Financial and Corporate Law Issues for Lawyers in Transition

Economies

(Selected excerpts)

25-27 June 2008

The London School of Economics and Political Science (LSE)

and

The European Bank of Development (EBRD)

Transcript edited by Alexis Rwabizambuga, PhD

Fellow, Weatherhead Center for International Affairs, Harvard University

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Table of Contents

Introduction........................................................................................................................ 5
I ........................................................................................................................................... 6
TYPICAL TRANSACTION STRUCTURE FOR CONCESSION BASED FINANCING
............................................................................................................................................. 6
1.2 Project Finance, Concession-Based Finance or Limited-Resource Finance.................. 6
1.3 Major Stakeholders’ Roles and Objectives....................................................................... 7
1.4 Project Risks........................................................................................................................ 9
1.5 Contractual Structure......................................................................................................... 9
1.5.1 Concession Agreement ................................................................................................................ 9
1.5.2 Construction Agreement ............................................................................................................ 10
1.5.3 Supply Agreement ..................................................................................................................... 10
1.5.4 Off-take Agreement ................................................................................................................... 10
1.5.5 Operation and Maintenance Agreement..................................................................................... 10
1.6 Finance Agreements.......................................................................................................... 10
1.6.1 Credit Agreement....................................................................................................................... 10
1.6.2 Equity Subscription and Sponsor-Subordinated Debt Agreements............................................ 11
1.6.3 Inter-Creditor Agreements ......................................................................................................... 11
1.7 Security Documents and Quasi-Security Agreements ................................................... 11
1.7.1 Security Documents ................................................................................................................... 11
Annex 1.1: Questions and Answers........................................................................................ 14
II ....................................................................................................................................... 21
COMMON LAW AND CIVIL LAW APPROACHES TO COMMERCIAL
DOCUMENTATION: COMMERCIAL DRAFTING AND NEGOTIATING RISK
ALLOCATION DEVICES............................................................................................... 21
2.1 Dense Contracting............................................................................................................. 21
2.2 Divergence.......................................................................................................................... 22
2.2.1 Divergences between Legal Systems ......................................................................................... 22
2.2.2 Divergences in Contract Law..................................................................................................... 23
2.2.3 Interpretation.............................................................................................................................. 23
2.2.4 Mandatory Rules........................................................................................................................ 24
2.2.5 Divergences in Other Branches of Law ..................................................................................... 25
2.2.6 Cultural Divergences.................................................................................................................. 25
Annex 2.1: Questions and answers.......................................................................................... 27
III...................................................................................................................................... 28
DRAFTING TECHNIQUES ON QUALIFYING OBLIGATIONS AND THE LAW
THAT UNDERLIES THEM: REASONABLENESS, ENDEAVOURS
QUALIFICATIONS AND MATERIALITY ................................................................... 28
3.1 Introduction....................................................................................................................... 28

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 3.2 Reasonable and Acting Reasonably; Limitations on the Exercise of Discretion ......... 28
3.3 Should One Imply a Duty to Act Reasonably in the Exercise of Discretion? .............. 29
3.3.1 Limitations ................................................................................................................................. 30
3.3.2 drafting implications .................................................................................................................. 30
3.4 Best Endeavours and Reasonable Endeavours............................................................... 31
3.4.1 Best Endeavours......................................................................................................................... 32
3.4.2 Reasonable Endeavours ............................................................................................................. 32
3.4.3 Reasonable Endeavours versus Best Endeavours ...................................................................... 33
3.4.4 Other Considerations.................................................................................................................. 33
3.4.5 Conclusion ................................................................................................................................. 34
Annex 3.1: Questions and Answers......................................................................................... 35
IV ...................................................................................................................................... 37
BANKABILITY – INTRODUCTION, POLITICAL RISK, COMPLETION
GUARANTEES AND SPONSOR SUPPORT ................................................................ 37
4.1 Introduction....................................................................................................................... 37
4.2 The Sectors......................................................................................................................... 37
4.3 What is a Public Private Partnership (PPP)?................................................................. 38
4.4 The Example of PPP and Immigration Detention Centres ........................................... 39
4.5 Infrastructure Sectors....................................................................................................... 40
4.5.1 Basic Transaction Structures...................................................................................................... 40
4.5.2 BOT Star Diagram ..................................................................................................................... 40
4.6 Risk..................................................................................................................................... 41
4.6.1 Removing Risk from the Public Sector...................................................................................... 41
4.6.2 Risk Allocation .......................................................................................................................... 41
4.6.3 Currency Risk ............................................................................................................................ 42
4.6.4 The Involvement of Government as a State-Owned Participant ................................................ 42
4.6.5 The Government as Off-taker .................................................................................................... 43
4.7 Political Issues ................................................................................................................... 43
4.8 Countries in Transition .................................................................................................... 44
4.8.1 Completion Guarantees.............................................................................................................. 44
4.8.2 State-Owned Companies............................................................................................................ 45
4.8.3 Guarantees of the Obligations of the Entity ............................................................................... 45
4.8.4 Commercial Issues and Political Issues ..................................................................................... 46
4.8.5 Issues Affecting the Legal Environment.................................................................................... 46
4.8.6 The High Ground of the Economy............................................................................................. 46
4.8.7 Not a Real Market ...................................................................................................................... 47
4.8.8 Conflicts of Interest.................................................................................................................... 47
V........................................................................................................................................ 48
SPONSOR SUPPORT IN PROJECT FINANCE TRANSACTIONS........................... 48
5.1 Introduction....................................................................................................................... 48
5.2 Why Sponsor Support? .................................................................................................... 48
5.3 Issues with Multiple Sponsors.......................................................................................... 49
5.4 Types of Sponsor Support ................................................................................................ 49

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 5.5 Completion Undertaking .................................................................................................. 50
5.6 English Contract Law ....................................................................................................... 50
5.7 Defining Completion ......................................................................................................... 51
5.7.1 Technical Completion ................................................................................................................ 51
5.7.2 Financial Completion................................................................................................................. 52
5.7.3 Security and Security Value....................................................................................................... 52
5.7.4 Policy Objectives ....................................................................................................................... 52
5.7.5 Equity Undertaking .................................................................................................................... 53
Annex 5.1: Questions and Answers......................................................................................... 53
VI ...................................................................................................................................... 56
SECURED LENDING: ISSUES OF LOCAL AND GLOBAL CONCERN ................. 56
6.1 Introduction....................................................................................................................... 56
6.2 Practice and Principles ..................................................................................................... 56
6.2.1 Corporate and Individual Debtors.............................................................................................. 56
6.2.2 Corporate Debtors and Shareholders.......................................................................................... 57
6.2.3 Creditors and Others Who Have Dealings with a Debtor .......................................................... 57
6.3 What Happens When Things Go Wrong ........................................................................ 58
6.3.1 Default ....................................................................................................................................... 58
6.3.2 Events of Default ....................................................................................................................... 58
6.3.3 Material Adverse Change........................................................................................................... 58
6.3.4 Litigation.................................................................................................................................... 59
6.3.5 Insolvency: The General Concept of Equal Misery among Unsecured Lenders........................ 59
6.4 Security .............................................................................................................................. 60
6.4.1 Security as a Method of Protection in an Insolvency................................................................. 60
6.4.2 Other reasons for taking security ............................................................................................... 60
6.4.3 Taking Security.......................................................................................................................... 61
6.4.4 Security Linked or Detached From A Personal Obligation........................................................ 61
6.5 Guarantees......................................................................................................................... 62
6.6 Cross-Border Issues: Introduction to Conflict of Laws................................................. 63
6.6.1 The Cross-border setting............................................................................................................ 63
6.6.2 Legal Systems ............................................................................................................................ 63
6.6.3 The Limits of English law.......................................................................................................... 63
6.6.4 Cross-border insolvency ............................................................................................................ 64
6.7 Case Study ......................................................................................................................... 64
Annex 6.1: Speaker biographies ....................................................................................... 67

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 Introduction

The European Bank for Reconstruction and Development (EBRD) and the London
School of Economics (LSE) have jointly established this course on financial and
corporate issues for the benefit for lawyers in transition economies. The course,
which took place for the first time in June 2008, comprised of a series of seminars
jointly hosted in London by the LSE and the EBRD. It was structured to provide
theoretical insights as well as to share the practical knowledge of highly accomplished
experts from these two institutions. The course covered extensive themes, explored
several topics and examined case studies that are highly relevant to the practice of
financial and corporate law in transition economies.

This report only includes selected excerpts that illustrate the topics covered. In
chapter one, Lilia Bylos outlines the role of concession agreements in project finance.
The chapter describes the typical transaction structure for concession-based financing,
discusses the relationship between key parties and the role of special purpose vehicles.
In chapter two, Hugh Collins discusses common law and civil law approaches to
commercial documentation, particularly focusing on commercial drafting and
negotiating risk allocation devices. In chapter three, Christoph Sicking provides some
of the tools that are used by English lawyers in softening or qualifying contractual
obligations, while Roger McCormick examine various aspects of bankability in
chapter four. In chapter five, Christoph Sicking examines the role of sponsor support.
Finally, Andrew McKnight introduces a discussion about secured lending, and
explores related issues of concern both local and global. Discussions that took place
are presented in annex after each chapter and illustrate the nature of the course during
which all participants and contributors highly engaged and had a mutually rewarding
experience.

By publishing these selected excerpts, we hope to make this wealth of expertise

available to broader audiences. I would strongly encourage lawyers working in
transition economies to attend the 2009 edition scheduled for 1-3 July in London (see
http://www.ebrd.com/country/sector/law/new/lseprog.pdf ).

Michel Nussbaumer
Chief Counsel - Legal Transition and Knowledge Management, EBRD
March 2009

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 I

TYPICAL TRANSACTION STRUCTURE FOR CONCESSION BASED

FINANCING

Lilia Bylos, Senior Counsel, EBRD

(Transcript of talk)

1.1 Introduction

The chapter gives an overview of project finance. It outlines who the main players
and stakeholders are (their interests, roles and objectives), what the main risks are,
(risk transfer and risk allocation), and the contractual structures used in project
finance (the underlying project structure, the finance structure and the security
structure). It will provide you with a more or less complete overview of what is
project finance.

1.2 Project Finance, Concession-Based Finance or Limited-Resource Finance

Project finance, concession-based finance or limited-recourse finance, are terms that

are used interchangeably. Essentially this form of finance is the provision of debt to
develop or exploit infrastructure, natural resources or other type of assets. The key
thing is that the debt is based on the revenue generated from the project, and not on
the credit worthiness of the sponsors or the security given. This is the key difference,
as most forms financings will be based on the credit worth of the person who is
borrowing the money or on the security given. In project finance it is purely based on
project revenue, with no other recourse. This dependence on project revenue means
that before the project is undertaken a number of feasibility studies and economic
models will be prepared to determine the viability of the project, and the viability and

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robustness of the revenue stream. There are many stakeholders and interested parties
involved in project finance. Key to the success of the project is how the risks of the
project are going to be shared amongst all the interested parties.

1.3 Major Stakeholders’ Roles and Objectives

There are four major parties/stakeholders. These include: host government, sponsors,
project company and lenders. There are other parties involved but these are the four
main players.

The host government will always be involved in a project finance endeavour. It will
either be granting the licenses and consents to the project company or the concession
contract. The concession contract is the contract that entitles the project company as
concessionaire to build and operate the project for a set period of time. The host
government will not normally be directly involved in the financing of the project.
However, in some cases financial involvement will be unavoidable because the
project will not be viable without some sort of government grants. There used to be
things like golden shares, etc. in the past but not so visible now. The host government
may take an equity interest in the project company or it may be the off-taker. The off-
taker is the person who purchases whatever product or service the project company
provides. That is called the off-taker, and is something we will be discussing a bit
more of later.

The host government’s main objectives are to pursue what is in the public interest.
What motivated it to do the project in the first place, to ensure that the project is
properly built and developed and that it achieves a better value for money than
conventional public financing. It will want to see that there are adequate assurances in
the contractual structure, that the project will be operated properly and in the public
interest. It will not want to have any fetter on its discretion to pass laws in any of the
contracts. It will want the project returned back to public ownership after the loan has
been repaid and the sponsor achieves an acceptable return on its investment or if the
private sector has failed. (We will discuss this later when we are going through the
contractual structure.) Finally, it will also want to reduce the need for public funds to
finance the project.

