Reconciling Two Legal Cultures in Privatizations and Large-Scale Capital Projects in Latin America
Shaw, Frank C., Law and Policy in International Business
Until the recent economic troubles that began in the Far East, spread to Russia and touched the shores of the Americas, Latin America enjoyed an investment boom spurred by free trade and privatization. A significant portion of the investments that have poured into Latin American privatizations and large-scale capital projects over the past decade have come from North America. Accompanying the North American investors were their attorneys, who are trained and experienced under the common law system originally developed in England. These attorneys were confronted with a region deeply rooted in the civil law tradition of their former colonizers, Spain and France. The clash of these two legal cultures required both sides to reorient themselves to reconcile the conflicts in their underlying legal and regulatory practices. This Essay discusses three areas in which reconciliation has been developing: contract authorization, rights of termination, and dispute resolution. Finally, some practical suggestions are offered for investors and host countries seeking to reach viable commercial agreements in the current environment, as such reconciliation continues.
II. PROJECT FINANCE
Much of the investment in Latin American privatizations and large-scale capital projects has come in the form of project finance. Project finance refers to lending in which the creditor extends debt based on the expected revenues of a project. The lender typically has no (or very limited) recourse against the project's sponsors, which is why project finance also may be known as off-balance sheet debt. The lender's security lies in the revenue and assets of the project, rather than the general assets of the borrower's parent companies. In the case of a power plant, for example, the lender, as security for the loan, may attach the revenues collected from electricity purchasers. If these are not enough, the lender may attempt to foreclose on and then sell the plant, or even dismantle it and dispose of the equipment for its salvage value.
Project finance may be utilized to build numerous forms of infrastructure, so long as forecasted revenues are sufficient to cover debt obligations, and are sufficiently predictable. As a result, project finance provides a flexible mechanism for governments and private parties to borrow without incurring debt on their balance sheets. Project finance, therefore, is used to develop such diverse projects as airports, water treatment facilities, liquid natural gas projects, toll roads, and even soccer stadiums.
From the creditor's point of view, the limitation of recourse against the project's sponsors creates a significant risk. After all, if the revenues of the project fail to service the debt, it can be unwieldy and expensive, if not impossible, to dismantle and sell the project assets. Thus, project finance lenders analyze three main factors when deciding on whether or not to provide nonrecourse financing: the projected revenue stream, and then the commercial and legal risks that could jeopardize that revenue stream.
The analysis of the predictability of the revenue stream involves the development and refinement of a financial model. Financiers will develop a model of the expected revenues and expenses of a project and run various scenarios of performance, with each scenario being assigned a probability of occurrence. The objective of this process is to analyze the likelihood that the project will earn enough revenues each year to cover debt service costs plus a comfortable margin throughout the life of the loan.
The first analysis to be tackled by the financiers is the identification and mitigation of commercial risks. The primary risk to be considered is the creditworthiness of the consumers of the project's services or products. In the case of a power plant, the offtaker (the customer) in most cases is an electric utility company that distributes the electricity to the population. …