14.2.1 Authorities will have to be sure that continuity of service supply is maintained even if their counterparty is insolvent. In many service contracts this can be done by way of a guarantee by a parent company (whether this company is the ultimate parent company in a group or a sufficiently claim worthy person will be a matter for negotiation). In a Contract for the period of time that PF2 contracts are typically provided for, such guarantees can be of much less value.
14.2.2 A limited recourse structure is used in many PFI/PF2 projects as it isolates and limits the liabilities of the Project from those of the shareholders. Consequently, the obtaining of direct guarantees by the Authority is not normally appropriate. The Authority should generally not insist on receiving guarantees from the parent companies of a Sub-Contractor or the Contractor's shareholders in respect of the obligations of the Contractor.
14.2.3 A well-advised Authority can usually obtain sufficient comfort from a well structured limited recourse project, provided Sub-Contractors have a suitable track record and financial standing that the levels of equity are sufficient to demonstrate a commitment of shareholders to the Project and the rest of the financing structure is sufficiently robust. If there is a project failure, the Authority's primary protection is that it stops payment until the Service is delivered again. It is the senior lenders who will be exposed in this situation (along with the equity investors) and it is they who are likely to have obtained guarantees from credit worthy bodies to protect them until the fault is rectified.1Appropriate levels of equity may well differ in the operating period from the development or construction period and will vary from project to project. This involves an analysis of the entirety of the structure (including the Contract, all Project Documents and any limits on liability of the Sub-Contractors under their Sub-Contracts), any liability interfaces (such as which Sub-Contractor is liable in the period between completion of construction and commencement of operation) and an understanding of the step-in rights of the Senior Lenders and other rights of the financiers (see Section 26 (Funders' Direct Agreement)).
14.2.4 One of the advantages in structuring projects on a limited recourse basis is that it requires bidders to thoroughly investigate all risks relating to the Project and clearly allocate the risks in a manner that delivers a robust project.2
14.2.5 If the Contractor is funding the Project from its own internal resources and there is no third party Senior Debt being provided to the Contractor, the Authority should:
• assess the credit strength of the Contractor and consider whether or not it should require the Contractor to provide it with a guarantee from its parent or strongest credit within its group; and
• consider whether or not it should require the Contractor to maintain financial covenants throughout the term of the Contract.
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1 One area where the Authority might seek a guarantee however is of its Collateral Warranties from primary Sub-Contractors - allowing it to take over the sub-contract (subject to the prior step-in rights of the Senior Lenders) on a Contractor Default. See Section 14.4 (Collateral Warranties) below.