February 28, 2013

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Securities and their Enforceability

- Santosh B. Parab, Sr. Director [ IDFC ]

Santosh B. Parab

"The enforceability of the securities and subsequent realisation of dues differs according to their nature of the security as well as the type of infrastructure project from where they emanate"

We often see lenders stipulating a comprehensive security package in financing documents for securing loans granted by them for development and construction of infrastructure projects. Such a security stipulation is based primarily on the type, characteristics and inherent risks of the project. Various types of infrastructure projects financed by lenders include road, power, telecom port, airports, schools, hospitals, SEZs, etc. These projects have typical characteristics, such as development and operation through a single special purpose project vehicle (“SPV”), reliability on the cash flows of SPV, very limited or no recourse to the project sponsor and heavy reliance on contractual commitments between various project participants.

The security package usually gets stipulated based on the type of infrastructure project being financed. The funding for infrastructure projects is usually backed by a security comprising: - (a) a charge by way of mortgage of all the immovable properties (both present and future); (b) a charge by way of hypothecation of all the movables, cash flows and receivables of the SPV; (c) security by way of assignment of rights of the borrower under the project documents (comprising EPC Contract, O& M Contract, Work Orders, Purchase Orders, Power Purchase Agreements, Concession Agreement and other contracts typical to each infrastructure Project); (d) pledge of

"As long as the project is successfully implemented and operated and debt is serviced regularly as per the terms of the financing documents, the security taken remains a mere paper security."

promoters shares in project SPVs; and, (e) undertakings from the sponsors to the Project.

The security cover stipulated by lenders is normally ranging between 1.5 to 2.5 times the loan. Lenders further reserve the right to call for additional security in the event the security cover falls below the stipulated levels or where the current security package is insufficient in preserving the rights of the lender under the financing documents.

As long as the project is successfully implemented and operated and debt is serviced regularly as per the terms of the financing documents, the security taken remains a mere paper security. However, where the borrower defaults in payment obligations the lenders are left with the sole choice of enforcing the securities charged to them under the financing documents.

The question, which very frequently gets asked amongst lenders, is how enforceable are the securities taken for the financial assistance granted to infrastructure projects? The enforceability of the security and subsequent realisation of dues therefrom differs according to the nature of the security and the type of infrastructure project from which such security interest emanates. Through this article, we seek to evaluate the various securities available to the lenders and their enforceability vis-a-vis the concerned infrastructure projects.


Infrastructure projects undertaken on a Public Private Partnership (PPP) basis are governed primarily by the terms of the Concession Agreement (also called as the License Agreement), which forms the heart of any PPP project. The Concession Agreement is typically an agreement between the Concessioning Authority (usually a Government Agency) and a successful bidder of an infrastructure project who is entrusted with the obligation of developing, operating and maintaining the project during the lifetime of the concession agreement in return for cash flows to be generated from those projects.

As mentioned above, lenders funding such PPP projects stipulate a host of security conditions as a protection against the default by the borrower. Irrespective of the lenders stipulating such security conditions, what needs to be seen is whether such securities can be created and enforced in the true sense. For instance, in a road or a port project, providing for a mortgage of immovable properties will be of little practical use as the project SPV will not be able to create a mortgage over the road or the port as the ownership of such road or port remains with the Government Agency. Moreover, the Concession Agreement for these projects also explicitly restricts the concessionaire from creating any encumbrances over Project Assets and the Site for the Project.

The only tangible security the lenders of such projects have is the charge on the cash flows (toll collection amount) which is subject to the terms of the Escrow Agreement (providing for the waterfall mechanism through which the cash flows gets percolated down for various purposes) and the rights under the Concession Agreement (substitution right and right to receive termination payment). The enforcement of pledge of shares of the SPV is also subject to the approval of the Concessioning Authority as the Concession Agreement will usually have negative covenants restricting the Sponsors from diluting their shareholding in the SPV beyond a certain level which differs for both construction and operational phases.

So how do the lenders to such PPP projects go ahead with enforcement of security? The lenders upon occurrence of an event of default shall inform the Concessioning Authority about such event of default along with their intention to substitute the concessionaire. If the lenders are not able to find the substitute, the Concession Agreement will be terminated, and the lenders would be entitled to the termination payment as per the terms of the Concession Agreement. This might sound simple and easy, but in reality it is un-tested. Though there is a clear and unambiguous right to the Concessioning Authority to terminate the Concession Agreement, there is huge possibility of the same being challenged by the project company and what looks like a simple remedy can become a complicated and a time consuming legal process. Nevertheless, the lenders can rely on the termination payment for recovery of dues (though not full) in PPP projects which are concession based (whether it is a road project, a power project or a port project). This, of course, will depend upon the credit worthiness of the Concessioning Authority which the lenders can take a call on. Therefore, the lenders who have granted the loan for meeting the original project cost of the PPP projects are protected through the termination payment (though short of the entire debt in the concessionaire event of default) and can technically enforce the rights under the Substitution Agreement (i.e., the security).

