key takeaways
What is bankability in the context of a construction project?
A project structure is "bankable" if lenders are prepared to finance it.
When parties negotiate a construction contract, the concept of ‘bankable’ is usually:
- Negotiated by reference to what the Principal has been able to agree with lenders in the past; and
- What the Principal is taking to lenders on the current project.
What factors influence bankability?
The credit committees of lenders seek certainty. They tend to require that risks are capable of assessment or analysis and not open-ended. While many factors can influence whether and what a lender is prepared to lend into a project, a number of key issues in construction contracts often include those in the table below.
Issue | Risk Allocated to Principal | Risk Allocated to Contractor | Comment |
|---|---|---|---|
Step-In Rights / Tripartite Agreement | X | X | Lenders require step-in rights, whereby the Principal and Contractor are often required to execute a tripartite agreement with the lender that modifies termination rights and provides the lender with the ability to step into the Principal’s shoes to take over the project. |
Bank Guarantees / Bonds | X | Performance security in the form of bank guarantees or insurance bonds (or failing that, retention monies) are usual and typically range between 5% - 10% of the contract sum in many projects. | |
Parent Company Guarantee | X | Where the Contractor is not a company of substance or significant assets are held by a parent company, then a parent company guarantee may typically be required as part of the security package. | |
Third-Party Security - Contractor | X | Where the Contractor is not a company of substance or significant assets are held by related third parties (e.g. shareholders, individuals, other entities in the Contractor’s “group”), lenders may request third party security to secure the obligations of the Contractor. | |
Third-Party Security - Principal | X | Where the Principal is not a company of substance or significant assets are held by related third parties (e.g. shareholders, individuals, other entities in the Principal’s "group"), lenders may request third party security to secure the obligations of the Principal. | |
Conditions Precedent / Conditions Subsequent | X | X | Lenders will be concerned to ensure that both conditions precedent that are commercially agreed and those that are conditions to draw down on loan, are actively managed with open lines of communication. |
Additional Securities | X | Lenders will often require a number of additional securities that tie to the production or sale value of the asset. For example, in property development projects, lenders will often require a number of qualifying pre-sales as additional security for the lending. The requirements for a “qualifying pre-sale contract” can greatly vary depending on the project and the lender. In some circumstances, lenders may require existing pre-sale contracts to be varied or re-signed in order for the lender to be satisfied with their terms. | |
Key Warranties / Indemnities | X | Lenders will require warranties to ensure the project can be completed in a way that it could, if necessary, be sold to recoup the loaned funds and any losses. In a design and construct project, this will typically include a fitness for purpose warranty. | |
Assignment / Novation | X | Lenders will be concerned to ensure that there are no restrictions on the Principal’s rights to deal with, or give security over, the Contract. | |
Sub-Contracting | X | Lenders will seek certainty that the entirety of the works is not subcontracted and to control who is subcontracted for major subcontract packages or matters of significance. | |
Delay Entitlements and Caps | X | Lenders are often concerned to ensure that delay entitlements are not extensive (including force majeure rights, if applicable) and that there is certainty regarding project completion. | |
Payment and Set-Off | X | Lenders may require their own independent certifier, including to ensure that payment claims are not front-loaded and that the cost to complete does not outweigh the remaining payments to be made. | |
Insurance | X | X | A robust insurance regime is required for a project to protect the project and the interests of lenders. |
Termination | X | As noted above, default and termination rights are often modified by lenders through tripartite agreements to ensure that lenders have sufficient ability to step in and take over a project, complete it and sell it, if required. | |
Defects | X | Usual defects periods to ensure the integrity of a project are generally required. Although these periods can vary, they are generally at least 12 months | |
Limitations and Exclusions on Liability | X | An overall limitation of liability in favour of a Contractor is generally bankable, subject to the sizing of the limitation and subject to accepted carve-outs. |
Current trends in the market
In a resource-constrained market, we are witnessing contractors test historical risk allocations that they had once agreed to bear. When a market starts to change, it is beneficial for Principals to stay in close contact with their lenders regarding acceptable risk profiles and not to leave this discussion until those positions have been agreed upon with Contractors. The line of sight of lenders can otherwise lag the tender negotiations, resulting in pressure upon Principals from lenders on the one hand, who see the market as it was, and Contractors on the other hand, who have formed a different view as to acceptable risk profiles.
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conclusion
Ultimately, parties need to be able to agree on a risk allocation that can be managed and which lenders will finance. A way to help facilitate this is to engage with lenders early to keep open lines of communication regarding construction contracts.
We have experience in:
- Carrying out reviews for lenders, Principals and Contractors;
- Advising on loan arrangements for lenders and Principals; and
- Due diligence for lenders and Principals.
We also work closely with project participants to ensure that conditions precedent for loan drawdowns are met and to help ensure successful commencement and delivery of projects.
The next time you are looking at issues of bankability, please contact us. We would love to discuss your project and are always delighted to share thoughts and insights on the market.
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