Legal and contractual matters

Transcription

1 Sponsored by CHAPTER 10 Legal and contractual matters 10.1 Legal structures Corporate structures Contract structures Joint ventures Control of decision making Project financing Deadlock resolution procedures Bank funding/debt finance Documentation required for AD project financing Lender s advisors Equity funding Feedstock supply Feedstock specification Delivery Unloading, weighing and inspection Transfer of title and risk Term and price Shortfall in feedstock Force majeure Project lenders Summary Construction, engineering, operation and maintenance contracts Real estate issues Site identification Legal process Option Lease Insolvency and default Termination rights Turnkey projects Residual asset value Step-in rights Sinking fund Options The practical guide to AD 115

2 Legal and 10.1 Legal structures Corporate structures The choice of legal structure for an AD project involves consideration of a number of issues for developers and investors, including their risk in the event of insolvency, the ease with which the project can be sold and the flexibility to attract new investment. In most cases, the most appropriate legal structure for an AD project will be a private limited liability company (LLC), where the shareholders liability is limited to the capital contributed by them for the purchase of their shares. The veil of incorporation provides the greatest protection for the shareholders in the event that the company becomes insolvent, allowing the project company to be easily sold, or for investment to be facilitated by the issue of new shares. The solvency point is important given the current technology risk that is perceived to apply to the production of electricity or gas from AD projects. However, while the shareholders are protected in this structure, it should be noted that directors of an LLC may find themselves personally liable in certain circumstances, for example, if they are found to be trading whilst the company is insolvent. An LLC can be established quickly and cheaply. Therefore it is possible to establish a separate Special Purpose Vehicle (SPV) for each project if a series of projects is contemplated. Furthermore, an LLC is attractive to a lender since it is possible for a lender to take a charge over the company s shares as security for its investment. It is not possible for the lender to obtain similar security for its investment in other vehicles, such as partnerships or limited liability partnerships (LLPs), since there are no shares over which to take a charge. Although there are certain regulatory burdens associated with an LLC, such as annual filing of accounts and returns with Companies House, these are not sufficiently onerous as to make an alternative vehicle such as a partnership or LLP more attractive; the open-ended liabilities associated with a partnership are not well suited to the development of AD projects, while an LLP brings its own regulatory burden. The key issues in relation to the establishment of an LLC relate to ownership and control. The default articles set out in the Companies Act 2006 provide that the day-to-day business of the company is conducted by the directors, whilst control over more important decisions is reserved to the shareholders, who are the ultimate owners of the company. However, bespoke or amended articles of association are generally put in place to change the allocation of control between the directors and shareholders. If an LLC is established in the context of a joint venture between a developer and investor, a key area for negotiation will be the allocation of shares between the two parties (and any third parties) and the appointment of directors. Given the capital-intensive nature of AD projects, it is likely that a provider of finance will expect at least one appointment to the board in order to safeguard their investment, as well as perhaps a charge over the company s shares Contract structures The appropriate contract structure largely depends upon the type, size, sponsors/ investors and funding structure of the project. A merchant development will require a different structure to a local authority project, and on-farm AD is typically structured differently to food waste AD developments. The developer(s) will usually establish a special purpose company (sometimes known as a Special Purpose Vehicle SPV) which will enter into the various contracts described later in this chapter, including lease, feedstock supply, engineering and construction (or engineering, procurement and construction EPC), operations and maintenance, digestate off-take, heat and power sales, residual waste disposal, etc. Where the special purpose company is a joint venture company (as described in section 10.2) it may enter into a management services agreement with one of the shareholders or a third party management services contractor. The management services will typically include company secretarial and filing duties, HR and payroll (if staffed) and related administration. In the case of on-farm AD where the construction and operation phase contracts have not been entered into at financial close, the management services may extend to procuring and administering such contracts. Where there is debt finance, the full suite of EPC and operation and maintenance (O&M) contracts will usually be entered into at financial close. Alternatively, it may be acceptable for these to be entered into after financial close but be a condition precedent to drawdown of funding Joint ventures Sponsored by It is likely that an AD project will be developed pursuant to a joint venture between any of the following: project developer, finance provider, landowner or technology developer. A joint venture may take several forms depending on the desired level of cooperation between the parties. In the context of an AD project, the preferred vehicle for cooperation is likely to be an LLC (SPV) which is jointly owned by one or more parties. The SPV is in legal terms its own separate entity and can own and deal in assets, enter contracts in its own right and sue or be sued on those contracts. The legal relationship between the participants in the joint venture and the SPV is usually set out in the articles of association of the SPV, in a separate joint venture agreement or in a combination of the two. The SPV may be a 50:50 deadlock company or may be controlled by a single shareholder or group of shareholders. 116 The practical guide to AD

