1. INTRODUCTION
Project finance is a type of borrowing which has grown over the last 25 years throughout the world, particularly in developed and developing countries with emerging economies, because large-scale investments such as infrastructure, transportation, and natural resources projects cannot be solely covered by the equity of the investors. Distinguished from other types of borrowing, project finance is a long-term financing for capital-intensive projects, where the repayment of the financing of the high costs of the investment period and the operation period relies entirely on the cash flow generated by the project. Hence, the security package granted to the lenders merely consists of the cash flow to be generated by the project and the assets of the project, but not the assets of the owners (sponsors).
In Turkey, however, it is simply not possible to speak of a project finance model as defined in international practice. In addition to securities created over the project’s cash flow and assets, banks and credit institutions almost always insist on being granted security over the sponsors’ assets and ask for the sponsors’ personal guarantees. Thereby, when the cash flow generated by the project does not suffice to cover the principal and interest payments of the loan, lenders may have recourse to the project’s sponsors. In this sense, when it comes to the types of security granted in favor of the lenders, it can be concluded that many financing methods used in Turkey under the name of “project finance” are not really project finance but, as a matter of fact, are some combination of both project finance and structured financing models.
1.1. Main Features of Project Finance Model
Project finance structures differ between various industry sectors and from deal to deal. There is no such thing as a “standard” project finance and security package since each deal has its own unique characteristics. However, there are three common principles underlying the project finance approach, which stand out as important features within the context of the present article:
(i) Financing is provided for a self-contained project through a special purpose vehicle which is established by the sponsors to merely conduct the business of such project, with no effect on the sponsors’ balance sheet (off-balance sheet). The company which is incorporated exclusively for this specific purpose is called a “project company.”
(ii) The main security for lenders is the project company’s rights arising from the agreements that it is a party to, such as purchase agreements, concession agreements, licenses, and rights over natural sources, as well as its assets and receivables arising out of these assets. As a matter of fact, those rights and assets constitute the project itself.
(iii) Revenues of the project company generate the cash flow that is required for the repayment of the loan.
1.2. Creditors’ Approach to Security Package
As is well known to all, loan agreements include all manner of provisions in favor of the lenders designed, essentially, to ensure that the project and its assets are managed and administered by the sponsors with due care and diligence so that the loan is paid off in full and on time. In addition to these provisions, lenders demand a security package for their loans which is as comprehensive as possible, to constitute an integral part of the loan agreements. The securities that are granted in project finance serve mainly two purposes:
(i) In case the project faces any financial crisis, to ensure that the project company continues to operate without any interruption and to produce revenues. Lenders have the opportunity to take over the project and the management of the project company by exercising their step-in rights pursuant to the provisions of the loan agreements and the securities granted. Thereby, lenders aim at the continuity of the project company’s activities and its cash flow by stepping into the shoes of the project company.
(ii) To ensure that the receivables of the lenders have priority over the unsecured creditors of the project company and its shareholders, and to prevent the project company from creating any class of creditors that will benefit from the same priority rights as the lenders or that will be treated equally with the lenders (pari passu).
2. TYPES OF SECURITIES USED IN PROJECT FINANCE
The most common methods of establishing a security in the loan agreements which are signed within the scope of project finance shall be provided below. Also, how the securities are used by the creditors in order to achieve the goals referred to above and which type of securities will be provided within the framework of Turkish law will also be reviewed.
2.1. Security on Sponsors’ Shares: Pledge on Shares
Although the creditors establish pledges and mortgages on the project’s assets and receivables, the scope of security packages in project finance in favor of creditors is not only limited to these securities. In addition to such securities, creditors also desire to serve a pledge on sponsors’ shares in the project company for the purpose of repayment of the loan by the sale of the shares in case of the project company’s default, as set out in the terms of the loan agreement and other financial documents. Any property rights, receivables, accessory, due, and payable interest arising from the pledged shares which possess the ability for encashment are within the scope of the pledge that has been served on shares.
It is important to determine whether the shares are attached to share certificates and, if so, whether the share certificates are registered or payable to the holder, in terms of procedures that need to be followed when serving a duly pledge. Hence, in accordance with Article 955 of the Turkish Civil Code No. 4721 (“TCC”), it is not possible to transfer the shares that are not represented by the share certificate; therefore, a written pledge agreement and the submission of the agreement to the pledger’s creditor is a condition for such transfer. Serving a pledge on the registered share certificates will require endorsement, transfer of possession, and notification of the pledge to the company, whilst serving a pledge on the share certificate which is payable to the holder will require transfer of possession, signing of the pledge agreement, or registry of the pledge on the share certificate.
