The impact of Coronavirus on project finance
Projects around the region are being profoundly impacted by the rapid global spread of the Covid-19 virus and the preventative measures being put in place by governments to reduce infection rates.
Restrictions on travel, impact on supply chains and logistics, diminished availability of labour and a work force whose role does not lend itself to remote working have led, and will continue to lead to, uncertainty, delays, loss of money and investor nervousness.
Project finance stakeholders
Due to the high value and long term nature of project finance deals, the relationships of the numerous parties involved are governed by a network of contracts, designed, in part, to allocate the risk profile fairly. In a limited recourse project finance transaction, developers will own shares in a thinly capitalised project company SPV, which holds the title to the project assets.
The project sponsors may include private developers, trading companies and public entities. The sponsors will be ultimately responsible for the development and management of the project with a view to owning an operational income-generating asset which is able to service the associated debt. The bulk of the financing will likely originate from banks, institutional investors, government linked funds and export credit agencies. The lenders will enter into an intercreditor agreement which will describe their rights and obligations to the project company and its assets and determine, amongst other things, enforceability and debt subordination.
The project company will appoint a contractor who will be ultimately responsible for providing the engineering and construction services, typically on a turnkey basis via an engineering, procurement and construction contract (EPC Contract). The project company will also enter into an operation and management agreement with an operator who assumes a key role in safeguarding the value of the project assets and the ability to generate the revenue necessary to repay the lenders and create profit for the sponsors.
Force majeure and Covid-19
The ongoing interruption to the construction and operation of projects backed by project finance is leading stakeholders to review their contracts to analyse where the risk associated with the Covid-19 crisis sits. Interruptions during the construction or operation phases are likely to delay or reduce the income required to service the loans made by the lenders and have severe implications for subordinated creditors.
These projects typically have fixed repayment terms and closely modelled cash flows, any disruption will quickly lead to problems with repayment of debt.
The burden placed on contractors will also be significant as delays caused by an inability to obtain fundamental materials or depleted workforce will likely lead to time and cost claims under the EPC Contract.
The parties affected by the impact of Covid-19 will want to defend any breach of their contractual obligations which has arisen due to circumstances outside of their control. In relation to Covid-19 pandemic, many will look to force majeure or change in law.
A force majeure clause in a contract will detail the kinds of excusable extraordinary events which render the performance of contractual obligations impossible due to circumstances outside the control of the parties. Force majeure clauses may be prescriptive and list specific events which apply or they may take a more broad approach and set out criteria that needs to be met, or a combination of both.
Whilst the requirements for establishing force majeure will differ depending on the drafting of the clause, the three usual elements are (1) the event must be unforeseeable by the parties, (2) the event must be outside the control of the affected party; and (3) performance of the obligation must be adversely affected.
Provided that a contract was entered into before the onset of the Covid-19 virus, it should be reasonably straightforward to establish that the elements of force majeure apply. The only difficulty might be establishing that the affected party's performance has been adversely affected, however it would seem likely that difficulties in obtaining labour, particularly during the construction phase, or delays in the importing of materials could be proven relatively easily.
Mitigation measures will usually need to be demonstrated. It will need to be shown that there was no alternate source of materials or labour, even at a higher cost, provided not in breach of relevant financial covenants. A successful force majeure claim should enable delay or modification to the performance of contractual obligations, such as delaying project milestones, the completion date or, if the project is already operational, create allowances in relation to the output of the project. A long term force majeure event could ultimately lead to termination of the contract(s). Carefully drafted legal notices and good record-keeping are crucial to support parties successful claims to claims to, or thee successful defence of, force majeure.
Force majeure in Oman
Article 172 of Oman's Civil Transactions Law (RD 29/2013) states that if force majeure renders the performance of the obligation, the corresponding obligation shall be extinguished, and the contract shall automatically be revoked. Though the courts have a wide discretion in applying this article and in our experience, a court will generally uphold an agreed contractual provision, rather than enforce the statutory position.
In the absence of force majeure provisions, Article 159 of Oman's Civil Transactions Law imposes a statutory term, that cannot be contracted out of, which allows a party experiencing unforeseeable exceptional circumstances to seek relief from the court from its obligation under a contract where continuation of the contract would lead to serious loss. The courts may interpret this protection to extend to losses caused by Covid-19. If applied, the courts have the discretion to reduce burdensome obligations to reasonable limits.
Change of law
In many contracts, relief usually offered under a force majeure clause is for time only. In large infrastructure projects it is common to also provide the project company with protection for changes in law. If triggered, these clauses typically lead to financial relief, either through lump sum payments or adjustment to the tariff. The legislative and regulatory changes which have been introduced around the region fall squarely within these sorts of protection and we would expect there to be a large number of claims around the region against governments as a result.
Parties will need to consider carefully whether costs have arisen due to consequences of the virus of or due to consequences of a change in law; this will inform claims and defences.
Trowers & Hamlins have been closely monitoring the effects on contracts and have provided extensive advice on the appropriate placement of risk, serving and responding to contractual notices. If you would like to discuss the impact Covid-19 is having, or may have, on your contracts and business interests, please do not hesitate to contact our specialists.