Project financing enables sponsors of large projects to leverage their assets with minimal or no utilization of existing corporate credit. In a typical transaction, the project assets and cash flows are segregated from the project sponsors and independently evaluated by the lenders. The credit appraisal and lending decision is based on the inherent economics of the project as opposed to the credit standing or balance sheet of any sponsor.

For decades, sponsors of fossil fuel-based energy projects in North America have utilized project financing, but this type of financing generally has been less available to sponsors of renewable energy projects. Fortunately, as banks, insurance companies and other financial institutions are becoming more familiar with the technologies, regulatory landscape and transaction structures, this type of financing is being made available to fund wind projects. With positive trends in the cost and reliability of technology and the recent transition of the industry to one dominated by larger participants with proven track records and institutional relationships, the available financing options are expanding. Recent transactions in North America include several project-financed wind farms, the first-ever wind power flow-through income fund offered to investors in the Canadian capital markets and the first-ever investment grade-rated bond transaction for a portfolio of wind energy assets in the United States.


The Goal

The ultimate goal of a sponsor in a project financing is to have a highly leveraged project with little or no direct impact on the balance sheet or credit standing of the sponsor. This goal is attainable, but many lenders will insist on limited recourse to project sponsors or indirect credit supports in the form of guarantees and warranties from project sponsors and related third parties to mitigate specific payment risks. The nature and extent of any credit support can vary greatly based on the lenders' risk assessment. The need for such credit support can be minimized by project sponsors that are aware of lender concerns and that are willing to address them in the negotiation of the key project documents.


Participants and Risks

The financing of a wind power project generally will involve the project sponsors; utility, construction contractor; warranty, maintenance and service provider (typically the supplier of the wind turbine equipment); operator (often one of the project sponsors or an affiliate); and the lenders. Additional participants will include independent engineers and consultants engaged by the lenders to assist in evaluating particular aspects of the transaction.

The first step for the project lenders is to conduct an in-depth analysis of the owner's feasibility study and possibly even hire a consultant to conduct an independent feasibility study. Such studies will analyze the wind resource data and should demonstrate the financial viability of the project. These studies will detail technical, financial and other aspects of the project and are crucial to the lender in its risk assessment of the proposed project.

For a typical wind project, once the lenders have performed sufficient due diligence to become comfortable with the available wind resource, the remaining risks generally fall into three main categories:

1. Revenue risk.

2. Completion risk.

3. Operating risk.

Revenue risk is the risk that payments to be made under the power purchase agreement or any other material revenue-generating arrangement entered into by the project company will not be received.

Completion risk is the risk that the project will not be completed or that completion will be delayed.

Operating risk, which includes technology risk, is the risk that the project will fail to perform at levels sufficient to meet projected cash flows or that the costs of operating and maintaining the project will exceed budget forecasts. Each of these categories of risk is addressed in one or more of the principal legal documents.


Power Purchase Agreement

One of the most valuable assets of the project company, and therefore one of the items most closely scrutinized by the lenders, is the power purchase agreement, which represents the main source of revenue for the project. Ideally, the power purchase agreement is with a utility that has an investment grade or better credit rating and one that is motivated by a regulatory requirement, such as a renewable portfolio standard, to meet its obligation to take electricity under the power purchase agreement. The agreement must be structured to provide the project company with sufficient revenue to pay its project debt obligations and all other costs of operating and maintaining the project and to provide the project company and its lenders, as assignees of the project company, with a reasonable opportunity to cure any default before the utility's right to terminate the agreement matures.

Most power purchase agreements are structured to provide revenues to the project company on a fixed or scheduled price basis for a term greater than the term of the project debt financing. Owners and lenders prefer to have "take-or-pay" provisions, which obligate the utility to pay for electricity on a regular basis whether or not the utility actually takes the electricity. The power purchase agreement also should attempt to limit the utility's right to curtail production, such as only to events of force majeure or emergency situations.

The power purchase agreement also will address construction and operational matters of interest to the lenders, including the consequences of late completion of the facility, including liquidated damages and termination rights if an agreed final deadline is missed; the minimum delivery obligations of the seller; and damages payable to the utility.