3 Sponsored by Legal and Shareholders with over 50% of the issued shares can, subject to any other agreements which vary this, appoint and remove directors and approve all company matters for which the company s legislation does not require 75% or more approval, such as changing the company s articles and disapplying preemption rights on the issue of new shares. Shares in this context generally refer to ordinary shares, of which there can be more than one class, but commonly not to preference shares which tend to be non-voting (other than where any dividends attached to them are unpaid or where it is proposed that the company is looking to be wound-up). The articles and all other relevant shareholder agreements need to be considered carefully when looking at shareholders rights. The key areas for negotiation in a joint venture agreement are the control of decision making and financing of the project, as well as the deadlock resolution procedures Control of decision making Often a joint venture agreement will set out a list of matters or activities which are reserved and require the consent of the other party to the joint venture, or the minority shareholders in the SPV. A management committee may also be formed, comprising members from each party to the joint venture, which will undertake the day-to-day activities involved in developing the project. However, this creates a risk that participants in the committee could become shadow directors as they will be carrying out the same actions as the SPV s directors, and may therefore be subject to the associated duties and obligations as set out in the Companies Act Project financing Financing of the project under the joint venture agreement may be structured in a number of different ways. It is likely that one party to the joint venture agreement will be a provider of either debt or equity finance. Therefore, provision may be made for this party to enter into a loan agreement with the SPV, once certain conditions of the development of the project are met. Alternatively, it may be that financing of the project is undertaken by the developer until a certain stage in project development, when the SPV is transferred to the finance provider, who is responsible for financing the project from the date of transfer Deadlock resolution procedures Where both parties to a joint venture hold equal voting rights, or where matters require unanimous consent, the joint venture agreement should make provision as to the procedure to be followed in the event that the parties are unable to reach agreement on an issue. The joint venture agreement may set out a deadlock resolution procedure involving referral to an expert, or allowing one party to purchase the other party s shares in the event that agreement cannot be reached following attempts by the senior management of each party to reach agreement in good faith. If expert determination is used as a means of resolving deadlock, the removal of control associated with this procedure is likely to prove unattractive to the joint venture parties, providing an incentive for them to reach agreement Bank funding/debt finance As highlighted previously, there is a perceived technology risk associated with the production of electricity or gas from AD projects. This, coupled with a lender s need for certainty of proven outputs and income streams, has instilled a cautious approach in the UK lending market towards AD projects. As a result, a number of different funding structures have emerged in the UK lending market: Traditional secured lending (typically to farmers and landowners) using the lender s standard form loan documents. The lender will take security over assets which may not be directly connected with the AD project or corporate/personal guarantees which can deter some project developers from pursuing bank finance. This type of funding typically requires lower levels of project due diligence. Hybrid loans incorporating some features of traditional project financing (such as increased due diligence, project finance style covenants within the loan documentation and a thorough security package) but with the loan documented on a lender s standard terms as above. The borrower in the hybrid loans will typically be an SPV. Traditional project finance loans documented on standard project finance terms (as outlined below) with full due diligence being carried out. These loans are typically to an SPV with established shareholder sponsors providing the track record and expertise required by the lender Documentation required for AD project financing As detailed below, a large number of documents are usually required in AD project financing and therefore good project management skills are required. Facility agreement The facility agreement documents the terms on which the lender s debt will be provided, for example: The term and availability of the loan; Drawdown mechanism (the frequency and dates for drawdowns) generally drawdowns will be against project costs and require certification by the lender s technical advisor; Repayment schedule setting out the amortisation profile (this will match the financial model for the AD project); Loan amount how much is to be lent (and for what specific purpose) and the rate of interest to be charged; The practical guide to AD 117

