LIMITED RECOURSE AND NON-RECOURSE PRINCIPLES IN PROJECT FINANCE

I. INTRODUCTION

Project finance is a distinctive financing model frequently preferred in the execution of large-scale and long-term infrastructure investments. In this model, loan repayments are not covered from the project sponsor’s balance sheet, but directly from the cash flow generated by the project. Used in capital-intensive projects such as power plants, highways, and ports, this structure ensures that financial risks are allocated to the project itself and isolated from other assets. In project finance, the guarantee for financing generally consists of the project’s own assets and anticipated revenues. Therefore, limited recourse and non-recourse security structures are of critical importance for lenders to secure their rights and receivables. In the limited recourse model, while lenders primarily rely on project revenues, they also have the right to turn to the sponsor to a limited extent upon the occurrence of certain conditions. In the non-recourse model, however, in the event that the debt cannot be repaid, creditors may resort solely to the project assets, with the sponsor’s other assets being entirely immune from such risk.

II. FUNDAMENTAL FEATURES AND PARTIES OF PROJECT FINANCE

A. General Features of Project Finance

There is no universally accepted definition of project finance. However, project finance is generally defined as “The financing of the development or exploitation of a right, natural resource or other asset where the bulk of the financing is to be provided by way of debt and is to be repaid principally out of the assets being financed and their revenues”1. This definition highlights the fundamental characteristic of project finance, namely that debt repayments are made not from the sponsors’ general balance sheets, but directly from the revenues generated by the project itself. In this respect, project finance differs from traditional financing and offers a model in which risks are largely structured based on project revenues.

In traditional lending, the focus of lenders is on the current and historical financial condition of the individual or legal entity to which they provide credit, whereas the structure of complex projects in project finance renders traditional lending methods insufficient. Moreover, traditional lending methods lack the flexibility to independently assess the project-based revenue streams and risks present in large-scale, long-term, and technically complex projects involved in project finance. Traditional financing methods rely solely on the borrower’s overall financial condition without evaluating the internal dynamics of the projects, operational risks, long-term revenue-generating capacity, and economic and legal factors that may vary over the course of the project. This method, used in projects with high costs and long-term repayment structures such as energy, oil, transportation, telecommunications, sewage, and mining projects where traditional lending methods are insufficient is preferred because it allows financial risks to be managed more effectively on a project-specific basis.

In project finance, a loan is provided not to an individual or legal entity, but to a specific project with a defined scope. The main consideration for the banks or other lending institutions providing financing to the project is not the assets of the sponsor or sponsors, but the project’s efficiency and the ability of the cash flows generated by the project to cover the loan. In this regard, matters such as the sponsors’ balance sheets, the value of their assets, or their past financial performance are not the primary criteria; for the lenders, the key consideration is the expected cash flow from the project2.

In project finance, the concept of recourse arises at the stage of debt repayment and refers to the lender’s right to claim to the sponsor in the event that the loan cannot be repaid. In this context, project finance is structured around three main types of recourse. Full recourse is the recourse method whereby lenders can directly pursue the sponsors and recover the entire debt if it is not repaid. Considering that project finance is a lending method applied to high-risk, long-term, and complex projects, sponsors’ reluctance to be liable with their own assets often renders full recourse a less frequently used method in project finance. Another type of recourse, non-recourse financing, while advantageous to sponsors, has limited application because it prevents the lender from claiming to the sponsors if the project fails, leaving the lender to bear the entire loss. The most commonly used recourse method is the limited recourse structure. Under this method, lenders have the right to pursue the sponsor to a limited extent if certain material conditions occur, such as failure to complete construction, failure to meet performance criteria, or breach of sponsor commitments. This method, which allows a limited level of recourse to the sponsor, is widely used in most project finance transactions because it creates a more reasonable risk allocation for both lenders and sponsors and can be considered the industry standard3.