Finally, in a separate consent agreement to which the lenders are parties, the utility will acknowledge and agree to the security interest of the lenders and to the specifically negotiated, extended cure rights and step-in rights of the lenders or their transferees. Such a consent agreement will be required by the lenders for all key project company agreements. They typically will include restrictions on amending such documents and require early warning notices to the lenders.


Construction and Maintenance Agreements

Lenders prefer to have one turnkey construction contractor responsible for all engineering, procurement and construction and to whom the project company can shift the risks of project completion. This minimizes the potential for finger-pointing between engineers and contractors and provides the owner with a single contracting entity responsible for completion of the project. Most project financing construction contracts are fixed-price contracts, and owners will make an effort to limit the circumstances under which the construction contractor is entitled to change orders adjusting that contract price. Payments typically are made on a milestone or completed work basis. Retention often is withheld. This payment procedure provides incentives for the contractor to keep on schedule and useful monitoring points for the owner and lenders.

A detailed and well-articulated scope of work is very important and should take into consideration all deliverables and obligations of the project company under the power purchase agreement. Ambiguities in the scope of work can lead to costly disputes during construction. A well-defined scope of work also will facilitate negotiation of more precise warranties. Warranties commonly requested by owners and lenders include a defect warranty for design and workmanship and some form of serial defect protection for systemic problems.

Owners and lenders also will typically request performance guarantees. These guarantees usually come in the form of an availability warranty (accompanied by a power curve test of certain proxy turbines shortly after completion of the project or as a condition to final completion) or a power output warranty based on actual generation. These warranties may be included in the construction contract but often are covered in a separate agreement containing the ongoing service obligations of the equipment supplier. If the project does not meet the guaranteed levels of performance, the contractor typically is required to pay damages to the sponsor, and if the project performance exceeds the guaranteed minimum levels, the contractor may be entitled to bonus payments. Owners and lenders also may request additional lump sum damages for projected lost revenue if the project is unable to achieve guaranteed power curve or power output levels by a particular date.


The Loan and Security Agreement

In all project finance transactions, the borrower (typically a special-purpose project company formed by the sponsors to own the project) will enter into a loan agreement with the lenders. The loan agreement will set forth the basic terms, including maturity, interest rate and fees, and also will contain (or require separate documents for such purposes) many or all of the following provisions designed to protect the lenders:

	Disbursement controls in the form of conditions precedent to each drawdown under the construction loan, such as requiring the borrower to present invoices, builders' certificates or other evidence as to the need and purpose for which funds will be used.
	Borrower covenants not to amend or waive any of its rights under the principal project agreements without the consent of the lender.
	Borrower completion covenants requiring the borrower to complete the project in accordance with project plans and specifications and prohibiting material alterations without the consent of the lender.
	Borrower covenants restricting the payment of dividends or other distributions by the borrower during construction and, thereafter, only after satisfaction of required debt service and other reserves, debt service coverage ratios and certification of no existing defaults.
	Borrower covenants prohibiting incurring of additional liens and debt (except for customary liens and indebtedness as negotiated) or issuing guarantees.
	Requirements that project participants affiliated with the project sponsors enter into subordination agreements under which certain payments to such participants from the borrower under project agreements are restricted (either absolutely or partially) and made subordinate to the payment of debt service.
	The project loan typically will be secured by all project assets, including a mortgage on the project facilities and real property; assignment of operating revenues; liens on all personal property; and assignment of all project agreements and project permits, including any letters of credit or performance bonds to which the borrower is the beneficiary.

The Future

Wind power has enjoyed steady growth over the last decade, and that growth is expected to continue in both the United States and Canada in the coming years. Given the increasing number of credible sponsors with well-established relationships with the lending community, the improving credit position of many of the utility off-takers and the increasingly favorable regulatory environment in both the United States and Canada more project financing of North American wind farms can be expected.

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For more information about the issues covered in this report, please contact Ellen L. Bastier in our San Francisco office at 415-369-7617 or at ebastier@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.





©2004 Thelen Reid Brown Raysman & Steiner LLP