2.2. Security on Project Company’s Cash Flow: Pledge on the Bank Account
Within the context of project finance, creditors, in order to supervise all the cash flow within the framework of a project, require the project company to open some bank accounts that are determined in the loan agreement and maintain all the cash flow through these accounts.
Accounts that will be subject to pledge will differ in each project; however, there are several fundamental accounts that are foreseeable in the loan agreements which are signed within the scope of project finance, such as a revenues account, debt service account, share contribution account, insurance, asset and indemnity account, dividend account, and operating account.
In order to ensure that the obligations of the project company set out in the loan agreement are secured perpetually throughout the loan period, the project company and the creditors sign a pledge agreement regarding the pledge that will, in favor of the creditors, be placed on the deposits that are currently being held or will be held in the abovementioned accounts. The bank where these accounts are being held records a pledge on the relevant bank account upon the notification made by the owner of the deposits (project company) or pledgee (creditors) and the submission of the written pledge agreement.
If the bank account established in the context of the loan agreement is opened in Turkish banks, Turkish law will be the governing law regarding the pledge on deposits; accordingly, all the rules set out throughout the TCC regarding the pledge on receivables will be applied to the pledge on deposits as well.
2.3. Securities on Project Company’s Assets
2.3.1. Assignment of Receivables
The creditors receive the assignment of receivables in case of default by the project company within the frame of the loan agreement and other financial documents, for the purpose of using the assignments in order to repay the loan via barter deduction, in accordance with the assignment of receivables agreement signed between the project company and the creditors.
These receivables are as follows:
- Receivables arising from commodity and service agreements (such as receivables arising from the sale of energy and carbon).
- Receivables arising from supply agreements.
- Receivables arising from transfer agreements.
- Receivables arising from insurance agreements.
- Receivables arising from warranty or indemnity rights.
Thus, in case of default of the project company, creditors may obtain all kinds of receivables from a third party of the project company — present or conditional or conditional on time.
The assignment of receivables agreement, as stipulated under Article 184 of the Turkish Code of Obligations No. 6098, should be concluded in written form, does not require the consent of the debtor, and is entered between the creditor and a third-party assignee for the transfer of the particular right to demand arising from the debt/credit relationship. In this context, the creditors’ agreement with the project company should be concluded in written form; this is a condition for the validity of the agreement.
With the transfer transaction, the creditors permanently acquire the receivables that belonged to the assignor and will be entitled to the authority of ownership. Therefore, all legal transactions regarding receivables (right to bring an action, file attachments, and assignments) shall be carried out by creditors or security agents who act on behalf of the lender after the assignment is established. In addition, accessory rights stipulated in receivables (accrued interest and rights arising from securities, guarantees, pledge, mortgage rights, right of retention, right related to ownership, compensation, penalty for breach of contract) will be transferred to the creditors in the capacity of the assignee.
2.3.2. Pledge Over Business Concerns
In case of the project company’s default pursuant to the loan agreement and other financial documents, the lender shall demand the pledge over business concerns in addition to other securities with the intention of maintaining the project’s continuity. In pledges over business concerns, the project company’s movable properties and patent rights can be pledged without making a delivery to the lender via registration in the trade registry.
Pledge over business concerns is regulated in the Commercial Enterprise Pledge Code (“CEPC”) No. 1447. According to Article 3 of the CEPC, trade name, corporate name, commercial equipment, tools used for the operation of the business concerns, and patents, licenses, trademarks, and, more generally, the intellectual property rights may be included in the pledge over business concerns. It is a legal obligation to include the trade name, corporate name, and commercial equipment in the scope of the pledge, but apart from these, parties can exclude some components.
In addition, movable goods obtained after the regulation of the pledge over the business concerns agreement cannot take place in the scope of this agreement. The project company must sign a separate agreement for these goods, and this agreement also needs to be recorded in a notarial deed.
In the light of Article 4 of the CEPC, the pledge agreement needs to be registered at a notary office located around the registration place of the business and, upon the demand of one of the parties, the pledge agreement has to be registered in the trade registry located in the province where the business is registered within ten days following the registration.