B. Parties To Project Finance

The importance of sectors such as infrastructure, energy, real estate, transportation, communication, health, environment, industry, and technology is steadily increasing; and this situation enhances the interest in project finance and leads to diversification of the parties involved in projects. In project finance processes, which generally cover large-scale undertakings compared to commercial loans, a considerable number of actors may be involved by the very nature of the work, including investors, lenders, contractors, public authorities, operators, and purchasers. Since each project’s sectoral structure, scale, and financial requirements differ; the parties involved in the project may be structured in a project-specific manner. The relationships among the actors in project finance are generally regulated through detailed and long-term contracts, thereby aiming to ensure that the process is managed successfully by the parties4. The principal of these contracts include the loan agreement concluded between the project company and the lenders, the engineering, procurement and construction agreement (EPC), executed with the contractor, the operation and maintenance agreement (O&M) entered into with the operation and maintenance contractor, the concession agreement signed with the public authority in cases where the project is a public-private partnership project, and the sponsorship agreement that defines the obligations of the sponsors.

In project finance, for the management of the project and the overall process, special purpose vehicles (“SPV”), which are independent legal entities established specifically for the project, are generally incorporated. The purpose of incorporating SPV is to separate the assets and revenues of the project from the other assets belonging to the shareholders and to minimize the risks arising from the project. The SPV acts as a party to the relevant agreements and exists solely to conduct activities related to the particular project, with its operations being predominantly limited to the project term. The concession agreements, licenses, rights over natural resources, and similar assets held by the SPV that enable it to operate within the scope of the project, and the cash flow to be generated therefrom5.

In project finance, the loan is generally provided through an SPV established specifically for the project and having no other activity6. The loan provided by the lenders is granted not to the contractor or the investor of the project, nor to the parent company, but to the SPV. This legal entity manages all revenues and expenses of the project and assumes the debt obligations. The SPV acts as a party to all agreements to be executed within the scope of the project and also functions as a central structure managing the project’s cash flows.

Project sponsors are the investors responsible for initiating, planning, and executing the project, providing capital to the project, and bringing it into actual operation. Holding the position of founder and primary shareholder of the SPV. The shareholders of the borrowing party are the investors holding the shares representing the capital of the SPV. The general rule in project finance is that these shareholders do not provide direct financial resources to the project; rather, the financial obligations are met through the project’s own revenues7.

The banks, financial institutions, or syndications formed by multiple banks that provide financing to the project fall within the category of lenders providing project finance. Syndications get involved in large-scale and high-capital projects where it is practically impossible for a single financial institution to assume the entire loan and risk management on its own. Lenders are not limited to banks or traditional financial institutions. In project finance practices, institutional actors of different types such as international financial institutions, regional agencies promoting development, government-supported financial institutions, private investment funds, and venture capital companies are also among the funding providers.

In public-private partnership projects such as Build-Operate-Transfer (BOT), public institutions and organizations also participate as parties to the project. These entities may assume the role of the project owner or the final service recipient; moreover, they possess various administrative and regulatory authorities, such as granting licenses and concessions, providing revenue guarantees, carrying out expropriation procedures, granting tax incentives, supervising project activities, and approving contracts. In addition, public institutions and organizations may propose amendments to the legislation concerning financing in BOT projects and may initiate the process. The competent authorities generally both regulate and supervise the project through long-term agreements signed with the project company; in certain cases, they provide revenue or demand guarantees to ensure financial sustainability from the perspective of the private sector.

On the other hand, works such as construction, infrastructure installation, procurement of equipment, and integration of technical systems to be carried out within the scope of the project are undertaken by private sector actors. At this point, the contractors involved are obliged, under engineering, procurement and construction contracts, to complete the project within the specified period and in compliance with both the applicable legislation and the terms of the relevant contracts.

Insurance in project finance, and insurance companies as a party to the financing constitute another factor of critical importance. Especially in financing structures that contain limited recourse or are structured on a non-recourse basis, it is of great significance to secure the risks that may arise during the implementation of the project through insurance8. In this context, insurance companies enter into direct agreements with the contractor or the SPV and insure certain risks through project-specific policies. Accidents during the construction phase, fire, natural disasters, engineering defects, material and equipment failures, damages that may be caused to third parties, and suspension of works are among the risk factors.

