Operation & Maintenance Agreements are contracts between the project company and a professional manager to operate and maintain the project.
Operation & Maintenance Agreements (O&M Agreements) are project finance documents that establish a contractual relationship between the project company and a professional management company to operate and maintain the project.
Operation & Maintenance Agreements fulfill a similar role in the operations phase of the project as EPC Contracts serve in the construction phase. Before the completion of construction, the project company must decide on the operational structure of the project. There are essentially three options.
Project sponsors and project companies who want to strengthen the likelihood of project loan approval should always utilize Operations & Maintenance Agreements to engage a professional operator with the expertise needed to operate the project at the highest level. Even if the project company or project sponsor have the experience to operate the project, they will almost always get better results with third party operators. Without exception, project lenders strongly prefer professional third-party operators. In fact, many project lenders will not approve project financings without Operation & Maintenance Agreements.
Ideally, the operator will be a professional operating company with expertise and experience operating and managing projects which are not dissimilar to yours, in a not dissimilar location. It may be permissible for the operator to be one of the project stakeholders but it is not advisable, because of potential conflicts of interest. It may also be permissible for the project company to operate and maintain the project themselves. Engaging third-party professional operators to perform the work pursuant to Operation & Maintenance Agreements is almost always the right choice.
Properly drafted Operation & Maintenance Agreements are the most effective tool used to mitigate and manage operating risk in project finance.
Operation & Maintenance Agreements (O&M Agreements) are typically short-term contracts, ranging in duration from two to five years, that establish a contractual agreement between the project company and a professional operator to provide operation and maintenance services for the project. They set forth the range of operator’s duties and responsibilities, along with the compensation, which is usually a fixed fee. O&M Agreements also sometimes provide for performance-based fees and conversely liquidated damages for failure to meet required performance benchmarks.
O&M Agreements do not usually require or contemplate the transfer of project employees to the contractor. Instead, the contractor typically adds a layer of management over the existing personnel structure. Some Operation & Maintenance Agreements may also obligate the operator to maintain the project assets, even extending to the cost of routine replacement of small, low-value parts or equipment. Such features require more monitoring to ensure that the outputs are being achieved and usually involve higher onboarding costs.
The most substantial contractual obligation on the part of the operator in Operation & Maintenance Agreements is to operate and maintain the project for the term of the O&M Agreement. Of paramount importance is whether or not the responsibilities of the operator are set forth in sufficient detail. Operation & Maintenance Agreements must address terms such as:
Compliance with operational requirements imposed under the regulatory regime (for example, compliance with environmental controls and local ownership and industry participation requirements) and other project documents.
The description of the operator’s obligations is often complex and requires significant project management and technical expertise to enumerate. A simpler approach is to generally describe the operator’s requirements and relating them to the performance results required by the agreement and including anything else that is necessary and incidental to that performance.
This approach to broadly describe terms that should be technically listed in detail could potentially expose the project company to claims for additional compensation for work beyond the scope of the contract. Thus, care should be exercised when oversimplifying is a possibility. Project Sponsors should engage technical and legal consultants who can properly draft Operation & Maintenance Agreements.
Finally, parties to long-term Operation & Maintenance Agreements should be aware of the possibility that changes will occur that could affect the long-term nature of the operation, such as political regime change or regulatory change. In anticipation of such instances, the operator’s entitlement to relief and additional compensation must be clearly stated in the Agreement. In a perfect world, those entitlements will be balanced by the entitlement of the project company under an offtake agreement or other project documents.
The primary obligation of the project company under an Operation & Maintenance Agreement is to pay the Operator. Payment will be made from project revenues and should be limited to those amounts to the extent practicable. There will probably be other continuing obligations, such as the supply of utilities, fuel, water and other consumables. The O & M Agreement should also provide for any other specific obligations on the part of the project company.
There may be an obligation for the project company to provide the initial spare parts inventory, which should align with the spare parts inventory that is to be provided by the construction contractor under the EPC Contract. There may also be an obligation on the owner created by the Offtake Agreement to maintain records related to the Operator’s compliance with matters that may affect the owner’s payment obligations under the Agreement.
