The extent to which the government is concerned about the constitutional documents and shareholders' agreements of the project company will depend on whether the government has a direct interest in the project company. This subsection will deal with issues for the government in relation to the shareholders' agreement, shareholders' loan agreement and options agreement:
• if the government does not have an equity interest in the project company; and
• the additional issues if the government does have an equity interest in the project company.
(a) Issues whether or not the government is an equity investor.
If the government has no direct interest in the project company, then there are few issues in the shareholders' agreement that directly impact on the government. The main concern is to ensure that the shareholders' agreement is consistent with the terms of the concession agreement that the government has entered into with the company. Beyond this, the government should exercise caution and refrain from unnecessarily or unjustifiably interfering with the issues relating the internal management of the project company. Some of the issues that the government may consider are:
• Change of control. The government would have selected the private consortium partly on the basis of the reputation and experience of the sponsors. A change of control of the project company effectively means a change in the identity of the sponsors. This should not occur without the government's permission. Normally a provisions dealing with change of control is contained in the concession agreement, but the government may have no remedy other than damages (that would have to be sued for) if there is a change of control of the project company in breach of the concession agreement. The government may also have a right to terminate the concession agreement, on change of control, though obviously this is an option of last resort. It would be more reassuring for the government to see restrictions on change of control in the constitutional documents of the project company itself. Though this makes a change of control less likely to happen in practice, it does not change the quantum of damages for the government.
The government should also watch up for options agreement and shareholders' loan agreements that are convertible into shares. The government should ensure that the exercise of these options do not constitute a change of control that is unacceptable to the government, and that if this is acceptable to the government the change of control provisions in the concession agreement is consistent with this option.
• Capacity. The government needs to review whether the corporate law country and the constitutional documents of the project company permit the project company to enter into the concession agreement and to perform its obligations under the concession agreement.
• Authority. The law and constitutional documents of the project company should confer the persons authorised to enter into agreements on behalf of the project company. The government needs to ensure that the concession agreement, and any agreement the government enters into with the project company, is validly executed by the project company.
• Information. Even if the government does not directly hold any interest in the project company, it may determine that transparency and accountability of the project company is important in view of the significance of the infrastructure asset that it provides. The government may insist on disclosure of audited financial reports of the project company, or that it be informed if specified significant events occur in relation to the project company.
• Control. If the government is not a shareholder, it has very little influence on the internal management issues of the project company. This is fine because the obligations of the project company in relation to the infrastructure project are set out in the concession agreement (to which the government is a party) and the project company should be entitled to conduct its business without unwarranted government interference. There are, however, some circumstances where the government should insist on having some control of the internal management of the project company (this needs to be carefully weighed against the desirability of allowing the project company to operate freely). One example is where the government has provided financial guarantees to lenders or made other financial commitments in relation to the project. Another is where the construction of the facility has national and security significance. The government may request for a right to nominate a director to the board of the project company, alternatively it may request a right of veto for any changes in the board of directors or senior management of the project company.
• Priority of Payments. In relation to the shareholders' loan agreement, the government should ensure that any payment due to the government by the project company, for example compensation for default of the project company under the concession agreement, has priority over the subordinated debt.
• Solvency. ubstantial subordinated debt affects the solvency position of the project company. The project company may technically be regarded as "insolvent" if subordinated debt payable on demand of the sponsor is greater than the current assets of the project company. Although strictly speaking not the government's issue, the government has an interest in ensuring that the project company is solvent. The government should confirm with its legal and financial advisers that this is not an issue if sponsors propose to inject capital as subordinated debt rather than capital.
(b) Additional issues if the government is an equity investor
The government may wish to exercise certain control of the project company by holding shares in the project company or having a representation on the board of directors or management of the project company. Private operators would be reluctant to allow the government to impede on the operations of its business operations, but it may be necessary if other forms of control through the concession agreement, and regulations are insufficient. If the government has a direct concern in the project company, then its interests in the shareholders' agreement is not unlike those of other shareholders. In particular, it is important that the government consider the following issues:
• Control at the board of directors (management) level. The government as a shareholder may have the right to appoint a director or directors to the board of the project company. There is likely to be minority protection to disallow the board to pass certain resolutions without the consent of the director at the board. If the government holds a substantial stake in the project company, it is reasonable to request that the minority protection issues to be decided with the affirmative vote of a director nominated by the government. The government, however, should consider the duties of the director nominated by the government, in most countries the director has a duty to act not only in the interest of the government but in the interest of the company as a whole
• Control at the shareholders' level. Usually the government would not have a majority control of the project company. This means that the government is unlikely, unless it has the agreement of other shareholders, to compel the project company to pass certain resolutions. As a minority shareholder, however, the government should be entitled to certain minority protection. This is an assurance that the project company would not take certain actions unless it has the agreement of the government. For example, a project company should not liquidate, or invest in a new business without the consent of the government as a minority shareholder. One that is usually present, and that minority shareholders should insist on, is the right to veto any new issue of shares because this would have an impact of diluting the value of the existing shareholders' shares.
• Dilution. If the government has an equity interest in the project company the exercise of the options would effectively dilute this interest, and this should be reflected in the price of the equity payable by the government.
• Access to information. The government as a shareholder has access to certain information. Obviously the government should have access to financial reports and audited accounts of the company (company laws may provide for this anyway).
• Restriction of share transfer. Share transfer restrictions need to be consistent with the concession agreement and the financing agreements. In addition, transfer provisions need to be consistent with other provisions in the internal documents, such as drag along, tag along, transfers on default and transfers in cases of disputes. It is not uncommon for a project company to prohibit share transfers absolutely during the construction period of the project. Even without unusual restrictions, shares in private companies are usually transferable subject to a right of first refusal by the other shareholders of the company.
• Tag along/Drag along rights. A tag along is a right of one shareholder (the "First Shareholder") to compel another shareholder (the "Second Shareholder") to buy, or procure a third party to buy, shares held by the First Shareholder when the Second Shareholder has or will sell its shares. A drag along is the right to compel the other shareholders to sell their shares so that the shares may be sold to a third party as a block. These rights should obviously be subject to more general restrictions to the transfer of shares discussed above.
• Dispute resolution. In relation to shareholders of a project company, there are broadly two types of disputes. First, a dispute relating to the performance or the interpretation of a project agreement. Second, a dispute of commercial or strategic nature about the direction of the project company. The first dispute is capable of being arbitrated by an arbitral body or resolved by courts. The second is usually called a "dead lock" and can be resolved in a number of ways, including by escalation (referring the dispute to senior members of the shareholders), forced sale to another shareholder (one party buying the others out through procedures that are provided for) or a forced sale to a third party or liquidation of the project company (the rationale being that parties will come to an agreement if they are forced to). The main problem with dealing with a deadlock through forced transfer mechanisms is that such mechanisms tend to favour the party that is financially stronger. From the government's point of view, there may be legal or pragmatic restrictions on the government acquiring further shares in the project company. Silence is sometimes a way to deal with deadlocks, with the rationale that the parties will discuss and come to a mutual compromise because it is not in any shareholders' interest to leave the project company at a deadlock.