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Project Sponsors are the people who will sponsor the project. That means they will
create a subsidiary that will enter into the various contracts with the government, the
contractors and the lenders. It may be any one of a number of interested parties. It
may be the contractor who will be developing the project. It may be the supplier, the
person who is going to be supplying the raw material for the project. It may be the
off-taker, for example, in an electricity project the sponsor might be the turbine
manufacturer. Invariably, the sponsor is a shareholder of the project company. There
may be a number of shareholders, not just one. The main objectives of the project
sponsors are to exact a profit by way of dividends or contractual payments. However,
they may have other corporate objectives as well, for example, diversification or
expansion of its business.

The project company is the key player in the project. It is the focus of all
responsibility. It is the party that will be contracting with all the other parties. It will,
typically, be a special purpose vehicle (SPV) set up by the sponsors. The identity and
domicile will depend on where it is registered. Generally, it will be in the jurisdiction
of the host government. The objective of the project company is to exact profit - the
same as the sponsor. However, the interests of the project company will differ to that
of the sponsors when it comes to the allocation of risk.

The Lenders are the providers of the debt finance and the beneficiaries of the security.
Their objective is to exact a profit, very much the same as the sponsors. They do so
however, by way of a margin on a accrued interest. There is no upside for the lenders
if the project does very well or is very successful. They still only get the margin on
the accrued interest. This is key to understanding the appetite of the lenders for risk.
They will want to adopt risks that are commensurate with the return, not more. In
conflict with that of the host government, the lenders will also want to have control
over the key decisions of the project company in times of financial difficulties. When
the project company is not doing too well, it will basically want to have complete
control over the project.

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1.4 Project Risks

A successful project is one where there is a correct allocation and transfer of risk.
This means the correct identification, quantification and allocation of risk to the party
that can most sensibly bear that risk. The willingness of a party to bear risk will
depend obviously on its bargaining position, the strength of the project and its
expected return. The risk allocation forms the commercial negotiation between the
parties and determines the contractual structure. The acceptability of the risk and risk
allocation will determine what is called ‘bankability’, how bankable the project is.
The risks must be considered as a whole. There is one rule, basically, that the project
company must not be the receptacle of all residual risks, otherwise it just will not
work. There should be a good-faith attempt to share the risk.

One of the tasks that you will have to do as a lenders’ lawyer is to prepare a risk
analysis table. Lenders lawyers are normally involved in projects a little bit further
down the line when all the main project contracts are in place. You will have to look
at all the underlying project contracts to see how the risks are dealt with in those
projects, and note whether there are any gaps and or inconsistencies within the
projects.

1.5 Contractual Structure

The underlying project documents and agreements used for project finance vary in
structure and complexity. Important to the success of the project is the development
of a structure that secures the revenue stream, accurately addresses all the commercial
objectives of the main players and correctly allocates the risks between the parties.

1.5.1 Concession Agreement

The first and most important underlying project agreement is the concession
agreement. This is the grant of a concession from the host government to the project
company to build, finance and operate the project for a set term in return for the right
to receive the revenue generated.

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1.5.2 Construction Agreement
The construction agreement is what it says it is the agreement to build the project
facility, which will be entered into with a contractor. The contractor will have to
build the facility according to a set of specifications for an agreed price by a stated
time.

1.5.3 Supply Agreement

The supply agreement is the contract with the supplier for the supply of the raw
materials needed for the project. This is the main contract that will attempt to manage
the resource risk.

1.5.4 Off-take Agreement

The off-take agreement is the agreement with the entity that will purchase the project
product or service. It will be a long-term contract with take-or-pay obligations. It
will be the main contract that will attempt to manage the commercial risk.

1.5.5 Operation and Maintenance Agreement

This last contract is the operation and maintenance agreement. As we said, the project
company will typically be a special purpose vehicle. This is an agreement that will
normally be entered into with one of the sponsors, whereby the operation and
maintenance capabilities of the project company will be provided to the project
company by one of the sponsors.

1.6 Finance Agreements

There are two sets of finance agreements. The first sets out the sources of funding
and seconds sets out the security and quasi-security to be provided to the project.

1.6.1 Credit Agreement

The main source of funding for the project will be provided by banks pursuant to the
credit agreement. The syndicate of commercial banks will provide the loan to fund
the development and the start-up costs of the project. This is the customary term loan
agreement, which will be adapted to suit the project finance structure and needs.

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1.6.2 Equity Subscription and Sponsor-Subordinated Debt Agreements
This is the second source of funding. It is rare for 100% of the funds to be provided
by your commercial banks. The sponsors will be expected and required to raise the
money to provide the balance of the funds needed to develop the project. They will
do this through equity or subordinated loans. The ratio of debt-to-equity in each
project will differ.

1.6.3 Inter-Creditor Agreements

There will be more than one source of funds for the project and if the financing
package includes different tiers, classes of lenders, complex inter-creditor issues will
arise. This is the agreement that attempts to regulate the relationship between them.

1.7 Security Documents and Quasi-Security Agreements

1.7.1 Security Documents

The security documents are the documents that will grant security to the lenders over
all the assets of the borrower. One should not confuse non-recourse with non-secured.
The bankers will require the whole gamut of security: pledges over moveable and
immovable assets, an assignment of the underlying project documents, and
assignment of the insurances and a pledge of the shares of the actual borrower. The
purpose of taking the security will not necessarily be for the traditional aggressive
purpose. It will be mainly for defensive purposes. It is to stop 3rd parties from
interfering with the project assets, and the project revenue, and to enable the lenders
to step in and take control when the project starts going badly.

1.7.2 Sponsor Support Agreements

As we said earlier, it is rare for the lenders to take the entire commercial risk,
particularly where you do not have off-take agreements. The sponsors will therefore
be required to provide some sort of support to the project. This can be in the form of
volume underpinning or price underpinning. It can be anything, basically. However,
you will normally find that the sponsors will be required to support the project and
take away some of the commercial risk from the lenders.

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1.7.3 Direct Agreements

There are a lot of direct agreements that are entered into. These are agreements
between the lenders and project counterparties, for example, the contractor, the host
government and the off-taker if there is one. The basic objective of these agreements
is to allow the lenders to exercise some control over the counterparties’ contractual
rights in the underlying project agreements, in particular the termination rights. uld
like to have to step in and take over the project when things go badly.

1.8 Conclusion

Project finance is basically just another form of finance. Corporate debt is (most
times) a lot cheaper: the margins are lower, it takes less time to negotiate and the
documents are a lot less complicated. In project finance the margins are higher
reflecting its complex nature and the fact that the lenders are taking more commercial
risk. Project finance is therefore more expensive, but it has other advantages.

The main advantages are: risk transfer, the avoidance of sponsor borrowing
restrictions and un-creditworthy borrowers, the favorable accounting treatment given
to the sponsors in respect of their involvement and the fact that sponsor’s the credit
rating (if any) remains unaffected. Borrowing restrictions of the sponsor are avoided
because the loan agreement is entered into by the special purpose vehicle and not the
lender - lets take for example a sponsor who wants to develop a project, but in its
constitutional documents, it has some sort of borrowing restrictions or indeed it has
entered into other loan agreements wherein there are negative pledges which prevent
it from incurring further debt. The project finance structure enables the sponsor to
pursue the project without falling foul of its borrowing restrictions. The special
purpose vehicle shall be borrowing the money from the lenders and entering into all
the contractual liabilities in relation to the development of the project. This enables
the sponsor’s support for the project to be given favorable accounting treatment. The
sponsor will certainly support the project but the support that it will give will
normally be logistical and technical in nature. That is very different from entering
into a loan agreement itself or providing a guarantee; and so the accounting treatment
is very different. Finally, project finance will have a neutral effect on the sponsor’s

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credit rating. If the sponsor is a big company and has a credit rating its involvement
in the project will not affect its credit rating. If the sponsor is seen to be undertaking
very speculative projects, this will affect its credit rating. The corollary to that is that
if you have an uncreditworthy sponsor, project finance is the only way that it will be
able to raise money to fund a project. A lot of developing countries find themselves
in this position. They have levels of debt at which commercial lenders would be
unwilling to lend and, in addition, there is no money in the national coffers. Project
finance is then the only way to raise money to fund a project. There are many
advantages therefore to project finance even if it is a bit more expensive and will be
certainly be attractive if you have a viable project with a dedicated cash flow.

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Annex 1.1: Questions and Answers

Question: You mentioned that one of the purposes of the security documents is to
establish control. How is it usually done?

Answer: Lenders want to have the right to step in and take control over the project.
They want to have the assets secured in their favour. They want to have all the
underlying project documents assigned to them, and through the direct agreements,
they are able to step into those contracts and take over the assets and take over control.
Whether this is done in practice is another matter. In fact, I think what ends up
happening is that they start refinancing.

Comment (Roger McCormick): It is certainly true in practice. Lenders are very

reluctant to use their rights. Although they have very extensive rights, they are very
much the ‘fall back scenario’ to negotiations around the table to achieve a solution
short of enforcing security. It might be helpful if I give my own analysis of how
step-in rights came to exist. I think it throws a certain amount of light on the attitude
of lenders and also on the legal structure. One of the first documents I drafted as a
practising lawyer was a charge over a bank deposit, a very simple document. Well,
you might think it is. In fact, we got ourselves into a number of knots in English law
over just that simple transaction. However, it takes the form of the depositor
assigning by way of security his rights to the deposit, which is with Bank A, if you
like, to the person who is taking the benefit of the charge, say Bank B. When you take
an assignment by way of security or even just an outright assignment by way of sale,
it is usually very prudent to serve notice on the debtor that you have now acquired an
interest in what was assigned. Therefore Bank B would serve notice on Bank A
saying ‘I have a security assignment of this debt and from now on you do not pay
anyone but me if the deposit has to be repaid.’

In drafting this notice I was told by my supervisor and various other people that you
usually add on a few other things to this process. You usually get Bank A to

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acknowledge that it has received the notice. You do not just deliver it and hope they
received it. You get them to acknowledge it. The acknowledgement of the notice is
not required under law relating to priorities or anything like that. It is just a prudent
thing to obtain. But lawyers being what they are, go on to say ‘maybe we should try
to get a few more things built into this. So why don’t we say that Bank A will not just
acknowledge that it has received the notice, but it will actually undertake to directly
pay the assignee bank, Bank B, unless it has been told otherwise? Why don’t we also
say they’ll pay without any setoff or counterclaim or any deduction? Then, of course,
a lawyer will say ‘is there a problem here of whether these undertakings are
enforceable? They are just being given for nothing by Bank A to Bank B. Therefore
we’ll say it’s in consideration of the payment of £1 or some nominal consideration.
Or we might put it under seal which would have the same effect to make it legally
binding.’

That is how direct agreements started. The assignee of a debt started building in
direct contractual rights against the person whose obligations were being assigned.
Exactly the same thinking goes into direct agreements in project finance transactions.
It is the same idea. It has just become more complicated. The reason it is very
important in project finance is if you look at the underlying project documents and the
concession agreement, you can see that before the project has been completed –
before construction is completed – nearly all of the assets of the borrower, apart from
a usually modest amount of cash, consist of rights under contracts. That is it. It may
have a bit of cash put in by way of equity. However, as Lilia said, that would be quite
small because the debt-equity ratio tends to be quite aggressive. Those are the assets
of your multi-billion dollar borrower, so it is pretty important that you are happy that
they work. Of course, you are going to take an assignment by way of security of
those assets because there is not really much else at this point. You are going to serve
notice of that assignment as Bank B did with Bank A, and you are going to want
rather more than ‘thanks for the notice’ when you look at the government under the
concession agreement.

One very good reason for that is when you look at the concession agreement and you
bear in mind that an assignee cannot get any better rights than the assignor had – so
merely by virtue of an assignment you cannot put yourself in a better position than the
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grantee of the concession – and you see in the concession agreement that in various
circumstances the host government can terminate the concession. If those
circumstances arise, the assignment of the concession will be worthless because it
could be terminated. Those circumstances include the bankruptcy or insolvency of
the concession company, of your borrower.

In the very situation where you might want to enforce your security, there is a very
severe risk that the concession agreement disappears because the government could
terminate it in just the same circumstances. You have to do something about that if
your security over the concession agreement is going to be worth having. Therefore
you negotiate with the government a direct agreement that will go on to say that the
government understands that if you are enforcing your security, it may also be a
situation where the government would have the right to terminate the concession
agreement. If that happens, the government will allow you, the lender, the
opportunity to find somebody else to come in to operate the project instead of this
borrower that has gone bust – to put it another way, the opportunity to step into the
shoes of the borrower. There are a number of requirements that the government would
impose as conditions of giving that right.