4 Legal and Sponsored by Information and project-specific undertakings for example, a requirement to provide financial information such as management accounts on a quarterly basis; to provide progress reports at an agreed frequency during the construction phase; to provide updates on compliance with the agreed budgets during both the construction and operations phase and undertakings to ensure that the AD project is constructed and operated in line with the relevant project agreements (which are approved on the lender s behalf ahead of completion); Financial covenants the higher the gearing the more debt (and less equity) is invested in a project. The typical gearing ratio for project finance is for the lender to provide 80% of the funding with the shareholders/sponsors/third party providing the remaining 20%. However, significantly lower gearing is currently common in the AD sector in hybrid loan structures. The lender will also test the ongoing financial performance of the AD project by utilising the following key financial covenants: i. Debt service cover ratio this looks at the ratio of net revenues of the AD project compared to the debt service costs under the lender s facility agreement. ii. Loan life cover ratio this looks at the ratio of the net present value of the SPV s future net revenue during the life of the loan to the principal amount of the debt outstanding as at the calculation date. iii. Events of default upon an event of default (which the lender has not chosen to waive), the loan will be deemed to be repayable on demand. Typical events of default on project finance include a material breach, termination or material amendment to the project documents to which the lender has not consented, breach of financial covenants, suspension or abandonment of construction of the AD project and the entry into an insolvency event of certain entities (including shareholders in the SPV, each security provider and the SPV itself). Accounts agreement The lender will normally require control over the SPV s cash flow resulting in restrictions on payments and withdrawals from project bank accounts. A number of accounts will need to be established to manage cash flows, including project and insurance proceeds, a compensation account, a debt service reserve account, a maintenance reserve account, a proceeds account and a distributions account. The SPV will typically provide first ranking security over all project accounts in favour of the lender. Security documentation and typical security package The lender will usually receive first ranking security over all of the SPV s assets including real estate, accounts, insurances, contractual rights under the project agreements and all equipment. A number of documents will be used to document these arrangements, such as a debenture, possibly a legal mortgage and assignments by way of security over key project contracts including, for example, the EPC contract (contract for the design and construction of the plant), the O&M contract (operations and maintenance contract), key feedstock supply contracts and key off-take contracts. The lender will also receive first ranking security from the shareholders in the SPV over their shares in the SPV and may also seek parent company guarantees to guarantee the performance by a contractor of its obligations under a key project agreement. If security is also being granted in favour of third parties in relation to subordinated loans from shareholders/junior debt providers, then an intercreditor deed may be required to rank the lender s debt and security first, ahead of these third parties, since the lender will be the senior lender. Direct agreements The lender will typically enter into direct agreements with each key project contractor and off-taker with whom the borrower has contracted. These typically give the lender rights to step in and remedy a breach of the SPV s obligations owed to a contractor or off-taker under a project document prior to the contractor being able to terminate the relevant project document or take other such steps due to the SPV s breach. EPC contract The lender may sometimes require all construction risks to be contracted out by the SPV to a single EPC contractor under a turnkey engineering, procurement and construction contract. It will address all design, programming, construction interfaces, technology supply, commissioning, process performance guarantees, availability guarantees and defects rectification. The SPV will require effective remedies including robust default termination grounds, delay liquidated damages, performance liquidated damages, appropriately sized liability caps, collateral warranties with step-in rights from key sub-contractors, and adequate security in the form of bonds, parent company guarantees and/or letters of credit. O&M contract The lenders will require all operational and maintenance risks to be contracted out of the SPV to a single operating contractor for the term of the debt repayments. As referred to above, in a project-financed merchant food waste project, in addition to undertaking to meet availability and processing performance requirements (usually set out in the KPIs) for a fixed operating fee, the operator (typically also a shareholder in the SPV) may be required to guarantee future project revenues such as heat and power sales, digestate off-take and feedstock supply gate fees (see section 10.5 for further consideration of feedstock supply). This will therefore be a more sophisticated operating contract than would be necessary in the case of an equity funded project. Interface agreement The SPV must be protected from risks associated with the interface between the construction and operation phases, with particular regard to the relationship between the commissioning/acceptance testing/take-over regime and ongoing performance guarantees; and liability for defects rectification, maintenance and availability guarantees. 118 The practical guide to AD

