REVIEW OF BIJURALISTIC SYSTEMS
WITH REFERENCE TO PROJECT FINANCE AND
FOREIGN INVESTMENT VEHICLES
Kenneth Cutshaw
Holland & Knight LLP [*]
I. INTRODUCTION
II. MODELS OF PROJECT FINANCE AND INVESTMENT VEHICLES
A. Elements of Project Finance
B. Project Finance Structures
1. Commercial Loan Financing
2. Export Credit Financing
3. Lease Financing
4. Bond Financing
5. BOT
6. Co-Financing
7. Production Payments
8. Forward Purchase Agreements
C. Common Investment Vehicles
1. Host Country Requirements For Investment Vehicles
2. Investment Vehicle Types
a. Corporations
b. General Partnership
c. Limited Partnership
d. Limited Liability Company
e. Joint Venture
f. Development Consortium
III. CASE STUDY
A. U.S. Investment Model
B. Project Finance Model
C. Parent seeks opportunities outside of the United States
IV. ISSUES IN APPLYING U.S. MODELS TO LATIN AMERICA
A. Argentina
B. Brazil
C. Caribbean and Belize
D. Andean Region (excluding Venezuela)
E. Mexico
F. Mercosur (excluding Argentina and Brazil)
G. Venezuela
H. Central America (excluding Belize)
V. OPPORTUNITIES FOR HARMONIZATION
A. General Considerations
B. Investment Vehicle Harmonization
1. Foreign Ownership Restrictions
2. Repatriation of Profits Restrictions
3. Public Service Activity Exclusions
4. Preferred Equity
5. Subordinated Debt
C. Project Finance Harmonization
1. Security Interests and Mechanisms
2. Currency Exchange Regulations and Controls
3. Availability of Floating Liens or Charges on After-acquired Property
4. Process for Registering Liens and Movable Property
BIBLIOGRAPHY
I. Introduction
The American States benefit form the co-existence of two legal traditions: the traditional common law system adopted from the British Commonwealth and the civil law platform based on French civil law principles traditionally observed throughout Latin America.
The purpose of this paper is to identify how a bijuralistic reality may affect the current globalization trends on issues typically relevant to project finance models and investment vehicles.
The paper presents a typical case-study example of an investment and project finance model transaction in the United States in the electrical power sector. Issues encountered in applying the U.S. model transaction to eight Latin American sub-regions are then identified to highlight bijural tensions present in fostering development through investment and project finance throughout the Americas. Taking into account the application of the case-study example to the sub-regions and the issues encountered in that analysis, the final section of the paper suggests which areas present opportunities for harmonization at either the regional or sub-regional level.
II. Models of Project Finance and Investment Vehicles
A. Elements of Project Finance
Project finance refers to financing an asset based upon a non-recourse or limited recourse financial structure where the debt and equity used to finance the asset are repaid from the cashflow generated by the asset. The attractiveness of project finance is the ability to fund projects off balance sheet with limited or no recourse to the equity investors i.e., if a project fails, the project lender's recourse is to ownership of the actual project and they are unable to pursue the equity investor for the debt. For this reason lenders focus on the projects cashflow, as it shall be the main source for repaying project debt.
Project finance is used by private sector companies as a means of funding major projects off-balance sheet. At the heart of the project finance transaction is a special purpose vehicle (SPV), established by shareholders (sometimes operating as a consortium) who may be investors or those who have other interests in the project (such as contractor or operator). The SPV is created as an independent legal entity and enters into contractual agreements with a number of other parties in the transaction to be financed.
The government, municipality or other public body (often known as the "Authority") typically grants the SPV a license to exclusively own or operate (or both) a specified facility or asset for a fixed number of years or indefinitely. If the license expires, the asset is handed back to the public sector in a specified condition.
Central to the project finance transaction are the contractual agreements put in place between all the parties (the "Project Documents"). These contracts apportion risks between the numerous parties. The Project Documents are designed to fit within the overall framework of the host country for the project.
