Rather than investing in the project as equity, sponsors sometimes invest by way of providing subordinated loans. The advantages of investing as subordinated loans rather than equity are:
• Priority. Subordinated loan can be secured (subject to lenders' priority), and this would enable to capital contribution to be ranked ahead of unsecured creditors.
• Tax. Payment of interest by the project company is tax deductible whereas payment of dividends is not.
• Flexibility. Subordinated loans is often more flexible that share capital. It is, for instance, easier to repay the capital than the share capital. In most jurisdictions, it is also easier to pay interest than it is to declare dividends.
Key Issues
A shareholders' loan agreement needs to do the following:
• disallow payment of junior debt (other than interest until a default or unless the cover ratio is not met);
• prevent acceleration and enforcement of junior debt and security;
• allow bank to advance prior ranking new money;
• contain no covenants, because this would hamper a restructuring;
• subordinate the debt as well as the security (in case the senior security fails or is inadequate);
• permit the lenders to change their loan agreements or security documents;
• compel junior creditors to co-operate in a private sale; and
• prevent junior creditors from instituting insolvency proceedings.