5 Sponsored by Legal and Unless the EPC contractor and the operator are the same company or party of the same group of companies, it may be necessary to address responsibility for such interfaces in an interface agreement between the EPC contractor and operator in order that they have a direct contractual relationship and the SPV s liability is excluded. It is worth remembering that an EPC arrangement will normally attract a 15% premium on the whole project cost Lender s advisors A lender on traditional project finance will have a team of professional advisors. Legal advisor The lender will require due diligence to be carried out on the key project documents, for example the EPC contract and the O&M contract, and for these to be lender-approved prior to completion. The legal advisors will ensure that risks have been appropriately transferred to contractors/sub-contractors away from the SPV where possible and/or appropriately managed (which may be by way of insurance). Since project finance is essentially cash flow lending, as opposed to balance sheet lending, thorough due diligence is carried out on the projected revenues since the revenue stream will be used to repay the loan. As such, on AD projects there is always particular interest in power purchase agreements (PPAs) or gas trading agreements, and in digestate spreading agreements (whether these are revenue generating or a cost), given the importance of finding a reliable digestate distributer. Technical advisor The lender will require a technical advisor to report on the technical solution for the AD project and to demonstrate its functionality. Model auditor The lender will require a model auditor to prepare and stress test the financial model prior to completion; the financial model must demonstrate sufficient revenues to meet costs, repay the loan and generate the anticipated profits for shareholders. Insurance advisor The lender will require an insurance advisor to report on the required insurances and levels of cover that the SPV is to procure and maintain for the AD project. Additional considerations The lenders must be satisfied with the modelled costs and revenues in relation to heat and power sales, digestate off-take and feedstock supply. To the extent responsibility for these costs and revenues is contracted out to counterparties of the SPV, both the robustness of the contract terms and the covenant strength of the counterparty are key. In a merchant food waste project this may require the operating contractor to effectively guarantee these costs and revenues over the term of the debt repayments, in which case the lenders need to be satisfied that the operator has adequate covenant strength and/or the guaranteed levels are realistic. Further, lenders will require the SPV to have some form of directly enforceable contractual rights or security over the key off-take/sale/supply contracts and/or revenue streams. However, it may not be realistic to secure such sale, off-take and supply contracts for the full term of the debt repayment, and the operator may not therefore be able to guarantee that it will secure direct agreements with step-in rights. In this case, in addition to the operator guaranteeing project revenues, the lenders may require the SPV to insist on certain controls and approval rights in the operating contract in respect of the terms of significant off-take/sale/supply contracts entered into by the operator from time to time, as well as an obligation to endeavour to secure step-in rights for the SPV. The lenders may also require security over such revenues by way of agency or trust arrangements in case the operator defaults Equity funding AD projects are capital intensive, lending themselves to investment by venture capital or private equity investors alongside landowner and technology providers. This form of joint venture has at times been the only viable means of getting projects off the ground when bank funding is not forthcoming, with the potential to refinance using bank debt once a project or series of projects are proven in terms of output and therefore income stream. The limited liability company (LLC) is the only practical option for this type of investment; LLPs do not lend themselves to this type of investment for a number of reasons, which are beyond the scope of this Guide. The insurance advisor will typically prepare an insurance schedule to the facility agreement and will advise the lender on any rights it requires under the insurance policy, for example, whether it should be named as a co-insured party under the insurance policy. The practical guide to AD 119

6 Legal and Sponsored by It is also generally the case that equity investors due diligence procedures are not as onerous as banks. However, investors will require a certain minimum level of return to view a project as attractive, often based on internal rate of return (IRR) and an exit within a period of around three to five years. The key legal documentation required for a pure equity investment comprises: Shareholders subscription or investment agreement (one and the same thing); New articles of association for the investment company; Management team service/employment contracts or consultancy agreements; Share option scheme rules or agreement and warrants for the investor to subscribe for further shares; and If a joint venture: Management services contract for an investor to provide to the SPV management services such as company secretarial, filing, reporting and company administration. The documents will contain a number of standard provisions and others which are more rigorously negotiated. The key provisions are summarised below. Warranties and representations The management team will be required to give a number of commercial and financial warranties (factual statements) surrounding the company s business and affairs and regarding the intellectual property/technology used to operate the plant where the co-investor is the technology provider. The warrantors will seek to have limitations imposed on their liabilities under the warranties and will need to undergo a disclosure exercise to determine how the warranties should be stated to limit any potential further liability. Good and bad leaver It is not guaranteed that the management team will stay intact for the duration of an AD project. Commonly, a director or senior manager is required to sell his shares back to the company or to other shareholders when leaving the company and the circumstances in which he leaves (such as a bad leaver, dismissed for misconduct, or a good leaver, leaving to look after a sick family member) will determine the price it receives for its shares, which may be virtually nothing, fair value, or based on a specific method of valuation. This is often a key issue for negotiation