25.7.1 The Contractor should always be obliged to reinstate the Asset and the Service if an insured event occurs. If the Authority does not require reinstatement, then any insurance proceeds should go to the Contractor but the Authority should be aware that this effectively results in a voluntary termination and the Authority will be obliged to make a full payout to the Contractor (see Section 21.5 (Voluntary Termination by Authority)), but deducting such amounts from the payment.
25.7.2 In some projects, Senior Lenders may want to impose a project economic test to determine whether reinstatement will enable them to recover their outstanding debt in full. If the economic test shows that this is not possible, Senior Lenders prefer to appropriate the insurance proceeds instead of allowing reinstatement. This should not be a first resort for the Senior Lenders and there should be good reasons for the Authority to agree to the inclusion of an economic reinstatement test in the Contract. Senior Lenders should focus instead on ensuring that the amounts insured under the delay in start up and business interruption insurances are sufficiently high, or that there is sufficient contingency in the Contractor's finances to deal with their concerns.
25.7.3 A project economic test should not be necessary where there is a low risk of total destruction of the asset (such as with a road or rail project, or a project that has a number of geographically diverse sites). Where the risk exists (e.g. a single-site project), the Authority may accept a project economic test but this should be based on the default senior loan life cover ratio so that Senior Lenders cannot abandon the Project if the test shows that debt service is achievable (even if there is a minimal amount of headroom). Including annual debt service cover ratios in an economic test is not recommended (as these ratios give only an annual "snapshot" of performance, which is not relevant here). There should be no need to specify a threshold amount of insurance proceeds below which the economic test should not be applied because the test should in any event only be applied in cases of total or near total destruction.
25.7.4 If the result of the project economic test allows the Senior Lenders to appropriate the insurance proceeds or an amount equal to the outstanding Senior Debt (whichever is the lesser), the Contractor remains under an obligation to reinstate the asset. If, as is likely, it is not financially able to do so, it will be in breach of contract and the Authority will terminate for Contractor Default in the usual way (see Section 21.2 (Termination on Contractor Default)). The Authority can then rebuild the asset through a new competition.
Where an economic reinstatement test is used the following is the required drafting:
25.7 Economic Test
(a) If all of the Assets are destroyed or substantially destroyed in a single event and the insurance proceeds (when taken together with any other funds available to the Contractor449) are equal to or greater than the amount required to repair or reinstate the Assets, then the Contractor450 shall calculate451 the senior debt loan life cover ratio452 as used in the Base Case (on the assumption that the Assets are repaired or reinstated in accordance with Clause 25.6(c)).
(b) If the calculation referred to in paragraph (a) above shows that the senior debt loan life cover ratio is greater than or equal to [event of default level] then the Contractor shall be subject to the procedure set out in Clause 25.6 (Reinstatement).
(c) If the calculation referred to in paragraph (a) above shows that the senior debt loan life cover ratio is less than [event of default level] then an amount equal to the lesser of:
(i) the insurance proceeds; and
(ii) the Base Senior Debt Termination Amount, or, if any Additional Permitted Borrowing has been advanced, the Revised Senior Debt Termination Amount,453
shall be released from the Joint Insurance Account to the Contractor.454
(d) If, pursuant to paragraph (c) above, insurance proceeds are released from the Joint Insurance Account the Contractor shall be in breach of its obligations under this Contract and shall not, pursuant to Clause 5.3 (Relief Events), be relieved of its obligations unless it can demonstrate, to the satisfaction of the Authority, that it can carry out the works necessary to repair, reinstate or replace the assets which are subject to the relevant claims in accordance with Clause 25.6(d) (Reinstatement) and within a reasonable timescale.
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449 Such funds could, for example, include sums made available to the Contractor by the Authority to ensure that the test in paragraph (b) is passed and that, as a result, reinstatement occurs in accordance with Clause 25.6 (Reinstatement).
450 The calculation will be controlled by the Senior Lenders in the Financing Agreements, and checks will need to be made by the Authority that this calculation allows reinstatement.
451 There will be a debate as to how this should be done. Since the Senior Lenders are those whose interests are being protected, the formulae set out in the banking financial model should be used, having agreed exactly how the formula will work and memorialised this in the Contract (see footnote 448 above).
452 For the meaning of this ratio see Section 5.2.3 (Calculation of Compensation).
453 As set out in the relevant definition, excluded from this will be amounts standing to the credit of the Joint Insurance Account.
454 This will mean the amounts are released to the accounts secured to Senior Lenders and the Senior Lenders will apply such amounts as a prepayment against Senior Debt.