By Martin Preston
THE majority of the features of a project finance loan agreement are the same as a corporate loan agreement. However, because the basis on which the lenders are advancing the loan is the forecast revenues of the project, rather than the assets or creditworthiness of the sponsors, the risks taken by the lenders and, therefore, the controls that they require under the loan agreement, are greater than would be required under a corporate loan agreement. Inevitably, some of these additional controls impact on the construction contract.

Conditions precedent

Conditions precedent are those that must be met by the project company for financial close to occur, which is when the loan becomes effective. Additional conditions precedent may also need to be satisfied before first drawdown under the loan can occur.

Typical conditions precedent to financial close that affect the construction contractor are that the construction contract and all ancillary documents (including the direct agreement to the lenders) have been executed and become effective. Since the construction contract will often itself contain a condition precedent stating that it does not become effective until financial close (to prevent the project company being committed to construction of the project before it has funds available to pay for it), it is important to avoid circularity between these two requirements. The usual way that this is dealt with is for the condition precedent in the construction contract to state that all conditions precedent to financial close under the loan agreement have been satisfied other than the effectiveness of the construction contract.

Representations & warranties

The representations and warranties made by the project company are the facts upon which the risk is allocated between the parties and form the basis of the lenders’ decision to commit funds to the project. These will normally be made at the date of the loan agreement and deemed to be repeated at financial close. Alternatively, one of the conditions precedent to financial close will be that no changes have occurred that render any of the representations and warranties previously made inaccurate.

Where the project company is required to make representations and warranties relating to the construction of the project, these will be passed down to the construction contractor, who will be required to make the same representations and warranties to the project company.

The representations and warranties commonly required to be given by the construction contractor in a project-financed construction contract include the following:

The construction contract is legally binding;

No defaults have occurred under the construction contract;

No force majeure event has occurred under the construction contract;

All necessary licences and consents required for the construction of the works have been obtained;

Completion will occur by an agreed date;

No variations will be made to the works; and

No amendments will be made to the terms of the contract.

Undertakings & discretions

Undertakings and/or reserved discretions are the means by which the lenders control the project company and its implementation of the project. They may be positive or negative and prevent the project company from exercising any discretion it has under the construction contract without the lender’s consent. Thus, the project company will not be able to vary the terms of the contract or the scope of the works, issue certificates or terminate the construction contract without obtaining the lender’s consent.


Payment will be due to the construction contractor when it has met the payment conditions under the construction contract (which will usually be based on the achievement of milestones). However, the project company will only have funds to make payment to the construction contractor if it is able to draw down funds under the loan agreement. This will usually require demonstration by the project company that not only are the amounts due to the construction contractor under the construction contract, but also that:

When aggregated with all amounts paid to date, the amount sought is within the agreed construction budget;

The sum of the amounts paid to date and the remainder of the loan allocated to the construction costs is sufficient to complete the works;

The representations and warranties remain accurate in all respects;

No event of default has occurred under the loan agreement; and

There has been no material adverse change affecting the project.


Where the works suffer a total loss (or a loss in excess of a pre-agreed amount) and this is covered by insurance, the usual position would be that the insurance proceeds would be paid to the contractor who would then undertake the rebuilding of the works.

However, in a project finance transaction, the insurance proceeds will be paid into an account controlled by the lenders who will decide how they are to be used. If they decide that the insurance proceeds and the outstanding amount of the loan are insufficient to complete the works, then rather than the works being rebuilt, the insurance proceeds will be used to repay the debt. This is known as a “head for the hills” clause and will need to be replicated in the construction contract.

Gulf Construction

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