Restructurings related to projects can prove especially complex. Robert Vitale of Cadwalader, Wickersham & Taft, New York, provides guidance on how to approach an infrastructure workout
No workout, reorganization or company liquidation is ever easy. But workouts, reorganizations and liquidations of infrastructure-related projects, or companies specializing in infrastructure-related lines of business, can prove especially challenging.
The past decade has witnessed a remarkable global construction boom in infrastructure projects, both large and small. Many of these projects will perform as well as, or better than expected. But a significant portion will falter due to a host of disparate causes, such as changing market conditions, global economic events, defaulting suppliers, unexpected physical perils, acts of God (including severe weather phenomena), sudden political events and innovative, more nimble competition.
When dealing with a troubled project, or a company engaged principally in the infrastructure area, it is critical that the legal and business analysis takes into account some of the special risks and considerations inherent in this area.
Preserving agility
Depending on its source of financing, a project can often be encumbered with an array of covenants in its financing and security documents. These covenants frequently mandate that lenders be given notice of, and approval rights over, a substantial number of business decisions that will have to be made in the context of working out or renegotiating a troubled project. One of the first tasks to be undertaken is a complete review of all the project's contracts to determine what responsibilities the project owes to third parties regarding critical business decisions. For example, as noted below, a project may be forced to breach or even terminate in whole or in part one of its operating contracts due to unforeseen circumstances. Such a breach or termination may trigger cross-default provisions in the project's financing documents - or maybe even other critical non-financial contracts, such as an authorizing concession. It is therefore important to determine early on to what extent the project's financiers, participants or regulators must be consulted before actions are taken.
This task can be complicated in the case of large financing syndicates, when an agent bank or bond trustee must be given sufficient time to notify its syndicate of the problems in question and often conducts a vote seeking instruction. The time necessary to contact the syndicate members and undertake such a vote may be pivotal to the project's ability to address and respond to a quickly deteriorating situation.
In circumstances where the project's owners know, or even suspect, that a potential breach may be on the horizon, it is prudent to approach the financing syndicate even earlier than contractually required, seeking a way to streamline decision-making for the benefit of all parties. These methods can include the appointment of a more agile creditors' steering committee or the expansion of matters over which the agent or trustee may act without further pre-approval by the syndicate. It may also be prudent for the project company to negotiate a method of reporting progress to all syndicate members on a regular basis to avoid distracting the project company's management with having to field repetitive questions while also minimizing the possibility of incorrect information being passed around the syndicate.
Preserving cash flow
Cash flow is the lifeblood of any non-recourse project and this also holds true for many companies engaged in the infrastructure area, as they are often highly-leveraged entities. In part, this high degree of leverage is necessary to provide the economic returns sought by companies engaged in these high-risk endeavours, but extensive leverage is also often dictated simply by the sheer amount of capital necessary to undertake many projects. In either case, cash flow preservation must be focused on early.
As noted above, a project's covenant package may often impose extensive controls on the project company's right to administer its cash flow. These restrictions may take the form of limitations on the project's ability to enter into additional contracts exceeding a specified dollar value, or its ability to make capital outlays, or its ability to incur additional indebtedness of various types. Likewise, the project may have covenants requiring it to fund - on a preferential basis - certain reserve accounts (such as major maintenance or debt service reserve accounts or other types of sinking funds) or to maintain minimum amounts of working capital in reserve to satisfy financial ratios, all of which can restrict the project's ability to utilize in-hand cash flow at a critical moment.
The project company and its advisors must undertake an analysis of the project's cash flow situation to determine if its lenders, or other parties with similar control rights, must be approached for a waiver or other relief to allow access to restricted funds. This problem may be further compounded in consortium situations, where the willingness or ability of the consortium members may not be the same when it comes to further equity injections to save a faltering situation.
Creating a cash reserve
One possibility is to examine whether cash trapped in such reserve accounts can be accessed by the use of replacement letters of credit, guarantees, surety bonds or even insurance products, on a short or longer-term basis. Moreover, on the assumption that many of these accounts have been established to address some perceived risk for the project, it may be possible to address that risk in a way other than creating a cash reserve. For example, cash in a major maintenance account (which may not be intended for access for several years) may be freed up by entering into an overhaul agreement with a reputable company or by having the sponsors themselves agree to fund this cost if sufficient funds cannot be put aside in the future after the immediate crisis has passed. Although the later suggestion obviously increases a sponsor's own exposure to the project, it may be willing to accept such potential future exposure as the price to achieve immediate access to critical cash.