Step-in rights first arose in transactions with the Eurotunnel transaction. Prior to that,
we were not really doing much infrastructure project financing. Eurotunnel was a
pre-PFI project. They had to document something like a direct agreement. Returning
to the point Lilia was making: do banks ever actually use these rights? Eurotunnel
was in default virtually from day one. The history of the Eurotunnel financing is a
history of refinancing, rescheduling, granting waivers of default, waivers to allow the
financing to continue, etc. It got to the point where the waivers became so complex
and so heavy in documentation that it might, in some ways, have been easier to start
again. Throughout all of this process, the banks could have enforced their security.
The conditions were there. They could have used step-in rights. They did not. They
still have not. That is perhaps the example par excellence of a troubled project. I
think it demonstrates how much banks will absorb in terms of difficulties before they
will pull the trigger and actually enforce security. They will go to any lengths to
avoid having to do that.

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Question: Banks are not Eurotunnel operators. They would not even know how to
begin. Which contractor would they find to go and step in? Nonetheless, they want
to have that so they can squeeze the project company and actually exercise greater
bargaining power.

Answer (Roger McCormick): Yes. Stepping in is not without liability and

responsibility. Banks shrink very fast away from the idea of becoming personally
liable for the operation of a project. If they wanted to do it, they would only do so if
they could find a substitute operator. As time has gone on, that has become easier.
When this wave of infrastructure financing started it was quite difficult to find
operators for some of these infrastructure projects because there was not much of a
market in it. I remember when we first started doing prison projects in the
United Kingdom, there were only a handful of companies that were capable of
operating prisons. If you wanted to exercise step-in, you would have a choice of
about two others. Things have moved on a bit since then. It is not so difficult to find
new operators, but it is still easier said than done.

Question: The Eurotunnel deal was so high profile. Is the reason why the lenders
have never exercised the step-in rights because there is no one out there who would be
willing to take this project over for them?

Answer (Roger McCormick: I think that is part of the reason. There are so many
exceptional things about Eurotunnel but one of them is that the equity was raised from
the public. They floated shares on the stock market. There was not a market in
cross-channel tunnel operators. I am not sure if there is even now. It would be very
hard to find someone to take it on. It is full of risk. Admittedly now that construction
has been achieved and the thing is running there are operating profits that could be
made, but it must be very hard to assess that sort of risk. It is probably easier to find a
substitute operator now than it was in the mid-1990s.

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Question: What is your experience with direct agreements with governments? Are
they broadly accepted by governments and easily negotiated? [Inaudible] Under
Hungarian law, a concession right is not freely transferable. If you want to enforce
your security, you really need the consent of the government in order to transfer
ongoing business pledge. So you have no other option than to have an agreement
with the government.

Answer (Roger McCormick): Yes. It works by way of a novation, so the

government’s consent is needed anyway. The form of the direct agreement between
the government and the lenders is that if certain conditions are satisfied, the
government will enter into a new concession agreement with a new operator. In a
very technical sense, it is not a transfer. It is a novation. Whether that would
overcome the problems under Hungarian law, I do not know. Clearly it cannot be
done without the agreement of the government. However, the government has agreed
in advance with the lenders that it will do it if technical and financial conditions are
satisfied. This is a key area. It is absolutely crucial. The other contractual rights are
important. Certainly pre-completion, the construction contracts are terribly important.
The concession represents the crown jewels of the assets of the borrower and if you
cannot get security over it, because you cannot assign by way of security, then it is
potentially a huge problem. If the government wants to do infrastructure financing it
would have to find a solution to that problem.

Question: Which provisions are the most important?

Answer: I would say termination rights. If you are reviewing them to assess the risks,
you will ask ‘when can they terminate? Under what circumstances can the
counterparty terminate those rights? Does it give the project company the rights that
are required to develop the project?’

Comment: (Roger McCormick) The question is ‘which provisions are the most
important?’ I think the first thing you have to ask yourself is ‘on whose behalf am I

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reviewing them?’ Let us assume that it is from the point of view of the lender, as
opposed to the project company or the counterparty. To start off with that puts you in
a slightly peculiar situation because you are reviewing a contract to which your client
is not a party. What are you looking for? You immediately say ‘my client is going to
take a security assignment of these provisions so they are as important to my client as
they are to the project company. Furthermore, I am by nature a sceptical person,
being a lawyer, and I am a little bit wary that the counterparty owns a lot of the shares
in the borrower and has representatives on its board of directors because it’s a
sponsor. There is a risk that this might be a rather cosy, sweetheart deal where the
borrower has been too easy on the obligations of the counterparty. If the counterparty
is, say, the construction company, the borrower may be tempted to give it far too
relaxed a force majeure, or let out, clause, because there is a relationship between the
two. But I’m the lender. I don’t have this relationship and furthermore I’m providing
debt not equity so I’m by nature more conservative in the way I look at risk. You
would bear in mind that the key thing for you is that the cash flow of the project keeps
coming through and that the project gets built. You would look at all of the
provisions that can affect that. In fact, most of them can: You would look at the
specification of what is being built:

• Is it what you thought it was going to be?

• How firm is the price?

• What are the possible price escalators, which as the lender you would be very
skeptical about because you might not wish to provide the financing.
• To what extent could revenue streams under, say, off-take contracts be
interrupted by counter-claims and set offs?
• Termination rights.
• Disclaimers of liability.
• Caps on damages
You would look at all of the things which could affect how much money your
borrower could extract from the counterparty for failure to perform, either according
to specification or on time. This would be your concern.

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Question: That is probably, basically, everything. To say the termination – when can
the counterparty stop performing what they are required to perform? Does it give you
what you need or what the project needs in order to develop the projects?

Answer: Most things are potentially important. The key thing is that you are looking
at it with a more sceptical eye because you are representing the lender, not the direct
counterparty. It is an odd triangular situation but as the lender’s counsel you are have
the wintry eye over these clauses and you look at them with a very hard-nosed
attitude.

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 II

COMMON LAW AND CIVIL LAW APPROACHES TO COMMERCIAL

DOCUMENTATION: COMMERCIAL DRAFTING AND NEGOTIATING
RISK ALLOCATION DEVICES

Hugh Collins, Professor of English Law, LSE

(Transcript of talk)

2.1 Dense Contracting

Dense contracting is an Anglo-American contract phenomenon. The common-law

tradition of writing contracts is one where the contracts have enormous length and
detail in them. They go on for many, many pages. In comparison, at least until
recently, in Europe – in France and in Germany – the contracts have tended to be
rather shorter and very incomplete from a common-lawyer’s perspective. I want to
make a contrast between incomplete contracting, as in the civil-law tradition, and
dense contracting. I have called it dense contracting because you can never have a
complete contract. You always forget something, or it is a bit vague on some point.
However, this is something that is much denser and more thorough, and dealing with
all of the issues. I have looked at these common-law contracts over the years, and
tried to work out why they are so long. Like any contract they do specify what the
deal, the transaction, is supposed to be. One will also find that in civil-law contracts.

The common lawyers seem to spend an enormous amount of time in getting to what is
called the ‘arms race’ where the lawyers on each side negotiate more and more detail,
trying to get some little advantage. The issues seem to be about: Exclusions,
limitations, qualifications of liability in particular circumstances – very specific on
that. There is lots of stuff on what the remedies are going to be in the unlikely event
on breach, and what procedures will be followed – therefore things like the arbitration

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clause and exactly how that will work, security over assets, the precise measure of
liquidated damages, and the application of the contract to other people – third parties,
other businesses, other parts of the network involved in creating the transaction.

2.2 Divergence

I have been pondering for some time why there is this difference between the short,
incomplete civil law contract and the dense common law contract. I will look at
possible reasons why there is this divergence, and why common law traditional
contracts in commerce are very long: I will first look at divergences between the
character of the legal system: common law as opposed to civil law. Secondly, I will
discuss other aspects of the law, outside contract law. Finally, the very interesting
topic of cultural divergence. It is possible that all these explanations are completely
beside the point. It may be that because English and American lawyers charge by the
minute, the longer the contract is the better from their point of view.

2.2.1 Divergences between Legal Systems

Is there some profound difference between common law and civil law systems in
relation to the whole structure of the legal system, which explains why contracts are
law in the common law? Is it something to do with the contrast between a codified
legal system and a common-law system based upon precedent, as most of our
commercial law is? Civil lawyers tend to think that having a code and a system does
produce a rather more certain or predictable legal system. My observations are that is
completely wrong and that instead what the common law system of precedent gives is
a very detailed set of rules and principles to guide commercial lawyers. It is true that
it is very opaque. It is very hard to find out what it is. You have to spend many years
in practice, studying the law, to find out what the precedents say. This is a very
detailed regulatory system, provided you know your cases and you can understand
how to interpret them. I do not think the difference between codes and the
common-law system based upon precedent can explain the different length of
contracts. The common law provides more predictable outcomes. Therefore, there
would not be any need to write lengthy contracts to combat the uncertainty of the law.

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2.2.2 Divergences in Contract Law
Are there differences in contract law between the systems? Yes, certainly there are
differences between the common-law system of contact law, commercial law, and
civil law systems. There are many differences, three of which may be relevant to the
question of the length of contracts. These are:
• Interpretation of contracts.
• Difference between strict liability and fault liability, by which I mean ‘is
someone liable simply because they failed to perform the contract?’ or is there
an additional question asked that ‘they will only be liable if it was somehow
their fault for the breach?’
• The relevance of mandatory or compulsory rules in contract law.

2.2.3 Interpretation
There does seem to be quite a significant difference at least between England and
France regarding the interpretation of contracts. What the contract means in the
common-law system is a question of law for the judge. It is possible to appeal this up
to the highest courts. However, in France it is always said that it is just a matter of
fact, a decision for the lower courts subject to some exceptions. The German system
used to be like the French, but has now moved much closer to the English.

The consequence of this difference between the English and French systems is that
once a court of appeal has decided what a phrase in a contract means, then that is a
precedent and other judges are going to follow that interpretation of exactly what it
means and how it applies in particular circumstances. In contrast, an interpretation of
that kind in a French court can be completely ignored by the next court. You can read
commercial contract amounts to a series of signposts pointing to judicial decisions
that ‘this phrase has been used because in an earlier case this phrase was used and the
judge said that is what it meant, explained its meaning and applied it in a typical
situation where there might be a dispute.’ For a common lawyer there is an advantage
in writing contracts using all these signs based upon precedents because that gives
you quite a lot of certainty. You can be pretty sure what the next judge is going to say
that contract means. By contrast, in French law there is not this certainty that the

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judge is going to interpret the phrase the same way next time as it was interpreted last
time.

2.2.4 Mandatory Rules

The third difference in contract law systems seems to me that there are very few
mandatory rules in the common law of contracts. It includes a discussion about
freedom of contracts, how the courts allow freedom of contracts and allow the parties
to write their contract and that the court will enforce it as it is written. There are
important mandatory principles about fraud and illegality, etc. Beyond that there is
not much. Civil law always strikes me as absolutely full of mandatory rules, and if
not mandatory, then almost mandatory because you have to have some special reason
to depart from the default rules. I was involved a bit in the project to harmonise
European contract law involved in franchising contracts. My Dutch colleague had a
very elaborate legislative scheme for Europe on franchises. He asked me, ‘what’s the
English law?’ I could tell him in one line, ‘freedom of contract. There are no special
rules.’ Civil law systems have quite a lot of mandatory rules. Very often those are
real ‘nasties’ that English lawyers hate: the good-faith clause, which allows the courts
to sweep in and, in effect, rewrite the contract. I think the courts feel empowered to
do this in civil law jurisdictions because this is the code. It has been democratically
chosen by the legislature. It gives them the power to do this. English courts do not
have that legislation. It is precedent. They are their own decisions. They do not feel
the power to rewrite contracts or impose mandatory rules. Normally all they will do
is enforce what is written in the contract. Therefore there is some advantage to
commercial lawyers to write a long contract, spelling it all out, because you know that
is what is going to happen, what the court will do – whereas in a civil law system you
can write a long contract but if the court does not like it, it will call for “good faith’ or
a “more cooperative approach’. They will override the contract. There is perhaps
little point writing a long contract.

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2.2.5 Divergences in Other Branches of Law
Litigation costs. My third topic is divergences in other branches of law. I will touch
on this very briefly. The litigation costs do vary around Europe. As you might expect,
we are at the expensive end in London. I think lawyers do spend some time in writing
the contracts to minimise the potential costs of a dispute by putting it into arbitration
and trying to agree what the remedies will be in the event of breach. This is because
you really do not want to go to court. It is too expensive.