Operation & Maintenance Agreements should also provide payment mechanisms for payment of owner-supplied spare parts, major overhaul expenses, costs arising for work performed by the Operator that are beyond the scope of services described in the Agreement, changes in law and other factors that give rise to necessary adjustments to the payment provisions.
A fully wrapped Operation & Mantenance Agreement is one where all of the obligations and responsibilities for the operation and maintenance of the project are clearly transferred to the operator, and both the project company and the project lenders have a direct line of recourse to the Operator. Assume, for example, that key aspects of the operation and maintenance of the facility (particularly those that may impact on the performance of the facility) will be performed by a third party under a different agreement.
Then the lenders will require a clear allocation and delineation of all obligations and responsibilities for the operation and maintenance of the facility between the parties so there are no gaps where continuing risk or obligations remain with the project company. In project financings, the project lenders will usually require some form of sponsor support if the owner retains significant risk or responsibility for operating and maintaining the facility.
Operation & Maintence Agreements should set forth the operator’s performance obligations, if any. Performance benchmarks typically include items like availability, outages, production levels and other technical, quality, safety and environmental performance criteria. The Agreement should also establish the minimum performance levels that will trigger the owner’s rights to damages or termination under the agreement if they are not met. In some cases, the O & M Agreement may also provide for an upside share mechanism that provides for additional compensation in the event project performance exceeds contractually established levels.
Operation & Maintenance Agreements should reference any performance levels that were achieved by the EPC contractor at handover. Those established levels, adjusted for degradation should establish the baseline of the operator’s performance obligations. For example, for a power project, it is imperative that the technical and legal advisors ensure that the performance testing and performance guarantee and liquidated damages schedules to the agreement are back-to-back with the corresponding schedules to the construction contract.
The O & M Agreement should include provisions that set forth, with as much detail as is practicable, the consequences of a default by the operator in its performance obligations, including liquidated damages or other monetary damages. In most instances, Operation & Maintenance Agreements will specify minimal performance levels below which the operator is deemed to be in default under the agreement, along with the options and remedies which are available to the owner.
Typically, performance requirements include output, availability, outages and other specific performance-related occurrences. The Agreement may also provide for the imposition of liquidated damages if the operator fails to perform to the specified levels. The inclusion of a liquidated damages mechanism under the Agreement is necessarily linked to a limitation of liability clause, which effectively caps the operator’s potential losses in respect of any under-performance by the operator.
Operations & Maintenance Agreements should provide for adjustments in operator’s compensation when the obligations of the operator are extended or reduced during the term of the Agreement. For example, where amounts paid to the operator are based on the operational efficiency of the facility, the Agreement should make allowances for an adjustment in the payment to the operator where the quality of fuel or other consumables falls below the technical criteria specified in the Agreement.
Similarly, the Agreement should provide for an adjustment in the payment entitlements of the operator where there is a material adverse event (such as change in law), which results in the operator being required to perform obligations beyond the obligations enumerated in the Agreement when it was executed.
To the extent that potential future changes in the Agreement can be anticipated at the time the Agreement is executed, provisions that change any fees or payments as a result of the changes should also be specified in the Agreement. To the extent that potential future changes cannot be anticipated the Agreement should provide a mechanism to determine the resulting price adjustment.
In the absence of any such contractual mechanism, the operator will probably be able to resist the imposition by the owner of the obligation to perform the operator’s changed duties. As a result, it is imperative that the owner includes a suitable contractual mechanism in the Agreement to fairly address such changed circumstances.
If the Operator is also a project sponsor the conflicts of interest cannot be ignored. Should this circumstance arise, project lenders are likely to act to ensure the operator cannot use their alter-ego project sponsor position to avoid obligations or obtain concessions under Operation & Maintenance Agreements.
If this arrangement is what’s intended by the project sponsor it should be addressed in the Shareholder Agreement by and between the project stakeholders and in the loan documents. Although this arrangement would severely impact the bankability of the project.