between the parties. Pre-emption and anti-dilution rights Investors will want the right to follow their money by making further investments when the company requires additional finance. Existing shareholders have pre-emption rights on the issue of new shares to prevent them being diluted. There are various formulae which are used to determine the number of shares that stakeholders receive in such circumstances, especially when there is a down-round, meaning the issue price is less than the price at which shares were issued during the last funding round. Drag and tag Investors holding an agreed proportion of shares, frequently between 66-80%, can force a sale to a third party by dragging the minority shareholders along on the same terms, as buyers seldom want less than 100%. The tag right is a benefit for the minorities, meaning they are not left behind on a sale by the majority to a new investment partner they may not know or wish to invest with. Convertible loans It is not uncommon for investors to invest initially by way of a convertible loan which, as the name suggests, is a loan which can, at the investor s request, be converted into shares of a certain class. There can be various conditions attached to such loans and they may be unsecured or secured. It is a matter for negotiation as to whether the accrued interest on the loan is also capable of conversion into shares or whether this is to be repaid in cash at an agreed time Feedstock supply The feedstock supply agreement is one of the key contracts a developer will enter into as part of its project procurement process. The parties to the feedstock supply contract(s) are (1) the AD developer (or SPV or operator as applicable) and (2) the feedstock supplier(s). In the case of an on-farm or single-site industrial AD facility (for example in the food and drink industry where by-products are a feedstock) the feedstock supply may be from a sponsor or stakeholder to the project, such as the farmer or the food manufacturer. In the case of municipal food waste AD, the feedstock supply will be part of the main project agreement. In the case of a merchant or semi-merchant food waste project, the SPV or the operator will be responsible for securing feedstock supply throughout the project term, which it may not be possible to secure within one single contract. Where the operator is an established organic waste contractor with the requisite technical and financial standing (for example with existing feedstock contracts, a track record of securing local authority or commercial food waste contracts and/or waste transfer infrastructure) it may be possible to satisfy the lenders and investors that the operator can guarantee feedstock supply to the SPV without necessarily having secured all of the necessary feedstock supply contracts as at financial close. (See section with regard to the O&M contract.) Depending on the project, a feedstock supply agreement might have a term of up to 10 years (it is unlikely that suppliers will offer a term longer than 10 years and in practice supply agreements more often have a shorter term than this). As a result, it is important that the parties to the agreement give careful consideration to how it should operate. Exit preference Often called a liquidation preference, this is really a liquidity event (a sale or listing), rather than a liquidation or winding-up of the company. Commonly, the main investors would first receive back all or twice their investment; the other shareholders would then receive their pro-rata entitlement, with the main investors often getting to participate further here, called a double-dip. 120 The practical guide to AD

7 Sponsored by Legal and Feedstock specification A feedstock supply agreement should contain a detailed specification setting out the type and quality of feedstock to be supplied. Technical input should be sought to ensure that the specification set out in the feedstock supply agreement corresponds with the requirements of the AD plant Delivery The delivery provisions in a feedstock supply agreement should clearly deal with the amount and type of feedstock to be delivered, frequency of deliveries, site-specific restrictions such as delivery times, access arrangements and safety considerations at the site Unloading, weighing and inspection A feedstock supply agreement should set out which of the parties is responsible for unloading and weighing feedstock and recording quantities delivered. Developers will usually seek a right to inspect consignments of feedstock to ensure they conform to specification (and a right to reject if they don t) Transfer of title and risk The parties should consider the point at which ownership and risk in the feedstock pass from the supplier to the developer. This will usually occur on delivery but in some instances, suppliers may look to try and retain title in feedstock until payment is received. From the customer s perspective, title should pass when the customer accepts the delivery, but does not pass if the customer rejects the delivery. The customer may wish to specify that it is entitled to require the supplier to remove forthwith any rejected material or itself dispose of rejected material and recover the cost from the supplier; however, from the supplier s perspective this will be resisted until full payment is received Term and price Developers are often keen to tie suppliers into long-term, fixed price (albeit indexed) contracts. However, suppliers may want to retain some flexibility on price-setting in the contract, particularly in long-term arrangements where it will be difficult to predict variations in the supplier s costs. The payment profile in a feedstock supply agreement will generally require payments to be made monthly or quarterly in arrears for the feedstock delivered in the relevant period Shortfall in feedstock It is common practice to agree a volume of feedstock to be delivered within a specified period and for the supplier to be under an obligation to deliver within a percentage tolerance above and below that monthly volume. Feedstock supply agreements may set out a formula for calculating