Ben Donovan Partner Dewey & LeBoeuf South Africa

Ben Donovan Partner Dewey & LeBoeuf South Africa

About Dewey & LeBoeuf Dewey & LeBoeuf is a NYC-based international law firm with more than 1100 lawyers in 26 offices in 15 countries on 4 continents Firm focus on energy practice Office in Johannesburg since 2000; Africa practice also active out of London, Paris, New York, Washington, Middle East and China offices I am a partner in the energy and project finance practice areas; have been working on power projects in Africa since 1995, and have been living in South Africa for several years In Africa, I have advised on the development and financing of power projects in Ghana, Liberia, Mozambique, Namibia, Nigeria, South Africa, Tanzania and Zambia; over 40 projects and 16,000MW total worldwide

Dewey & LeBoeuf LLP Dewey & LeBoeuf Offices Worldwide

Legal and Commercial Issues in Structuring and Financing Hydroelectric Power Projects in Africa Issues covered: Financing Participants Structural Issues - Project Financing Additional Africa Issues Parastatal Risk (Sponsor/Offtaker) Government Support Dispute Resolution Governing Law

Financing African Hydropower Projects Historically most Africa hydro project financings led by DFIs However, Chinese are increasingly active in the market. They present serious competition for the African and Western commercial lenders and DFIs, as the Chinese tend to come into the projects in a package: EPC Contractor (e.g., Sinohydro) Financing (e.g., China Exim, Bank of China) Interest rates are comparatively low Terms & conditions are generally flexible and comparatively attractive Insurances (e.g., Sinosure) As conditions improve and new market entrants arrive, commercial lenders will also increase exposure to the sector

Structural Issues Structural issues often relate to financing considerations (and who the lenders are!) Traditionally, parastatals did projects on-balance sheet IPPs and foreign investors generally require project financing to mitigate risk IPP/foreign investor participation in African power sector continuing to increase Parastatals increasingly using project financing principles in structuring projects Fundamentally, in project financing lenders take very little contractual risk, and will not permit borrower to take risks as recourse is limited. Therefore risk is commonly allocated as much as possible to project agreement (EPC, FSA, PPA) counterparties.

Corporate vs Project Financing In a corporate/on-balance sheet financing: Borrower places its entire balance sheet at risk, but Borrower has more control over operation and maintenance of the plant. use of cash flow In a project finance: Borrower (an SPV) has no other assets or business Lenders and investors (debt and equity) rely on project cashflows for repayment; theoretically limited recourse to sponsors Credit analysis of counterparties vital to credit quality Security structure limits borrower s control of his business

Project Financing A Typical Structure

Typical risks in Hydroelectric Projects Development Construction/Completion Demand Water Supply Performance Technology FM events political/natural Political Financial Environmental Contractual

Project Risks Construction Risk cost overruns late completion inadequate performance/specification failure limitation of remedies Demand Risk (PPA) market for product/service Interruptibility of demand (capacity charges) comparative cost of alternative product/service protection of market term and pricing of offtake

Project Risks (continued) Water Supply Risk availability delivery failure and remedies cost term Performance (Operating) Risk performance/efficiency of project facilities responsibility of performance

Project Risks (continued) Technology Risk protection of technology Life of technology Proven/non-prototypical technology Force Majeure Risk definition natural events/ political events/others insurance consequences/allocation of FM risk

Project Risks (continued) Political Risk change in law/taxation/other legislation revocation/non availability of consents and permits other political risk (e.g. discriminatory action, industry reorganisation)

Project Risks (continued) Finance Related Risk interest rates exchange rates repatriation risks (exchange controls/withholding taxes) inflation Environmental Risk liabilities imposed by legislation cost Contractual Risk all relationships in project governed by contracts enforceability and remedies

Why is Performance Risk Important? Example: breach of offtake agreement (PPA) Risks sponsors and lenders must consider: value and collectability of penalties/termination payments useless product, lost or stranded investment no revenue or reduced revenue earned to pay debt/interest/fees/return on investment the value of second hand projects is difficult to estimate, particularly in restricted market such as (historically) much of Africa

What Gaps Remain? Still some risks even where contracts in place; e.g. poor performance or failure to perform Default by project company or other contract counterparties Contracted limits on liability will limit recourse Counterparty credit risk Government action, particularly where no government offtaker

Risk Mitigation For the benefit of the Sponsors as well as the Lenders Due Diligence Tight contractual structure minimised gaps in coverage, back-to-back third party liability coverage in project agreements Insurance Construction (EAR/Marine Cargo/TPL/BI) Operational (TPL/BI) Political risk cover (if applicable) Hedging NOTE: Much of a project structure is of benefit to Sponsors even where limited recourse financing is not utilised, due to benefits of ring-fencing of contingent liabilities