The ultimate purchasers or users of the products or services intended to be produced at the end of the project may also be considered as parties, particularly in projects with long-term purchase guarantees. In such cases, the ultimate purchaser is generally a public authority or a publicly-owned corporation that undertakes to purchase the service or product produced by the project for a specified period and quantity. For example, the state’s authorized electricity distribution company acts as the ultimate purchaser in energy projects. On the other hand, the users are the persons or entities who actually make use of the service. As an illustration, the drivers in motorway and bridge projects who pass through are considered users; although by the nature of the transaction these users are not parties to the relevant agreements, public institutions may make commitments such as transition guarantees on their behalf. Projects involving ultimate purchasers and users constitute an important collateral for both lenders and sponsors in the financing of the project and enhance the project’s financial sustainability.

III. THE CONCEPT OF LIMITED RECOURSE IN PROJECT FINANCING

A. Definition

In most project finance transactions, under certain circumstances where the cash flow and assets generated by the project insufficient, recourse beyond the financed assets to the sponsors is permitted. This structure is referred to in project finance as limited recourse9.

Under the limited recourse method, unlike in non-recourse financing, the lender is not confined solely to the project assets and revenues but may seek recourse to the sponsors when occur of a limited number of specific events. These specific events are typically set out expressly in the loan agreements executed between the SPV and the lenders, as well as in the support undertaking agreements concluded with the sponsors and in ancillary documents such as guarantee or security agreements. Situations such as the failure to complete the project construction on time, the failure to fulfil turnkey commitments, or the failure of the sponsor to provide the committed capital contribution if included in these documents are among the events that generally allow the possibility of recourse to the sponsors. Financial institutions, rather than taking on a risk that is entirely dependent on the success of the project, seek the assurance of being able to resort to the sponsors, even if only to a limited extent, for the credit they extend. For these reasons, in practice, the limited recourse structure has become the most common project finance model, as it provides a balanced allocation of risk between the principal parties to project finance, namely the sponsors and the lenders.

B. Reasons for Preference

The preference for the limited recourse structure in project finance is based on the search for a practical and flexible solution that balances the interests of both the lenders and the project sponsors. This model enables the effective management of project-specific risks and is frequently chosen in project finance because it provides the parties with a certain degree of assurance.

In this model, as stated above, the repayment of the debt is based primarily on the project’s own cash flow and assets; only upon the occurrence of certain predefined and specific conditions do the lenders acquire a limited right of recourse against the sponsors. Thus, the sponsors assume liability limited to the capital they have invested in the project while protecting their own corporate balance sheets from the risks associated with the project. This structure also facilitates the decision-making processes of financial institutions by enabling a clearer identification of project-specific risks and, in particular, enhances access to financing for large-scale, long-term investments. Furthermore, since debt structured on a limited recourse basis is generally kept off the sponsors’ balance sheets, it creates an additional advantage from the perspective of the company’s financial statements10.

C. The Relationship Between Limited Recourse and Surety Guarantee

A surety agreement, regulated under Articles 581 et seq. of the Turkish Code of Obligations No. 6098 (“TCO”), is the most applied form among personal guarantee agreements. Article 581 of the TCO11 defines a surety agreement as “An agreement whereby the guarantor undertakes to be personally liable to the creditor for the consequences of the debtor’s failure to fulfil their obligation”. In doctrine, guarantee is considered an agreement whereby a third party undertakes to the creditor to be personally liable for the debt if the main debtor fails to pay it12. The guarantor’s liability under a surety agreement does not consist of directly performing the debtor’s obligation or making any effort to ensure the debtor’s performance. The fundamental function of guarantee is to secure compensation of the loss suffered by the creditor in the event that the debtor fails to perform or fails to perform properly. In this context, the guarantor undertakes to indemnify the damage, mostly in the form of monetary debt, arising from the main debtor’s non-performance. In other words, the guarantor’s obligation is not to assume the debt itself directly, but to ensure that the adverse consequences suffered by the creditor due to the non-performance of the debt13.

Although a surety agreement, by its legal nature, gives rise to liability dependent on the principal debt, it constitutes an independent and separate contract from the principal debt relationship. In this respect, while the surety agreement is ancillary in nature, its validity and legal effects are entirely subject to its own specific provisions. The source of the principal debt may be a contract, a statutory relationship, or another debt-creating transaction; however, the rights and obligations of the guarantor are shaped solely within the framework of the surety agreement. The primary purpose of guarantee is to provide an additional personal security to the creditor against the risk of being unable to collect the claim from the principal debtor. Therefore, for the surety to be held legally liable, the existence of a valid principal debt is not sufficient; the surety agreement must also be concluded in compliance with the form and content requirements set forth in the TCO14.