these damages based on a pre-estimate of the costs the developer will incur in obtaining the shortfall in feedstock from another supplier. Developers should ensure that there is also nothing contained in the contract that would preclude them from sourcing supplies from a third party supplier in the event of a failure to deliver feedstock by the supplier. On a practical note, developers can also look to mitigate the effects of a oneoff delivery failure by ensuring sufficient storage capacity is available to enable the plant to continue running despite a missed delivery. A developer may also wish to seek performance assurance in the form of a guarantee to ensure that the supplier (or its guarantor) will be able to perform its obligations under the contract. In practice, suppliers are reluctant to provide this and/or it may not be possible to identify an entity within the supplier group to act as guarantor. A supplier may also seek credit support from the developer in respect of its payment obligations under the contract Force majeure Force majeure is the term used to describe an event beyond the parties control and which adversely affects performance of a contract. Where a party is affected by an event of force majeure, that party s contractual obligations will usually be suspended while the force majeure event subsists. Parties are free to agree in the contract which occurrences will constitute force majeure events. Key items to consider in the context of a feedstock supply agreement might include fire, destruction of feedstock by weather or inability to complete deliveries due to strike or unavailability of transport Project lenders Where a project uses funding from a bank or other lender, the lender may request that the principal feedstock supplier enters into a direct agreement in favour of the lender. This agreement will enable the lender to step in and take over the feedstock supply agreement from the developer if, for example, the developer becomes insolvent. Few suppliers will be prepared to enter into a direct agreement. In the case of a local authority waste contract under a procurement exercise, for example, the terms of the tender and procurement law may prevent or deter the developer/ operator from insisting on or proposing a direct agreement as part of its bid for the contract. Equally, where the operator is responsible for securing an amount of feedstock through short-term contracts in the market, direct agreements will not be worthwhile or appropriate. Conversely, principal feedstock suppliers may view a direct agreement with the lenders or SPV as a benefit in that it allows for step-in by the lenders or SPV should the SPV or operator (respectively) default. It is also common practice for parties to agree that the annual volume delivered by the supplier must be within a set percentage of the specified annual forecast requirement for the feedstock. Failure by the supplier to deliver the feedstock required by a contract can have significant implications for the developer. A developer may therefore wish to ensure that it is entitled to payment of damages by the supplier where this happens. The practical guide to AD 121

8 Legal and Sponsored by Summary A secure and guaranteed supply of sufficient suitable feedstock is a fundamental building block of any AD project and is critical to securing funding. In most cases (including on-farm and industrial waste projects and local authority projects) this means one or more feedstock supply contracts in place at financial close for the required tonnage throughout the term of the project. In exceptional cases (such as merchant food waste AD with a particularly strong business case and/ or robust security package), funders may be able to rely on an undertaking by the operator or other party to the project to source suitable feedstock provided they have the market presence, track record and financial standing to guarantee such supply. In any event, clear and detailed feedstock supply terms will help underpin the development and successful performance of the project Construction, engineering, operation and maintenance contracts Once land, planning consents and feedstock are obtained, an AD developer is faced with the prospect of having to procure the construction and operation of the AD plant. This ought to be a relatively straightforward process, but there are some fundamental issues that need to be contemplated before embarking upon the construction process, as follows: The developer of the AD plant should choose a building (EPC) contractor and consultants with experience in designing, building and commissioning electrical and mechanical plants (see section for contractual considerations). The entire construction team must be familiar with the takeover, commissioning and possibly post-commissioning testing regimes that are necessary for AD projects. As the appetite for AD plants grows, there will inevitably be new entrants to this market who lack mechanical and electrical experience. It is important that such entrants to the market are not learning at the developer s expense nor failing to meet the project requirements. The developer must be careful in its choice of technology provider. Preferably, the technology should be reliable and have a proven track record and the technology provider should have sufficient financial covenant strength. Developers should exercise caution when dealing with technology providers who request any payment in advance of the equipment being delivered to the site. The preferred route is for the EPC contractor to be responsible for the plant and any associated works provided by the technology provider. Accordingly, the EPC contractor will likewise share the concerns listed above. Developers should opt for contractual terms that most accurately reflect what is actually being built. This may appear to be stating the obvious but the standard form engineering contracts produced by bodies such as FIDIC (International Federation of Consulting Engineers) are, subject to projectspecific amendments, a far better starting point than those construction contracts that do not envisage