THE ROLE OF LEGAL DUE DILIGENCE IN PROJECT FINANCE

I. INTRODUCTION

Project finance, which is used for the realization of large-scale infrastructure, energy, and industrial projects, has a unique structure that fundamentally distinguishes it from traditional corporate finance1 models. The essence of this model is that the repayment of the financing relies not on the general balance sheets and creditworthiness of the sponsors or parent companies undertaking the project, but directly on the project‘s own assets and future cash flows. For this purpose, a new company is generally established for the project. This entity, known as a Special Purpose Vehicle (“SPV”), legally isolates the project from the sponsors’ other business activities and risks. Thus, in case of project failure, the recourse of the lenders is limited only to the assets of the SPV; this is known as “limited recourse” or “non-recourse”2 financing.

The “limited recourse” or “non-recourse” structure of project finance demonstrates that legal due diligence is not only for risk identification, but also serves as a tool for the fair and effective transfer of risk between the parties. In this financing model, while lenders seek to minimize the risk of non-repayment, investor companies aim to eliminate financing and project risks. Due to the nature of project finance, lenders rely on the project’s cash flows and assets. This necessitates a thorough assessment of all risks related to the project (construction, operational, market, etc.). Legal due diligence ensures that these risks are allocated to the parties best able to manage them through contracts. If legal due diligence fails to properly transfer and allocate these risks, a structure with no recourse for lenders could result in significant losses in the event of project failure3.

Therefore, legal due diligence provides a solid legal foundation for the project’s financial model and risk matrix. Comprehensive legal due diligence not only increases investors’ and stakeholders’ confidence in the project but also ensures the most efficient use of resources. By providing detailed information on the feasibility and profitability of the project, it helps investors make informed and strategic decisions about whether to proceed with the project. Furthermore, legal due diligence is one of the fundamental elements that makes a project “bankable”4.

Consequently, project finance transactions involve multiple parties due to their complex structure. If the roles and commitments of each party and the legal basis of the project are not clearly established, uncertainties may arise that could jeopardize the project‘s success. For this reason, lenders and investors conduct a detailed legal due diligence process before deciding on the project. During this process, the legal structure of the project, contracts, and relevant regulations are examined to identify potential risks. The aim is to detect legal issues that may harm future cash flows in advance and take the necessary precautions, thus ensuring the continuity of financing and the reliability of the project. It should be noted that legal due diligence is not a one-time process, but a dynamic process that continues throughout the project’s lifecycle.

II. THE ROLE OF LEGAL DUE DILIGENCE IN PROJECT FINANCE

A. Stages and Scope of Legal Due Diligence

Legal due diligence, which is of great importance in the context of project finance discussed in this article, also plays a critical role in many commercial areas such as public offerings, mergers and acquisitions, business transfers, venture capital investments, and joint ventures. In its most basic definition, legal due diligence is the comprehensive process of investigation, auditing, and examination carried out by the parties—especially the investor—with reasonable care and diligence before a specific commercial transaction.

Although this concept, originating from the American legal system, has been translated into Turkish as “gerekli özen” or “aşırı itina,” these phrases do not fully reflect its comprehensive nature; thus, both in academic literature and practice, the original English term “due diligence” is used. The main purpose of this process is to identify potential risks related to the target company or asset, to assess and limit the extent of these risks, and thus to eliminate uncertainties. In this respect, due diligence can be regarded as a process that enables the investor to fully see the legal, financial, operational, and commercial structure of the target company, essentially providing an X-ray of the company. This detailed analysis allows the investor to make more accurate decisions and helps to complete commercial transactions with minimal legal and economic risk5 6 7.

In summary, legal due diligence covers a case-specific examination in line with the requirements of the target company. The legal due diligence process begins with the determination of objectives and scope. Then, relevant documents are collected and thoroughly examined, potential risks are assessed, findings are verified, and finally, a comprehensive reporting phase follows. The starting point of this process is the negotiation of documents that form the basis of the project, such as construction, supply, operation and maintenance, shareholder, and loan agreements. This negotiation stage is also when legal due diligence is most intensive and potential risks are evaluated. After these detailed negotiations on project contracts, financial close is reached with the signing of the documents, and only after this stage can construction-related works commence8.

