Security means assets or rights given by the project company to its lenders to ensure repayment of principal and interest of the loan. Although security is often described as a right to recover the monies lenders advance plus interest if the project company defaults, a more sensible view is that security essentially confers to the lenders the right to be heard if the project company is in trouble. Experienced lenders know that security interests in projects are often non-marketable, and sale of security is unlikely to mean a recovery of the monies advanced and interest (if a sale is possible at all). As discussed above, a characteristic of a PPP project is that physical assets in a PPP projects generally require substantial investments to build and are extremely valuable to the project company and the government, but they may have little or no value to third parties. Half completed toll roads are not particularly valuable to lenders as security, so they need to look to a range of other arrangements for security arrangements.
There is a distinction between security in favour of the lenders, which are properly security to be provided by the project company as the borrower for the loan, and security for the performance of, for example, a party's obligation under the concession agreement or the EPC. An example of security for performance obligations would be performance bonds, which is money paid in advance to guarantee the performance under a contract. "Security" in this section refers to the security in the former sense. That is, security in favour of the lenders in the event of default of loan repayment obligations.
The laws of a particular jurisdiction will determined for a large part what interests in the project are capable of being used as security. The ability of the lenders to enforce its security will be highly significant to the lender's decision to finance a particular PPP project. From the perspective of the lender, the important issues to consider with security are:
• Priority. In the event of liquidation, where the lender rank in relation to other lenders and shareholders.
• Perfection of security. Steps that need to be taken to ensure that the security interest the lender holds is capable of being enforced in the event of default. This will depend on the legal system of the country concerned.
Types of security package
A "security package" for a project finance project typically includes:
• Bank accounts. This means an arrangement to use the available cash in the project as collateral. This may include an assignment of bank account, creation of a new (usually offshore) account for revenue, arrangement to put revenues in escrow. Some loan agreements require that the project company sets aside some of its revenues to a debt reserve account until the account balance reaches a certain point (eg sufficient to cover six months of operating costs).
• Pledges in the shares or equity of the project company. The ability to take control of the project company given certain specified defaults under the credit agreement. The concession agreement and the other project agreement to which the project company is a party normally have a "change of control" clause. This is a right of one or the other party to terminate the agreement if there is a change of control (as defined in that agreement)
• Pledges in other assets. Other assets of the project company that may be capable of being pledged are inventory and equipment.
• Mortgage or liens. The project company may have real estate assets which would be subject to a mortgage. Whether or not the project company has an interest in land that is capable of being pledged.
• Contract assignments. Project agreements such as the concession agreement, the construction contracts, off-take agreements, O&M agreements may be assigned to the lenders.
• Insurance. Most financing agreements will require that the project company take out adequate insurance cover. More often then not, the lender will also require that they be named as a "Loss Payee" or "Additional Insured" under the relevant insurance policy.
• Sponsors guarantee or undertaking. The government may give a financial guarantee or a performance undertaking to the project.
• Government guarantee or undertaking. The government may give a financial guarantee or a performance undertaking to the project. Often a guarantee by the government will attract investors to the project. A concern is that where these guarantees exist investors can pay less interest in the fundamentals of a project, causing ill-conceived projects to be funded. Also, it exposes the public to large liability when the benefits of that risk would go to the private sector.29
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29 See Clive Harris, Private Participation in Infrastructure in Developing Countries: Trends, Impacts, and Policy Lessons, 15.