engineering input, such as the JCT (Joint Contracts Tribunal) suite of contracts. Irrespective of the funding stream for the project at the outset, it is prudent to structure the contracts for the construction, operation and maintenance of the project as though external finances (debt and/or equity) may, at some stage, be involved in the project. The project therefore needs to be capable of being packaged up and meeting certain financeability requirements such as: Certainty as to quality, price and programme; Direct rights of recourse for the financier against the EPC contractor and O&M contractor; Clear and unambiguous risk allocation between the developer and the EPC contractor/o&m contractor (preferably with the developer taking on as little risk as possible); and Contractual mechanisms to allow the developer to recover compensation from the EPC contractor/o&m contractor by way of delay damages if the project is late; or performance damages if the project does not meet the performance requirements. The developer should consider whether the O&M contractor (assuming that the developer is not undertaking this role) is better placed than the developer to provide the feedstock for the plant. Security of the feedstock supply is critical to the viability of all energy from waste plants and some O&M contractors retain exclusivity arrangements with feedstock suppliers, or are of sufficient size to take on feedstock risk (full or in part), as part of their operation and maintenance offering (see section for contractual considerations) Real estate issues This section mainly relates to larger-scale centralised AD plants (CAD), as with on-farm digesters the AD plant is owned by the farmer who also owns the land on which the plant is located. There are therefore fewer issues to consider from a property perspective with on-farm digesters than with CAD plants. The matters set out below are from the point of view of a developer trying to locate a site and from the perspective of a funder for such a transaction Site identification An AD development will be restricted in terms of its location by various constraints that make the site suitable for development. The main constraints relate to access, planning, feedstock and a viable area over which to spread any fertiliser or digestate. Further restrictions may arise dependent on the nature of grid connection Legal process A developer will need to secure a property interest in the land to then allow time to make a planning application and secure funding. This is done by way of an option for lease. The option binds the landowner so that when the developer is ready to proceed, it simply has to serve a notice and the landowner will grant a lease for the site. Prior to entering into the option with the landowner, the developer will carry out searches and title enquiries to ensure that the site is suitable for the intended use, for example by checking the landowner is in fact the owner and that there are no covenants on title which would prevent or restrict the development. 122 The practical guide to AD

9 Sponsored by Legal and Option Option document key areas summary: Assignment The developer and funder will require certainty that there is flexibility to move the option agreement within the developer s group of companies. The funder will also require the landowner to enter into a direct agreement which allows the funder to step into the shoes of the developer should the developer have financial difficulties. This permits the funder to keep the project going and pass it on to another third party developer thus protecting its financial interest. Planning obligations The option will make it clear who is responsible for obtaining planning (almost always the developer unless a joint application) and what obligations are placed on the landowner in assisting with obtaining planning, for example attending public meetings. Extension of the option period Certain circumstances (such as delay in obtaining planning) will necessitate an extension to the initial option period and the developer will require the option to accommodate this. Restrictions on use of land During the option period the developer will require the landowner to covenant not to use the land for certain purposes or, at least, not to grant other rights over the land which would either prevent the development or infringe its operation or profitability Lease The option attaches to it the form of lease that will be granted on completion. A summary of the key points for a lease is as follows: Rent This will usually be a flat rent but there is potential for it to be linked to the turnover the developer receives from the generation of electricity and the sale of by-products. Assignment The funder will require a direct agreement to be entered into by the landowner in relation to the lease to ensure the funder s interest is adequately protected. There will also be restrictions on the landowner terminating the lease where there is funding in place. Term Whereas with many other types of development the term of the lease is not necessarily linked to any particular issue and can be freely negotiated. With an AD development the term is linked to the length of the planning permission. Right to renew Notwithstanding the above, the developer may require a right to renew the lease on similar terms, although the rent will invariably be reviewed at the time of renewal in line with market conditions. The lease will set out the procedure for doing this. It will be the developer s responsibility to obtain a further planning consent permitting the continuation of the development. Environmental matters Any developer and funder will require statements that neither the developer nor funder is responsible for any historic contamination at the premises. It is likely that the developer will have carried out environmental searches (desktop or fully investigative) during the option period, but these statements will still be required. Landowner restrictions As with the option, the developer will require certain restrictions on the property and landowner, including covenants from the landowner not to register