Legal due diligence is not limited to a single area of expertise but covers all aspects of the project with a multidisciplinary approach. In this process, consultants, legal advisors, and in-house specialists collaborate. The inherently complex nature of international project finance has led legal due diligence to adopt a standardized but adaptable methodology to the specific conditions of each project. This complexity has especially necessitated the use of technological tools such as Virtual Data Rooms (“VDRs”). The creation of a diverse team with expertise in finance, law, operations, and technology demonstrates that legal due diligence requires an integrated analysis covering not only legal compliance but also operational and financial risks.

B. Information Gathering, Document Review, and the Use of Virtual Data Rooms

In the legal due diligence process, information gathering involves collecting and analyzing a wide variety of documents, such as the project‘s financial reports, legal contracts, operational documents, and regulatory compliance records. VDRs are of critical importance for storing and sharing these documents securely, centrally, and in an organized manner among relevant parties9.

VDRs significantly enhance the transparency and efficiency of the due diligence process through built-in security measures, access controls for sensitive information, audit trails, and advanced search/indexing features. By overcoming the challenges of traditional physical data rooms—such as document volume, inefficient organization, and time constraints—VDRs provide secure and simultaneous collaboration opportunities. Especially in international project finance, the secure and simultaneous access of multiple parties (lenders, sponsors, consultants, law firms) to sensitive documents significantly accelerates the transaction process and improves accountability by enabling traceability of who accessed what in case of potential breaches. This demonstrates that VDRs are not just a technological convenience but a strategic necessity for the secure management of sensitive information, transparency, and the acceleration of complex international transactions, while also providing a robust audit trail for accountability10.

C. Preparation of Legal Opinions and Reporting Structure

At the end of the legal review process, all findings are compiled into a comprehensive legal opinion or a detailed report. These reports typically include an executive summary, an overview of the company, the purpose of the legal review, and sections on financial, legal, operational, market, and regulatory/environmental reviews, as well as information on risk management strategies and growth expectations.

The main purpose of the report is to summarize the identified risks and opportunities, highlight the key risk points, and provide actionable recommendations11. These reports enhance investor confidence and support informed strategic decision-making by providing detailed information on the feasibility and profitability of the project. The inclusion of actionable recommendations in the report offers lenders not only the problems but also concrete steps on how to address these issues. This demonstrates that the report is more than just a document presenting historical data; it is a tool that shapes forward-looking risk mitigation and value creation strategies. Through this report, lenders can clearly understand the legal risk profile of the project, adjust financing terms accordingly, and even gain negotiation power to resolve potential issues. Therefore, the structure and content of the legal due diligence report—especially its clear risk assessments and actionable recommendations—directly affect the lenders’ decision-making processes and negotiation leverage, transforming complex legal findings into strategic business intelligence.

III. KEY LEGAL ELEMENTS SUBJECT TO DUE DILIGENCE

In project finance transactions, the key legal elements subject to due diligence are examined in depth to ensure that the project rests on a solid legal foundation and that potential risks are minimized. This review covers critical areas that directly affect the project’s financial health, operational efficiency, and long-term sustainability.

A. Company Structure and Corporate Governance

In project finance, the SPV established specifically for the project serves as the cornerstone of the transaction, functioning to ring-fence project assets and revenue streams from the financial risks of the project sponsors and their affiliates. Therefore, the legal review focuses on whether the SPV’s corporate structure is robust enough to achieve this isolation.

Beyond confirming that the SPV has been established in accordance with the Turkish Commercial Code (“TCC”) and relevant legislation, the company’s articles of association are analyzed for potential legal gaps or future sources of dispute. Issues such as the shareholding structure, share transfer records, and whether the capital has been fully and in cash paid are examined not merely as formal elements, but also as evidence of the company’s economic and legal independence.

The minutes of the general assembly meetings and board of directors’ resolutions are reviewed. It is verified whether major transactions and agreements have been duly authorized in accordance with the company documents and relevant laws. Provisions regarding shareholder disputes, non-compliance with corporate formalities, voting rights, board representation, veto rights, and the protection of minority interests are examined in detail. Related party transactions and potential conflicts of interest are also investigated. In particular, the financial condition of the project sponsor and group companies may raise the risk of “piercing the corporate veil”. One of the main arguments in legal due diligence is that, if there are de facto situations such as the commingling of assets or personnel, or joint management between the SPV and the sponsor, creditors may assert claims against the SPV’s assets in case of the sponsor’s insolvency or indebtedness. This would undermine the principle of limited recourse, which underpins project finance. To mitigate this risk, it must be legally demonstrated that the SPV has separate management, accounting records, and its own unique corporate governance.