When the operator and the EPC contractor are the same or related entities, the Agreement should prevent one from relying on a delay or under-performance by the other to obtain relief from the owner under their contract. The agreement should also prevent one contractor from relying on the actions of the other as a defense to a claim by the owner for delay or non-performance.
Contract clauses such as these are called no relief and horizontal defenses provisions. These provisions can be included in O & M Agreements, which should also cause them to be included in EPC Contracts as well or otherwise in a separate coordination or wrap agreement that sets out the coordination and interface obligations of the parties in relation to the project.
In cases where the project company’s obligations are largely limited to paying the operator, force majeure provisions should be included in Operation & Maintenance Agreements and should be common to all project finance documents. To the extent such provisions are not aligned, and there are significant gaps in liability which are retained by the project company, it is customary for the project lenders to require some form of sponsor support or guarantee to cover the exposure. The parties to an O & M Agreement should be aware that consequences for a force majeure event during project construction can be severe but are usually manageable because a force majeure event will simply increase construction costs and delay completion.
This risk is minimal and can be allocated among project participants prior to the commencement of the project. Conversely, force majeure events during the operations phase could lead to an insolvent operator. In this event, the operator may not be capable of performing its obligations according to the performance standards in the Agreement. The Agreement should impose an obligation on the party affected by the force majeure event to take all possible steps to overcome the event, including the reasonable expenditure of funds. The failure to perform contractual obligations because of the event, however, will typically prevent such a party from being in default.
Project finance is the lending structure that has financed a great many of the massive infrastructure and sovereign projects in emerging market countries throughout the world.
Project finance was first used in 1299 when an Italian merchant bank provided the project financing to finance the development of English silver mines. England repaid the Italian merchant bank who funded the project with the output from the mines. Project financing has been used to finance thousands of projects since those silver mines, including such notable projects as the Panama Canal and North Sea oil platforms. Our Project Finance Learning Center includes information we hope will improve understanding of this type of finance.
Project finance is not as well understood than it should be due largely to the fact that there is no consensus definition of project finance. Perceptions of what constitutes project financing vary depending on the definition of project finance you first learned. We list three of the most widely accepted definitions below.
A financing of a particular economic unit in which a lender is satisfied to look initially to the cash flow and earnings of that economic unit as the source of funds from which a loan will be repaid and to the assets of the economic unit as collateral for the loan. 1
The raising of funds to finance an economically separable capital investment project in which the providers of the funds look primarily to the cash flow from the project as the source of funds to service their loans and provide the return of and a return on their equity invested in the project. 2
The financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project. 3
We separate the due diligence functions in project finance into two distinct packages. The preliminary due diligence investigation, which is the more affordable of the two segments, is performed more or less coincidentally with the site visit to see your project. The final, comprehensive due diligence package, which is the more expensive of the two, is performed only after your project has received preliminary approval.
The borrower pays for both investigations. The borrower also pays for the cost of the site visit for two of our senior managing partners, and one senior staff person, along with all related expenses.
Review Project Finance Due Diligence for additional information.
What is the due diligence process in a project financing? Scott Schaefer 2022-02-07T11:49:54-05:00 What is the due diligence process in a project financing?Before we submit a project finance loan request or documents to our financial partners, we perform a preliminary due diligence investigation. While not the final, comprehensive due diligence that will be required if the deal continues forward, the preliminary due diligence investigation is intended to uncover any sponsor or project deficiencies that would hinder the closing of the project financing.
We will verify the Sponsor’s reputation, financial strength, and relevant experience. We will verify the quality and sufficiency of the project documents (at least those that have been prepared to date), and we will analyze the project and property in tandem with our site visit. Our Preliminary Due Diligence Report will be prepared after the site visit and provided to the lenders.
Review Project Finance Due Diligence for additional information.
Is the borrower required to have equity in the deal? Scott Schaefer 2019-06-30T15:10:56-04:00 Is the borrower required to have equity in the deal?Yes. We require actual cash equity in the deal. All project finance lenders, project finance arrangers and project finance providers require the borrower to have equity in the deal. We have never funded a project financing with less than 10% equity, and then only once in the last decade. The average project financing last year closed with 63% debt and 37% sponsor equity.