A critical cash flow analysis may also be required outside the context of the project itself. For example, as mezzanine and acquisition company financing becomes more common in infrastructure projects, a project's inability to declare and pay a dividend may prove disastrous. This problem can be compounded because many project financings preclude the payment of dividends when virtually any form of default has occurred - even defaults that do not directly affect the ability of the project to pay its debts as they come due. Some form of historical or forward-looking financial ratio as a restricted dividend test is not uncommon. Approaching the project-level lending syndicate to seek relief for a dividend declaration to allow funds to flow to another, upper level lending syndicate, can be a challenging task. To maximize the chance of success the project's sponsors will need to be prepared to demonstrate (by the use of new financial projections) that the underlying project is sound, and the release of requested funds will not be fatal. If the sponsor's credit can support it, a request for releasing funds may be coupled with a claw-back right in favour of the affected lenders, requiring the sponsors to re-inject (if necessary) as equity or subordinated debt, previously released funds.
Preserving critical contracts
A hallmark of the classic non-recourse infrastructure transaction is the extensive interdependence of a wide variety of contracts. Contracts related to the project's construction, operation, maintenance, repair, insurance, financing and authorization to operate are usually interwoven in such a manner that the termination or breach, in whole or in part, of any one can quickly cause a ripple-through effect in a host of other areas. A problem often faced by a troubled project is to prevent an otherwise controllable situation from spinning out of control as creditors race to protect themselves from what they may perceive as a deteriorating situation. This problem is often exacerbated because suppliers and creditors to non-recourse projects know that the financial cushion under which most projects operate is relatively tight, and often secured in favour of more senior creditors, and there can be no assurance that the project's owners (or its lenders) will determine to keep a stumbling project propped up.
Thus, when advising the troubled project, one of the first tasks is to determine which contracts provide the greatest leeway in terms of dealing with the problem, default or breach in question. This analysis often includes a review of the force majeure, notice, termination, default and remedy provisions in each contract, as well as considerations of local law that may overlay other rights and obligations on the parties. If it becomes clear that the project will not be able to timely satisfy all its obligations to its contractual counterparties, a kind of legal triage becomes necessary, as the project company and its attorneys must make a frank assessment of which counterparties are to be approached for waivers, etc., and which contracts can be terminated (voluntarily or involuntarily) with the least damaging effect on the project. This may include a lowest cost option analysis in which the parties determine if a voluntary buyout of an affected contract may be cheaper than outright breach, with its attendant costs of litigation or settlement.
Favouring creditors over others
Likewise, in circumstances where a project's cash flow or operational state make it impossible to fully pay all debts or perform all obligations as they come due, the project company must analyze which creditors and counterparties must be satisfied in the immediate future, and which must be approached for voluntary (or perhaps involuntary) extensions for time to pay or perform. In the case of payment delays, offers to pay outstanding sums with interest or offers of equity positions in lieu of payment are not uncommon. Likewise, in circumstances where operational problems impede or prevent a project from delivering negotiated goods or services, an interim solution to the problem may be providing for replacement goods and services obtained from another vendor. To the extent that market pricing for the goods or services in question is higher in the market place at that time, the project can expect to have to cover the difference - but this may still be far less costly than a breach or termination of the contract in question (and its potential to bring down the entire project by virtue of the cross-default clauses discussed above).
A recent decision from the US Supreme Court underscores the ability (and tendency) of a troubled project company to make strategic decisions as to which creditors will be favoured and which will not. In that case, a project company formed to operate certain toll roads in Mexico intended to use some of its last remaining unpledged financial assets to satisfy first its local employees and tax authorities, rather than its US-based financiers. The financiers, upon learning of the project company's intention, sought an injunction to prevent the project company from favouring these creditors with such assets. Lower level courts granted injunctions only to see the Supreme Court declare that so long as the lenders did not have an express or constructive lien over the assets in question, the project company could do as it wished with the assets.
Preserving critical permits and authorizations
Another challenge often faced with troubled projects is the preservation of critical operating or authorizing permits. This task cannot be underestimated in terms of importance and effort, as certain permits may take long periods of time to reapply for, or may be difficult to obtain again because of deteriorating operating characteristics, or may be impossible to obtain again without significant refurbishing costs where laws have changed and the project was operating under some form of grandfathering legislation. While certain permits may automatically follow in favour of a new owner or operator, or require relatively simple notice filings, a number of permits will by their own terms forbid a transfer without re-application, if a transfer is permitted at all. Indeed, the prudent lender will often include in its financing documents special covenants at the project level - and perhaps even at the sponsor level - requiring all parties to assist it in the preservation of critical permits during and after any exercise of remedies.