Board of directors and general assembly resolutions are examined not only as a record of past actions, but also as an indicator of potential future liabilities. Failure to approve major transactions or contracts in accordance with the authority and quorum requirements set out in the TCC carries the risk of invalidity or annulment of such transactions. This directly threatens the legal validity of the project’s core agreements (such as construction, supply, operation contracts, etc.). The shareholders’ agreement, on the other hand, is the most important safeguard against the risk of project deadlock. From the lenders’ perspective, the main argument is that a dispute among shareholders on matters such as voting rights, profit distribution, board representation, or veto rights can bring the project’s operations to a standstill. Therefore, it is meticulously reviewed whether the agreement contains effective mechanisms to resolve such disputes (for example, “buy-sell” provisions like Russian roulette12 or Texas shoot-out clauses)13.

The “limited recourse” structure, which is the fundamental feature of project finance, demonstrates how critical the financial health and corporate governance of the SPV are. This structure creates a legal regime in which the repayment of the debt relies solely on the project‘s own cash flows and project assets14. In order to achieve this isolation (bankruptcy remoteness), the corporate governance of the SPV must be flawless. A gap in the articles of association, the absence of a deadlock provision in the shareholders agreement, or an improperly adopted board resolution are not merely administrative errors, but legal risks that undermine the priority right of lenders over the project revenues that form the basis of the security package. Such vulnerabilities may lay the groundwork for the diversion of funds from the project or for the disruption of the project‘s operational integrity, directly causing lenders to suffer principal and interest losses.

A discrepancy in corporate records should be regarded as a symptom of a material risk. For example, a missing board resolution book may indicate that a significant financial commitment was undertaken without proper authorization or that a dispute among shareholders has been concealed. Such a situation may lead not only to potential lawsuits or monetary penalties, but also to a breach of the representations and warranties in financing agreements. Such a breach may entitle lenders to immediately accelerate the loan. Therefore, legal due diligence is not merely a process of checking the existence of documents, but an analytical exercise that questions the consistency of these documents with each other and whether the legal consequences they create are in line with the project financing agreements.

B. Agreements

The legal infrastructure of project finance consists of an integrated and complex set of contracts. In Türkiye, under Law No. 3996 on the Implementation of Certain Investments and Services through the Build-Operate-Transfer Model, the first step in Public-Private Partnership (“PPP”) projects is the Concession Agreement, which is signed between the relevant public authority and the private sector bidder awarded the tender. Following the execution of this primary agreement, the sponsors establish a SPV to undertake the obligations under the agreement and to carry out the project15.

The formation of the SPV identifies the legal counterpart for the project’s financing negotiations. At the heart of these negotiations is the Credit Agreement, which legally and financially governs the entire structure and serves as the cornerstone of the system. While the terms of the Credit Agreement are being determined, the other fundamental agreements that establish the project’s operational and commercial framework are also addressed concurrently. These include the Intercreditor Agreement, which regulates the relationship among the lenders, and the Project Agreements such as the Engineering, Procurement and Construction (“EPC”) and Supply Agreements, which govern the construction and operation of the project.

All these negotiations on the legal documents are executed simultaneously on the date of the Financial Close, following a process that may last more than one year, thereby achieving legal integrity. Therefore, rather than a chronological order in the preparation of the agreements, the Credit Agreement has a central function of consolidating all the other agreements and giving them meaning.

During the legal due diligence, a detailed analysis of each of these agreements (the Project Agreements) is conducted. The project’s fundamental agreements and the critical legal provisions contained therein are examined, and red flags16 are identified. For example:

1. State/Concession Agreements: The concession period, state guarantees, regulatory framework, expropriation provisions, and dispute resolution mechanisms are examined. A short concession period, weak state guarantees, and insufficient protection against expropriation risk constitute priority red flags.

2. Credit Agreements: Elements such as the debt repayment schedule, security package, events of default, step-in rights, financial covenants, interest rates, and foreign exchange risk are examined. Insufficient security, weak step-in rights, covenants that increase the borrower’s default risk, and lack of protection against foreign exchange risk constitute priority red flags.

3. Intercreditor Agreements: The priority among different lenders, the sharing of collateral, and the coordination mechanisms in the event of default are examined. Conflicts of interest among lenders, uncertainty in collateral priority, and slow decision-making mechanisms in the event of default are considered red flags.

