Typical security package in a project finance transaction

Security in a project finance transaction is particularly important because the borrower is typically a special purpose entity which is set up specifically to develop and operate the project. In such cases, the borrower will have no credit history and its only assets are likely to be the project assets.

Some of the reasons for taking security in a project finance transaction include:

• • giving the project lenders priority over unsecured creditors of the borrower (typically the project company);
• • giving the project lenders a better chance of recovering their money in an insolvency scenario;
• • giving the project lenders the right to appoint a receiver or administrator if certain conditions are met; and
• • providing a way for the project lenders to control the borrower’s and any other security provider’s assets.

This guidance note outlines the key assets of a project, looks at what to consider when putting together a security package for a project finance transaction, and overviews the types of security in a project finance transaction. Guidance is also provided on possible alternatives to taking security, and matters relating to onshore and offshore security.

See Typical security package in a project finance transaction.

Taking and registering security over assets relating to the project — real property

Land (or real property) is commonly offered as security for a loan. This is the case for project finance transactions where the project site represents a significant proportion of the borrower’s assets.

Generally, security in respect of land extends to fixtures that form part of the land, unless the contrary is expressly provided for.

This guidance note explains some key matters relating to taking security over land located in Australia in a project finance transaction, including matters relating to creating a legal mortgage and an equitable mortgage over land. Guidance is also provided on key provisions of a mortgage over land in a project finance transaction, including key covenants and common representations and warranties.

See Taking and registering security over assets relating to the project — real property.

Taking and registering security over assets relating to the project — personal property — selected examples part 1, part 2 and part 3

Other than real property, key assets of a project includes various personal property. In short, personal property is any form of property, other than land or a right or entitlement under a Commonwealth, state or territory law that declares that the right or entitlement is not personal property for the purposes of the Personal Property Securities Act 2009 (Cth) (PPS Act).

The PPS Act is a law about security interests in personal property, and the operation and application of the PPS Act is very relevant in project finance transactions. A personal property security is created when a secured party, such as a project lender, takes an interest in personal property of a grantor, such as a project company as borrower, as security for a loan or other obligation, or enters into a transaction that involves the supply of secured finance (project finance is a type of secured lending).

Part 1 of this three-part guidance note overviews the taking and perfecting of a security interest over shares and a security interest over bank accounts. Part 2 overviews the taking and perfecting of a security interest over contractual rights and a security interest over receivables. Part 3 overviews the taking and perfecting of a security interest over a project company’s assets by way of a general security deed.

See Taking and perfecting security over assets relating to the project — personal property — selected key examples part 1.

See Taking and perfecting security over assets relating to the project — personal property — selected key examples part 2.

See Taking and perfecting security over assets relating to the project — personal property — selected key examples part 3.

How to register real property security at state-based land titles office

In most cases, a legal mortgage will have priority over an equitable mortgage, even if the equitable mortgage is prior in time, provided the legal interest was taken in good faith, for value and without notice. This is a key reason why project lenders will prefer a legal mortgage over an equitable mortgage.

A legal mortgage is a mortgage that complies with all of the requirements imposed by common law and by statute for the creation of a mortgage. Importantly, under the Torrens system, a mortgage is not only required to be in writing and signed by the mortgagor, but it is also required to be registered. This guidance note explains what is the National Mortgage Form and the role of PEXA, and provides State and Territory specific guidance relating to how to register a mortgage over land in Australia.

See How to register real property security at state-based land titles office.

How (and when) to register personal property security on the Personal Property Securities Register

A security interest will have its best possible priority position, will be least likely to be lost on a disposal of the collateral, and should resist vesting in the grantor on its insolvency, if the security interest is “perfected” in accordance with the PPS Act. Registration on the Personal Property Securities Register (PPS Register) is the most common manner in which perfection is completed.

This guidance note considers some key rules relating to how and when to make registrations on the PPS Register that are of particular relevance or importance in project finance transactions.

See How (and when) to register personal property security on the Personal Property Securities Register.

Determining priority in real property security

In addition to ensuring its personal property security has been validity created, a project lender will want to ensure its security ranks as it expects against any other competing security interests. Disputes as to priority arise less commonly than might be expected due to the use of documents such as deeds of priority and inter-creditor agreements. However, these are only of use if the creditors are aware of each other’s security interests and agree on whose interest should take priority. Where there is no contractual agreement, the general law as to priority will apply.