Tort liability. My second point is about tort liability. I am drawing the distinction
between concurrent liability and non-concurrent liability. In common law systems
you can sue in contract and tort law. It is an old trick. If you think you are going to
lose in contract law, you try a claim in tort. That may work. That may get around the
problem. In French law you are not allowed to do that. If there is a contract between
the parties, then you cannot also sue in tort. This risk of tort liability much exercises
the minds of common lawyers. They are going to put stuff into the contracts in order
to block that or control what might happen, what possible claims by other parties, as
well in tort. That is something they need to do and they cannot rely on the court to
throw that out.

2.2.6 Cultural Divergences

Finally, are there differences in culture? Do English lawyers just love to write long
contracts, whereas French lawyers like a few elegant phrases and just leave it at that?
I do not know. Is there a difference between societies? Does everybody trust each
other in Germany, whereas in England nobody trusts anybody so they write
everything down in detail? These are possible explanations. How important is
reputation in the marketplace? People tend to keep their contracts if it will damage
their reputation and that will have knock-on effects – all their other customers will
dislike them. There do seem to be some differences in respect to the significance of
reputation in the marketplace between different countries. It is hard to generalise.

The difference between English and German practice, which is quite well documented,
is that German businesses seem to be much more willing than English businesses to
accept standardised solutions to common problems or transactions. They will just say,

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‘just use the standard form,’ which is often developed by the relevant trade
association. They are content with that. Therefore it will be less customised to a
particular transaction than you might expect from a common-law system. In Germany,
the law firms publish their standardised contracts so that you can actually see what
you will get, whereas the London firms keep what their vicious paperwork will do as
a closely guarded secret. They will not disclose it to anybody else, other than clients,
unless they absolutely have to. In Germany there is a willingness on the part of
businesses just to use the standard transaction even though it may not quite fit and
then trust the other party and the court to sort out the details later. I have not noticed
that practice in Britain at all. I do not really have a neat explanation of why common
law contracts are longer. They certainly are, though practice in Europe does seem to
be changing and gradually moving towards the Anglo-American model. Whether this
is a good thing or not is much debated. I think the factors relating to interpretation,
and the difference between fault and strict liability, are quite critical here. I think they
are the main drivers. However, no doubt these other cultural factors play their role.
As a broad generalisation it is true that common law imposes strict liability in
contracts so that if you have broken it, even though it was not your fault in some way,
it is tough. You are liable. Whereas civil law systems start with the opposite
presumption: that you should only be liable if it is somehow your fault.

Both systems have exceptions in particular circumstances. However, the starting

point always in common law is that you are liable if you have not performed what is
written in the contract. The consequence of that seems to me to be that if you want to
have excuses, limitations, exceptions, whatever it might be – if you want to start
getting out of your contract for force majeure or change of circumstances, you have to
spell it out in the contract. You cannot leave it to chance that a judge may take pity
on you and say ‘well, perhaps it wasn’t really your fault and we’ll create a little
exception here.’ In practice the judges will not do that most of the time. If you want
some excuses, you need to write them into the contract. I think that accounts for a lot
of the contract. You will be talking about some of the favorite phrases used by
lawyers to do that.

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Annex 2.1: Questions and answers

Question: Is there any mechanism for unification of practice in common law? How
are you sure that you are looking at the correct practice? Do you have controversial
practice?

Answer: Yes, sometimes apparent disagreements between the cases may arise. This is
the meat of professors like me, that I can write learned articles saying which judge got
it right and which judge got it wrong. That is certainly the case. Undoubtedly
sometimes there are mistakes. Sometimes the judge will fail to notice that an earlier
decision on a particular point was there. That happens as well.
Ultimately the only solution is for another case to arise. The judge in that case will
then say ‘there is this view and there is this view. The better view, following the
article written by Professor Collins, is that view.’ That is how it happens.
Actually they usually disagree with my recommendations. Contracts are a device to
incorporate judicial precedent decisions about the meaning of the contract.

Question: Do you think maybe it will be the same tendency on commercial

transactions.

Answer: I suppose it is the fear of the English lawyer that Europe will introduce
legislation into this area and unsettle this practice, evolved over 500 years, of a
dialogue between the court setting precedents and commercial lawyers writing
contracts – that central dialogue to establish certainty and predictability in business
transactions. There is a fear that will be disrupted. Presumably the City of London
will resist this, but perhaps unsuccessfully.

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 III

DRAFTING TECHNIQUES ON QUALIFYING OBLIGATIONS AND THE

LAW THAT UNDERLIES THEM: REASONABLENESS, ENDEAVOURS
QUALIFICATIONS AND MATERIALITY

Christoph Sicking, Chief Counsel, EBRD

(Transcript of talk)

3.1 Introduction

This chapter provides some of the tools that are used by English lawyers in softening
or qualifying contractual obligations, and in qualifying the rights a party, such as a
lender may have in relation to the exercise of a discretion. One of the favourite
techniques that we see common lawyers use in contractual drafting are the concepts of
“best” or “reasonable endeavours” as ways to qualify what would otherwise be
expressed as absolute obligations, as well as the ‘material’. There is nothing special
about the word ‘material’. However, there is a lot to say about ‘reasonable’ and
‘endeavours’. The fact that those words are so incredible popular and arise so many
times in contractual negotiations is a feature of the common law.

3.2 Reasonable and Acting Reasonably; Limitations on the Exercise of Discretion

One of the features of project finance from a lenders point of view is that there will be
numerous provisions in the agreements – certainly in the loan agreements – where the
lender will be asked to exercise discretion. A traditional example would be: prior to
disbursement you need to be happy with the security that is in place. It is not unusual
for the lender to say, ‘security has to be in form and substance satisfactory to us’. If
you are negotiating these provisions with the client who does not come from a
common law jurisdiction, they will ask ‘is this an absolute discretion that you have?’
Are there any limitations at all on your decision making when you have to decide
whether you like the security or not? […] The basic position of English law is that it

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will typically not imply anything into these words. That is the basic rule. The law
that applies to when terms can be implied into contracts sets out a very limited test.
One of the seminal cases is Westernport. The courts will only imply a term if the
term is reasonable and equitable. They will only imply it if it is necessary to give
business efficacy to the contract. […] That is a much, much higher standard than
what civilians will be used to when they refer to some of the mandatory rules that
arise under civilian codes.

3.3 Should One Imply a Duty to Act Reasonably in the Exercise of Discretion?

There is a recent very interesting cast that gave an answer to the question of how
much discretion a lender has in exercising a discretionary right. It is Socimer v.
Standard Bank. Standard Bank entered into a forward purchase agreement with
another bank, Socimer. It was a forward purchase agreement for emerging markets
securities. Socimer had made an initial payment. Socimer then went bankrupt. The
bankruptcy gave Standard Bank the right to terminate the contract. There was
language in the agreement that said ‘at the moment that we terminate, we,
Standard Bank, have the right to determine the value of the securities’. In other words,
by termination of the contract it no longer had to perform, but by the additional
language it said it had the right to terminate the value of the securities. It was
basically given discretion to determine what the loss was to it of Socimer no longer
being able to perform under the purchase agreement.

Unfortunately, Standard Bank did not go through the exercise of valuing it and instead
sold them. The trial judge went ahead and said, ‘okay, now I am going to determine
what you should have determined the value to be.’ The trial judge applied an
objective test. It said, ‘what would a reasonable person have concluded the value of
those securities would be?’ That was then appealed because Standard Bank said, it
had a full discretion to determine such value “subjectively”. […] The
Court of Appeal supported Standard Bank's view. By doing so it held up what is the
general understanding under English law that in exercising discretion there is no
implied duty for the person who exercises it to act reasonably.

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3.3.1 Limitations
There are, however, some limitations on the exercise of discretion.
One has to act honestly, and in good faith. One is not allowed to act arbitrarily or in a
capricious manner or perversely. To the extent ‘reasonableness’ does appear in the
analysis, because there are some cases that suggest that one has to act reasonably, the
Court of Appeal was very clear. ‘Reasonableness’ does not mean a duty to act
reasonably. ‘Reasonableness’ is akin to acting rationally. […]

3.3.2 drafting implications

Many of you deal on a regular basis with English-law governed agreement. The
drafting implications of this approach of the English law is that English lawyers will
try to put the words ‘reasonable’ or ‘acting reasonably’ in as many provisions as
possible. […] The reason is: English law does not provide for it. Two thoughts on
how you, as a petitioner – or how I - are to go about assessing whether we should
agree or not agree to putting the word ‘reasonable’ into a contract. There can be a
difference between using ‘reasonable’ as an adjective, and using it as an adverb. For
example, in your drafting if you use the terms ‘the parties will agree on a reasonable
time period,’ or that ‘reasonable price has to be set forth somewhere,’ in the case of a
dispute you are inviting the judge to make some form of objective determination of
whatever was qualified by the word reasonable.

It is slightly different in my view when the word is used in its adverbial form; i.e.,
‘acting reasonably’. If you had to write them out in a sentence, the words ‘acting
reasonably’ could be paraphrased as saying, ‘the lender agrees to apply reasonable
care in coming to its decision’. I think those words are much, much more likely to
imply that the lender or whomever has agreed to the provisions has assumed a duty
towards the other person. This is a duty that can obviously be breached. I think you
want to think twice about using those words. My rule of thumb, as someone who
negotiates contracts on a daily basis, is when clients raise the issue of whether the
word ‘reasonable’ should be use, I usually say, ‘try to avoid it’. It is hard to argue
because the first thing they will say is, ‘do you intend to act unreasonably?’ Of
course the answer is no.

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In circumstances where I know that we are going to be on very antagonistic terms
with the client already, I certainly try to avoid it. For example, under our standard
loan agreement if the client is in payment default, we, as a bank, retain the right to
determine the default interest period more or less at our discretion. The clients
usually say, ‘well, that is quite bullish. Can you at least agree to act reasonably in
determining the default interest period?’ It affects how much they will have to pay if
they ever can repay the loan. I say, ‘no, wait a minute. You can avoid the issue
altogether by paying us, by not defaulting. I am not interested in qualifying my rights
in a significant matter in the face of your default.’ Another scenario is enforcement of
security. Sometimes when clients look at enforcement provisions, they ask ‘would
you please add the words “acting reasonably” in enforcing security?’ Think about it.
When you enforce security on someone, do you think they will ever believe that
anything you do is reasonable? Probably not. You will be in a state of war. You do
not want to give additional ammunition to the other side by qualifying the rights that
you have.

3.4 Best Endeavours and Reasonable Endeavours

Another favorite technique used by English lawyers to soften or qualify the strength
or the binding force of obligations that people undertake is to use the word
‘reasonable’ or ‘best endeavours’. Coming back to what I said earlier about spending
the first year of legal education in the civil law, my guess is these concepts
‘reasonable’ and ‘best endeavours’ occupy the space that in the civil law jurisdictions
is occupied by concepts such as ‘obligations of means’ and ‘obligations of result’. In
the French court they are “l’obligation de résultat and l’obligation de moyens”. In
other words, there is an implied reading when you read an undertaking. Does it want
to achieve a result or does it want to do your best to achieve the result?

They also occupy the space of a doctrine that does not exist at all in English law. I am
drawing on French law. I think it must exist in your jurisdictions also. It is
abus de droit, the abuse of rights, the idea that you can abuse rights. There is no such
concept in the English law. The English lawyer would say, ‘if you abuse the right
then it’s a right you didn’t have in the first place.’ It is a bit tautological but the
doctrine does not exist. As a petitioner I found that in assisting their clients a lot of

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English lawyers will try to qualify the undertakings that the clients make by using the
words ‘best endeavours’ and ‘reasonable endeavours’. For example, the borrower
agrees to use ‘reasonable endeavours’ to obtain a construction permit, to bring it back
to the context of project finance. It turns out that there is a great deal of jurisprudence
in England that has developed around those two words. […]

3.4.1 Best Endeavours

There is a lot of case law on these two words: ‘reasonable endeavours’ and ‘best
endeavours’. There is a ton of case law, which suggests to me two or three things.
Firstly, if you are a litigator it is a good thing because you can give meaning to these
words. There are lots of cases you can draw on. It also tells me that they are
inherently subjective terms, even if you do use them. Otherwise people would not
have to litigate them so much. Let me go into what ‘best endeavours’ and ‘reasonable
endeavours’ mean.