4. EPC Agreements: Provisions such as scope, timeline, fixed price, performance guarantees, delay and performance penalties, force majeure, and termination conditions are examined. In these agreements, an uncertain scope or timeline, insufficient performance guarantees, low penalty clauses, and unilateral termination rights are considered red flags.

5. Operation and Maintenance Agreements (O&M): Service Level Agreements (hereinafter “SLA”), maintenance schedules, costs, performance metrics, and provisions on default and termination are examined. Inadequate SLAs, high operating costs, weak penalty clauses in case of performance deterioration, and long termination periods constitute priority red flags.

6. Power Purchase Agreements (PPA): The sale price, quantity guarantees, “take-or-pay” provisions, default, termination, and transfer restrictions are examined. A low sale price, insufficient quantity guarantees, transfer restrictions to the lender, and the risk of early termination are considered significant red flags.

7. Fuel Supply Agreements: The supply quantity, pricing mechanism, quality standards, supply interruption provisions, and clauses on default and termination are examined. Dependence on a single supplier, the risk of price volatility, insufficient supply guarantees, and weak compensation provisions in the event of breach of contract are considered red flags.

Contractual rights, obligations, risk allocation mechanisms, termination provisions, transfer provisions and the lenders’ step-in rights are examined meticulously. For example, in EPC agreements, elements that make the project bankable such as a fixed completion date, a fixed price, limited technology risk, output guarantees, and delay/ performance penalty clauses, are sought. Offtake agreements are vitally important for financing as they secure the project’s revenue stream17.

The “red flags” in these agreements may directly undermine the project’s revenue stream and the lenders’ security. For instance, ambiguous or vague contractual terms, unbalanced provisions that excessively favor one party, automatic renewal clauses, or restrictive transfer rights carry serious risks. In addition, the inadequacy or misinterpretation of the definitions of “Material Adverse Effect” (hereinafter “MAE”) may limit the rights of the lenders. Such deficiencies jeopardize the project’s cash flow and directly affect its repayment capacity, thereby creating a systemic risk for the entire financing structure. Therefore, the legal due diligence assesses not only the legal validity of these agreements but also the extent to which they properly allocate financial and operational risks.

C. Real Estate and Property Rights

In project finance transactions, real estate and property rights constitute a critical area that determines the legal robustness of the project’s physical assets and their collateral value for the lenders. A title search is conducted to verify the legal right to transfer ownership. It is determined whether there are any unpaid mortgages, liens, easements, or restrictions on the property. Failure to address title issues may lead to legal disputes or financial losses. In Türkiye, the land registry examination is of vital importance to verify legal ownership, encumbrances (annotations, mortgages, liens), and cadastral history. Legal remedies may be pursued to resolve disputes arising from joint ownership.  

The legal validity and duration of the land use rights (ownership, lease, easement, etc.) of the land on which the project will be carried out are examined. Especially in large-scale infrastructure and energy projects, instead of the ownership of the land being purchased by the project company, it is a common practice to establish a superficies right in favor of the SPV18. Lease agreements, particularly financial lease agreements (leasing) and lease agreements to which the administration is a party, are specifically assessed. Lease agreements may need to be executed in writing and registered with the relevant registries. Provisions such as the lessor’s authority to transfer ownership to third parties and insurance obligations are also reviewed.

Red flags in this area include uncertainties in title records and incomplete or misleading ownership information. Unpaid mortgages, liens, or easements that may restrict the use of the property are also significant warning signs. Title issues that may lead to legal disputes, ambiguous or adverse provisions in lease agreements concerning termination, transfer, or duration, as well as non-compliance of the property with zoning plans, land use restrictions, or environmental regulations, must also be carefully examined.

In project finance, the project’s physical assets (real estate) generally constitute the primary security for the debt. At this point, in cases where the land is not owned by the project company, the superficies right itself, registered in the land registry as an independent and permanent right, is provided as collateral in favor of the banks against the loan19. Therefore, any legal defect on the real estate (title issues, zoning non-compliance, hidden encumbrances) directly threatens the financial health of the project and the lenders’ security. Legal due diligence ensures that these risks are identified and mitigated before the financial close, thereby making the project bankable. The ownership status or land use rights of the land on which a project will be constructed or operated constitute the foundation of the project. If there is any annotation, lien, or mortgage in the title records, this directly affects the lenders’ collateral and puts the project’s future cash flow at risk. In addition, non-compliance with zoning plans or environmental regulations may lead to the suspension of the project or the imposition of significant penalties. These elements must be examined in depth, assessing not only the current legal status but also its potential adverse effects on the project’s construction, operation, and debt repayment processes.

