PART II PROJECT PREPARATION AND STRUCTURING
CHAPTER 3 RISK IDENTIFICATION AND DUE DILIGENCE
C. SPECIFIC DUE DILIGENCE ISSUES
In recent years several issues have emerged that often require more focused due diligence. They are:
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1. ENVIRONMENTAL, SOCIAL, AND COMMUNITY RELATIONS ISSUES
Environmental and social issues have emerged as one of the most crucial due diligence areas for major project financings. It has become common for projects to be questioned, delayed and even cancelled because of potential impacts on the environment and/or communities likely to be affected by the project. This means that sponsors, their lawyers, and other advisors must be prepared to devote substantial time and resources to identifying and mitigating the expected environmental and social risks of a project. In addition, the lawyer should ensure that the sponsors and other participants are aware of these issues and undertake extensive consultations with the local communities affected by the project to obtain their input before proceeding. Some law firms and other advisory firms have created teams of specialists in environmental and social risk assessment and mitigation which can assist in both due diligence and project implementation. Issues that may need investigation include:
• environmental laws and regulations of potential application, including home and host country laws and regulations; applicable international treaties; and lender regulations and requirements (e.g. multilateral development bank and export credit agency guidelines and the private sector Equator Principles);
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• review of all environmental impact assessments made in connection with the project;
• various “soft law” guidelines, including the Equator Principles, OECD and UN Codes of Conduct;
• the nature of the consultation with the communities most directly affected by the project to assess whether “free, prior, informed consent” has been obtained;
• the nature and extent of any greenhouse gas emissions or other impacts that contribute to climate change;
• site and right-of-way acquisition problems due to farmer, tribal, or other opposition;
• water rights issues, including protection of riparian rights, flooding, and pollution;
• impact on indigenous tribal lands and customs, including hunting, fishing and growing rights, spiritual sites, and weather pollution;
• endangered species issues; and
• social and compensation issues relating to the relocation of peoples.
2. CORRUPTION
In recent years there has been increased enforcement of anti-corruption laws and codes of conduct which means that corruption and bribery
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issues have become a growing part of project finance due diligence. The US Department of Justice and the US Securities and Exchange Commission have been especially aggressive in enforcing the US Foreign Corrupt Practices Act (or FCPA) that applies to the worldwide activities of any foreign company (and its officers in their individual capacity) with securities publically traded in the US. In addition, the 2011 UK Bribery Act applies to the worldwide activities of any firm that does business in the UK and also covers commercial bribery (e.g. the payment of bribes to agents of private companies) as well as bribery of public officials. Individual country laws are supplemented by two major “soft law” codes of conduct promulgated by international organizations: the UN Convention Against Corruption and the OECD Convention on Bribery of Officials in International Business Transactions (with accompanying guidelines for adequate compliance procedure).
The large number of parties and contracts in a typical project finance transaction creates many opportunities for corruption at various stages of the project. This means that compliance lawyers need to look carefully at each phase (e.g. the bidding and bid
evaluation process, the award of the concession, the EPC contracts and the various sub- contracts, and the licensing and permitting process). The worldwide scope of the US and UK laws, the fact that the UK law applies to private actors as well as public officials, and increasingly aggressive enforcement mean that corruption issues should be an important part of due diligence and that every
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major project financing should consider developing an effective anti-bribery compliance program.
3. PUBLIC-PRIVATE PARTNERSHIP ARRANGEMENTS
Many governments—in both developed and developing countries—lack the resources and/or the expertise to provide all of the infrastructure and other government services needed for economic growth. This has led to increased use of public-private partnerships (“PPP’s) in which the private party uses project finance techniques to raise money and construct a project to provide services traditionally provided by the public sector, including economic infrastructure like roads and power and social infrastructure like hospitals and educational facilities. During the next decade, most project finance lawyers will become involved in some type of PPP project. When this occurs, the lawyer will need to carefully review all of the basic PPP laws and regulations of the relevant jurisdiction and ensure that all documentation is designed to ensure conformity with these law and regulations.
(See Chapter 24 dealing with the application of project finance techniques to the infrastructure sector for a more detailed discussion of PPP’s).
4. INTERNATIONAL INVESTMENT LAW
Every international project financing takes place within the context of the broader principles of international investment law. The widespread use of Bilateral Investment Treaties, the increased
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regulation in many countries of inward investment, the increased impact of “soft law”
codes and guidelines, and the introduction of specialized treaties like the Energy Charter are all factors which may impact an individual project financing. Some of the rights and duties of project participants may arise out of customary international law and various international investment agreements. These sources may create legal obligations on the host country with respect to the standard of treatment it accords to foreign investors and on the sponsor with respect to how it conducts its investment activity. These obligations may impact how a project is structured and operated and should be evaluated by the
project lawyers as part of the project preparation and due diligence stage.
5. USE OF DERIVATIVES
Most major project financings now involve the use of derivative contracts to hedge various financial and commodity related risks. The use of derivatives raises a number of issues that merit attention in the financial due diligence process. They include: added counterparty risk; the possible need for the SPV to provide collateral to hedge providers;
and various intercreditor issues involving the senior lenders and the hedge providers. A project finance lawyer would not be expected to be an expert in the details of the use of derivatives. However, she should have an elementary knowledge of the general nature of the most common derivative instruments, how they are used to reduce risk in project financings, and the legal issues raised in order to conduct basic due
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diligence. (A summary of the use of derivatives in an international project finance transaction is found in Chapter 16).
6. DISPUTE RESOLUTION PLANNING
Although dispute resolution mechanisms are generally not activated until later stages of a project, it is advisable to start planning for dispute resolution in the due diligence and drafting stage. In order to devise the most appropriate method of dealing with disputes, the legal due diligence process should review: any relevant bilateral investment agreements and other investment related treaties that might provide fora or methods for dispute resolution; the dispute resolution laws and practices in the host country, including the quality of the courts, the judges, and the arbitral and ADR systems; and the basic attitudes towards arbitration and enforcement of arbitral awards. Based on this due diligence, the dispute resolution clauses of the various project documents should be drafted in a consistent manner that takes into account the strengths and weaknesses of the host country dispute resolution regime.
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CHAPTER 4