‘Best endeavours’ is the qualification that imposes the highest burden on the obligor,
the person who is making the commitment. The early cases on this were very strict.
There is a case called Sheffield District Railway, where the defendant agreed to
develop the traffic of Sheffield. The judge basically said, ‘it is such a high obligation
you should leave no stone unturned. You need to do anything that you can to make
sure that you comply with this obligation.’ Since then the standard has softened a little
bit. It is recognised now that in complying with a ‘best efforts’ obligation you will
have to expend money. You cannot say, ‘I am not going to do it because it costs so
much money.’ However you do not have to spend so much money as to cause your
own financial ruin. […]

3.4.2 Reasonable Endeavours

‘Reasonable endeavours’ is a lower standard. It is a standard that is typically more
interpreted from the point of view of the person who is giving the undertaking. ‘Best
endeavours’ is usually interpreted from the point of view of ‘who is the beneficiary of
it?’ When you look at ‘reasonable endeavours,’ you have further softened the
strength of the obligation. The general principle is the obligation to take action but
only to the extent that it does not significantly disadvantage the obligor, the person

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who made the undertaking. There is a clear recognition that one will have complied
with it even if the desired result cannot be achieved. This goes back to the idea of
obligation of means, l’obligation de moyens, as opposed to result.

3.4.3 Reasonable Endeavours versus Best Endeavours

The word ‘reasonable’ in ‘reasonable endeavours’ is an objective standard. In other
words, one asks, ‘what would a person who agreed to this undertaking have done in
similar circumstances?’ Most importantly the person who gives the undertaking will
be able to say that if it is too expensive to them – if the financial burden of complying
with it is too high – it can get out of it.

There is one interesting case that is relevant to our discussions about project finance.
I got to know the lawyer on the other side quite well. He was someone from a civilian
background, from France. At one point we were not able to agree on how we should
deal with certain provisions. The idea came up that we make it subject to a
‘reasonable endeavours’ standard. When he asked what that meant, I sent him a case
called Phillips v. Enron. […]

3.4.4 Other Considerations

There are other principles that will override, no matter what you say on the question
of endeavours. Contracts that use terms like ‘people will use their “best endeavours”
or “reasonable endeavours” to agree to a certain term,’ or ‘to agree to a contract’ –
you may know that English law has a strong bias against agreements to agree. They
are perceived as not being enforceable because there is not a sufficient level of
certainty. […] Another case was where a director had given a ‘best endeavours’
undertaking that it would bring a certain contract to be submitted for approval to the
shareholders. The director then decided that it was no longer in the best interests of
the company to enter into the contract. The court decided that the fiduciary duty of
the director trumped the ‘best endeavours’ undertaking he had made to the third party.

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3.4.5 Conclusion
To summarise, if you use these words realise that they are a significant qualification
to the undertakings that you have in front of you. Even the ‘best endeavour’
undertaking is less than an absolute obligation. The case law draws a distinction
between the two. The interpretation that is given by the case law will very much
depend on the context. This explains why there are so many cases. Also, I think if
you do have to use the terms, avoid what I would call wordplay. The case law that is
available does use those specific terms: ‘best endeavours’ and ‘reasonable
endeavours’. It does not use ‘utmost endeavours’. It does not say
‘commercially-reasonable endeavours’. If you do have to use the term, it makes sense
to be precise about them and use them as they appear in some of the cases. One caveat
to that: there are three or four cases now that suggest that ‘all reasonable endeavours’
is actually a separate standard. The most recent cast suggested that ‘all reasonable
endeavours’ is closer to ‘best endeavours’ than ‘reasonable endeavours’. However
there are at least four cases that someone can point to that suggest that it is a
third standard that people can use in their contractual drafting.

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Annex 3.1: Questions and Answers

Question: Let us assume that we have indicated ‘acted reasonably’ with respect to the
default. How will the court decide what was reasonable? By comparing the actions of
the lenders?

Answer: It is hard to predict. I think the fundamental difference is the court rather than
saying, ‘am I satisfied that this lender, in its own subjective position acted in a good-faith
type of manner?’ – if you add the words ‘acting reasonably’ the court is likely to apply an
objective standard. It will say, ‘how would another lender in a similar position have
acted? Did you act accordingly?’ It seems like a nuance but there is an important
difference between the two. At a time when you want to have a high level of discretion,
especially in a default scenario, those nuances can really bite you.

Question: What is the difference between rationally and reasonably?

Answer: I think rationally means that if you had to go in front of a judge and explain what
you did, you need to show that there was at least some logical thinking behind you
coming to the judgment call that you made. This is different from saying that the
judgment that you made is the kind of judgment that a reasonable lender would have
come to in similar circumstances.

Question: Lender’s lawyers will often present a first draft of a financing document, which
is so extreme in favour of the lenders that the borrower’s lawyers would be negligent if
they did not start putting blue pencils through all sorts of things. Therefore you get
things like, ‘if the agent determines that an event of default has occurred, the following
things will happen.’ The borrower’s lawyers will say, ‘excuse me a moment. Can we
just say, “if an event of default has occurred”?’ and then, ‘shall we say “if the agent
reasonably determines if an event of default has occurred”?’

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Answer: You should go for the former. You are right to raise this. Another way of
thinking about the distinction between rational and reasonable is the rational person acts
entirely in their own self interest at all times, whereas a reasonable person takes into
account the interests of the other party to some extent. That is another way of thinking
about it. The rational person can also be opportunist, take advantage of somebody else’s
bad situation.

Question: Why is not possible to say ‘rational’ in the contract?

Answer: The English courts will assume that all you are promising to do is to act
rationally, not reasonably. You have to put the word ‘reasonable’ into the contract if you
want someone to behave reasonably. I think that is what the argument was. I think it
would be slightly insulting to the other side if you say ‘we expect you to act rationally.’
The word ‘rational’ is not a word people would take kindly to.

Comment: I have never seen it but I am sure there is a first time for everything.

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 IV

BANKABILITY – INTRODUCTION, POLITICAL RISK, COMPLETION

GUARANTEES AND SPONSOR SUPPORT

Roger McCormick, Visiting Professor, LSE

(Transcript of talk)

4.1 Introduction

In this session, we examine various aspects of bankability. You will realise that
bankability is a theme that keeps recurring. This exercise of negotiating transactions of
this kind involves trying to get the suite of documents to fit together in a way that gives
lenders confidence to lend very large amounts of money. In other words, to be
‘bankable’. That is part of the skill of being involved in this kind of work, whichever
party you are representing. It is not a success if you have negotiated so well on behalf of
your client that the terms are completely unacceptable to the other parties and no one will
lend any money on them. It is about compromise in some ways.

4.2 The Sectors

In broad terms, you can look at three different types of sector with this type of transaction:
Infrastructure Natural resources, Industrial plant and buildings
Infrastructure is a large area. In a sense, natural resources use the same kinds of
techniques. They may not talk in terms of concessions always. It sometimes will be a

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license or some sort of permit to extract oil and gas or minerals of some kind. It can also
be used for industrial plant and buildings. One of my more enjoyable transactions when I
was representing EBRD was for a chocolate factory in Russia. That was financed using a
project finance technique with an off-take contract.

4.3 What is a Public Private Partnership (PPP)?

You will often hear about Public Private Partnerships (PPP). It used to be Private
Finance Initiative (PFI) in the UK. One thing you have to understand with PPP is that it
does not involve a partnership. That is just one of those words that means what you want
it to mean in this context, but it certainly does not involve a partnership in law. There is
no precise definition of PPP. It usually involves project finance, but it does not have to.
It is the successor to the PFI in the UK. It also looks much like ‘Build Operate Transfer’
(BOT), although that expression is somewhat outmoded now. It is the same concept.. It
is a kind of privatisation. It does not involve the selling of shares to the public, such as
with British Gas, but it is privatisation in the sense that it involves using the private sector
to provide services which, 15-20 years ago, would generally have been provided by the
public sector. You do occasionally see PPP structures used where government money is
used. This is quite interesting because it illustrates a particular point about them. I came
across this when advising the UK Home Office on what were first called ‘Immigration
Detention Centres’. That was a bad enough name. They then started calling them
‘Immigration Removal Centres’ which I thought was even less friendly. It was to deal
with a problem which many countries have: extremely large numbers of illegal
immigrants and how to repatriate them. Leaving aside the politics of that which is
infernally complicated, there clearly was a need to do something about it because of the
huge numbers involved.

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4.4 The Example of PPP and Immigration Detention Centres

The government wanted to set up detention centres where they could place these people,
pending their removal from the country. There was a political necessity to get it done
quickly. It was felt that the detention centres were similar in some ways to prisons. PPP
had been used to build prisons in the past, so they decided to use something similar for
these centres. However, the problem with PPP is that it takes a long time to negotiate
with the banks and time was of the essence. They therefore decided to use Treasury
money, but with the PPP structure. They liked the idea that the emphasis is not just on
building something and then leaving it to be run by the public sector; they liked the idea
that the private sector builds it and then also provides the service. There was a single
point of responsibility for both the construction and the operation. That is, if you like, a
by-product of PPP and project finance that is very valuable to the public sector.
In the past, if you arranged for the private sector to build on a traditional public works
contract, with the public sector operating it, if and when it was found there was
something wrong with what was delivered and they complained to the builders, the
builders would say that it was a problem with how they were operating it. If you went to
the operator and said it was not being operated correctly, they would say that it had been
built incorrectly and had not been built properly for the purpose. There was therefore a
‘falling between two stools’ problem.

With the PPP/PFI structure, you have a single point of responsibility. The government
says to the private sector, ‘You formed a concession company to build and operate this
service. You cannot get the government involved in the squabbles between yourselves.
If you have a problem, you must sort it out yourself.’ There is a single point of
responsibility. That is why the immigration detention centres used Treasury money, but
still had a PPP-style star diagram structure with a concession agreement, an off-take
agreement, and so on.

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4.5 Infrastructure Sectors

There are many different infrastructure sectors, and the list continues to expand. The UK
public sector, and with many other countries, seems always to be in retreat from the
frontline of responsibility for delivery of services.

4.5.1 Basic Transaction Structures

There are various basic transaction structures. The concession has the effect of
something similar to a mini monopoly. This involves a number of issues. Whenever you
create a mini monopoly, you want to ensure that it is not abused, as people can abuse
them if allowed. The concession has to have a form of regulatory provision that prohibits
abuse. Perhaps we could talk more about that later in the day.

4.5.2 BOT Star Diagram

There is the construction, the operation and the financing. That all culminates in a star
diagram, which looks similar to the one that was in Lilia’s presentation this morning.
This is a slightly different version. All presentations on project finance tend to involve
some consideration of a structure such as this, including: An SPV project vehicle
company is in the middle. The host country public sector letting the concession is one
counterparty. Shareholders injecting equity including subordinated loans are another.
Then there are the debt funders, who include a whole range of people from commercial
banks to IFIs, such as EBRD, and export credit agencies. The other parties are the
counterparties to so-called project contracts, for items such as fuel supply, off-take and
other contracts. Often, they are also the shareholders.

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4.6 Risk

4.6.1 Removing Risk from the Public Sector

There are one or two basic risk points. From the UK government’s perspective, the
exercise is justified on the basis that it transfers risk away from the public sector. The
government is keen to remove risk from the public sector and to keep the risk with the
private sector. It is also concerned that it gets ‘value for money’. These two elements are
used by the UK government to justify using PFI and PPP. There is an interesting question
with regard to the extent that the public sector can really remove risk. Whatever the
contracts say, the public – the people who vote – still tend to regard the government as
responsible for these services. If the services are not being delivered, it is not an answer
to the voters to say that those responsible are in breach of contract and will be fined. The
public still do not receive the service they need. If the services are not delivered, the
public is not interested in what the contract says. The public simply wants the service
restored.

The London Underground is an example of this. People are very angry when trains do
not run properly. There was also a famous case of a detention centre being burnt down a
few years ago. Another one, I believe, was also burnt down recently. These examples
are very embarrassing for the government. Whatever the contractual position is, it looks
as though the government has got it wrong because they had not selected responsible
people.

4.6.2 Risk Allocation

We are looking at risk allocation. One of the most basic points that should be borne in
mind is in terms of how the payment structure is arranged. Whether you are paid
according to availability or usage has a key effect on who is taking what risk. Going
back to prisons again, in the early days, some thought the government could persuade the
private sector to build prisons on the basis that they would be paid according to how

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many prisoners were sent to a particular prison. In other words, it would be a ‘usage’
structure. Not surprisingly, this did not work. They had no control over how many
prisoners would be sent to any particular prison. That would be a decision for the public
sector. It was therefore decided that the government would pay the private sector on the
basis of availability. It was simply not feasible to think in terms of there being a market
for prisoners. Wherever they feel there is a market they will try to pay on the basis of
usage. For example, just as people pay tolls for the use of a motorway or bridge, there is
a market risk. There are many other examples where you are paid on the basis of
availability; where the private sector does not take the risk of usage. From the
government’s point of view, the government is taking the risk that it may have a facility
that it does not need as much as it thought it would. However, because the facility is
available, it still has to pay the same amount of money. Whichever way you look at it,
there is a risk. It is a question of who takes the risk.