Long-term lease agreements may constitute a significant portion of the project’s operating expenses. If these agreements do not clearly set out rent increases, termination conditions, or maintenance obligations, or if they fail to protect the interests of the lenders, the project’s cash flow may be adversely affected. Particularly in financial lease agreements, issues such as the insurance of the asset and the transfer of ownership directly affect the lenders’ security structure. When reviewing these agreements, not only their legal validity but also their compatibility with the project’s financial model and risk allocation must be assessed. In addition, in lease agreements concluded with public authorities, it should be taken into account that different regimes under public law may apply.

D. Legal Compliance and Permits

In project finance, legal compliance and the obtaining of necessary permits are of vital importance for the smooth progress and operational sustainability of the project. While the project’s compliance with all applicable laws, regulations, and rules is verified, particular attention is given to documents such as Environmental Impact Assessment (“EIA”) reports, construction permits, operating licenses, zoning status, and land use regulations.

There are certain issues specific to legal due diligence in project finance under Turkish law. In the field of real estate, details of the land registry, the processes of establishing and registering mortgages, condominium easement/condominium ownership, and the risk of urban transformation are examined within the scope of the Turkish Civil Code, the Land Registry Regulation, the Zoning Law, and the Urban Transformation Law. With respect to security interests, the validity and enforceability of mortgages, share pledges, commercial enterprise pledges, assignment of receivables, and account pledges are evaluated under the Turkish Civil Code, the TCC, the Commercial Enterprise Pledge Law, and the Enforcement and Bankruptcy Law. From a regulatory compliance perspective, licenses issued by the Energy Market Regulatory Authority (“EMRA”), EIA processes, construction permits and occupancy permits, as well as sector-specific regulations in energy and mining, are addressed under the Energy Market Law, the Environmental Law, the Zoning Law, and the relevant regulations and communiqués. In the area of dispute resolution, the recognition and enforcement of foreign arbitral awards, state immunity and waivers, and enforcement proceedings are examined in light of the International Private and Procedural Law, the Enforcement and Bankruptcy Law, the Code of Civil Procedure, and the relevant international conventions. The validity of agreements under the Turkish Code of Obligations (“TCO”), the interpretation of MAE clauses under Turkish law, and the nature of agreements concluded with public authorities are evaluated within the framework of the TCO, the TCC, the Public Procurement Law, and relevant administrative case law. Regarding tax implications, property taxes, VAT, corporate income tax, transfer pricing regulations, and tax incentives are examined under the Tax Procedure Law, the Corporate Tax Law, the VAT Law, and Double Taxation Avoidance Treaties. Finally, in matters of labor and employment, the provisions of the Labor Law, collective labor agreements, occupational health and safety regulations, trade union rights, and the conditions for employing migrant workers are addressed under the Labor Law, the Trade Unions and Collective Labor Agreements Law, the Occupational Health and Safety Law, and the relevant regulations.

The “red flags” in this area can significantly increase the project’s risk. Expired licenses, the existence of past legal violations or ongoing investigations, resistance to regulatory inspections, or irregular/ incomplete documentation may result in suspension of the project, substantial fines, and even legal liabilities for the lenders. For example, non-compliance with environmental regulations may lead to long-term costs such as pollution remediation expenses, lawsuits, and monetary penalties.  

E. Litigation and Dispute Resolution

One of the most critical components of the legal due diligence process in project finance is the review of litigation and dispute resolution history, conducted with the aim of identifying the project’s potential legal risks, future operational continuity, and hidden financial liabilities. In this process, lawyers begin by comprehensively analyzing the project company’s past and ongoing lawsuits, legal claims, and regulatory investigations.

F. Tax Implications and Liabilities

In project finance, tax implications and liabilities have a direct impact on the project’s financial feasibility and profitability. Legal due diligence carefully reviews the project’s tax returns, outstanding tax debts, transfer pricing practices, past and ongoing tax audits, and potential tax advantages or exemptions.

The “red flags” in this area are of critical importance for uncovering hidden financial liabilities that may not be immediately visible in the financial statements. For example, situations such as regularly late or missing tax filings, unpaid tax debts, questionable tax positions (particularly transfer pricing issues), or underreported payroll taxes carry serious risks. Such issues may result in significant unexpected costs, fines, and legal disputes after acquisition, thereby directly affecting the project’s profitability and cash flow.