Project Contracts: Risk allocation Concession Agreement (if applicable) Change in law/tax Construction Contract on a turn key basis Fixed time Fixed price Offtake Agreement Take or pay Pass-through of costs Escalation/currency peg Supply Agreement Fixed price Flexible quantity Operating and Maintenance Agreement Guaranteed Performance

Security - Project Undertakings Financial information undertakings Positive undertakings Negative undertakings Project specific undertakings Restrictions on distributions Other financial covenants Negative pledge Restrictions on disposals Restrictions on capital expenditures Cash waterfall (discussed below)

Cash Waterfall and Repayment profile Cash Waterfall Revenue Regulatory costs (eg, tax) Operational Costs: Supply / O&M costs Flow of the revenue in order of rights/preference (1) Senior Debt: Scheduled Interest and Capital (2) Subordinated Debt: Scheduled Interest and Capital (3) Equity: Dividends

Payment Flows Taxes and other regulatory costs Other operating expenditures wages of staff Insurance Operation and maintenance costs (fixed and variable) agreed capital expenditure Senior debt principal repayments interest and other financing costs

Payment Flows (continued) Reserve accounts debt service reserve account major account Free cash/ return on equity NOTE: O&M structure can be (and often is) manipulated to increase effective ROI

. Typical Project Account Structure Offtake Payments Other revenues (eg insurance proceeds Day of Receipt Monthly Transfer Date Revenue Accounts (held by Account Bank) Operating Account (Local/Offshore) Debt Service Accrual Account Debt Service Reserve Account monthly quarterly as needed Operator/ Suppliers Lenders Maintenance Reserve Account periodically Periodic Maintenance Providers Borrower s Account periodically Sponsors

Project Security Typical project security includes: Mortgages over project property (fixed and movable) Security assignment of shares in project company Security assignments in project accounts Assignments of insurance proceeds Direct Agreements over: EPC Contracts PPA/Offtake Agreement FSA/Feedstock Supply Agreement

Security Construction Period (additional) Under the EPC Contract, the lender will generally require: Approval rights over invoices Assignment of all project security Assignment of liquidated damages (performance and delay) Assignment of construction insurance proceeds Lender rights under a direct agreement: Extended cure periods/stay on enforcement Assignment/assumption rights Lenders have minimum requirements as to amount and type of security, liquidated damages and insurances check before signing Lender will also often require contingent equity against cost overruns

Security Remedies on Default Drawstop Acceleration of loan Dividend Lock-up (bottom of cash waterfall) Enforcement of project security Enforcement of step-in rights Extended cure periods/stay on enforcement Assignment/sale and/or assumption rights Priority in Bankruptcy local law security interest in land, fixtures, movables and local accounts NY/English law security interest in offshore accounts, if any

Typical Financing and Security Agreements. SECURITY AGENT ACCOUNT AGREEMENT ACCOUNT BANK SECURITY DOCUMENTS BORROWER INTERCREDITOR AGREEMENT LENDERS SPONSOR SUPPORT AGREEMENT SHAREHOLDERS AGREEMENT FACILITY AGREEMENT ECAs Multilaterals OPIC/MIGA. FACILITY AGREEMENT

Africa Issues - Parastatal Risk In most countries in Africa, the primary offtaker remains the parastatal Parastatals have been improving immensely, particularly in the past few years, but sheer size of most hydro projects impacts project viability Continuing issues with collections Subsidized retail tariffs Lack of hard currency As a result, often require government support As equity participant, lack of cash/credit rating, other issues impact lending profile

Africa Issues - Government Support Offtaker financial support Project support Licences, Permits Economic Stabilisation (Change in Law) Political Force Majeure Politicisation of project or parastatal often complicates the project Creating understanding of project requirements (for any project worldwide) with political participants is paramount

Dispute Resolution Choosing the correct dispute resolution provisions is vital to the viability of a project Four major types of dispute resolution are negotiation, mediation, arbitration and litigation Governing law is a factor, but not the only factor, in determining dispute resolution processes Negotiation is the first step in any dispute resolution process Mediation is often used as a second step. In this context, mediation is almost always non-binding. D&L advice is often to not utilise non-binding dispute resolution where possible Non-binding nature ensures appeal, and is waste of time and money

Dispute Resolution (continued) Arbitration or litigation common options for final, binding dispute resolution Decision between two options is usually made on considerations of time, cost, and robustness of decisionmaking In Africa, local courts often do not meet criteria for international lenders Litigation in the commonly used international jurisdictions New York and England is often time-consuming and expensive, and establishing jurisdiction is often difficult Other factors in selection Assets/security structure Governing law New York Convention

Governing Law Local law generally governs specific local documents Mortgages and security charges Government support arrangements English or New York law generally governs lending documents (some South African DFIs and commercial lenders require South African law) Local requirements and Politicisation of governing law selection process complicates financing structures and security requirements