In accordance with the principle of contractual freedom of the parties, the parties may limit the guarantor’s liability in terms of scope, amount, or duration. Accordingly, where the guarantor is held liable for only a specific part of the debt, a surety guarantee arises. The most significant implication of surety guarantee in the context of limited recourse is that the guarantor’s right of recourse following performance is restricted. Within this framework, limited recourse becomes the natural and inevitable legal consequence of surety guarantee.

As noted above, under a limited recourse structure, the lender’s ability to seek recourse directly against the sponsors is confined to certain specific events explicitly stated in the agreements. This structure allows the lender to make recourse claims in a limited manner only upon the occurrence of certain risks or conditions, rather than for the entire debt. In this context, the surety guarantee mechanism, which is frequently encountered in practice, has become a tool that embodies the limited recourse structure. The relationship between the limited recourse structure and surety guarantee holds significant importance in project finance and security law practices.

Surety guarantee, on the other hand, is a specific type of security under which the sponsor or a third party acts as surety only for certain risks, periods, or amounts. For example, the sponsor may undertake to act as guaranteeing up to a specified amount for certain risks, such as delays or cost overruns that may arise during the construction phase of the project. In such cases, if the relevant risk occurs, the lender acquires the right to seek recourse directly to the sponsor, limited solely to that amount and risk15.

Surety guarantee and limited recourse mechanisms both reduce the lender’s risk and make the obligations to be assumed by the sponsor predictable and manageable. In particular, in large-scale projects, since sponsors may be unwilling to assume all risks, surety guarantees and limited recourse mechanisms are used together to ensure balance between the parties.

D. Cross Guarantee in a Limited Recourse Structure

A cross guarantee is a mechanism whereby, in cases where the same sponsor owns multiple SPVs, these companies provide security for each other’s obligations under certain conditions16. Within the scope of limited recourse, the cross guarantee structure offers lenders the benefit of access to multiple project revenues, while creating a more complex and carefully managed obligation for the sponsors.

The cross guarantee structure is particularly preferred in projects that are operationally or strategically interconnected within the same group and primarily provides an advantage to the lenders. In the event that the sponsor fails to fulfil its obligations, the lender gains access to the cash flows of other projects under the same sponsor’s control, thereby expanding the lender’s collateral pool. For example, if there are two energy plant projects under the control of the same sponsor, and one fails to meet the targeted benchmarks, the cash flow from the other project can serve as a security element for the lenders. For the sponsors, however, an adverse event in one project may impact the financial resources of the other projects; assuming a cross guarantee obligation becomes a process that must be carefully managed on behalf of the sponsors.

E. Parent Company Guarantee in Limited Recourse Structure

In limited recourse financing structures, one of the guarantee instruments frequently preferred to reduce the lenders’ risk and enhance confidence in the project is the parent company guarantee. Guarantees are regulated under Article 128 of the TCO under the heading “undertaking the act of a third party”. According to this provision, “a third party who assumes responsibility for another person’s act is liable to compensate for any damage arising from the failure of that act to occur”. Accordingly, if a person undertakes that a third party will perform a certain act or achieve a certain result, and such act or result does not materialize, the person who made the undertaking is held liable. Although Article 128 does not define a guarantee agreement directly, in doctrine and practice, the legal nature of parent company guarantee agreements is assessed within the scope of TCO Article 128. This guarantee arises independently of the principal debt relationship, and the parent company’s obligation is not an accessory obligation like guarantee; lenders have the right to pursue the parent company directly without having to seek recourse from the sponsors. If there exists a contractual internal relationship between the parent company and the project company, the parent company has the right of recourse against the project company. This arrangement ensures that any damages are compensated based on the parent company’s internal contractual relationship17.

The parent company guarantee is typically preferred in large-scale, multi-party, and complex projects to meet the lenders’ requirements. In such projects, the guarantee provided by the SPV alone may be deemed insufficient to secure the financing. In this case, the parent company, to which the SPV is directly or indirectly affiliated, steps in to guarantee third parties (primarily the lenders) that the SPV will fulfil its financial or contractual obligations on time and in full. This guarantee aims to compensate lenders for their losses in the event of risks such as the project not being completed, revenues falling below expectations, or the SPV’s bankruptcy. By assuming this obligation of the parent company not only enhances confidence in the project but also facilitates the distribution and management of risk from the perspective of the financing institutions.