Tax review helps identify potential tax liabilities not reflected in the project’s financial model, enabling lenders to make a more realistic risk assessment. Tax non-compliance is not merely a legal issue, but also a direct threat to the project’s financial stability and, consequently, its access to financing. Therefore, early identification and effective management of tax risks are indispensable for the success of project finance.

G. Labor and Employment Matters

In project finance, legal due diligence on labor and employment matters not only ensures compliance with local legislation, but is also becoming increasingly critical for managing the project’s Environmental, Social, and Governance (“ESG”) risks and reputational risks. This review covers workforce practices, occupational health and safety standards, collective bargaining agreements, and other relevant employment obligations.

The “red flags” in this area may include high employee turnover rates, ongoing disputes with trade unions or subcontractors, and violations of occupational health and safety standards. Such issues may cause project delays, regulatory fines, and serious reputational damage, thereby negatively affecting its bankability. One of the most tangible reflections of these risks from the perspective of lenders is a potential payment crisis between the main contractor and the SPV. A disruption in the SPV’s payments to the EPC company, resulting in the EPC company’s inability to pay its workers, could trigger a domino effect on the entire project. Therefore, lenders may contractually require that the EPC company directly notify them in the event of such payment difficulties. The primary purpose of this mechanism is to prevent a disruption in wage payments from escalating into large-scale strikes, suspension of the project, and ultimately termination of the Concession Agreement. Such termination would carry the risk of lenders losing their entire investment; hence, lenders reserve the right to intervene at an early stage in such operational issues to ensure the project’s continuity.

H. Insurance Policies and Coverage

Insurance policies constitute a fundamental method of risk management in project finance, serving as a critical risk transfer mechanism that protects both borrowers and lenders against unforeseen losses. Legal due diligence assesses the adequacy and appropriateness of the insurance program covering all stages of the project (construction and operation). The main types of insurance reviewed include Contractor’s All Risk (“CAR”), Erection All Risk, Advance Loss of Profit, and Third Party Liability Insurance. The private sector party (the concessionaire) relies on mechanisms such as insurance to further manage the risks transferred from the public authority.

One of the primary objectives of legal due diligence is to identify gaps in insurance coverage and the interdependencies between different types of policies. Business interruption risks arising from force majeure events such as natural disasters are also generally among the insurable risks. A distinctive feature of project finance, and particularly of PPP structures, is the transparent accounting and valuation of risks. If a risk is insurable, its value is calculated using the premium cost paid for the insurance. These insurance premiums represent the actual cost of the risk assumed by the private partner and serve as a critical data point in the project’s “Value for Money” analysis.

The “red flags” in insurance policies include insufficient coverage limits, significant exclusions, the absence of waivers of subrogation (failure of the insurer to waive its right of recourse against the liable party), and adverse effects of local law on the enforceability of policies. Such deficiencies or issues may result in the project’s risks not being fully transferred to the insurer, thereby causing uninsured liabilities to fall directly back on the lenders or sponsors. This demonstrates that insurance is more than just a cost item; it is a critical risk transfer mechanism for the project’s financial security, making rigorous legal due diligence in this area indispensable20.

IV. “RED FLAGS” ENCOUNTERED IN LEGAL DUE DILIGENCE and approaches to rısk management

In the course of legal due diligence, the “red flags” that may arise in different areas of the project serve as early warning signs of potential risks and issues. The proper identification and management of these signals are of critical importance for the project’s financial soundness and long-term success.

A. Red Flags by Legal Area

The “red flags” identified during legal due diligence typically arise across different legal areas of the project and are often interconnected. For instance, weak corporate governance (e.g., insufficient authorizations) may lead to contractual red flags (e.g., unenforceable agreements), which in turn can increase litigation risks or financial liabilities. This interdependence necessitates a holistic risk assessment rather than isolated checks.

There are critical aspects to be considered in the fundamental areas forming the basis of the project. In the core project agreements, elements such as ambiguous or unbalanced provisions, restrictive transfer clauses, inadequate termination/step-in rights, and uncertainties in MAE21 (Material Adverse Effect) definitions may undermine the project’s revenue stream and financial backbone22. In corporate structure and governance, shareholder disputes, non-compliance with corporate formalities, and financial distress of the sponsor may block decision-making processes and increase operational risks23. Similarly, in real estate and property rights, issues such as defects in land title, zoning non-compliance, or illegal constructions may diminish the value of the project’s physical assets, thereby jeopardizing the lenders’ security24.

