Equity to Debt Scale in Iranian Legal Framework for Project Finance

Equity to Debt Scale in Iranian Legal Framework for Project Finance

Debt ratios is one of the principal matters in context of the contractual design of investment agreements, especially when it comes to BOTs (Build, Operate and Transfer contracts) and other similar models.

The company in charge of the project, is also the entity responsible for financing and all the necessary process to pave the way thereof, including banking, issuing bonds, signing instruments with third parties and other highways to raise money.

For this purpose, one thing to do is establishing a platform to calculate the scale of invested values in comparison with the values received from financing process plus small sized loans.

Companies decide for each single project what proportion of the finance should be provided by company shareholders. This decision is a bottom line of considering elements like the probable profits, risks and significance of the relevant project.

When the risk is high, the company tends to finance the project at the cost of the shareholders, because banks and other financial institutions are bound with a maximum rate of risk over which they can’t provide finance more than a certain percentage. So it’s commonplace to see a company provide almost half of the whole project financing from the shareholders’ money, whereas in normal cases usually ten percent of whole financing would be provided thereby. In first case, there are consequences of course. When you get more, you give back more.

 

High-Risk Projects and Shareholders Demands

Shareholders expect more profits when you involve them in high-risk projects. On the other hand, third parties always want the company to engage her shareholders more and more. That’s a common assumption that when the shareholders are engaged, the future of the project are brighter, as they are more of an authority to put pressure on directors and operators.

In the case of BOTs, as normally one of the parties is a state-owned company or a public organ, there are binding documents instructing drafters on defining equity to debt ratios. one example of these clauses is read as follows:

“The company is in charge of providing financial resources for the project (for doing so, equity to debt ratio is 30% to 70%, by adding up small-sized loans) as has been articulated in article X (total costs). The company is responsible for repaying all debts and honoring all commitments as much as concern providers of the project finance”.

 

Unexpected Events and Rearrangement of the BOTs

There is another aspect of the BOTs that determines when extra financing is possible. Also one should be noted of unexpected events which may postpone the whole projects. All of these are categorizes as costs further required for rehabilitation of the project. Therefore, certain clauses in the BOTs articulates matters such extra financing, rearranging the time table of the project and transferring all risks and delays to the company if the applicable law hold her responsible. One example of these clauses is articulated as comes below:

“in the case of raising additional costs in result of unexpected events, then the time tables for the Authorization, Construction, Commercial process, Project milestones and charges must be renewed regarding changes and rearranged between parties to cover before mentioned figures”.

It goes without saying that if the parties decide to put an end on the contract because of some unexpected events, then there would be no necessity to rearrange the terms mentioned above and the termination rules of contracts will speak thereafter.

It’s noteworthy that if the unexpected events occur overseas, there will be no choice of termination and the parties are bound to continue their relationship under contract, even if the circumstances remain the same after three months.

If the company present evidence for proving the unexpected events, Tavanir (an organ related to the Iran Ministry of Power) will extend the contractual deadlines so the company could accomplish her commitments.

 

Company Misconduct and Reinstitution

Charges originated from company’s misconducts have to be reinstituted. The company has to reinstitute charges originated from her own misconduct or derogation from the contractual terms. In this context no extension will be granted and rates formerly agreed remains as such and no other change is allowed. In such condition, the company is liable for everything and anything. A clause to this effect would be like this:

“extra financing necessary to make up the postponements or extra charges resulting from mere misconduct of the company, will be imposed upon the company herself and will not be assumed as fees. In this regard, deadlines remain as before, including Construction, Authorization and Commercial process time tables, unless otherwise expressed in this contract for the purpose of termination”.

 

Elements Shadowing Equity to Debt Ratios

1. To some degree, there are always speculations as how market will react to the project in the future. If the third parties who are providing financial resources for the project evaluate the risks and find them quite high, they will request the company to increase company share in the project by the means of equity investment.
2. On the contrary, if the outcome of the project is bought beforehand or public sector is committed to buy the final production, third parties are more than happy if the company choose to increase the debt ratios.
3. One of the model mechanisms for this type of assurance is take-or-pay provisions that are included in a purchase contract and thereby the party is legally bound to pay the price even if he would not be inclined to buy the production afterwards.
4. At the other hand, equity investors demand higher rate of profits, because the priority of receiving the benefits of the project is usually given to the other financers up to the initial amounts plus due interests. Therefore, in the projects that public sector is involved, finding a compromise between these two groups is vital for the public best interests.
5. In assessing the risk of the project, one of the most important factors is the level of country development where the project is running. Less development means higher risks and all other consequences as we discussed above, including financer demands of higher scale of the equity investment and more engagement of the shareholders.
6. In terms of concession contracts which are granted by the country in which the project would be running, some countries request a level of investment by the project sponsors according to their applicable laws. This policy is based on the assumption that more engagement of the project sponsors assures the project will wind up more successfully. Another requirement in some countries is about local entities or individuals to take part in the investment. This strategy in turn will also shadow the equity to debt ratios.