This guidance note answers the question “why is it important to determine priority between competing security interests”? It goes on to consider the rules which determine the priority of competing security interests in real property where the holders of those interests have not specifically agreed an order of priority among themselves by contract, such as the first in time rule for competing registered interests.

See Determining priority in real property security.

Determining priority in personal property security

Similarly, in addition to ensuring its personal property security has been validity created, a project lender will want to ensure its security ranks as it expects against any other competing security interests.

This guidance note considers the rules which determine the priority of competing security interests in personal property where the holders of those interests have not specifically agreed an order of priority among themselves by contract. It considers, among other things, the ”default” priority rules in the PPS Act and how the rules apply in a project finance transaction, and explores some specific scenarios in terms of determining priority in a project finance transaction.

See Determining priority in personal property security.

Managing priority arrangements between security interests

The order of priority between competing security interests determines the order in which each of the secured creditors can claim and be paid out on the secured property in an enforcement or insolvency scenario. This makes priority something very important in the context of a project finance transaction, where for eg, the project lenders would want to be a higher-ranking (or the highest-ranking) creditor.

This guidance note considers the contractual arrangements that can be put in place for managing priority as between security interests in a project finance transaction, in particular, regarding the use of an inter-creditor agreement. It also explains the role of a deed or priority and a subordination agreement. Importantly, legal practitioners should note that the PPS Act refers to priority agreements for security interests subject to the PPS Act as "subordination agreements". This guidance note explains this, as well as discusses the relevant model documents that legal practitioners may choose to utilise in a project finance transaction.

See Managing priority arrangements between security interests.

Enforcing security over real property

Enforcement is an important matter to consider. If a borrower cannot meet its obligations under a loan agreement, lenders will need to consider the options available to them in enforcing their security. For eg, project lenders would want to be able to access the project assets so that on enforcement, they can for eg, sell the project as a going concern.

It is important to recognise that for many project lenders, taking enforcement action often is seen as a last resort. A project lender would often first consider the following options:

• • refinancing, for eg, having the borrower pay off the existing loan, then enter into a new loan that has more favourable repayment conditions and/or less onerous interest rates for the borrower;
• • restructuring, for eg, making changes to the borrower’s operations so its business run more effectively and profitably so that repayment of the debt becomes more likely; and
• • the project lender or another party providing additional financing in return for further security being granted by the borrower.

Further to these points, in this guidance note, legal practitioners will find guidance regarding two main issues that a project lender should consider before enforcement, being the possibility of a consensual sale, and the validity of security. Importantly, with regards to enforcing security over real property, this guidance note explores the concept of default in mortgage enforcement, and provides an overview of the typical mortgage enforcement process.

See Enforcing security over real property.

Enforcing security over personal property

Enforcement under the PPS Act is the key focus of this guidance note. Chapter 4 of the PPS Act contains rights and remedies of enforcement of security interests on the default under a security agreement, such as a general security deed (GSD) in a project finance transaction. This means a GSD or other security agreements do not need to include these remedies as parties to the agreement can instead rely on the Ch 4 enforcement provisions in the PPS Act.

Generally, under Ch 4, on the default of a grantor under a security agreement, the secured party can commence enforcement action, and the first step in enforcement is for the secured party to seize the collateral. If a secured party has a security interest that is subordinate to another security interest in the collateral, the secured party with the higher priority security interest is entitled to seize the collateral from the subordinate secured party. Having seized and obtained possession of the collateral, the secured party may either dispose of or retain the collateral.

While Ch 4 of the PPS Act includes enforcement provisions dealing with seizure, disposal and retention of collateral, parties in a project finance transaction can contract out of specified provisions of Ch 4: s 115, PPS Act. This, as well as rules that apply after enforcement under the PPS Act, and the effect of insolvency on personal property security, are explored in this guidance note.

See Enforcing security over personal property.

The role of guarantees and comfort letters in a project finance transaction

Guarantees (which often include indemnity provisions) are typically used in finance transactions (including project finance transactions) as a form of collateral for a debt. In such circumstances, they are a contractual arrangement where one party (the guarantor) agrees to answer for the liability of another party (the principal) to another party. They do not create rights over property. In this context, guarantees are characterised as quasi-security.

On occasions where a lender is not able to obtain a guarantee, comfort letters are often used. Comfort letters are generally intended to be non-legally binding, however, in certain cases, they may contain features that indicate that they are legally binding.

This guidance note explores the use of guarantees and indemnities and comfort letters in a project finance transaction. See The role of guarantees and comfort letters in a project finance transaction.