There are also various risks concerning the operational and legal continuity of the project. Under legal compliance and permits, expired licenses, past violations, or deficiencies in the EIA report may lead to suspension of the project and severe fines. Gaps in insurance coverage or insufficient coverage limits may result in unforeseen financial losses. High-risk litigation or allegations of corruption in the history of litigation and disputes may cause project delays and reputational damage. In addition, violations in labor and employment matters, union disputes, or high employee turnover rates may lead to legal penalties and deterioration of financing terms. Finally, in the area of taxation, incomplete filings, unpaid debts, or questionable transfer pricing practices may create unexpected tax penalties and hidden financial liabilities, thereby negatively affecting the project’s cash flow and profitability25.

B. Direct Agreements and Step-in Rights

The step-in right is a contractual safeguard in large-scale projects such as project finance and PPPs, which grants lending financial institutions (the lenders) the ability to directly intervene in the project and the management of the project company in cases where the borrower mismanages the project, breaches its contractual obligations, or falls into default. This right is considered a standard component of the security package obtained by the lenders under the financing agreement. It is typically formalized within a legal framework through direct agreements executed among the contracting authority, the project company, and the lenders26 27.

The primary purpose of exercising this right is to enable the lenders to take control of the project company, either directly or through the appointment of a professional management team, when they consider the project company to be mismanaged, with the objective of restoring and improving the project’s cash flow. By ensuring the continuity of the project in this manner, lenders aim to facilitate a smoother and more efficient repayment of the debt. Such intervention may also extend to the replacement of an underperforming contractor with a new entity capable of completing the project28.

The step-in right also serves several secondary, yet equally important, purposes. First, the mere existence of such a right in the contractual framework exerts significant pressure on the project company and its sponsors, acting as a deterrent and encouraging them to avoid breaches and to ensure sound project management. Furthermore, this right safeguards the prioritization of project revenues for the repayment of lenders’ claims, thereby preventing the diversion or misuse of cash flows for purposes other than those intended under the financing arrangements29.

This intervention right is typically triggered in circumstances that could otherwise result in the termination of the main project agreement. However, the absence of clear contractual provisions defining the conditions, duration, and procedures for the exercise of step-in rights carries the risk of generating new legal disputes among the parties. Ultimately, the step-in mechanism functions not merely as a debt recovery tool for lenders, but as a multifaceted and critical risk management instrument designed to safeguard the project’s overall viability and financial discipline.

V. CONCLUSION

Project finance, distinguished from traditional financing models by its “limited recourse” structure in which repayment relies directly on the cash flows and assets generated by the project, places legal due diligence at the very core of financial sustainability and bankability. As discussed in this article, legal due diligence is not merely a static assessment of the existing circumstances, but rather a dynamic risk management tool that extends throughout the entire lifecycle of the project.

Within this comprehensive process, the fundamental elements forming the legal and financial backbone of the project are scrutinized. At the center of this review lies the robustness of the SPV’s corporate structure and governance, which ensures the insulation of the project from external risks. Any weakness in the corporate integrity of the SPV may give rise to the risk of “piercing the corporate veil,” thereby rendering the principle of limited recourse ineffective.

Another critical focus of the review is the integrated suite of agreements that underpin the project, such as Concession Agreements, Credit Agreements, EPC Agreements, and Offtake Agreements. By rigorously analyzing the risk-allocation mechanisms, termination provisions, and, in particular, the step-in rights that enable lenders to intervene in the project, the review seeks to secure the project’s revenue stream. Likewise, the real estate and property rights that constitute the project’s primary collateral, the permits and licenses ensuring operational continuity, tax and employment matters that may give rise to hidden financial liabilities, and insurance policies as risk-transfer mechanisms are all subject to detailed scrutiny.

In conclusion, the legal due diligence process identifies potential “red flags” at an early stage and transforms them into manageable strategies. The reports prepared eliminate uncertainties and provide actionable recommendations, thereby enabling lenders and investors to make informed decisions. For this reason, a successful project financing transaction cannot be conceived without a comprehensive legal due diligence that transparently evaluates complex legal, commercial, and financial risks, allocates them appropriately, and grounds them on a solid legal framework. This process represents the most critical stage in transforming a project’s theoretical feasibility into a viable and reliable investment.