4.6.3 Currency Risk

Currency risk is also an issue. Finance is often raised in a currency other than that of the
host country whereas the revenues may well be earned only in that currency. It depends
on what it is. If it is oil or gas, it would be earned in dollars. If it is toll roads or
infrastructure it is usually earned in the local currency. If the local currency plummets as
against the hard currency of the financing, there is a potential problem there.

4.6.4 The Involvement of Government as a State-Owned Participant

Another issue to bear in mind is that the government is often involved either through
state-owned participants or otherwise as a sort of joint venture participant. This will
depend on the economic structure of the country and how much of the economy is still
state-owned. You might find that the company is a state-owned company. The provider
of coal for a power station, for example, may be a state-owned company or the off-taker
of electricity may be a state-owned company. If you go back to the star diagram, you
might find an alarming number of state-owned entities around the star. In more extreme
cases, the government itself might want to have equity in the project. That is not
unknown.
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4.6.5 The Government as Off-taker
In the case of prisons, the government is the off-taker. It is the person that wants the
service of the prison. It provides the prisoners. They do not come from anywhere else,
but the government. Electricity may be another example. This depends on how the
electricity industry is structured. There are a variety of government roles that may come
into play. They do affect bankability.

4.7 Political Issues

Political issues tend to permeate the bankability question. Risk transfer is far from a
black-and-white issue. The political reality of responsibility is quite different.

There can be 'sensitive' sectors for private sector operation. Again, this depends on the
politics of the country. For some time, it was thought outrageous that the private sector
could get involved in Ministry of Defence procurement, for example. It now has and we
have become used to it. There is sensitivity about the private sector making too much
money out of these things. Once the construction risk has been removed, the ability to
make profits can be quite considerable. As they have a monopoly, there is a need to
regulate what they can charge and the level of the service. The London Underground is
an example again. We delight in pointing to how much profit the private sector might be
making out of any particular service. It raises different political issues for the
governments if there are thought to be too many ‘fat cats’ as a result.

We also have the political impact of certain 'incidents'. If people die as a result of the
private operation of a facility, such as with the railways, it is rarely considered that
railway accidents tend to happen regardless of who is running the railway. If there is a
railway accident when the operation is run by the private sector, it is a much bigger
political problem than if it is run by the public sector.

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The procurement competition must be fair. There are issues around the world as to the
way procurement is carried out and the possibilities for bribery and corruption in that
process. There are legal consequences. If a government changes and the new
government does not like the status quo, it can say that the concession is void because it
was obtained using bribery and corruption. This has happened in various countries.
Therefore, lenders cannot ignore questions of whether procurement is properly carried
out.

One can't avoid the fact that there are also political requirements of certain funding
entities. If you bring them to the party as funders or sponsors, as you may wish to do as
they bring certain benefits that are not available from the private sector, you must
acknowledge that there will be political requirements of various kinds. Export credit
agencies have political requirements. Their job is to promote exports from their
particular country. They need to be sensitive to the NGO lobbies that will criticise them
if they are seen to be funding environmentally-unsound projects, for example. They do
not have a free hand. Politics arise.

4.8 Countries in Transition

4.8.1 Completion Guarantees

The impact of the political risks has effects which crop up in different ways. The
multilaterals and the ECAs offer a number of benefits. One of them is that they will
accept a degree of political risk as well as some commercial risk. This means that there is
a question of definition that can vary from deal to deal, and the form in which it is offered
can be varied as well. Without pre-empting that too much, one of the interesting aspects
of completion guarantees is that an institution like an ECA or an EBRD may well say that
there is an exception to the obligations under a completion guarantee if the inability to
deliver the project on time is due to a political risk. There would be a ‘political risk
carve-out’ from the obligation. It is a slightly unusual way of approaching the problem,
but it makes perfectly logical sense given the structure of the transaction.

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4.8.2 State-Owned Companies
When you are dealing with countries in transition, you are frequently looking at entities
that are still in the public sector – such as the coal supplier or the electricity grid – that do
have monopolies. That, in itself, poses quite a lot of interesting risk issues. For example,
we worked on a transaction involving a new high-speed rail facility, where the state
railway company was an important party, but the state railway company had not
published accounts for about 10 years. It was quite clear that such financial information
was completely unreliable. It was difficult to see how you could negotiate anything
meaningful with an entity like that.

If they are in the public sector now, but there is a prospect of privatisation, that in itself
could involve risks. This seems slightly perverse because there are disadvantages in
being in the public sector, from the point of view of someone who is taking your risk, but
at least you know where you are. If you know it is going to be privatised some time
within the next five years, but you do not quite know how it will happen, you ask
yourself a lot of questions. Will that privatised entity be credit worthy? What do I know
about it? How can I provide for this eventuality in the documentation?

4.8.3 Guarantees of the Obligations of the Entity

The consideration may be: perhaps we need a guarantee from the government after all for
the obligations of this entity; not a guarantee of the loan, but at least a guarantee that this
entity, for as long as the deal lasts, will be guaranteed by the government even if it is
privatised. If they cannot be guaranteed can they provide security? The problem with
that sometimes is that the best security they can give is security over the receivables. For
example, the electricity charges paid by the customers or those who buy coal from it.
However, that in turn can inhibit the sector reform for privatisation. If you are trying to
sell shares in a government-owned electricity company, imagine how your prospectus
would read if it said, ‘By the way, all of the revenues of this entity have been charged to
this syndicate of international banks in relation to a project financing that was carried out
five years ago”. You would probably not want to buy shares in a company like that.

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4.8.4 Commercial Issues and Political Issues
At this point, the consideration is whether these are commercial issues, political issues or
a mixture of the two. Can we expect them to honour long-term commitments? Is there a
history or a culture of being committed to contracts? These contracts can be of many
years’ duration. The individuals involved have a tradition of working in the state sector;
they are not used to being tied down by contracts at all. Looking forward, these
individuals do not even know what their own future is going to be. Whatever you might
put into the contract, you do have to consider various difficult questions in terms of
whether it is realistic to expect the contracts to be honoured.

4.8.5 Issues Affecting the Legal Environment

We talked about a discriminatory change in law before the lunch break. I will not go
through that again now. One of the difficult areas with countries in transition is that you
have uncertain aspects of the law as it currently stands. Sometimes the impact of the law
is untested on the particular kind of transaction you are trying to do. There may be
publicity questions. Some countries do not necessarily publish their laws as quickly as
one might like. It can be difficult to find out just what the law is. It does not always
translate that easily. Legal concepts are notoriously difficult to translate from one
language to another. Are there going to be further changes to the law in the pipeline?
How do we deal with the need for government approvals? India is, or at least used to be,
a famous example of what people used to call the ‘Permit Raj’ where it seemed you
needed to get a permit for almost everything. If you cannot get a permit that will endure
the life of a project, how certain can you be that they will be renewed on an annual basis?
Is that risk something that lenders can be content with? Can you get comfort letters from
the government assuring future approval?

4.8.6 The High Ground of the Economy

If the high ground of the economy is still in the public sector, this does raise the impact of
possibly wanting guarantees from the state because every significant company is owned
by the state. They are not guarantees of the loan, however, and this must be remembered.
Nevertheless, it does give rise to the obvious criticism: ‘We thought this was a private
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sector financing off the balance sheet of the public sector, yet when we get into the detail
you keep asking for guarantees from the state for other company’s obligations.’

4.8.7 Not a Real Market

It is also a feature of this kind of economy that there is often not a real market. You may
have a ‘monopsony’ where there is only one off-taker, usually the government, or a
monopoly. For example, you can only get fuel, such as coal, from a government
company.

4.8.8 Conflicts of Interest

You can get conflicts of interest where the state owns multiple parties. This is heightened
where the state owns some of the banks. Amongst our list of potential funders, we
mentioned commercial banks as though they were one type of entity, but in some
structures you have international commercial banks on the one hand, and state-owned
local commercial banks on the other. As you can imagine, the motivations and incentives
of the state-owned commercial banks are not necessarily the same as those of the
international commercial banks. When it comes to drawing up the inter-creditor
agreements, and you add the political parties into the mix as well, you have quite an
interesting task. The future changes, to achieve ‘corporatisation’ and subsequent
privatisation may also change the source of fundamental credit support during the life of
the loan.

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 V

SPONSOR SUPPORT IN PROJECT FINANCE TRANSACTIONS

Christoph Sicking, Chief Counsel, EBRD

(Transcript of talk)

5.1 Introduction

I am going to talk about the role of sponsored support. This morning, Lilia taught us that
in order to call it ‘project finance’ you need to separate the risk of the project from the
other parties. The lender is asked to take the risk of the project itself. Roger began his
presentation by saying that in order for a transaction to work, it has to be bankable. Some
transactions simply are not bankable without some element of support from someone.
This is what I am going to talk about. If that support stays with a transaction for the
duration of the transaction, then arguably you no longer have project finance, you have
something else.

5.2 Why Sponsor Support?

There are two points that are interesting to talk about here. The first consideration is:
what is the nature of the sponsor support? If you want to stick to the philosophy of a
project finance deal, you have to consider when the support will be released so that the
transaction moves to the traditional project phase. Bankability is one reason why sponsor
support appears. Another reason may simply be basic economics. A sponsor of a project
may not want to suffer the very high interest rates that often lenders charge during, for
example, the construction phase of a transaction. It may not fit well within the

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economics. When they look at the overall picture, they may very well be willing to give
a guarantee knowing that that will attract financing on better terms.

5.3 Issues with Multiple Sponsors

When you deal with one sponsor, it is straightforward. You know who you are dealing
with and you know who to ask for the undertakings. Things can get a little trickier when
there is a consortium or some form of joint venture of sponsors who stand behind a
project company. I have dealt with many transactions where joint sponsors or joint
venture sponsors have been most hesitant in providing information to the lender
concerning their own arrangement. A lender will need to know what agreement governs
the relationship between multiple sponsors. This is because the lender needs to find out
how the relationship could impact on the project company. ‘Deadlock’ is one example.
What happens if the two sponsors who stand behind a project do not agree on what to do
going forward? How are those decisions resolved?

[…]

5.4 Types of Sponsor Support

The most important thing is to agree with the sponsor the nature of the support that they
will provide. I will talk about some of the traditional ways that this support can take. I
will talk about the strongest way at the beginning continuing to the weakest way towards
the end. The strongest way is the ‘full payment guarantee’. It is fully-enforceable and
governed by a law that you trust. There are variations on guarantees. There are interest-
only guarantees where the sponsor agrees it will only pay the interest of the project
company. An interest-only guarantee from a sponsor’s point of view is also a guarantee
of the principal because the only way they can stop the project hemorrhaging is to pay the
principal. There are short-fall guarantees. This is a guarantee where a sponsor will agree
that if there is a default, the lender has accelerated, but there are still amounts outstanding

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– as there often would be – the sponsor would pay the difference between the security
realisation value, the actual value to the lender, and what remains outstanding. Finally, a
very common form of guarantee, especially in real estate financing, is the capped
guarantee. This is where the sponsor will pay up to a certain limit.

5.5 Completion Undertaking

Another form of sponsor undertaking is the ‘completion undertaking’, which is also

known as the ‘project completion guarantee’. You should all have a handout. In section
2, there is an example of the way that a project completion guarantee can be worded.
There is obviously no strict rule on this and they can be worded in many different ways.
Often there are two elements. One element has to do with time, where the sponsor agrees
that projection completion will be achieved by a certain date. The second element is
where the sponsor agrees to put the project company into funds to make sure that the
project completion can occur. […]

5.6 English Contract Law

For those of you who are not familiar with English law, it is important to distinguish a
project completion guarantee from a payment guarantee. English law draws a distinction
between a claim for debt and a claim for damages. A guarantee is a claim for debt. You
do not have to show a loss. You have to show only that the trigger that would allow a
guarantee has occurred. A project completion guarantee is where the sponsor has agreed
to put the project company into funds. The claim is a damages claim […]

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5.7 Defining Completion

When does the time come when the sponsor wants to be relieved of its support obligation?
This is called ‘completion’. It is the key moment in transactions that have sponsor
support. It is very heavily negotiated. Much time is spent getting the definition of
project completion just right. The lender would obviously want to have as much leeway
as possible to say that completion has not been achieved. The sponsor has an interest to
get the highest level of certainty that it can reach completion in that it can force the lender
to release the guarantee or the sponsor support at that point. These slide show the
ingredients that often go into the provisions, although there is no strict rule. In the
handout, in the first section, I have given you an example of a project completion
definition. We can go through these quickly.

