Project Finance and the efficiency of Direct Agreements under Swedish law – the treatment of the debtor’s contracts in bankruptcy
Public private partnership (PPP) is an alternative method for the financing of public infrastructure, based on the concept of financing public undertakings by private funds. The technique can be used in a number of different sectors such as transportation, energy, waste management, housing, education and healthcare. However, the focus for this essay is made to large-scale capital-intensive infrastructure projects such as, inter alia, motorways, railroads, bridges, water supply and energy facilities. PPP is commonly used all over Europe, particularly in England, and have recently grown exceedingly in the Nordic countries. Despite this European trend, the Swedish government has so far been hostile against making use of the PPP. However, given the positive outcome from the development that has taken place in the Nordic countries, Sweden is likely to follow the track. There are various forms of private public partnerships, however, the basic concept is that a private company, solely established for the purpose of carrying out the project in question, takes the primary responsibility for the financing, designing, building and operating of a project facility, which is then transferred to the public sector. Using such a single purpose vehicle (SPV) reduces the risks for the project sponsors thus making it possible for them to attain a “non-recourse financing”. This means that the lenders have no recourse against the project sponsors and therefore only may take recourse to the assets held by the project company for the repayment of their loans and for interest payments on such loans. However, the value of the asset of the project company, at least at the beginning of the construction phase, is significantly limited and uncertain. There is often no established market for project assets such as a power plant or a motorway and the facilities are in general owned by the public sector, rather than the project company. The non-recourse financing technique in addition to the fact that there is no real asset to take security in thus exposes the creditors to considerable risk. The lenders are forced to almost solely rely on the future revenues of the project company. Both the creditors and the equity holders therefore focus their attention on the prospective future cash flow of the project company. The most important objective for the creditors as well as for the equity holders is thus to keep the project running. The future revenues are generally provided by the public sector party, once the project is finalized. Hence, the key threat is a public sector party cancellation of the contract. In order to make these projects “bankable” the parties involved are forced to create innovative contractual solutions taking these foreseeable conditions into consideration. Apart from the traditional form of security, various forms of “quasi security” are often used. One of the most important features in this regard is direct agreements. Direct agreements are entered into between the project company, the banks financing a project and the parties to the project’s key underlying commercial contracts. The key contracts for this purpose would typically include the concession agreement, the main construction contract, any operation and maintenance agreement, any long-term supply contract and any long-term sales contracts. The objective of a direct agreement is basically to enable the banks to “step into the shoes of the project company” if it defaults in its loan obligations. The agreements provide a right for the creditors to assume the project company’s rights and obligations under the contract for a specified period of time or allow the transfer of the contract to a separate company established by the banks for this purpose. If such an assumption is made, then the project contractors can not terminate the defaulted contracts prematurely, their cancellation rights are to say “frozen”. Hence, direct agreements draw third parties into a projects finance agreement in that compulsory consent to accomplish an eventual assignment is obtained prior to such transfer is being considered. In doing so, the lenders can hinder third parties from exercising their contractual rights. However, direct agreements are met in accordance with English law, which is generally considered more ‘creditor friendly’ than the Germanic law tradition. Albeit the parties involved have agreed upon this solution, implications in the Swedish jurisdiction may render these agreements ineffective. The key threat to the efficiency of using direct agreements in Sweden is the potential bankruptcy of the project company. The bankruptcy itself does not necessarily create significant complications for the lenders, however the expected right of the bankruptcy’s estate to enter into the debtor’s contracts exposes the lender to higher risk. The purpose of this essay is to examine the efficiency of direct agreements used in private public partnerships and project financing in general, relating to large-scale infrastructure projects, in the light of Swedish law, particularly with regard to the project company’s bankruptcy and the principal rule of the estate’s right to enter into the debtor’s contracts. The two basic questions are, firstly whether the bankrupt estate is entitled to enter into the project company’s contracts, (or from a contractual perspective, whether the solvent party is entitled to cancel its contractual obligations) and secondly whether the right of the estate to accede to the project company’s contract is mandatory and hence an agreement opposing such right is void against the estate. The essay seeks to discuss these basic questions de lege lata as well as de lege ferenda in Sweden and to compare the legal situation in the Nordic countries and in England. Furthermore, the purpose of this essay is to suggest solutions of the problems evinced, principally to devise a law reform. The essay holds that the two perspectives deliberated in doctrine, the solvent party as opposes to the bankrupt estate and its creditors prove inadequate pertaining to project finance. There is considerably more interest to take into account that renders the traditional argumentation invoked in legal literature inapplicable for the particular circumstances at stake in project finance. The concept of “all creditors” must be modulated. The interest of protection noticeably varies among different creditors and hence there are reasons to give preference for the syndicated lenders who comprise the major part of the creditors and those subjected to the major risks. It is held that none of the likely risks expressed in legal literature or key arguments invoked in favour of the bankruptcy perspective is pertinent considering project finance where the lenders have step in rights. There are incitements to consider other creditors in the contracting of the solvent party and the debtor prior to the bankruptcy. The solvent party does incur an inconsiderable further damage or inconvenience beyond what he would have suffered if the contracts instead had been cancelled on the day of the bankruptcy judgement. Besides this inconvenience is not a matter of concern solely for the single contracting party however encompasses the public interest of infrastructure and the quality of such. Besides the lender’s step in comprise a substitute providing a noticeably better solution. The most efficient and favourable solution for “all creditors” will be achieved by entitling the lender’s and hence not the estate to enter into the project company’s contracts, particularly the project agreement. It may certainly be questioned why the estate should be considered as a “new third party” not possible to include in direct agreements prior to a bankruptcy, when all major creditors participate in such agreement. However, the essay states that de lege lata as well as de lege ferenda remain uncertain. The principal rule de lege lata give preference to the right of entry for the estate in analogy with the 63 § SAG. Albeit exceptions can be made in analogy with anticipatory breach such deviations from the basic principle is subjected to inconveniences. The debate de lege ferenda indicates a highly trend towards company reorganisation and increased priority of secured creditors. The objectives behind the new insolvency rules and the essence of the debate of incorporating the two insolvency proceedings are considerably more likely to be achieved if the lender’s are entitled to enter into the debtor’s contract. The commission advocates flexibility and the importance of giving all the creditors incentives to participate. It can be questioned if the best way to achieve such goals is through mandatory rules is. Conversely, the principle of freedom of contract and encouraging private work out insensitive, as provided for in direct agreements, is without doubt a better solution for the particular circumstances in project finance. In conclusion, a balancing of interest, de lege lata, definitely points in favour of entitling the lender’s to step in and the solvent party to cancel and hence not entitling the estate to accede to the debtor’s contracts. However, uncertainty prevails. Besides, it is just a matter of time before a legal reform is brought into force, prescribing general rules in favour of the bankruptcy estate to enter. It is thus essential to carve out exceptions for project finance and public private partnership in such proposal. Against this background the essay concludes with a proposal of a law reform.
Göteborg University. School of Business, Economics and Law