The pledge over business concerns is an exception to the pledge on movables because of the establishment of the pledge without the delivery of assets; therefore, the project company can continue to conduct its commercial activity. However, the project company has to obtain the lender’s approval for the transfer of commercial concerns or assets and for the limitation of commercial concerns through limited property rights.
The pledge over business concern cannot be terminated automatically even if the project company fulfills its obligations within the loan agreement and other financial documents. The project company has to demand deregistration of the pledge from the relevant registry. The pledge record on the register shall be canceled in case of: (i) written consent of the lenders, (ii) court’s final order, or (iii) foreclosure of pledged property.
2.3.3. Mortgage on Real Estate and Superficies Rights
2.3.3.1. Mortgage on Real Estate
The other security demanded by the lender is the establishment of a mortgage on real property of the project company. A mortgage is a type of security where the debtor secures repayment of the debt with the value of the real property without bearing any personal liability regarding the debt.
In accordance with Article 1008 of the TCC, a mortgage has to be recorded in the relevant land register to be effective. As for a valid registration, (i) a written consent statement (registration request) of the real estate owner, (ii) a valid purpose of issue, and (iii) a debt relationship that gives rise to receivables are the necessary conditions that need to be fulfilled.
Should an event of default be declared against the project company within the frame of the loan agreement and other financial documents, creditors have the ability (as stipulated in Article 45 of the Enforcement and Bankruptcy Code) to initiate legal proceedings and file a notice for the foreclosure of the real estate. In addition, in accordance with Article 150/e of the relevant Code, creditors shall request the sale of mortgaged real estate from the debt collection office of the state starting from one year after the debtor received the notification of the notice of order.
It should be noted that the abovementioned explanations only apply in case the ownership of the real property belongs to the project company. However, because in most cases the project will be established by a public-private-partnership structure and in a build-operate-transfer model, the ownership of the project’s plant construction site regularly does not belong to the project company but to a public authority. In this case, superficies rights will be granted to the project company by the public authority who is the owner. Afterwards, the project company will establish a mortgage in favor of the creditors on the superficies rights. Our further explanations regarding the superficies rights can be found below.
2.3.3.2. Mortgage on Superficies Rights
A superficies right, as set out in Article 826 of the TCC, in general terms, is an easement right which provides one individual the right of ownership of a building (construction) on another individual’s land. As mentioned above, because the financing project usually is structured as a public-private-partnership in a build-operate-transfer model and the land that the project will be based upon belongs to the related governmental institution, not to the project company, superficies rights are commonly encountered in project financing. Likewise, the usage of publicly owned lands through superficies rights allows the State to gain revenues without losing ownership rights. When the superficies rights are provided in favor of the project company whilst the related governmental institution retains ownership of the land that the project will be based upon, the project company becomes the owner of the construction.
Superficies rights can be considered as an independent security, separately from the land. Mortgage on superficies rights can secure receivables arising from loan agreements which are due alongside with receivables arising from loan agreements which are not due yet. To this end, mortgage on superficies rights is quite common in project financing where the creditors set out a loan limit for the financing of the project.
According to Article 853 of the TCC, superficies rights have to be registered as a real estate in the land register in order to become a subject of the mortgage for the purpose of providing security for the loan. Article 998 of the TCC stipulates that superficies rights must be qualified as an independent and perpetual right in order to become registered as a real estate in the land register. A superficies right which is set out for a minimum of thirty years is considered a perpetual right.
The independence of superficies rights means that the superficies can be transferred without being subject to any restrictions. Accordingly, for example, if the establishment of superficies rights is restricted in the related authenticated deed, superficies rights will not possess the qualification of being independent; because then the superficies rights will not be transferable. Consequently, the authenticated deed regarding the superficies rights should be carefully examined for any transfer restriction; and if one is to be found, the qualifications of such a restriction should be carefully examined as well. This particular matter is vital for our subject, especially in transfer restrictions of superficies rights on publicly owned lands. Inasmuch as transferability of the superficies rights without the permission of the related governmental institution, provisions that affect the ability of being a subject for limited property rights will determine whether the superficies rights can be subject to mortgage and be considered as security.
3. CREDITORS’ RIGHT TO INTERVENE IN THE PROJECT (STEP-IN RIGHTS): PRACTICE IN OUR COUNTRY
The right to intervene (step-in rights), a common method used by creditors in international project finance practice, allows the creditor to substitute the project company or the contractors to secure the completion of the project. The right to intervene becomes exercisable in the event of default of the project company or the contractors, due to failure to fulfill the obligations that are set out in the contract, or when it is certain that the default will occur in the near future.