5.7.1 Technical Completion

Technical completion is to do with the physical aspect of the project that had to be
completed. If it is a building, you have to make sure that the construction is final. It can
be rented or used commercially. One of the key issues in connection with technical
completion is: who decides that it is complete? On large, sophisticated finance
transactions, lenders will almost always insist that it is their technical advisor who
decides whether it is complete or not. In transactions where the completion element is
not as significant, I have seen where both lenders and borrowers agree. If that agreement
changes during the course of the transaction, or if they cannot agree, they give the
decision to an arbitration tribunal. Very rarely is it the borrowers’ technical expert who
will confirm technical completion. If you are a sponsor, you want to be very specific
about defining what technical completion is and about what other criteria has to be
fulfilled. Often, during drafting, it makes much sense to attach the specific requirements
to the loan agreement. It makes sense so that you avoid uncertainty. It also makes sense
to attach to the agreement the form of certificate that you expect the technical expert to
provide. This avoids any uncertainty and even litigation when the time comes.[…]

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5.7.2 Financial Completion
In many instances, the lender will say that they will only agree completion and give relief
when it can be shown that the project is financially complete. This can mean many
different things, but typically it means that, from the lender’s point of view, that the
financial performance for the project is such that the lender feels it is now viable to
accept that the sponsor support is no longer needed. Typically it is captured using
financial ratios or a debt service coverage ratio, and so on[…]

5.7.3 Security and Security Value

Some transactions will require security to be in place before the lender is willing to
release the sponsor. In many jurisdictions, it is not possible to take any meaningful level
of security over work in progress. Sometimes a meaningful immovable mortgage can
truly only be given when the building is finished. There are often issues about making
sure that that security is in place. Security is absolutely essential to project finance
transactions. A lender will want to have a very broad right to reject completion if there is
any issue at all on the security side. […]

5.7.4 Policy Objectives

Lenders such as EBRD or expert credit agencies will have policy issues that they would
want to see addressed before they are willing to complete. These are not so much out of
a credit concern, but project completion is obviously a convenient date by which to test
that the project has achieved some of the policy objectives it had. If the project had
significant environmental issues, you will have asked the borrower to sign up to an
‘environmental action plan’. […]

There are some sponsor obligations that survive completion. The classic example is that
of share retention. Often a borrower will require for the sponsor to retain its interest in
the project company – either its entire interest or at least a controlling interest – for as
long as the lender is on the deal. Contractual subordination is when the sponsor agrees
that it will only permit the project company to make payments to it as long as there is no
event of default under the loan agreement. […]
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5.7.5 Equity Undertaking
Another form of sponsor support is an equity undertaking. It is typically an agreement
between a sponsor and a lender where the sponsor will agree to put in a certain amount of
equity into the project company. […] It is an agreement that typically runs directly to
the lenders. It is not just a subscription agreement between the sponsor and the project
company; it is a direct agreement between the sponsor and the lender. There are two
kinds of equity. One is the base equity, which is the equity that is needed under the
financial model as it is conceived of as of day one. The second is the standby equity,
which is the equity that is supposed to be available in case there are cost overruns. Again,
these come in various different varieties. Whether the standby equity also involves debt
service or not is something that is negotiated.

One other issue that is heavily negotiated is whether there is the opportunity for the
lender to accelerate the standby equity. If the lender is given the right to accelerate that –
in other words, it is required to come in earlier than anticipated – is it only allowed to do
so once it has decided to accelerate the loan or can it only do so if there is an element of
default? It is a key timing issue from a lender’s point of view, but it is something that is
often resisted.

Annex 5.1: Questions and Answers

Question: Certainly, undertakings to put the company in funds are legally much messier
and involve many more uncertainties than a straight guarantee of the loan which can be
triggered if completion is not achieved. All of the things that Christoph has mentioned
are potential problems. It is certainly true that specific performance is an equitable
remedy, and you do not get it if damages are an adequate remedy. Much could turn on
whether the undertaking is given to the project company and assigned to the lenders, as
opposed to being given to the lenders directly where very different considerations might
apply. If it is given to the company and assigned, it does raise the question that Christoph
alerted us to: and even if the project was completed it was going to be hopelessly un-
economic anyway, then there is an argument that there is no point in putting the money in

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because the company would still be a loss-making company, and it would not be able to
sell the project so it would not suffer any loss. That however comes around in interesting
circles as you can then say that that is why damages are not an adequate remedy. It
insists on specific performance of the payment. There are clearly a number of
interconnected issues there. They are affected also by whether it is given directly or
assigned. Of the possible ways of getting completion guarantees, that is the one that I
always dread. It does throw out very difficult issues.

Answer: In preparation for this course I tried to do some research. I have not seen project
completion guarantees being litigated. I do not think there is a great deal of case law that
one can draw on. Alternatively, the sponsor may insist that, if the lender requires more
equity, they must undertake not to accelerate. The money is being put in for a purpose: to
help the project. There is the same menu of possibilities in English financing as well.
There is even some case law on one of them. The most famous case is the Kleinwort
Benson case. There is also an interesting Australian case. They all turn on the precise
wording of the letters; whether it amounts to a legal obligation or not.

Comment: To state the obvious: if you do want it to be legally binding say so. Also, if
you want it to be legally binding try to make sure that it is more than just a letter between
a parent company and its subsidiary that is provided to you. Make sure that it is a letter
that the parent company is giving to you; that is addressed to you. We have some
interesting legislation at the moment about third parties being able to enforce things.
This is relatively new to English law. From the point of view of the sponsor, it is even
better if it is automatically released once completion is achieved, without there being a
need for a notice from the lender.

Comment: It depends on the deal, but as a drafting matter, you do need to agree at what
moment in time the project completion has been agreed. Often the margin may go up,
after project completion. If the date has not been fixed, it can be difficult to manage.

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Question: Under legislation, there are some projects that are considered completed when
the state authorities issue the documents.

Answer: I think a lender will typically say, ‘Do what the concession says you need to do
in order to complete, but that is not what we mean by completion.’ That is simply one
small element of completion. When there are elements of financial completion or
security issues that are not in the underlying concession, the lender will require that
completion is reached under the concession and then, in addition to that, request that they
meet the additional requirements.

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 VI

SECURED LENDING: ISSUES OF LOCAL AND GLOBAL CONCERN

Andrew McKnight, Consultant to Salans LLP, Visiting Professor at Queen Mary,

University of London and author of The Law of International Finance (OUP 2008)

(Transcript of talk)

6.1 Introduction

This talk introduces secured lending. There are three relevant themes. First, some general
concepts are outlined that both set the scene for, and are relevant to, subsequent
discussions throughout the report. Secondly, the way that English law addresses the
concept of secured transactions and other matters of security is examined. Finally,
insolvency and cross-border issues are discussed.

6.2 Practice and Principles

6.2.1 Corporate and Individual Debtors

Debtors are people to whom banks lend money in the expectation (perhaps, fond hope)
they will pay the money back. As events in New York and other places have shown over
the last 12 months, that is not always the reality. For the most part, our discussion will
focus on corporate debtors because 99.9% of international finance transactions involve
corporations that are raising finance. However, one must always remember the
possibility that an individual might turn out to be a debtor in a transaction; for instance,
because you have taken a guarantee from the individual. Thinking about individuals as
debtors leads to all sorts of extra things such as the issues relating to consumer protection
legislation. Therefore, although the focus of our attention will be aimed primarily at
corporate debtors, one must always remember that, in addition, most jurisdictions have
extra levels of protection for individuals.

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6.2.2 Corporate Debtors and Shareholders
It is imperative to remember, when thinking about corporate debtors, that a clear
distinction must be made in most jurisdictions between the corporation which is the
debtor and those that own shares in it or control it. They are separate entities. In English
law, a corporation is entirely separate and distinct from its shareholders. This means that
the shareholders, as a matter of general rule, are not liable for the debts and liabilities of
the corporation. The precedent was established 110 years ago, following the Salomon v.
Salomon case. In other jurisdictions, the above principle may not apply either at all or to
the same extent. It is, however, firmly rooted in English law, although there are statutory
erosions of the principle. There are now instances, particularly in insolvency legislation,
but also in tax and consumer legislation, where that principle has been eroded.

6.2.3 Creditors and Others Who Have Dealings with a Debtor

Financial and General Commercial Creditors. The sort of people to whom a debtor may
owe liabilities may well include financial creditors, being banks and others that lend
money to people. One level of creditors is, then, bound to be financial creditors. In
addition, there will be general commercial creditors: people who supply goods and
services to a debtor. Quite often, that will lead to a competition when things go wrong
between the rights and entitlements of all of the creditors and as between financial
creditors and general commercial creditors.

Preferential Creditors. Another type of creditor that one must also think about in this
scenario is those creditors who receive some special protection as a matter of law, which
we can label ‘preferential creditors’. It comes as no surprise to know that first in the list
of preferential creditors in almost every country is the state. The UK may be the only
jurisdiction where this is not the case; in 2003 the state gave up its position as a
preferential creditor for unpaid taxes. Other types of preferential creditor might include
employees (for unpaid wages), unpaid pension contributions and payments and other
types of social security entitlements.

Secured creditors. These are mentioned below.

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6.3 What Happens When Things Go Wrong

6.3.1 Default
When banks lend money, they expect in the usual course that the borrower will repay—
they would be mad to lend if they expected that the borrower would default. However,
default does occur, as the present economic climate amply demonstrates. There is one
obvious sign of default, which is that the borrower does not repay you when he should.
That is about the most obvious form of default.

6.3.2 Events of Default

When you look at loan agreements, you will see that the concept of default extends to
encompass many other things, which in the contract are given a correlation to default.
The mechanism to achieve this is normally referred to as an Events of Default clause. The
Events of Default clause sets out a whole list of possible things that might go wrong,
which will be treated as if a default had occurred. One should look carefully at that
clause when advising a borrower.

Although it talks about events of “default”, one must bear in mind that the clause covers a
wide variety of events, even though they may not amount to default in the traditional
sense. It is possible, as a matter of English contract law, put anything into the clause and
call it an “event of default’. One might find, for instance, that an event of default in a loan
agreement might relate to the circumstances of the borrower’s country; for example, if
the country falls out with the International Monetary Fund (IMF) in a bad way; or – and
this is quite common – there might be an event represented by a change which is beyond
the control of the borrower.

6.3.3 Material Adverse Change

Another typical event of default will be found in the Material Adverse Change provision.
Depending on how that is worded, it could be very broad. In basic terms, the provision is

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aimed at a deterioration in the economic and financial circumstances of the borrower (and
its group) such as in relation to its assets, revenues and profits. Sometimes a
determination as to whether an adverse change has occurred will depend upon an
objective determination of the facts and, in other cases, it may simply involve a
subjective assessment by the lender. There is now case law that says that, when you
assess the facts in the context of such a provision, you can look at it independently of all
the other things that have been mentioned in the event of default clause.

6.3.4 Litigation
If the borrower has not paid or an event of default has occurred, you might launch legal
proceedings to enforce your rights. That is a matter of jurisdiction and, in international
loan agreements, it will depend upon whether there has been a submission to a
jurisdiction so that you can haul in the borrower before the lender’s preferred courts. In
such a case, you might still have to enforce a judgment of the preferred courts in your
borrower’s home jurisdiction and that will depend upon the rules of recognition of
foreign judgments in that jurisdiction. An alternative course might be to use arbitration (if
agreed in the finance documentation) and then seek to enforce an award under the New
York Convention. None of this, however, guarantees that the borrower will pay.

6.3.5 Insolvency: The General Concept of Equal Misery among Unsecured Lenders
You may have a debtor who has not paid and is facing insolvency. In most concepts of
insolvency (forgetting for the moment the secured and preferential creditors) whether
they are commercial or financial creditors, they are all swilling around in the mire of
whatever is left of the debtor’s assets. There is an equal sharing of the misery and the
pain. This leads to a pari passu (rateable) distribution of what is available. In most
insolvency regimes, this is associated with the thought that an individual creditor’s right
to pursue the debtor ceases. In one way or another, its right is simply turned into a claim
in the insolvency.