The parent company guarantee is generally formalized through a written guarantee agreement in accordance with the limited recourse structure, and its scope, duration, and the obligations explicitly defined. In other words, the parent company providing the guarantee does not assume unlimited or absolute liability against the lenders; the liability is predetermined and limited to the obligations of the SPV. This structure differs from the general and unlimited assumption of debt typically encountered in full recourse systems. With these characteristics, the parent company guarantee allows the limited recourse nature of the project finance model to be maintained, while, unlike letters of credit, providing lenders with an additional guarantee element without incurring extra costs, thereby improving financing conditions.

IV. THE CONCEPT OF NON-RECOURSE IN PROJECT FINANCING

A. Definition

In project finance, non-recourse financing is a method under which the debt is repaid to the lenders through the project’s cash flow and, which will be explained below financing method does not allow recourse to the debtor, except in cases of intentional negligence or fraud. Under this financing arrangement, any loss arising from the project’s inability to generate sufficient cash flow is borne directly by the lenders.

In non-recourse financing, since the lenders’ sole security consists of the project’s assets and expectations revenues, the financial, legal, and technical due diligence processes are conducted in greater detail compared to other financing models. This is particularly significant in scenarios where the financial strength of the project sponsors or the borrower is relatively weak in relation to the project’s scope. In the event of project failure, the non-recourse structure preserves the borrowers’ personal assets and creates liability solely at the level of the SPV18.

The non-recourse financing model is generally preferred in infrastructure and energy projects, the reason being that the loan repayment largely depends on a single stream of revenue, which reduces the risk of non-repayment. Particularly in hydroelectric power plant projects, since the revenue stream is directly linked to electricity generation, lenders provide financing by taking into account various scenario analyses of the project’s cash flow. In such projects, as the amount of electricity to be generated and its marketability directly affect the financial success of the project; lenders evaluate numerous factors such as detailed feasibility studies, energy production forecasts, hydrological regime analyses, power purchase agreements, and the risks of market price fluctuations before making their investment decision, thereby ensuring the reliability of the revenue stream.

B. Reasons for Preference

Compared to traditional borrowing methods, the non-recourse financing method creates less adverse impact on the balance sheet of the debtor and/or the sponsors. Because as will be explained below, such debts are generally structured as off-balance sheet liabilities due to their advantages. In this regard, non-recourse financing allows for the realization of large-scale investments without placing a burden on the financial structure.

In the non-recourse financing model, since the revenues of the project are presented as guarantee, it also enables borrowing of substantial amounts with limited equity. Thus, through the effect of financial leverage, it becomes possible to realize larger investments with lower levels of capital. The reason for this is, in this model, investors utilize their equity at a minimum level, while securing long-term debt financing based on the project’s future cash flows. Moreover, the project-specific structuring of the financing allows sponsor companies to invest simultaneously in multiple projects without affecting their main balance sheets.

C. Exception to Non-Recourse: “Carve-Out”

Although the fundamental principle in non-recourse financing structures is that the lender may not have recourse to the debtor or the sponsors, “carve-out” provisions constitute an important exception to this principle19. Carve-out provisions in loan agreements generally pave the way for recourse to the debtor or guarantor in circumstances such as wilful misrepresentation, fraud, non-payment of tax liabilities, breach of insurance obligations, violation of environmental obligations, misuse of revenues, unauthorized transfer, change of control, or insolvency of the debtor.

When the conditions set forth in carve-out clauses are met, lenders, pursuant to the provisions of the relevant agreement, may exercise limited recourse against the project sponsors or the debtor. In this context, the financing structures cease to be fully non-recourse and effectively transform into a limited recourse financing model.

Another circumstance in which the financing structure evolves from a non-recourse model into a limited recourse model arises when the project fails to meet certain completion requirements or financial indicators. Lenders seek to ensure, both through reports and through their own site visits and/or audits, that the financing provided to the project is being utilized in line with the agreed objectives and that the project’s performance is progressing accordingly. To this end, performance-based conditions are defined in the agreements and are measured at specific intervals as the project advances. If the project fails to satisfy these predetermined performance criteria, the financing, which was initially structured as non-recourse, may be restructured to grant lenders limited recourse rights20.

