additional Protections within the EPC Contract Ø To minimize their exposure, in addition to the protections offered by the back-to-back principle, the Lenders usually also require: Ø Additional guarantees Ø Construction timetable: shorter deadlines for the Contractor to perform its obligations so as to enable the SPV to comply with its own deadlines under the Concession-BOT Contract; Ø Additional penalties, notably those incurred in relation to the Loans: § Example of provision: “Within the limit of the penalty cap, the Concessionaire may apply to the Contractor … any sum intended to repair … damages suffered by the Concessionaire as a result of a failure to perform or poor performance of the D&B Contract by the Contractor, and, for example, an increase in management costs for the Concessionaire and/or late payment interest and/or financial costs and/or costs connected with adjusting or liquidating interest rate swap agreements and/or loss of operation and/or indemnities owed to the Operator and/or indemnities owed to third parties”. § Specific caps for more accurate assessment of the risk borne by the SPV. Ø Liability cap, notably adjusted so as to cover the remaining amount of the outstanding debt of the SPV, not already covered by the indemnity paid by the Grantor in case of termination for breach of the Concession-BOT Contract. Ø Performance deadlines depending on completion (≠ taking-over). FIDIC MDB HARMONISED CONSRUCTION CONTRACT CONFERENCE Session 10: Client Perspective Borrowers, private clients, finance issues (26 June 2012) White & Case

Lenders’ Involvement Taking into consideration of the Lenders in the project documentation and appointment of a technical advisor by the Lenders (LTA) to ensure there is no management of the project by the Lenders but only a technical involvement. Illustrations: Ø LTA: § Validation of (i) technical aspects such as key milestones, (ii) payment to the Contractor… § Participation in (i) the meetings, (ii) the taking-over process… § Access to the site and information (copy of technical documentation, modification, studies…) Ø Lenders: § No offset by the Contractor of any sum due to the SPV with sums due by the SPV to the Contractor until Lenders are entirely paid § In case of termination of the Concession-BOT Contract, neither imputable to the Contractor or to the SPV (i. e. force majeure), the Lenders have to be repaid before the SPV indemnifies the Contractor (Subordination principle); § Agreement by the Lenders to the EPC Contract’s assignment FIDIC MDB HARMONISED CONSRUCTION CONTRACT CONFERENCE Session 10: Client Perspective Borrowers, private clients, finance issues (26 June 2012) White & Case

Construction Direct Agreement (7) The Construction Direct Agreement, as its name implies, organizes the relationship of the Contractor directly with the Lenders and the SPV. It notably contemplates major principles in favor of the bankability of a project: Ø Subordination principle: the Contractor, in its capacity as creditor towards the SPV, is subordinated to the Lenders to be paid. Ø Remediation principle: the Contractor may not suspend or terminate the EPC Contract without having notified the Lenders and granted them a time extension to decide whether to remedy to the SPV’s breach or not. Ø Substitution principle: in case of contractual breach by the SPV under the Concession-BOT Contract, the Lenders may substitute a new entity to the SPV to avoid the termination of the project. In this respect, the Contractor undertakes to comply with its initial contractual obligations towards the new entity as if it was the initial SPV. Ø Representations and warranties: towards the Lenders and the SPV, notably in order to avoid that its subcontractors compete with the Lenders as creditors. FIDIC MDB HARMONISED CONSRUCTION CONTRACT CONFERENCE Session 10: Client Perspective Borrowers, private clients, finance issues (26 June 2012) White & Case

Interface Agreement (9) The Interface Agreement organizes the relationship between the SPV, the Contractor and the O&M Contractor as, during the construction phase, the O&M Contractor intervenes: Ø to comment, or validate, design plans and documents of the Works ; Ø to assist the SPV during the taking-over process. It notably tend to determine which actor assumes which tasks, responsibility, indemnity and penalty: Ø Possible “fronting”: the Contractor, during the construction phase, assumes in back-to-back the penalties potentially applied or the indemnities claimed by the Grantor under the Concession-BOT Contract. Thus, the SPV do not have to research which of the Contractor or the O&M Contractor has actually caused the breach. And as (i) during the construction phase, the Contractor is more likely to be causing the contractual breach of the SPV under the Concession-BOT Contract and (ii) the liability cap of the Contractor is more suitable to cover the sums potentially due (higher cap). Ø Afterwards, the Contractor may challenge the O&M Contractor. Sums paid under the fronting do not impact the global liability of the Contractor. FIDIC MDB HARMONISED CONSRUCTION CONTRACT CONFERENCE Session 10: Client Perspective Borrowers, private clients, finance issues (26 June 2012) White & Case