Project finance is not speculation. It was developed more than 700 years ago as a method of financing that is specifically intended to mitigate or eliminate risk. In fact, almost every element and procedure in project finance are for risk mitigation. For every project finance transaction closed there are more than 20 applications because project finance lenders are extremely careful about taking risk. Deals with no equity don’t get funded and deals with very little equity stand very little chance. For additional information see
We perform enhanced due diligence on all project stakeholders with an emphasis on project sponsors. The due diligence investigations are mandatory and project finance underwriting cannot be completed until all of the due diligence has been implemented. We have a form for project sponsors which is furnished at the start of underwriting. Due diligence investigations are performed by a third party service with whom we have an agreement for discounted investigative fees and you are only responsible for the actual fee.
When does due diligence occur? Rhonda Schaefer 2022-02-07T11:32:36-05:00 When does due diligence occur?Before we submit a project finance loan request or document package to one of our financial partners, we perform a preliminary due diligence investigation. It’s not the comprehensive due diligence that will be required if the deal continues forward, the preliminary due diligence investigation is intended to uncover any sponsor or project deficiencies that would hinder the closing of the project financing.
We will verify the sponsor’s reputation, financial strength, and relevant experience. We will verify the quality and sufficiency of the project documents (at least those that have been prepared to date), and we will analyze the project and property at about the same time as our site visit. Our Preliminary Due Diligence Report will be completed after the site visit and provided to the lenders with the loan application and project finance documents.
Review Project Finance Due Diligence for additional information.
Will you invest financially in my project? Scott Schaefer 2019-06-27T10:24:39-04:00 Will you invest financially in my project?If the lenders do not appoint us as loan supervisors we may join the lending syndicate.
Accounts Receivable is money owed to a company by a customer for products and /or services sold. Accounts receivable is considered a current asset on a balance sheet once an invoice has been sent to the customer.
Accounts Receivable Factoring is a method of Trade Financing where a company sells their accounts receivable in exchange for working capital. The purchaser of the receivables relies on the creditworthiness of the customers who owe the invoices, not the subject company.
Advances Against Documents are loans made solely based on the security of the documents covering the shipment.
Asset Based Lending is a method of Trade Financing that allows a business to leverage company assets as collateral for a loan. Asset-based loans are an alternative to more traditional lending which is generally characterized as a higher risk which requires higher interest rates.
Cash Against Documents is the payment for goods in which a commission house or other intermediary transfers title documents to the buyer upon payment in cash.
Payment for goods in which the price is paid in full before shipment is made. This method is usually used only for small purchases or when the goods are built to order.
Cash with Order is the payment for goods whereby the buyer pays when ordering and in which the transaction is binding on both parties.
Commercial Finance is defined as the offering of loans to businesses by a bank or other lender. Commercial loans are either secured by business assets, accounts receivable, etc., or unsecured, in which case the lender relies on the borrower’s cash flow to repay the loan.
A Confirmed Letter of Credit is a Letter of Credit issued by a foreign bank, which has been confirmed as valid by a domestic bank. An exporter whose form of payment is a Confirmed Letter of Credit is assured of payment by the domestic bank who confirmed the Letter of Credit even if the foreign buyer or the foreign bank defaults.
Consignment is a delivery of merchandise from an exporter (the consignor) to an agent (the consignee) subject to an agreement by the agent that the agent will sell the merchandise for the benefit of the exporter, subject to certain limitations, like a minimum price. The exporter (consignor) retains ownership of and title to the goods until the agent (consignee) has sold them. Upon the sale of the goods, the agent typically retains a commission and remits the remaining net proceeds to the exporter.
Service For details go to Consignment Purchase »
A Cross-Border Sale refers to any sale that is made between a firm in one country and a firm located in a different country.
Factoring is the selling of a company’s invoices and accounts receivable at a discount. The lender assumes the credit risk of the debtor and receives the cash when the debtor settles the account.
