Summary of Chapter 12
Introduction Yescombe presents on Chapter 12 issues between the lenders and the Project Company related to Cash-Flow Controls, Security and Enforcement (202). The author posits that the Public Authority has to review the lenders’ documents to make sure there will be no impediments for the Project Company to carry its mandate.
Control of Cash Flows: The Project Company’s cash flows is closely controlled by the lenders, as they will depend on the residual flows to receive their payments (Yescombe 202). The lenders control expenditures via the Disbursement Account, which receives the inflows from equity and loans, and is drawn in the outflows. They may take its control in events of default (Yescombe 203). The lenders can use Drawstop if something goes wrong, and refuse advances until the default issue is solved. (Yescombe 204). The lenders decide the priorities of the project using a Cash-Flow Cascade, which will determine the most important payments first (such as opex, financial agent expenses) down to cash sweeps and distribution to investors (Yescombe 204). The lenders’ cushion is found in the Reserve Accounts, which protect the company’s liquidity. They usually include accounts dedicated to Debt Service, Debt Payment, Maintenance, Tax, Change in Law, and Insurance Proceeds (Yescombe 205-7). There are Controls on Distribution to Investors by the use of financial hurdles such as interest cover ratios (Yescombe 207).
Security: Since lenders cannot take security over the PPP Facility – which is linked to the public interest – they have to make do with the Control of Cash Flows (Yescombe 208). Furthermore, they have other layers of security, such assignment of rights of the Project Company’s major Contracts and Financial Assets in the event of default. This right includes lenders’ need to consent to any major changes in the contracts (Yescombe 209). Their third layer of security is Project Company’s Shares, which enables lenders to take over management if necessary (Yescombe 209). The fourth and last layer of security are Direct Agreements, which are tripartite deeds that include Lenders, the Project Company, and the Public Authority. The latter acknowledges specific rights and interests of the lenders in these agreements (Yescombe 210).
The Role of Insurance: The Public Authority can rely on self-insurance on the majority of cases. However, the Facility needs to have proper coverage (Yescombe 211). Insurance Brokers and Advisors play a vital role to keep insurance costs down. They should be independent of the lenders’ insurance advisers to avoid conflict of interest (Yescombe 212). Construction-Phase Insurances include ‘Builder’s All Risks’, which covers loss or damage at the project site, sometimes including ‘Third-Party Liability.’ ‘Advance Loss of Profits’ can be claimed by the Project Company in the case of delays. ‘Force Majeure’ allows the Project Company to pay debt services if the project is late (Yescombe 213-4). Operation-Phase Insurances include ‘All Risks’ and ‘Third-Party Liability,’ akin to their construction-phase counterparts. ‘Business Interruption’ covers losses incurred by the Project Company. ‘Contingent BI’ covers debt services, similar to the Force Majeure (Yescombe 214-5), All of these insurance contracts are subject to Deductibles, which increase as the cost of insurance lowers (Yescombe 215), Insurance Premium Cost Risk has grown in recent years because of unexpected premiums. Sometimes these risks are shared with the Public Authority to decrease costs (Yescombe 215-6). If there is Uninsurability, as in cases such as prison PPPs, the Public Authority may have to indemnify the Project Company (Yescombe 216). Lenders may have the option to take Control of Insurance Proceeds in cases of total loss (Yescombe 217) Lenders’ Requirements may be rather stringent and add other clauses to the insurance contracts, which increase their cost (Yescombe 218).
Events of Default may be triggered by lenders who do not wish for a company to fail before they take action. They include cost overruns, failure to complete construction, low interest coverage ratios, among others. Such events of default may elicit the following lenders’ actions: waive, impose a Drawstop, control cash flows or enforce their security (Yescombe 218-9).
Intercreditor Issues arise when there is more than one lender or syndicate. Interest-Rate Swap Providers are necessary when swap quotations direct from the market are not feasible, due to the complexity of the financing deal (Yescombe 220). Fixed-Rate Lenders also have complex issues related to breakage costs and make-whole clauses, which differentiate them from other lenders (Yescombe 221). Inflation-Indexed Loans or Swaps can become an acute problem when some lenders have indexed instruments while others do not (Yescombe 221). Mezzanine Lenders and their junior loans require a new level of security, adding complexity to the deals. Their issues include drawing priority, akin to equity; higher priority in the cash-flow cascade; lastly, there are enforcement concerns by senior lenders which may suspect mezzanine defaults (Yescombe 221-2). Subordinated Lenders have nearly no rights other than residual claims after other loans have been paid (Yescombe 222).
IMPORTANCE OF THE CASH FLOW CONTROL ISSUE FOR PPPs
Public-Private Partnerships involve many different players with various issues and positions on some matters. Cash Flow Controls are an essential part of the equation because they can be the difference between a losing or winning position for Lenders and the Project Company. For example, if a cash-flow cascade is not drawn correctly at the early onset of the PPP, lenders may find themselves having to provide more funds to sustain the project, or worse, may not be repaid. Likewise, investors in the Project Company expect to recover their capital and its cost. This can only be achieved if the project is profitable and liquid. Furthermore, the Public Authority and its advisers have to be able to understand all of such controls and how they are spelled out in the many documents that support the PPP. After all, the Project Company needs to fulfill its services, which are in the public interest.
CRITIQUE
The text of Chapter 12 tried to encompass a broad view on the complicated issue of Lender’s Cash-Flow Controls, Security and Enforcement. It was able to convey the necessity of drawing detailed and complex documents to support the PPP players and each of their group of interests. For example, there is usually tension between groups of lenders (senior, mezzanine, subordinated) as they each want a higher priority on the cascade list or to establish a different event of default, the trigger which enables their right. The issue of Security also indicated the importance of the public interest, the ultimate reason for establishing a PPP: as services to the public cannot be halted, the facility cannot serve as the ultimate lender guarantee. The author was able to convey these ideas clear and efficient.
Works Cited
Yescombe, E. R. Public-private Partnerships: Principles of Policy and Finance. London:
Elsevier, 2007. Print.