Generally, Project Documents specify the methods for construction and operation of the assets being financed and provide agreed procedures to be implemented in the event of default, failure to complete the construction or failure to perform during the operational period; they also allocate risks for unforeseen circumstances.
Because lenders in a project finance seek to be repaid principally from the asset's cashflow, the Project Documents constitute a key component of the security package for the financing. The combination of a security interest over the rights under the Project Document as well as in the assets physical components form the basis against which the lenders finance the project under loan agreements and various other credit instruments. During the construction phase, equity and debt funds are used to finance the project construction with funds generated from the project cashflow covering the operation and maintenance period. If the project assets are to be handed back to a public authority at the end of the license period, a specified standard of maintenance will have been agreed at the start of the project.
Other components of a project finance structure are the supplier and purchaser agreements, which are best illustrated by power plant example.
B. Project Finance Structures
Project finance structures are virtually unlimited by the creativity and flexibility of bankers and lawyers. Largely, the structures are influenced by the risk appetites of the lenders and investors involved in the financing, the economic condition of the host country and such country's legal and regulatory system.
1. Commercial Loan Financing
The general structure of a loan financing in the project finance context is not unlike the structure used in other loan transactions. In the typical project finance transaction, funds are lent to the project company for the construction and operation phases of a project. The debt is repaid by the project company, together with payments of interest and bank fee. In contrast to other type of loan transactions, however, the project finance loan is either nonrecourse or limited recourse to the project sponsors.
2. Export Credit Financing
Export credit agencies are designed to promote trade or other interests of an organizing country. Funding for bilateral agencies comes from their organizing governments. Examples of such entities active in the region include: Export-Import Bank of the United States, U.S. Overseas Private Investment Corporation, Canada's Export Development Corporation, the United Kingdom's Export Credit and Guarantees Department, France's Compagnie Francaise pour l'Assurance au Commerce Exterieur (COFACE), and Germany's HERMES Kreditversicherungs-AG.
3. Lease Financing
Lease financing is the general term to describe the separation of ownership and use interests in all or part of a project for financing a project. This structure might be useful in reducing the withholding tax rate otherwise applied to interest payments under commercial bank loans in certain Latin American jurisdictions. A typical lease transaction involving commercial bank funding has two simultaneously-occurring phases: (a) an offshore special-purpose company purchases the items and takes legal title, with the purchase price financed by the bank under a loan made to the special-purpose company; and (b) the special-purpose company leases or "rents" the items to the ultimate purchaser, who pays for the use of the items throughout the finance term. The stream of payments under the lease transaction are then assigned to the bank to satisfy the payment obligation under the loan to the special-purpose company. At the end of the finance term, the ultimate purchaser makes the final payment and takes title to the items.
4. Bond Financing
The bond financing structure is similar to the commercial loan structure, except that the lenders are investors purchasing the borrower's bonds in a private placement or through the public debt market. The bondholders are represented by a trustee that acts as the agent and representative of the bondholders.
5. BOT
The build-own-transfer ("BOT") structure is sometimes called temporary privatization. This structure provides to a private entity the right to build, own and operate a project that would otherwise be developed, owned and operated by the host government. It is a temporary privatization because at the end of a specified period, the project is transferred to the government.
6. Co-Financing
The International Finance Corporation (IFC) and the Inter-American Development Bank (IDB) are multilateral, private-sector lending institutions that provides loans for projects on a non-concessionary basis. While IFC programs are available worldwide (IFC is a World Bank affiliate), IDB programs are available only in the Americas, generally to its members states. Involvement by either IFC or IDB as the "lender of record" in a financing provides comfort to private-sector banks and institutional lenders that the host government will not fail to support the project or make hard-currency available for loan repayment. The access accorded to IFC and IDB by host governments attracts commercial banks and institutional lenders as participants that fund a share of the loan transaction that is led by IFC or IDB. The resulting structure is called an "A/B" Loan, in which IFC or IDB funds a nominal "A" portion and the participant banks and institutions fund a more significant "B" portion of the overall financing. Both the "A" and "B" Loans are documented together and share in the repayment stream and collateral securing the financing. Another program built upon a similar framework is the "partial guarantee", in which the IFC or IDB provides a loan guarantee to banks and institutional lenders rather than directly funding into the transaction. A portion of the total funding provided by the banks and institutions is covered by the loan guarantee, which the remainder is funded on an uncovered basis.
