Lessons Learned in Project Financing: Revenue Streams That Are Not Absolute & Unconditional

by Ken Weinberg January/February 2016
In the final installment of a two-part series, Attorney Ken Weinberg draws upon lessons learned through use of project finance structures that involve bundled or PPA transactions. By taking a close look at the methods used in these transactions, he clarifies the inherent risk.

This edition of Dispatches from the Trenches is the second in a two-part series on non-hell or high water obligations sometimes present in bundled transactions and PPA transactions. As discussed in detail in the first installment, “bundled transactions” involve the leasing or financing of equipment that is coupled with services, licenses or other products. PPA transactions involve leases or financings of energy facilities in which the ultimate obligor supporting the transaction only agrees to purchase energy, or other outputs, so the revenue supporting repayment of the investment is derived from a power purchase agreement or other similar documentation.

The last installment focused on statutory and case law supporting hell or high water obligations present in traditional equipment leasing and finance transactions and how bundled and PPA transactions differ. This installment draws upon lessons learned through use of project finance structures where bundled or PPA transactions are involved. Although these techniques may be suited only for larger transactions, a close look at the methods that have developed over time helps to clarify the types of risk inherent in these transactions.

Borrowers participating in project financings collaterally assign to the lender the borrowers’ rights under various contracts that collectively generate the revenue necessary to repay the debt. The assigned agreements generally do not contain hell or high water payment provisions, and the lenders need adequate rights to assure that the goods, products or services are actually produced in order to generate the revenues needed to repay the debt.

To that end, and in order to assure the ability to foreclose on the assigned contract in a manner that preserves the anticipated revenue stream, lenders in project financings frequently require a Consent to Collateral Assignment, sometimes referred to as a Lender’s Direct Agreement, which creates contractual privity between the lender and the obligor, and clearly articulates the lender’s rights and obligations as collateral assignee. This step is generally taken even when the underlying contracts being assigned expressly allow collateral assignment of the agreement to a lender providing financing for the project.

Without more, such a statement is of limited value to the lender. After all, what does the obligor mean when it allows “collateral assignment of the agreement to the lender?” Does this language merely mean that the lender has the right to payments generated under the agreement? Does it mean that the lender can become the counterparty to the agreement, step-in and perform the borrower’s obligations sufficiently to generate the revenues? If the lender takes such actions, does the lender become bound as the counterparty to the agreement? Does the consent to a collateral assignment of the
agreement to the lender mean that the lender can foreclose on its lien on the agreement by transferring it to any third party, no matter that party’s qualifications? In order to clarify the above, and address other risks associated with bundled or PPA transactions, forms of consents have evolved to address a variety of matters, including those described below.

Substitute Owner

A foreclosure by a project finance lender on its rights in an assigned agreement does not involve the mere repossession and sale of tangible assets. Rather, “foreclosure” in this context means transferring the assigned agreements to a third party (substitute owner) who can perform in a manner that keeps the revenue flowing. Effectively undertaking this action means the obligor has to accept the substitute owner as its new counterparty to that document. Since the view is that the obligor has much more of an ongoing relationship with the assignor/borrower than it does under chattel paper or an account — where the assignor is merely the addressee to whom payments are sent — the law protects the obligor.

To assure the lender of its right to insert the substitute owner as the counterparty to the assigned agreement, the lender negotiates a consent with the obligor to address the objective parameters a third party must satisfy to become a suitable substitute owner. The items addressed vary widely depending on the nature of the agreement being assigned and the particular counterparty to that agreement. Some examples include the financial and technical abilities of the substitute owner, a requirement that the substitute owner cannot be a competitor of the counterparty, a lack of prior material litigation between the substitute owner and the counterparty and, in certain regulatory situations, the legal ability of the counterparty to be party to such a contract with the proposed substitute owner. Certain additional issues can arise if a default currently exists under the assigned agreement at the time the lender elects to replace the borrower with a substitute owner, including the extent such existing defaults must be cured as a condition precedent to the insertion of the substitute owner, and which defaults are specific to the borrower being replaced and therefore not curable.

