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Project Financing In India

By Tanuj Sud
Posted: 2nd November 2012 09:56
Introduction – Macro Economic Considerations/Initiatives for Project Finance:
With a Gross Domestic Product (GDP) averaging around 6-8% in the recent past, and growth prospects enhanced by progressive liberalisation and a relatively stable political and financial system, capital inflow and mobilisation in India continues to present opportunities for maximising benefits accruing to investors and developers alike.  Despite a brief slowdown, the Indian infrastructure sector, which has in the not too distant past witnessed wide-ranging and far reaching policy initiatives, such as setting up of dedicated Infrastructure Development Fund, duty exemptions for import of certain capital equipment and reduction of withholding tax on interest servicing for foreign currency borrowings, continues to attract significant levels of funding.
Overview of Project Financing:
Funding of infrastructure projects, a fair majority of which are implemented on public private partnership basis, requires careful planning (often entailing significant investment of time and resources at the planning and conceptualisation stage) and closely supervised implementation.  Financiers typically commit funds to projects that have clearly identifiable and definite revenue streams.  Projects in India are typically financed on non-recourse or limited recourse basis where lenders have no (or limited recourse) to the sponsors since the projects are implemented through special purpose vehicles.
Project financing structures in India are not too different from those prevalent internationally and generally entail funding the project through debt and equity contribution (which could be in the form of pure subscription to equity share capital or through hybrid instruments such as preference shares and subordinated debt) from the sponsors in a special purpose vehicle.  In addition to primary security and collateral (such as mortgage of immoveable properties and pledge of shares), one of the principal recourse of the financiers is to the cash flows of the project which are typically routed through a trust and retention account and utilised in accordance with a contractually defined sequence and priority.  Lenders typically also have a charge on such trust and retention account in order to be able, in an event of default, to freeze the accounts and appropriate requisite monies therefrom.
Key Considerations:
Though project financing continues to grow in India, there are several considerations (commercial as well as legal), other than the overall political and force majeure risks (that may vary across projects depending, inter alia, on the location thereof), that need to be borne in mind by financiers and borrowers alike.  Pricing of the debt component, for instance, may vary across different lenders as, even though banks are required to price their loans with reference to their base rates, there is some discretion available as to the methodology that banks may use to arrive at their respective base rates which consequently affects the cost of debt.  Spreads also differ across banks based, inter alia, on their appraisal parameters such as track record and creditworthiness of the sponsors.  Needless to mention, financiers tend to be most concerned about, and thoroughly assess, the viability of projects before committing resources and usually follow strict appraisal norms.  The nature of the project, assets being offered as security, status of obtainment of various statutory permissions, consents and clearances therefore feature as key issues in preliminary discussions.
Some of the key constraints facing infrastructure projects are timely obtainment of clearances and smooth land acquisition.  Environmental clearances, for instance, which typically follow a feasibility study called Environmental Impact Assessment, can take upto 12 months to be accorded from the date of assessment of the viability, from an environmental perspective, of the project.  Similarly, land acquisition can be a tedious and cumbersome process with various Governmental agencies/departments to be dealt with and compensation, which in certain cases goes up to several times the actual cost of the land (usually calculated on a pre-historic basis), being one of the most frequently and extensively litigated subjects.  Further, issues surrounding rehabilitation and resettlement of displaced individuals and families also have to be taken into consideration while determining the merits and bankability of a project.  Apart from the foregoing, availability of inputs (such as fuel for thermal power projects) and procuring state support (both at pre-construction and post-construction stages) may also serve as challenges.
Security for funding of infrastructure projects:
Often, identifying the most appropriate assets to be secured and determining the manner in which to effectuate such security creation can be important considerations as stamp duty (in the nature of a fiscal payment to the revenue authorities) varies from state to state and can sometimes be extremely high.  For example, instruments like those pertaining to assignment are usually chargeable with stamp duty on ad-valorem basis with reference to the amount secured.  Whilst a bouquet of securities and collateral (such as pledge, guarantee and hypothecation of moveable assets, mortgage of immoveable assets) is usually available, and obtained by financiers, for infrastructure projects, it is imperative for the financiers to reserve step-in and substitution rights(1) whereby they can, in the event of default in implementation of the project, either compel the counterparties to project contracts to perform their respective obligations (relating to construction and/or operation and maintenance) towards the financiers or substitute/cause the substitution of the borrower and have the project executed through another entity.  This typically requires assignment of rights of the borrower under project contracts to be assigned in favour of the financiers.  Given that assignment is chargeable with ad-valorem stamp duty (under the head ‘conveyance’) in most state stamp legislations, innovative contractual structures such as agreement to assign (coupled with a power of attorney) and rolling in assignment with English mortgage (chargeable under the head ‘Mortgage Deed’, which is subject to a cap in most state stamp legislations), which is symbolic of, and subsumes, conveyance are sometimes used.
Enforcement and Recovery Process:
Whilst there are various special legislations, such as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, designed to facilitate efficient and smooth recovery by providing (in certain cases) for enforcement of security interest without the intervention of courts, taking possession of secured property and disposing off the same can be challenging in view of protracted proceedings before relevant judicial fora and Governmental authorities and multiple claimants say, for instance, in a liquidation scenario.  The cost of engaging in enforcement proceedings vis-à-vis the benefits accruing from enforcement (with realisation not always being proportionate to the outstanding amounts) also tend to be deterrents for financiers contemplating taking such action.  Owing to fairly streamlined (some view this as strict) provisioning norms applicable to banks, corporate debt restructuring has emerged as an option that financiers are willing to explore as reschedulement and repackaging of loans confers a degree of flexibility on borrower companies and, in certain cases, corporate debt restructuring has resulted in better servicing of loans.
Despite some of the constraints highlighted above, in view of the growing economy (as reflected by the GDP) and the strong demand for robust infrastructure, project financing in India has been, and will continue to be, on the upswing in the foreseeable future and there is enough available in the pie for financiers and developers alike, who harbour a long-term vision, to benefit in the long run.

Khaitan Sud & Partners, Solicitors & Advocates is a leading full-service law firm in India with principal offices in New Delhi, Mumbai and Bengaluru.  The Firm is renowned for its litigation, project finance, infrastructure and banking, insurance and corporate and commercial practice and is continuously expanding the multi-jurisdictional reach of its services with a view to provide seamless and quality cross border legal services to meet client needs.  The Firm thrives on a solution based approach and has extensive international capabilities across all its verticals along with the ability to call upon global expertise where required. 
Mr. Tanuj Sud is a Partner at Khaitan Sud & Partners, Solicitors & Advocates.  His area of focus is Project Finance, Infrastructure and Banking.  Mr. Sud completed his Bachelor of Laws (LL.B.) from Cardiff University, United Kingdom and his B.A. (Hons.) Economics from Delhi University. He has previously worked with Dua Associates and SJ Berwin LLP.  Mr. Sud regularly advises various banks and financial institutions in connection with their financing of various infrastructure and non-infrastructure projects. Mr. Sud renders advice on strategic acquisitions and joint venture transactions and has also been involved in advisory work relating to foreign exchange laws, corporate laws and acquisitions/mergers.

(1) This may not be available (or be available in a limited pre-defined fashion) in some projects such as those in the highways sector.

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