However, such new lenders, who have given additional loan over and above the original project cost, based on the future cash flows of the project, can land into problems as such lenders are not entitled to receive Termination Payments (unless the original lenders and new lenders agree to share the termination payment on pari passu basis after obtaining prior approval of National Highway Authority of India). In case the lenders are able to find a substitute, the substitute will operate the project and takeover all the outstanding debt obligations of the original concessionaire.


Project Company A is awarded a concession to build, operate and maintain a stretch of National Highway. The project is funded through the combination of equity and debt. The original debt amount is ` 500 crore which is higher than the Total Project Cost under the Concession Agreement. The Total Project Cost under the Concession Agreement is ` 400 crore. The lenders who funded the original debt amount of ` 500 crore get the security of the cash flows and other rights through the Substitution Agreement. On termination of the Concession Agreement due to Company A in the event of default, the termination payment will be limited to 90% of the debt due (i.e., outstanding on the termination date). If the outstanding loan amount on the termination date is ` 200 crore, the lenders will be able to recover only ` 180 crore and the balance amount of ` 20 crore can be recovered from promoters (only if the lenders have obtained some commitment for shortfall from the promoters). If Company A takes an additional loan of ` 400 crore from new lenders on the basis of future cash flows, unless there is an arrangement to share the termination payment on pari passu basis, the new lenders will remain totally uncovered and will not be able to recover any amount.

"Though there is a clear and unambiguous right to the Concessioning Authority to terminate the Concession Agreement, there is huge possibility of the same being challenged by the project company and what looks like a simple remedy can become a complicated and time consuming legal process."


Power Projects:
The security which can be taken in infrastructure projects which are not under PPP mode (such as power projects) and its enforcement is different than that of the PPP projects. The project companies undertaking such projects own tangible assets like the land, the building housing the power plant, plant and machinery, etc. Therefore, the lenders can take the liberty of stipulating each and every security on its template. The enforcement of such security technically is simple as most of the lenders can take benefit under the SARFESI Act and directly take possession of the assets of the power plant and sell it off to recover its outstanding loans without intervention of the courts.

This, however, may not be true in case of hydel, wind or solar power plants. The tangible assets in such power plants are different from that of thermal power plants, and therefore, sale of assets of such plants may be difficult and not practicable. However, if the lenders have taken a pledge of shares of the project company, it would further simplify the enforcement process and the pledge shares can be easily transferred to the prospective purchaser (which will depend upon the interest of the prospective purchasers). The lenders and the prospective purchasers may have to comply with certain provisions of tax laws, stamp laws, FEMA and FDI policy. If the power plant is facing few serious problems (like fuel supply, etc.,) the price which the lenders will be able to fetch from the sale of such power plant may not be sufficient to recover the entire outstanding debt.

Telecom Projects:
The telecom operators do not own many tangible assets apart from the towers and certain other equipment, which may not have any standalone saleable value. Thus, pledge of shares of the operating company as a security becomes important as the prime security for the lenders. Like the substitution agreement in the case of road projects, the Department of Telecommunications ("DoT") enters into a Tripartite Agreement with the lenders giving the lenders a right to substitute the original operator (i.e., the licensee) with a new operator in the event of default.

SEZ Projects:
SEZs have a peculiar problem, since the SEZ Rules, 2006 are silent on transfer of the immovable property of the developer to any other person. This raises a doubt as regards the validity of creation of mortgage or charge in favour of the lenders without obtaining a Letter of Approval or a No Objection Certificate from the Development Commissioner before creation of such mortgage. Though a pledge is taken, the enforcement depends on the approval of the Commissioner as, in terms of the SEZ Rules, a developer cannot sell the land in a SEZ without the permission of the Development Commissioner.

Educational Institutions, Hospitals and Other Social Infrastructure:
The enforcement of the security taken for funding social infrastructure projects will have to be carried out as an ongoing concern. The recovery of debt through enforcement of pledge can only be a proper option in case of social infrastructure project. A decision to enforce tangible security (school, college or hospital building) by the lender can be taken depending upon the operationality of such school, college or hospital so that there is continuity in the social services to the intended beneficiaries of such services.


Disclaimer–the views expressed in this article are the personal views of the author and are purely informative in nature.

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