Where a PPP is project financed, a 'special purpose vehicle' (SPV) Project Company will be created to deliver the project, which will have an asset and liability profile specific to that project. Under such arrangements, lenders typically have no recourse against the Project Company's equity investors or parent company, and they must look to the project's revenues to repay loans. This is a central feature of the project finance arrangements typically used for major PPP projects, and should shield the project from the insolvency of equity investors that own the Project Company. The focal point of project finance is therefore to match cash flows generated by the project to the Project Company's debt service obligations over the long term and allowing for an appropriate return on investment for the equity investors.
The result of this arrangement is that any disruption to the project performance and revenue streams (e.g. if a toll road experienced traffic volumes significantly below what was forecast) has the potential to threaten the Project Company's ability to make its loan repayments and remain solvent.
A typical project-financed Project Company will also have high levels of debt and tight cash flow models. Lenders are therefore incentivised to maintain a high degree of control, including when negotiating the risk allocation of a PPP contract. Lenders often require security against the PPP contract and the Project Company's cash flow, restrictive covenants, project monitoring and step-in rights to intervene and prevent termination of the PPP contract, as well as additional safeguards typically in place, contractors' security packages, insurance, hedging arrangements and project reserve accounts are all examples of safeguards designed to minimise the risk of financial distress and insolvency of the Project Company.
As well as being exposed to the project risks, the construction contractor and the operations contractor are typically exposed to additional risks outside of the project, and it is more common for either to become insolvent during the relevant phase of a PPP project than for the Project Company itself.