Note: Darin Lowder and Sunita Paknikar discussed this article on a recent episode of the Powered by Foley podcast. Click here to listen.
Construction financing is used to fund the construction of renewable projects prior to such projects obtaining long-term financing. Because construction loans are disbursed during a high-risk phase of a project, these loans carry different terms, pricing and conditions than subsequent longer term financing facilities. Negotiating construction loan agreement terms and provisions are therefore crucial in mitigating risk from both a Lender’s and a Borrower’s perspective. Parties negotiating construction loan agreements typically focus on these ten common areas:
- Lending Mechanics
- Conditions Precedent
- Representations and Warranties
- Affirmative and Negative Covenants
- Events of Default
- Lender Remedies
Each area is described in further detail below.
Certain definitions in the construction loan agreement are often highly negotiated. Key definitions include Change of Control, Debt Sizing, Material Adverse Effect, Maturity Dates, Project Costs and Revenues, and Required Lenders.
It is important for construction loan agreements to provide specific information on how the credit facility works, such as debt sizing parameters, the repayment dates for both principal and interest, and a roadmap to security interests, including the scope and termination of the security interests (for example, project-level security dropping away at the conversion of a financing from a construction to a term loan facility).
The interest provisions
Prepayment provisions typically provide for the ability to make (a) optional prepayments and any related additional fees or costs, and (b) mandatory prepayments for the loss of PPAs or for solar resource impairment events (such as shading) or other permanent revenue reductions.
The description of security interests should describe the collateral for the loan, such as the project level collateral (including security interests in real property such as mortgages), account collateral, and pledge of borrower party membership interests.
The conditions precedent specific to borrowing include the project construction status and diligence items, such as construction budget and timeline. If term loans are also contemplated in the same loan document, conditions precedent to term conversion typically address project completion deliverables such as a substantial completion certificate.
Representations and Warranties
Representations and warranties are borrower statements made at credit events, including the closing, funding and conversion. Examples of representations and warranties for borrower entities and related entities include no default and compliance with laws and regulation, while business related statements include conduct of business and taxes, and project related statements include permits and project documents.
Affirmative and Negative Covenants
Affirmative Covenants within construction agreements are promises to do something that reinforces contract compliance, such as reporting, the delivery of financial statements, and providing construction budgets and schedules. Negative covenants are promises to avoid actions to weaken commitments to the contract, such as not incurring liens, not making distributions without meeting various conditions, not amending or entering into project documents without lender consents, and not selling assets.
Events of Default
Events of immediate default
Lenders should also address potential events of default through various means within construction loan agreements, including provisions for no further loans, acceleration, exercising rights and remedies under collateral documents during and/or after construction, real property foreclosure, and remedies subject to a tax equity interparty agreement.
For more information on the top construction loan provisions, click here.