Energy Project Finance: Structuring Deals and Allocating Risk

The special purpose vehicle is the foundational entity in energy project finance, because it isolates the project's assets and liabilities from the sponsors' balance sheets while providing lenders with a single, clearly defined pool of collateral, and project finance counsel advising on energy project finance structure design should confirm whether the SPV's organizational documents, equity contribution agreements, and sponsor support arrangements adequately address the scenarios in which sponsors may be required to make equity contributions beyond their initial committed amounts and whether the limited recourse structure's non-recourse carve-outs are defined narrowly enough to preserve the economic value of the limited recourse protection.

Energy project finance debt is typically provided by a syndicate of commercial lenders, development finance institutions, or export credit agencies whose loan agreements specify the conditions under which the project can borrow, the covenants it must satisfy to remain in compliance, and the events of default that give lenders the right to accelerate the debt and enforce their security package, and energy capital markets counsel advising on energy project finance debt structuring should assess whether the debt-to-equity ratio proposed by the sponsors satisfies the debt service coverage ratio covenants that lenders will require and whether the distribution lock-up provisions allow the project sufficient operational flexibility to manage normal revenue fluctuations.

Construction risk in energy project finance encompasses the contractor's failure to complete the project on schedule or within budget, the occurrence of force majeure events that delay or prevent completion, and the failure of the project to pass performance tests that demonstrate it can produce the contractually specified output, and energy and construction counsel advising on energy project finance EPC contract negotiation should confirm whether the contractor's liquidated damages obligations for delay and performance shortfalls are sized to cover the project's actual exposure during the delay period and whether the completion guarantee provided by the EPC contractor's parent company is adequate to support the lenders' completion risk underwriting.

The power purchase agreement is the energy project finance transaction's most critical revenue contract, because the PPA's term, the counterparty's creditworthiness, and the price and volume provisions determine whether the project's projected cash flows are sufficient to service the debt and provide an equity return, and renewable energy and energy project finance counsel advising on PPA negotiation should assess whether the offtaker's payment obligations are unconditional, whether any force majeure provisions allow the offtaker to reduce or suspend purchases without liability, and whether the PPA's change in law provisions protect the project against regulatory changes that could affect the revenue the project was underwritten to receive.

Energy project finance lenders require that a project obtain all material environmental permits, including Clean Air Act permits, Clean Water Act permits, and any required consultations under the National Environmental Policy Act and the Endangered Species Act, before financial close, and environmental liability and energy project finance counsel reviewing the project's environmental permit package should assess whether all permits have become final and unappealable and whether any third-party legal challenges to the permits are pending.

The EPC contract and the PPA are the two project agreements that lenders scrutinize most carefully during energy project finance due diligence, because they are the documents that define whether construction completion risk and revenue risk have been transferred to creditworthy counterparties in a manner that supports the project's debt service model, and project development and finance counsel representing project companies in EPC and PPA negotiations should confirm whether each contract's dispute resolution provisions, governing law, and enforcement mechanisms are consistent with the requirements of the lending jurisdiction and whether the security assignment provisions in each project contract allow lenders to step in and perform the contract if the project company defaults.

When energy project finance involves multiple tranches of debt, including senior secured debt, mezzanine debt, and subordinated debt, an intercreditor agreement must define the priority of each lender group's security interest, the conditions under which each group can exercise enforcement rights, and the standstill periods that prevent junior lenders from accelerating the debt before senior lenders have had the opportunity to exercise their remedies, and debt finance and energy project finance counsel advising on intercreditor agreement structure should assess whether the standstill periods, cure rights, and purchase option provisions give each lender group the protection it needs and whether the intercreditor agreement's waterfall provisions accurately reflect the economic agreement among the lender groups about the priority of distributions.