7. Production Payments
Production payment project financing is a method of financing a project through transfer to a special-purpose entity (a financing vehicle owned by the lender) of a proportionate share to receive a share of proceeds from the sale of the natural resource. In return, an advance payment is made to the project company as compensation for the rights received.
This structure has been used in the United States as a financing structure for hydrocarbon projects. It has also been used as a structure for timber operations. This structure provides lenders a complete ownership interest in a proportionate share of the project's production.
8. Forward Purchase Agreements
A forward purchase structure is similar to a production payment structure, but is used in the context of manufacturing projects. Lenders financing plant construction create a special-purpose vehicle, which enters into an agreement with the project company owning the plant, under which the special-purpose vehicle makes advance payments for the plant's output. This advance payment is used to pay project development and construction costs.
C. Common Investment Vehicles
1. Host Country Requirements For Investment Vehicles
It is a common goal of companies involved in the development of large-scale facilities that a parent company not be directly involved in a project in a host country. The reasons for this view are the risks associated with subjecting the parent company to liability and regulation, and the difficulty in allocating taxable income between multiple countries. In most circumstances, a special-purpose subsidiary is organized and used for the investment or other activity.
Some countries' legislation requires that no foreign entity own real property in the country, others require a minimum level of local ownership in infrastructure and other projects. In other cases, a project entity may be required to be incorporated, or otherwise formed as a partnership or other non-corporate entity, in the host country.
2. Investment Vehicle Types
The following paragraphs briefly describe the most typical forms of Project Finance investment vehicles:
a. Corporations
The single-purpose corporate subsidiary is perhaps the most common project financing structure. In this structure, the sponsor incorporates an entity, frequently wholly owned, solely to develop, construct, own, operate and maintain a particular project at a specific site. This form of structure allows the owners of the corporation to enjoy limited liability for the actions of the entity.
b. General Partnership
A general partnership is a business entity created by and operated pursuant to contract, statute, or both, in which all partners share proportionately in the management and income of the business undertaken. This structure does not afford non-recourse or limited recourse liability. All partners must be willing to assume the associated joint and several liabilities from any negligent operation of the project.
c. Limited Partnership
A limited partnership is similar to a general partnership, expect that it have both general partners and limited partners. A general partner is liable for all the debts and obligations of the limited partnership. Liability of the limited partners is limited to the extent of their capital contributions to the limited partnership.
d. Limited Liability Company
Similar to limited partnership is the limited liability company. Liability of the members of the company is limited to the extent of their capital contributions. Unlike a limited liability partnership, the members need not abandon management control to enjoy the liability limitation.
e. Joint Venture
A joint venture is a combination of entities to achieve a common purpose. It is a flexible form of business enterprise that allows member companies great flexibility in how the venture will be managed and controlled.
f. Development Consortium
Similar to a joint venture is a consortium. A consortium is the term typically applied to a group of large, well-capitalized corporations that collectively develop a project. A consortium agreement is used to define the relationship of the members and regulate day-to-day activities.
III. Case Study
Archetypical US power sector investment and project financing transaction
The objective of this section is to provide an overview of the legal and financial mechanisms employed in the United States. This overview is presented in the form of a case-study example of a "model" electrical power sector investment and project finance transaction in the United States. Application of this "model" structure to the Latin American regions identified in the next section of this paper leads to identification of the legal differences encountered by investors and financiers operating in the Latin American context.