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This paper is submitted in partial fulfillment of the requirements for the degree of Doctorate of Finance
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Contents
Contents.................
Abstract..............
Project subcontracts....
Project finance covenants are not particularly important for the successes of
projects. Discuss.....
References....................... 8
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Dimitrios V. Siskos
Abstract
Complexities in project finance can have negative consequences on the delivery, operation, and profitability
of a project and can affect both lender and borrower in a similar way. This fact leads businesses into signing
numerous subcontracts within the overall framework of the project financing. A similar action to mitigate
such complexities is to sign loan covenants that affect, mostly, the actions of the borrower. Initially, the paper
describes the four types of contracts; second, it determines the pros and cons of the loan covenants; it
examines whether financial covenants are important for the successes of projects or not, and last, it explains
the role of security agreements and their special role in project finance.
Keywords: Project, Contractors bond, Representations and warranties, Events of default, Reserve accounts,
Loan covenants, Security agreements.
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Dimitrios V. Siskos
Project subcontracts
During a project life-cycle, the project financing faces a big number of complexities which can be
subject to numerous subcontracts within the overall framework of the project financing plan. Some of these
contracts are:
Contractors bonds
A contractor's bond is a financial assurance that a contractor will complete a job to a client's
satisfaction. Hence, it provides ways of securing the performance of contractors, subcontractors and suppliers
in the event that a particular job is not performed as desired (Fight, 2006). The single most important reason
which contractors need to purchase a contractor bond is that the bonds prevent project owners from losing
money.
Representations and warranties
A representation is a statement by a contracting party to another contracting party about a particular
fact that is correct on the date when made, while a warranty is the contracting party being asked to represent
and warrant certain facts (Fight, 2006). There are several purposes which representations and warranties are
important in project finance: they both endeavor to provide remedies for misrepresentation in the event of an
inaccuracy; they may operate as block against the borrower; and they may enable the lender to cancel the
commitment and accelerate the loan if they are linked to an event of default (Haynes, 2010).
Events of default
The conditions added for the purpose in a loan agreement is generally called the events of default
(Agarwal, 2001).Events of default in a project financing are similar to those in any classic commercial
lending situation. These include technical defaults, financial events of default and mechanistic events of
default (Fight, 2006). They are useful in that they put the lender into a position of power in being able to
threaten termination and thus negotiate from a position of strength (Haynes, 2010).
Reserve accounts
October 10, 2014
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Dimitrios V. Siskos
Project portfolio includes financing documents as reserve accounts, to maintain several accounts within
the project. For example, the Debt Service Reserve Account (DSRA), as one of them, is a key component in
almost every project finance term sheet and financial model. Establishing a reserve account satisfies the
beneficiaries of the reserve account and reduces the cost of debt (Crawley, 2013) as well as it ensures that the
project entity is protected in the event of any future legislative (Fight, 2006).
A simple leverage ratio framework is critical and complementary to the risk-based capital framework.
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Dimitrios V. Siskos
style covenants (Goodison, 2011). Furthermore, setting tight appropriate levels for ratio covenants may be a
limitation for the borrower because it will place unnecessary restrictions and may trigger an unwarranted
default (Fight, 2006). For the lenders, there is one argument which claims that they may ultimately recover
more if an underperforming borrower is given time to improve its performance without the pressure of
financial maintenance covenants and the costs and distractions (Goodison, 2011).
Project finance covenants are not particularly important for the successes of projects.
Discuss
The financial covenants included in the various agreements are important not only to the investors but
also to all stakeholders. The project financial covenants examine all possible eventualities, as the minimum
equity to debt level, the restriction on the payment of dividends, or the minimum debt coverage ratio. Project
covenants reveal the state of the firm during the borrowing period. According to Achleitner et al. (2012), if it
is good, equity holders remain in control and might even reap private benefits, otherwise financial
covenants are violated and the company is in technical default, control rights shift to lenders, who then
have the right to call their loans. If the call is executed, the borrower might be forced into bankruptcy.
However, when covenants are too restrictive, they are likely to constrain a borrowers optimal
management strategies and might even trigger a default that is not warranted (Mather and Peirson, 2006).In
the opposite, when the covenants are too loose or they are absent, the risks tend to increase. Reports in the
financial press regularly provide evidence about the importance of covenants for the success of projects. For
example, a recent report on the exposure of a major Australian bank, ANZ, to the financially troubled UK
group, Marconi, states the company was so popular that banks, including ANZ, agreed to lend billions of
pounds without requiring covenants to protect their investment (Mather and Peirson, 2006). Hence, project
finance covenants are important for the successes of projects, but their use should be reasonable and be
performed with the intention to improve the company position and not to intimidate it.
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References
Achleitner, A.-K., Figge, C., and Lutz, E. (2012). Drivers of Value Creation in a Secondary Buyout: The
Acquisition of Brenntag by BC Partners. SSRN eLibrary
Agrawal, A. (2001). "Common Property Institutions and Sustainable Governance of Resources," World
Development, Elsevier, 29(10), pages 1649-1672.
Barad, M., (2010). A Study of Liquidity Management of Indian Steel Industry, thesis PhD, Saurashtra
University.
Chernuchin, C. (2011), Understanding The Terms Of Security Agreements, The Practical Lawyer.
Coles, I. (2009). Project Finance Documentation (PDF). Mayer Brown. Retrieved 2014-28-05.
Crawley, N. (2013). Debt service reserve account (DSRA), financial modeling considerations, Retrieved on
28 May 2014: http://www.corality.com/training/smart-campus/blog-list/blogs/october-2013/debtservice-reserve-account-%28dsra%29,-financial-mod
Fight, A. (2006). Introduction to Project Finance. Essential Capital Markets. Elsvier 1st Edition.
Goodison, E. (2011). Covenant-Lite Loans: Traits and Trends, Prac. Law J..
Haynes, A. (2010). The Law Relating to International Banking, Bloomsbury Professional.
Mather, P., Peirson, G. (2006), Financial covenants in the markets for public and private debt, Accounting
and Finance, 46 (2), pp. 285-307.
Rajan, R. G. and A. Winton (1995). Covenants and collateral as incentives to monitor.The Journal of
Finance 50(4), 1113-1146. Bank of England Inflation Report, (2007), pages 18 and 20.
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Dimitrios V. Siskos