Although in some circumstances permits can be preserved even in default situations by a transfer of stock or other ownership interests over the project company itself, this option may be complicated by other factors. By way of illustration, it is not uncommon in foreign projects for restrictions to exist on the ability to transfer equity positions in a project, whether voluntary or involuntary. These restrictions may exist because the host government insisted on such limitations to prevent or discourage flipping of concessions or because local laws may restrict or prohibit non-nationals from engaging in certain industries or owning certain assets deemed to be in the national interest. One way for the lender to protect itself from being unable to take control over a project without causing it irreparable loss of operating authority is to approach the issuing authority for special permission to exercise its remedies in return for the promise to convey the project to another company which is acceptable to local regulators. Often it is best to seek this permission at the outset of a project to avoid complicated negotiations at a project's most critical time.
Selling the project
Another situation in which the ability to transfer permits becomes important relates to the sale of some or all of a project, especially in the context of a voluntary workout. If the parties have determined that a project should be sold to another owner or operator to minimize further losses, the ability to transfer the project with its permits in place may be the difference between an acceptable sale price for a going (albeit ailing) concern and a sale for scrap. Negotiations with regulators and issuing authorities may be necessary to seek waivers or expedited re-approval processes for permits associated with any such transfer. The success or failure of such discussions may hinge on the project company's ability to demonstrate that it is in the public's interest to maintain the project as a going concern in the hands of new parties, because it provides local jobs, supplies critical goods or services to the neighboring community, contributes to the local tax base, etc.
Preserving other critical arrangements
Identifying and working around transfer restrictions is not, unfortunately, limited to permits and other forms of governmental authorizations. A variety of other contractual arrangements supporting a project's activities may need the same sort of analysis and proactive response. For example, it is not unusual for feedstock supply contracts, or other contracts providing for a project's operation or maintenance, to forbid assignment without the counterparty's prior consent. A sale of the project in circumstances where the project company is being merged or dissolved may trigger this approval requirement. As more and more vendors learn (sometimes at their own expense) the special risks associated with contracting to highly leveraged, heavily mortgaged, and easily transferred project companies, they are starting to insist on change in control provisions in their contracts to protect their own options in the context of project workouts. Needless to say, these discussions can be challenging for the project company and its advisors. In some eases, local law may be helpful, if it provides that such anti-assignment clauses are not enforceable in whole or in part (as is the case in some jurisdictions).
Warranties are another matter that should be considered in the context of a troubled project, particularly where a project finds itself having to replace one or more of its construction contractors, equipment suppliers or operating subcontractors. This is another area where careful negotiations are required with the company taking over the defaulted activity, as the new company will often resist attempts to provide wrap around warranty coverage for its predecessor's activities. In some case, the additional protection can be negotiated for, at an additional cost, so long as the parties remember to address the topic. In some cases, a baseline inspection by an independent expert may be required to establish as a matter of record which problems were inherited and thus are not covered by the new company's warranties and operational assurances. In some cases insurance products can be obtained to protect all parties against risks that cannot be fairly quantified and isolated. Again, local laws should also be consulted to determine what overlay they provide, in addition to the rights and obligations set forth in relevant contracts.
Insurance programmes are another matter often ignored at the parties' peril as they focus on seemingly more immediate concerns. Depending on the nature of the problem involved, the parties should also determine if any current insurance policies are susceptible to non-renewal or cancellation as a result of the situation at hand. A review of the relevant policies should be undertaken to be sure that the precipitating event has not rendered property or liability coverage ineffective in whole or in part. Negotiations with insurance carriers may also be necessary to ensure that access to an appropriate insurance programme remains available to the project while it works through its difficulties. In some cases, to maintain certain types of insurance, operations may need to be scaled back or altered until the project fully recovers.
Working with troubled projects requires much greater attention to a variety of details other than simple recovery of defaulted payments. Parties who find themselves having to grapple with such matters are well advised to work with advisors who not only understand the basic complexities of working with any troubled credit, but who also bring to the table a deep appreciation of the nuances and intricacies of project and infrastructure financing.
Reprinted with permission from International Financial Law Review © 1999.