Rights to Cure Defaults

Lenders in project financings also need the right to cure any defaults that occur under the assigned agreement in order to prevent its termination and to preserve any cash flow generated directly or indirectly under the agreement. Therefore, lenders generally require notices of default and rights to cure. Although some counterparties are uncomfortable with an affirmative obligation to notify the lender of any default, most will agree that the time period the lender has to exercise any cure rights should not begin to run until the lender has received notice of the applicable default.

Lenders generally require an “extended cure period” above and beyond the original cure period granted to the borrower. There are several reasons for this. First, the lender and borrower want the borrower to have time to remedy any problems and generally agree that the time frames originally negotiated for the benefit of the borrower should be preserved. Without an extended cure period, the lender would need to sound a fire alarm anytime a default occurred and immediately begin pursuing remedial action in order for it to have the same time as the borrower was originally granted. Such actions could interfere with the borrower’s ability to cure the defaults. Second, for lender liability reasons, lenders also prefer to provide the borrower with the maximum opportunity to solve any problems. The lender may need more time than the borrower to effectuate a cure. After all, the lender is not on the ground at the project location or otherwise heavily involved in the management of the project, and it does not have personal relationships with other key counterparties which may be needed to correct problems with the project. In larger syndicated transactions, the presence of multiple lenders may slow the response of the lender group. In short, the lender may not be able to move as quickly as the borrower.

The length of an extended cure period depends upon a variety of factors including the complexity of the project, the number of assigned agreements that must be coordinated for the project to perform as required and the nature of the default. For example, it is often easier for a lender to evaluate a monetary default than to evaluate, identify and fix technical problems with the facility itself.

A good consent also addresses the effect of the cure. At the end of the day, the lender cannot find itself bound by the full terms of a contract between its borrower and the applicable counterparty solely because of the lender’s exercise of cure rights. Consents typically make clear that the assignment of the agreement to the lender, and the exercise by the lender of certain rights under the agreement or the consent, do not cause the lender to be liable for any payment or performance owed by the borrower.1


The notice, cure and step-in concepts are designed to enable the lender to preserve the assigned agreement. Accomplishing this goal is complicated by bankruptcy or other insolvency proceedings that allow the trustee in bankruptcy or debtor-in-possession to “reject” the assigned agreement, thereby resulting in its termination. To address this issue, lenders typically require counterparties to agree in consents to enter into a replacement agreement mirroring the term remaining under the rejected agreement. Although such provisions are often viewed as addressing the unique aspect of insolvency proceedings, and are generally not considered controversial, certain counterparties may raise issues regarding the ability to enter into a new agreement. Consider, for example, the possible regulatory or other approvals surrounding an agreement that is subject to a formal bid or approval process.

Terminations & Modifications

Lenders involved in project financings carefully review the assigned agreements on which the financing is based to make sure the inputs, outputs and services on which the revenue projections are based are in line with the actual documentation. None of that diligence matters if the contracts could be changed without the lender’s consent. The UCC specifically provides that any such modifications made by the borrower and the counterparty to the assigned agreement are binding on the lender unless the modifications relate solely to the right that has already been fully earned by performance, and such payment modifications are made after the proper notice of assignment.2

The loan documents typically restrict certain types of modifications to key assigned agreements. However, if the borrower breaches that covenant and causes an event of default to occur, the lender would still be left enforcing the modified assigned agreement. Therefore, lenders often require the counterparties in the consents to agree that the assigned agreements will not be amended, modified or terminated without the lender’s prior written consent.


Due to technological improvements, the number of investment opportunities involving non-hell-or-high-water payment provisions continues to increase. Equipment leasing and financing companies can learn from their project finance brethren, who have dealt with the lack of absolute and unconditional payment for many years. A consent is a crucial tool used in project finance transactions that has developed over time to mitigate risks associated with the lack of hell-or-high-water payment provisions. Even if a consent is not a solution for various transactions encountered by equipment leasing and finance companies (due to size, timing or other reasons), the types of issues addressed in a consent help highlight the types of risks present in non-hell-or-high-water deals.


  1. Under certain circumstances, the lender or its designee may wish to formally “step-in” to the borrower’s shoes and perform under the assigned agreement for a more extended “step-in period” — particularly if the assignor has proven unable to operate the project properly and the lender is in the process of locating a substitute owner. It is not uncommon for the party exercising the step-in rights to be liable for certain obligations during the step-in period.
  2. UCC §9-405.

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