himself in relation to the equipment to obtain any of the benefits/subsidies that are paid for the generation of electricity. Whilst these are the main property documents, other documents may be required depending on the circumstances of the individual site. Easements may be required for transporting digestate through pipes across fields to facilitate spreading. There will also potentially be leases for the tanks that store the digestate. These are becoming more important from a funding stance in order to show that there is a viable business proposition for the sale of the fibre and residue. If the pipes and tanks are situated on land owned by the landowner of the development, the agreed draft easements and leases can be attached to the option. Alternatively, these may be with separate landowners, in which case further options will be required to ensure that when planning has been obtained, all the options can be triggered at the same time. Finally, there may also be a spreading contract, a commercial agreement between the developer (as owner of the digestate) and a farmer (possibly the landowner) for the spreading of digestate across fields. The numerous documents required for an AD development all need to be carefully considered and linked to ensure they can be exercised at the same time Insolvency and default AD projects are not guaranteed to succeed and there are a number of reasons why project companies fail, whether due to technical failure, an inability to service bank debt, failure to provide an adequate return for equity investors, or other outside factors beyond the control of any of the parties. One of the joint venture parties may also become insolvent due to its other business interests. The parties should consider at the outset of any proposed project what to do in such circumstances. The parties should also model the default scenarios and endeavour to ensure in the documentation that the risk of the default is mitigated as far as possible. For example, if the key default risk is interrupted feedstock supply, an alternative back-up supply contract should be entered into in advance. For present purposes, insolvency will generally mean: Administration Liquidation Fixed charge or LPA (Law and Property Act 1925) receivership Inability to pay debts as they fall due. The practical guide to AD 123

10 Legal and Sponsored by A non-insolvency event of default essentially means a material and persistent default of any of the transaction or funding documents which cannot be remedied within an agreed time period, for example, a breach of banking covenants or a major failure to provide feedstock in the agreed quantities. Any project which is bank-funded is likely to have particularly detailed (and onerous) insolvency and default provisions Termination rights The terms of all key project documents will provide that upon the insolvency of one party, the other party or parties will ordinarily have the right to terminate the contract. The most common situations are likely to be where the landlord and feedstock supplier is faced with a joint venture party s insolvency, enabling him to terminate the lease of the plant site or a feedstock supply agreement, or where the parties agree that the SPV joint venture company is no longer viable Sinking fund A further option is to establish a sinking fund at the outset of a project so that during its lifetime, a certain amount is paid on a periodic basis to deal with the decommissioning of the plant but which can also be used in certain circumstances where one of the other parties has become insolvent, in the same way that rent deposit deeds are required by landlords Options Whilst the insolvency of a party is clearly not ideal, this situation is not necessarily disastrous for the project itself or for the other parties. It is possible in certain circumstances to restructure the finances of failing projects to provide opportunities for other stakeholders who have specialist turnaround skills, although this is an area more than most where expert advice is required quickly Turnkey projects If the project is a turnkey project where an AD plant contractor is engaged to build the plant in its entirety, there will be specific provisions dealing with contractor (and employer) insolvency in the chosen standard form building contract, for example the Joint Contracts Tribunal (JCT), New Engineering Contract (NEC) or IChemE Red Book Residual asset value A plant may be partially or fully completed when a party goes into insolvency. It may therefore have a value, making it an asset which the insolvency practitioner will sell to the highest bidder, most likely the other party in a joint venture project situation. A number of the documents are likely to provide that there is no free right to assign the interests of one party to a third party, whether within the framework of an insolvency procedure or otherwise, making a purchase by the other party even more likely. It is a basic principle of the insolvency legislation that all creditors of a class are treated equally within that class (the pari passu principle), with secured creditors being paid first, followed by unsecured creditors. In reality, the latter are unlikely to obtain much, if any, of a return, and equity investors (the shareholders) receive nothing. Whilst it is not possible to change the statutory order of payment as such on public policy grounds, it is possible with carefully drafted agreements between commercial parties to have certain rights or assets return to the non-insolvent party on the other party s demise, rather than being for the benefit of creditors generally (the divestiture principle) Step-in rights Lenders and other investor stakeholders will seek to obtain step-in rights through direct agreements by which, in the event of the insolvency of one party, the other party can take over, or step into the shoes of the insolvent party. Share mortgages and debentures secured by the assets of a project SPV company will be required to allow a secured lender to acquire the shares of the company or its assets in priority to other creditors. 124 The practical guide to AD