In the existence of such events, creditors, by exercising their rights to intervene, will take over the project company or the project, or will decide in the name of the project company. In this way, creditors can undertake the project themselves and also appoint a professional third party for the completion of the project. In international practice, when the right to intervene is exercised, all permits, licenses, and concessions acquired by the project company due to the project will be transferred to the creditors.
In Turkish legislation, however, upon the request of an individual who is not a contracting party (creditor), the transfer of obligations belonging to a contracting party to a non-contracting party (professional third party) is only possible by assignment of contracts, which is set out in Article 205 of the Turkish Code of Obligations No. 6098.
The aforementioned article stipulates that the assignment of a contract is a contract which is entered between the acquirer of the contract alongside the assigning party and the party which remains on the contract. By this contract, all the rights and obligations of the assigning party that are born by being a party to this contract are transferred to the acquirer. For this reason, a transfer of contractual obligations to other individuals is not possible without obtaining the other party’s consent.
As an example, if the project that has been financed is structured in a public-private-partnership and in a build-operate-transfer model, the assignment of the contract which is entered between the project company and the governmental institution (administration) is only possible if the project company obtains the consent of the administration.
In our country’s practice, if a default occurs within the scope of the loan agreement, for the purpose of exercising their step-in rights, creditors will require the project company to provide a “commitment of an assignment” for the assignment of the contract that has been entered with the administration to the third person that will be determined by the creditors. In this commitment of assignment, the project company undertakes to make all necessary applications for the assignment, take steps to get the administration’s approval, agrees to the assignment in advance, and commits to provide all kinds of information, documents, and assistance that might be requested by the creditors in this process. Also, the company undertakes to perform any similar work and transactions in this context.
On the other hand, in Turkish legislation there is no general regulation that sets out the rules about automatic replacement of the project company’s permissions, licenses, and concessions, which are acquired within the scope of the project. The only example equivalent to automatic replacement is found in the Electricity License Regulation.
In Article 5/3(ç) of the Electricity License Regulation, it is stated that:
“If the banks and/or finance institutions provide limited or non-recourse project financing to the legal entity who holds the license for the production, as per the provisions of their loan agreements, the related banks and/or financial institutions may request from the Authority, together with their justification, that another legal entity be granted the related license provided that they assume all obligations of the related licensee in line with the provisions of this Regulation. The legal entity proposed by such institutions shall be granted a new license which succeeds the previous one on condition to comply with the obligations indicated herein.”
4. OVERALL ASSESSMENT
In our country, the acceleration of privatization activities brings up the method of assumption of the burden of financing by the private sector in the approaches that are used for the financing of large-scale projects. In today’s world, where traditional methods of financing are not sufficient anymore, the project financing method is an efficient way for the private sector to carry out high-volume investments.
Project finance, in international practice, is defined as a long-term financing method which provides limited recourse or non-recourse to the project company — an entity which is solely established for new projects that are to be developed — and for off-balance sheet financing for the sponsors. In project finance loans, banks and credit institutions place security upon all the project’s assets, such as the project’s facilities, revenues, contracts, licenses and permits, receivables, and the bank accounts that the revenues are transferred to. In this sense, within the scope of project finance, cash flow, revenues, and assets of the project will be the main source for the repayment of the loan. As a general rule, the project and the securities that have been established will be separated from the other businesses and transactions of the sponsors.
However, in our country’s practice, the distinction between the sponsors and the project company is not as sharp as it should be; despite the establishment of the aforementioned securities, banks and credit institutions, in addition to these securities, require warranties and guarantees from the sponsors, disregarding the fact that the project company is the debtor of the loan.
Requiring personal warranties or demanding to establish securities on the sponsors’ assets, which are not part of the project, hinders the development of project finance in our country and thereby large-scale projects become harder to finance. As a consequence, potential investors — especially foreign ones — lose their interest in such projects.
In order to prevent these problems and to harmonize the project finance practice in our country with international practice, the securities that will be granted in the context of project finance should be limited only to the future cash flow of the project and the assets of the project; assets of the sponsors which are not part of the project, alongside personal warranties and guarantees, should be excluded from the securities.
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