Invoice Discounting is a type of loan that is drawn against a company’s outstanding invoices but does not require that the company give up administrative control of those invoices.
factoring invoices is one of the most common methods of trade financing. Your company sells their invoices to a factor in exchange for immediate liquidity. The factor who purchases the invoices relies on the creditworthiness of the customers who owe the invoices, not the subject company.
Service For details go to factoring invoices »
Irrevocable Letter of Credit is a Letter of Credit in which the specified payment is guaranteed by the bank if all terms and conditions are met by the drawee.
Letter of Credit or LC is the most common trade finance solution in the world. A Letter of Credit is a document issued by a bank for the benefit of a seller or exporter, which authorizes the seller to draw a specified amount of money, under specified terms, usually the receipt by the issuing bank of certain documents within a given time.
Open Account is a trade arrangement in which goods are shipped to a foreign buyer without guarantee of payment. The obvious risk this method poses to the supplier makes it essential that the buyer’s integrity be unquestionable.
Service For details go to Open Accounts »
Pro forma Invoice is an invoice provided by a supplier prior to the shipment of merchandise, which informs the buyer of the kinds, nature and quantities of goods to be shipped along with their value, and other important specifications such as weight and size.
Receivable Management involves processing activities related to managing a company’s accounts receivable including collections, credit policies and minimizing any risk that threatens a firm from collecting receivables.
Revocable Letter of Credit is a Letter of Credit that can be canceled or altered by a buyer after it has been issued by the buyer’s bank.
Structured Trade Finance is cross-border trade finance in emerging markets where the intention is that the loan gets repaid by the liquidation of a flow of commodities.
Trade Credit Insurance is a risk management product offered to business entities wishing to protect their balance sheet assets from loss due to credit risks such as protracted default, insolvency, and bankruptcy. Trade Credit Insurance often includes a component of political risk insurance, which ensures the risk of non-payment by foreign buyers due to currency issues, political unrest, expropriation, etc.
› EPC Contract
› O&M Agreement
› Loan Agreement
› Offtake Agreement
› Supply Agreement
› Intercreditor Agreement
› Tripartite Deed
› Common Terms Agreement
› Concession Deeds
› Shareholder Agreement
The project company is the actual owner of the project. In project finance, which is off-balance-sheet financing, the project company must be a newly formed entity with no history, known as a Special Purpose Entity (SPE) or Special Purpose Vehicle (SPV).
The project sponsor is the individual or company that is organizing the project and has chosen the project finance, off-balance-sheet method of financing. If this were corporate finance or real estate finance the project sponsor would likely be referred to as a syndicator.
The project finance provider is the firm that is responsible for arranging the project finance loan and performing all of the work that is required to arrange and close the loan, such as preparation of the project documents. This is not the project finance lender.
Project financings typically involve very large amounts of money. The Project Finance provider arranges the project loan from the project lender or lenders, depending on the amount. But, because project finance is off-balance sheet financing, project lenders usually require the investment of substantial equity in the project. Project sponsors typically involve equity investors to spread the required capital and to share in the project risk. Equity investors may also stakeholders already and have a vested interest in the success of the project.
Project lenders provide most of the capital needed for project finance. Project lenders tend to be commercial banks, investment banks and even hedge funds. Regional development banks can also be project lenders.
Multilateral agencies are established by intergovernmental agreements to promote international and regional economic development. They can provide direct lending, political insurance to other lenders and even equity participation. They focus on projects in emerging markets and focus on socio-economic developmental rationale not just economic viability of a project.
Export credit agencies (ECAs) historically more relevant for financing projects in emerging markets due to the political risk cover obtained by commercial lenders who needed cover. This has changed in the wake of the global financial crisis, ECA finance is now a major source of global project lending.
The construction contractor for the project, who is also frequently referred to as an EPC Contractor enters into a contract with the project company to build the project. The construction contract usually takes the form of an EPC Contract, which is short for Engineering, Procurement and Construction Contract.
The O&M Operator is a management company or operator who contracts with the project company in a document known as an Operation & Maintenance Agreement to operate, maintain and manage the project for a fee for a fixed period of time, usually 2 to 5 years, but it can be longer.