D. Off-Balance Sheet Feature of Non-Recourse Financings

One of the most notable characteristics of non-recourse financing structures is that such debts are not reflected on the balance sheet of the project sponsors. Since these financings are structured through a Special Purpose Vehicle (SPV), the debts remain under the responsibility of that legal entity. With this structure, financing liabilities are managed without being included in the main sponsor’s balance sheet, thereby providing the opportunity for off-balance sheet financing21.

This off-balance sheet structure is particularly significant in terms of preserving the financial integrity of the sponsor company, despite the inherently high capital requirements of project financing. By preventing an increase in the parent company’s leverage ratios, it prevents a decline in its credit rating while also providing advantages in terms of maintaining investor confidence and accessing new sources of financing. Moreover, this structure not only offers accounting convenience but also enables the segregation of the legal, financial, and operational risks undertaken by the parent company and the SPV. Since the SPV is an independent legal entity separate from the sponsor company, debts and liabilities that may arise within the scope of the project are not directly reflected on the assets and liabilities of the parent company, and, as a rule, claims that may be asserted against the SPV cannot be directed against the parent company. In this way, liability is to a certain extent limited both financially and legally. Due to these advantages, non-recourse financing models are widely preferred, particularly in long-term and high-risk projects such as infrastructure, energy, and transportation22.

E. An Example of Non-Recourse Financing: Antalya Airport Capacity Expansion and Operation Rights Transfer Project

Antalya, one of Türkiye’s major tourism centers, hosts one of the country’s largest airports in terms of international passenger traffic. In order to meet increasing passenger demand and further enhance the region’s tourism potential, a comprehensive capacity expansion and operation rights transfer project has been implemented at Antalya Airport. This project is of particular significance to this article, as it constitutes one of the rare examples in Türkiye of financing through a non-recourse financing model.

The financing, structured with a long-term package of 13,5 years, was secured through a loan consortium consisting of various commercial banks operating at both national and international levels, as well as development finance institutions23. Within the framework of the financing structured via an SPV established for the project, the repayment of the borrowed funds was tied entirely to the cash flows to be generated from Antalya Airport; no personal guarantees or additional collateral from the sponsors were arranged. In the event of the project’s failure, the lenders do not have the right to make direct claims against the project sponsors or shareholders.

V. CONCLUSION

Project finance presents a distinctive model that enables the realization of large-scale investments by containing risks while providing long-term and sustainable financing. In this model, since the primary collateral for debt repayment consists of the project revenues, the concept of recourse carries significant importance. Limited recourse and non-recourse structures stand out as financing systems based on project-specific revenue streams, balancing the risks of both financiers and sponsors.

The reason limited recourse structures are preferred is that they allow project-related risks to be shared with the sponsor within a defined framework. In this respect, limited recourse structures provide security from the lender’s perspective while also enabling the sponsor’s parent company to protect its financial structure from risks arising out of the project. Particularly through mechanisms such as surety guarantees, parent company guarantees, and cross-guarantees additionally provided by sponsors under limited recourse structures, this model renders financial risks more manageable and ensures a balance between the parties.

The non-recourse financing model is a financing system in which the sponsor’s liabilities are limited to the project. Nevertheless, under this model, the institutions providing the financing are ultimately required to conduct due diligence processes, carefully performed in all financing models, at an even higher level, encompassing technical, legal, and financial examinations. Moreover, even in a non-recourse structure, “carve-out” provisions may be incorporated into the agreements, allowing the financing to be transformed into a structure where limited recourse can be exercised in the event of certain legal violations or serious breaches.

The limited recourse model offers a flexible and practical solution by granting the sponsor limited recourse rights under specific conditions, whereas the non-recourse model anticipates that the lender bears the risk. In this respect, it is attractive for the sponsor but requires a more cautious approach from the lender. In both structures, projects are executed through an SPV, thereby preserving the financial integrity of the parent companies. In conclusion, limited recourse and non-recourse financing models facilitate the allocation of responsibilities among the parties in project financing, and these arrangements are regulated in detail in the relevant agreements.