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6.4 Security

6.4.1 Security as a Method of Protection in an Insolvency

If you can take security, you are looking to the assets over which you have security as
your principal source of remedy in the case of default, particularly in the case of an
insolvent debtor. You would like to seize the assets, sell them and pay yourself out.
Whether you can do that or not will depend on various issues of law and it will have all
sorts of legal consequences. In London, you can have almost whatever security you like.

6.4.2 Other reasons for taking security

There are, however, other reasons for taking security than merely thinking about
insolvency. First, it is a useful weapon to defeat other creditors. To the extent that you
have security, you might stop other people getting their hands on it.

Secondly, in some sorts of transactions – particularly securities, commodity and

derivatives transactions and the like – the giving and receiving of security may be part
and parcel of the deal. That is usually referred to as margin. If I speculate on copper, for
instance, part of the contract may well require me to post security or margin as a
reflection of the difference between the contract price and the market price. If it moves
adversely to me, I might have to put in margin. One of the things that went wrong in the
credit crunch is that suddenly, all sorts of people who had issued various types of debt
found that they had to post margin as security, which started a rather nasty downward
spiral. Whilst on the subject, it is worth mentioning that set-off and netting techniques
can also be a very valuable form of quasi-security for a financial creditor.

Finally in most banking transactions, there is a banking regulatory aspect to it. The rules
now are now comprised in the Basel II regime. The basic formula in Basel is that you
weigh up the risks (including the likely consequences) of default in the business that the
bank has done, and it must have a minimum of 8% of the total of those risks as capital.
You can, however, reduce the risks by having security. For regulatory purposes, it might

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be particularly beneficial to be holding certain types of security, such as gold, cash or
government securities, as might rights of netting and set-off.

6.4.3 Taking Security

There are two questions that need to be considered when thinking about taking security:
(1) Over what assets can you take security over? (2) For what liabilities can you hold the
security? Both are very important questions.

With regard to assets, this involves a mixed question of fact and law. There is no point in
seeking to take security over gold stocks if they do not have any gold. It is also a
question of law. Depending on what system of law applies, you may or may not be able
to take the security over the relevant assets.

The other side of the coin is: for what liabilities can you take security? Similarly, that is
partly a question of fact and also a question of law. If one was thinking about it purely
from an English perspective, one might either take security for a specific liability – for
example, I take security over your house for the money I have lent you to buy the house,
so the security is specifically matched to the finance for that security – or you might take
security for a much more general set of liabilities. In English law this is called all-monies
securities. Each piece of the security stands as security for each piece of the liability.
Needless to say, the bankers love all-monies security, which is what they will normally
seek to achieve.

6.4.4 Security Linked or Detached From A Personal Obligation

While considering these concepts, by and large we are thinking about security being
secondary to the borrower’s liability, so it backs up the borrower’s liability. If I borrow
money from a bank and give them a mortgage over my house, the mortgage is there in
case I do not pay the bank. However, particularly when you are thinking about project
finance, it is relevant to see whether you can detach those concepts. In other words, is it
possible for the borrower to borrow the money but the liability to repay (and so the
assessment of risk) rests solely with the security? For example, I borrow money from a
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bank to buy a house, and the bank agrees that its only source of repayment will be the
sale of the house or the income that the house generates for whatever purpose I employ
the house. As a matter of English law, you can do this and it is called “non-recourse
security”. However, it will be a jurisdictional question in terms of whether you can do it
elsewhere.

From a borrower’s point of view, that is a good deal. Why would a bank want to do it?
The general answer is that the structure of the transaction demands it and the bank feels
that the rewards to it (e.g. because it will earn nice fees and interest) are justified by the
transaction, including the risks it is taking. The bank assesses the risks by looking
specifically at the project and its assets (and the availability of security), which is what is
going to generate repayment.

6.5 Guarantees

It might be possible to spread the risk. In a typical example, a bank lends money to a
subsidiary company in a group and wants the parent company to guarantee repayment.
Here is an important point: a guarantee alone is nothing more than a contract. It is
basically a contract under which the guarantor says ‘if the borrower does not repay you, I
will’, but it is simply a contract. All it means is that you now have an unsecured claim
against the guarantor. If you want to make the guarantor liable in a more substantial
manner, by having the right of recourse against its assets, you need to take security from
the guarantor to back up his obligation under the guarantee.

Consistently with what has already been said about non-recourse security you can,
instead, take security from the guarantor, which is intended to be the only remedy with
respect to the guarantor, without a personal obligation on the guarantor to repay. On a
practical level, of course, it is always better to make both the borrower and the guarantor
liable personally, in addition to taking security from them, so as to increase their
commitment to repay.

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6.6 Cross-Border Issues: Introduction to Conflict of Laws

6.6.1 The Cross-border setting

This may arise because one or more of the creditor, the borrower and the secured assets
may be located in one or more different jurisdictions. For instance, the bank may be
lending from an office in London, the borrower may be established in Ruritania and the
secured assets may be located in Absurdia and Pacifica.

6.6.2 Legal Systems

The various issues that we are thinking about will depend on the relevant legal system or
systems into which we have to place them. For example, if an English bank wants to take
a mortgage over a flat in Paris, there is not much point turning up with an English-style
mortgage, for example in order to register the mortgage in English form with the English
Land Registry. Similarly, a French bank in London cannot take security over a building
in French form and register it at the Paris registry.

6.6.3 The Limits of English law

It is not a satisfactory approach to think that all potential problems can be cured by
expressing in the documentation that everything which arises under the transaction will
be governed by English law. To begin with, English law does not provide a perfect model
or a ready and perfect solution for all problems There are many problems in English law
as there are in any other system of law. Secondly, English law cannot always override
foreign considerations. A good example of this concerns shareholder agreements. You
may not be able to avoid the difficult questions about whether the shareholders can agree
about anti-transfer provisions and buyout provisions under local law, just by putting it all
under English law and ignoring the law of the place of incorporation of the company
concerned. Similarly, as mentioned above, English law cannot lay down rules and
procedures for foreign land.

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6.6.4 Cross-border insolvency
The basic position is that a corporate entity should be subject to the insolvency
procedures and laws of its place of incorporation or establishment. However, cross-
border issues under this heading will arise where the borrower and its assets are located,
or have a presence, in more than place. Thus, it may be relevant to consider which laws,
and whose insolvency procedures, might be applicable if the borrower has a business
presence or assets in more than one jurisdiction, with the possibility that more than one
set of laws and procedures may be relevant. Those matters may affect more than just the
rights of unsecured creditors, as they may also affect the validity and enforceability of
security and other rights in rem. There could also be questions as to the effect of
competing jurisdictions where insolvency proceedings are current in more than one place,
including the possibility of co-operation between the jurisdictions, and between
insolvency practitioners, or deferment of one jurisdiction in favour of another. Within the
EU, these matters are now governed largely by the Insolvency Regulation 2000 and, at
the wider level, the UNCITRAL Model Law on cross-border insolvency may also be
relevant.

6.7 Case Study

In conclusion, it may be helpful to set up a case study, so as to provide a background to

many of these questions. It involves a consideration of the financing of a new
supermarket, including the funding that is required, an assessment of the assets of the
supermarket and the use of those assets as security. This may include the question of
whether, in terms of the security that is available, the assets must be tied to particular
types of finance or could be used to support all of the debt that the borrower will incur.

As bankers, you have a borrower which comes to you with a proposition to acquire land
so as to build and furnish a new supermarket and then run it.

In terms of finance, the borrower may need money to buy the land and put up the
building, which tends to be fairly long-term finance, so we might there be looking at a
12-15 year repayment period. Medium-term finance may also be needed, so that the

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buyer can acquire and install things like computer equipment, shelving and refrigerators
(commonly called plant and equipment). That sort of finance tends to be medium-term,
over, say five to eight years. In terms of these assets, we would usually expect that land
and buildings and (in accounting terms) the other types of “fixed” assets would be
suitable candidates to provide security. It might also be that some form of title financing
structure could be used for funding the acquisition of the computer equipment and such
like, rather than a borrowing structure.

The borrower will need to stock the supermarket with the things (stock) it intends to sell
(e.g. cans of baked beans) and well as raw materials (e.g. flour to make bread) which it
intends to use in manufacturing stock for sale. This (and other day to day expenditure
requirements) is likely to involve a working capital facility which would be used to meet
the borrower’s day to day expenditure.

The goods (the stock and raw materials) have the quality that we expect them to turn over
quickly, by sale, use and replenishment. In fact, we would be worried if this did not
happen, since it would mean that the supermarket was not a thriving success. Thinking
about these types of assets and their durability, they are obviously different from the
other forms of asset that we have previously mentioned. Any security that is to be taken
must be able to accommodate their transitory and revolving nature. English law can deal
with this through the mechanism of a floating charge, but the same is by no means the
case in many other jurisdictions. Perhaps, in the alternative, some form of supplier
finance might be available, but that would mean that the suppliers would have to take the
risk of non-payment.

Let us now think about another kind of asset. When a customer goes to the checkout at
the supermarket with his basket (or trolley) of goods for purchase, he may wish to make
his purchase by use of his credit card. In return for selling the goods in exchange for the
use of the card, the supermarket thereby takes on a different asset; namely, the debt due
by the credit card company (at least that is the position under English law). That sort of
debt is called a receivable. It is likely to be outstanding for 60-90 days but it is of a type

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that keeps turning over, as receivables are generated and paid off. In many senses, then,
although it is a different type of asset because it is a debt, it is very similar, in many
respects, to the tins of baked beans and flour, in that it is turning over and replenished and
the security considerations are likely to be of a similar nature. In this case, it might also
be sensible to think of an alternative financing structure based upon the receivables, such
as a debt purchase facility.

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Annex 6.1: Speaker biographies

Lilia Bylos, Principal Counsel, EBRD

Lilia, who is a Greek citizen, joined EBRD in 2004, has worked on various debt and
equity transactions throughout EBRD’s countries of operations. Prior to joining EBRD,
Lilia worked in UK-based international law firms, including Linklaters & Paines (1992-
1997) and Dewey Ballantine (1997-2004), where she worked, among other things, on
cross-border infrastructure and structured finance projects. Lilia holds degrees from
Witwatersrand University of Johannesburg (LLB – 1989) and Nottingham University
(LLM – 1989). She was admitted as solicitor in England and Wales in 1992.

Professor Hugh Collins

Hugh Collins is Professor of English Law and Head of the Department of Law at LSE.
He studied law at Oxford and Harvard, became a Fellow of Brasenose College, Oxford,
before moving to LSE in 1991. He has published numerous books including Regulating
Contracts (OUP, 1999) and Employment Law (2003). Recently he has been researching
in the field of European Contract Law. He is General Editor of the Modern Law Review
and a Fellow of the British Academy.

Roger McCormick

Roger McCormick is the Director of the Law and Financial Markets Project at LSE and
also a Visiting Professor there. He is also the author of Legal Risk in the Financial
Markets (Oxford University Press 2006) and the Editor of Law and Financial Markets
Review. He recently retired from full-time private legal practice, having practised law in
the City of London for nearly thirty years (twenty two of them as a partner of Freshfields,
where he was for several years the head of its project finance practice group). He has
represented clients on project finance transactions in Russia and Hungary as well as many
other jurisdictions, including China, India, the Philippines and various parts of Africa

Andrew McKnight

Andrew McKnight is a Visiting Professor at both LSE and Queen Mary, University of
London, where he teaches LLM courses in the law of banking and finance. He is a
solicitor who has practised in the City of London for over 25 years, specialising in
English, crossborder and international banking and finance transactions, as well as related
areas such as insolvency and banking regulation. He was previously a senior partner in
the banking department of a City law firm. In addition to his academic and teaching
work, he is now a consultant to an international law firm. He is the author of a large
number of articles that have been published in legal journals that specialise in banking
and international finance and is also the author of a textbook on the Law of International
Finance, which is due to be published later this year.

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Christoph Sicking, Chief Counsel, EBRD

Christoph, who is a German citizen, joined EBRD in 2000. Christoph has worked on
structuring, negotiating and implementing debt and equity transactions in both the public
and private sector throughout Central and Eastern Europe and Central Asia. Prior to
joining EBRD Christoph was an associate at the New York office of US-based law firm
Hunton & Williams, where he advised on cross-border project and structured finance
transactions, with strong emphasis on cross-border leveraged leasing. As of September
2005, Christoph joined the corporate recovery team where he is involved in corporate
restructuring and refinancing transactions. Christoph holds degrees in both common and
civil law from McGill University (Montreal) and political science from Simon Fraser
University (Vancouver). He is a member of the bars of New York (1996) and
Massachusetts (1995) and a qualified solicitor in England and Wales since 2001.

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