Offtakers in project financings are buyers of the resources produced by completed and operating projects. Offtakers contractually agree in an Offtake Agreement to purchase all or substantially all of the future production from the project. Offtake Agreements are negotiated prior to the development of the project which will become the means of production of the resources being sold to the Offtaker. When projects produce resources like electrical power or natural gas, Offtakers are vitally important to their success. They lock-in a significant amount of future revenue and allow the project company to account for recurring sales and profits for many years into the future.
African Development Bank
Asian Development Bank
European Bank for Reconstruction and Development
European Investment Bank
Inter-American Development Bank
Inter-American Investment Corporation
International Finance Corporation
International Monetary Fund
Multilateral Investment Guarantee Agency
Nordic Investment Bank
United Nations Development Program
World Bank Group
In addition to being non-recourse financing, it is also off-balance-sheet financing. In project finance transactions the borrower is a stand-alone project company which is known as a special purpose entity. Special purpose entities are sufficiently minority subsidiaries whose balance sheets are not consolidated onto the balance sheets of the project sponsors or shareholders.
This has the effect of reducing the impact of the project on the shareholder’s existing debt and on the shareholder’s debt capacity, allowing the shareholders to use their debt capacity for other investments.
Government entities and organizations can also use project finance to keep project debt and liabilities off-balance-sheet, relieving pressure on increasingly stressed fiscal space. Fiscal space indicates the debt capacity of a sovereign entity and is a function of requirements placed on the host country by its own laws, or by the rules applied by supra- or international bodies or market constraints, such as the International Monetary Fund (IMF) and rating agencies.
Unparalleled underwriting expertise uniquely positions us to identify financing obstacles and improve deal structure to minimize risk and attract lenders. Then we present an optimized loan package to our worldwide network of lenders and investors resulting in project finance with the best terms and least risk in the industry.
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Liquidated damages are monetary compensation for a loss, detriment, or injury to one party to an agreement, awarded by a contract provision regarding breach of the agreement. Contracts or agreements that involve the exchange of money or the promise of performance, such as O&M Agreements, often contain a provision for liquidated damages. The purpose of a liquidated damages provision is to establish a predetermined amount that must be paid if a party to a contract fails to perform as agreed. Liquidated damages can be assessed in a contract only if (1) the injury is either uncertain or difficult to quantify; (2) the amount is reasonable and considers the actual or anticipated harm caused by the contract breach, the difficulty of proving actual loss, and the difficulty of finding another, adequate remedy; and (3) the damages are structured to function as damages, not as a penalty. If these criteria are not met, a liquidated damages clause will be void.
A penalty is a sum that is disproportionate to the actual harm. It serves as a punishment or as a deterrent against the breach of a contract. Penalties are granted when it is found that the stipulations of a contract have not been met. For example, a builder who does not meet his or her schedule may have to pay a penalty.
Liquidated damages, on the other hand, are an amount estimated to equal the extent of the injury that may occur if the contract is breached. Liquidated damages are determined when a contract is negotiated, and serve as protection for both parties that have entered the contract, whether they are the owner or operator or other similar parties. The principle of requiring payments to represent damages rather than penalties goes back to the Equity courts, where its purpose was to protect parties from making unconscionable bargains or overreaching their boundaries. Today section 2-718(1) of the Uniform Commercial Code deals with the difference between a valid liquidated damages clause and an invalid penalty clause.
Liquidated damages clauses possess several contractual advantages. First, they establish some predictability involving costs, so that parties can balance the cost of anticipated performance against the cost of a breach. In this way, liquidated damages serve as a source of limited insurance for both parties. Another contractual advantage of liquidated damages clauses is that the parties each have the opportunity to settle on a sum that is mutually agreeable, rather than leaving that decision up to the courts and adding the costs of time and legal fees.
Liquidated damages clauses are commonly used in O&M Agreements. For the operator, a liquidated damage clause limits their loss if they default. For the owner, they provide a preset amount in a timely manner if the operator defaults.