It is a frequent refrain in negotiations on construction projects that the terms of a contract are not "bankable". In this alert, we consider issues relating to 'bankability', and why those issues warrant early consideration by developers, contractors and lenders.
What is bankability?
Bankability: this rather nebulous term is often used in negotiations to justify tougher contractual terms for a contractor, frequently without any further explanation as to why this may be the case - so what does it mean?
In essence, a project is bankable if lenders (traditionally banks, but increasingly other entities also) are willing to provide finance to the project. To ascertain the bankability of a project or a contract, lenders must take into account its technical, financial and legal characteristics. What this means for a construction contract varies depending on the sector and the nature of the works being undertaken, and whilst comparison to previous deals can be a useful guide, in practice, bankability will be different for each individual project.
It is challenging therefore to specify in the abstract what will be required to ensure bankability, but certainly, early consideration of relevant issues can speed up negotiations and avoid difficult discussions by removing last minute changes demanded by lenders. Even where the initial construction is not to be debt financed, it is valuable to consider these factors to avoid having to revisit the terms, if financing is put in place at a later stage.
In this alert, we explore some of those key themes of bankability and common ways in which it will apply to a construction contract so they can be considered right at the outset of negotiations.
Bankability: relevant factors
Amongst the contractual suite required for a complex project, such as a power plant or infrastructure development, the construction contract can represent the largest expenditure with therefore the largest potential to cause increased costs or delays to the project becoming operational. As lenders will provide finance to a project in different ways and in different circumstances, the nature of bankability and the factors to be considered in its assessment will differ.
Some examples of relevant factors are as follows:
On non-recourse lending, where debt repayment is dependent on the revenue stream from the project, key issues are potential delays to operational availability, reductions in planned performance or unexpected cost increases - all of which could significantly affect the availability of cash to make these repayments. Lenders will want to assess potential exposure in these areas and the contractual protection in place. Any entitlement for a contractor to claim relief or costs for force majeure, unforeseen ground conditions, changes in law etc. and also the inclusion of significant provisional sums. These factors can all adversely affect the availability of cash to the borrower and alter the financial analysis of the project. Where multiple contractors are involved, lenders will require comfort on how disputes and interfaces will be managed, and if there is a gap...