Plugging the Nigerian infrastructure gap – the legal milieu (1)

In 2014, after years of using antiquated data, the Nigerian Bureau of Statistics finally recalibrated the prices used in its Gross Domestic Product (“GDP”) calculations, expanding the sectors of the economy measured, and switching from 1990 prices to 2010 prices. The rebasing officially confirmed Nigeria as the largest economy in Africa and perhaps further highlighted the poor state of its infrastructure. With a GDP of about US$510 Billion and a population of nearly 170 million, Nigeria’s core stock of infrastructure is estimated at only about 20 – 25% of GDP compared to the middle-income country average of about 70%. The crippling infrastructure deficit coupled with the enormous investment required to fix this deficit, have a direct impact on project financing structures in Nigeria. From the current estimates of the Federal Government of Nigeria, more than $3 Trillion is required over the next three decades to plug the gap.

Generally, it is accepted that government and its development partners cannot realistically be depended on to provide the requisite finance needed for overhauling infrastructure in Nigeria; and possibly, public private partnerships and other private sector finance initiatives are required. In this regard, over the last few years, the government has focused on developing public private partnership (“PPP”) structures and on privatizing government utilities. While privatisations have largely been successful, PPP deals have tended to drag and there remain only a few successful examples of successful major projects.

In particular, following major power privatisations, which occurred in 2013, some attention shifted to development of gas to power projects expected to provide gas for various private and privatized power plants. However, deal development in this sector has been slow for various reasons including in some cases, perceived absence of government support and restricted/regulated gas pricing for power projects.

THE YEAR IN REVIEW

In 2014, riding on the back of the momentum garnered from the 2013 power privatisations, the Federal Government’s focus shifted to power transmission, the only aspect of the power industry which was not privatized. Up to six (6) different high voltage transmission projects were signed as PPP deals and are currently being developed on either a “Build and Transfer” basis or as “Build, Operate and Transfer” projects. Aside from these projects, which are being developed on behalf of the Transmission Company of Nigeria which is government owned, projects with combined value of about US$2.76 Billion, are also being developed as PPPs with either the Federal Government of Nigeria or various State Governments. These projects include the rather interesting Lekki Seaport Project, expected to be the largest seaport in Nigeria and estimated to cost up to US$1.5 Billion, as well as the Second Niger Bridge Project, a 1.6km bridge and associated approach roads and bypasses, estimated to cost around US$700 Million. Contracts for these deals were signed in 2014. Also, it was estimated that the financial close for the US$500 Million Lagos cable car system would be achieved in 2014 with the construction of the said system, commencing in November of 2014.

The pipeline of deals entered into in 2014 as highlighted above, only scratches the surface in detailing the infrastructure development situation in Nigeria. Specifically, year 2014 witnessed the completion of the buy back by the Lagos State Government, of the pioneer toll road project in Nigeria. The Lagos State Government had in 2013, announced its intention to buy-back the toll road ahead of the 2038 handover date in its bid to prevent the commencement of tolling at other toll plazas, which had proved unpopular with users of the roads. The buy-back, via a mutual settlement option provided for under a concession agreement, was ultimately completed in 2014. The total cost of the buy-back was estimated at N55 Billion with N15 Billion being paid to the Lekki Concession Company (the sponsor of the project), and N40 Billion paid to senior lenders of the project. The buy-back effectively put an end to the project, which had hitherto been the main point of reference for PPP transactions in Nigeria.

DOCUMENTS AND TRANSACTIONAL STRUCTURES

Transactional structures

As in most developed markets, project finance structures in Nigeria take various forms depending on a wide range of factors from the relevant procuring entities (i.e. Federal/state governments, ministries/departments/agencies etc.), the value or size of the project, the revenue generation model and the applicable legal/regulatory framework. Common structures include developmental leases, concessions, build-operate-transfer, build-transfer, and build-own-operate-transfer.

In virtually all of these structures the government/government agency will typically not provide any equity in the first instance but may sometimes be required to provide some express guaranties or other secondary commitments. In scenarios where the completed project may not generate sufficient revenue for the investor, the arrangement may sometimes be structured as a build and transfer whereby upon completion, government acquires the infrastructure and pays the investor based on an agreed schedule.

There is no particular structure that is generally favoured by the relevant authorities and procuring entities in Nigeria, and depending on the circumstances, the full bouquet of options tend to be employed. However, owing to regulatory restrictions, which require Federal Executive Council approval or House of Assembly approval in certain circumstances, projects may sometimes be structured as developmental leases rather than traditional PPP projects.

Documentation

Although in some jurisdictions model contracts have been developed for use in PPP transactions, to-date no such models have been developed in Nigeria. Documentation however tends to conform to international best practices save that in most cases the governing law for the agreement will normally be Nigerian law.

Projects will normally only be executed with limited liability companies incorporated in Nigeria, and thus, any investors or consortium of investors will normally need to incorporate a special purpose vehicle for the project. As is typically the case, requisite governance documentation will be required for this project vehicle. These documentation will normally extend beyond the basic constitutional documents of the company which will be registered in the companies registry, and include private shareholders agreements executed between the parties. The government procuring entity will not normally be party to these governance documentation. Also, beyond the incorporation in Nigeria, there are no specific local content requirements for Nigerian shareholders or directors of the company.

The main project document will be the concession agreement with the procuring entity. This will document the terms of the relationship between the government and the investor, clarifying rights granted to the investor and the manner in which these will be exploited. Under the concession agreement, the project company will accept responsibility for the construction of the project and for the operation and maintenance of the constructed building or facility and the delivery of associated services during the concession period. The project company will look to pass down all construction-related risks to the construction contractor under a fixed-price design-build (DB) contract. A separate operation and maintenance (O&M) contract will be entered into for the concession period following completion of the works.

In the absence of any standard government models, there is no rule as to which party generates the first draft of the concession agreement and this can sometimes be provided by counsel to the concessionaire. The document will normally be extensively negotiated and, will typically be approved by the relevant PPP authority prior to execution by the appropriate procuring entity. As the investor is likely to rely on significant third party funding, the agreement will normally clarify the extent of equity funding which the investor must provide as well the extent to which security can be created over the concession agreement and assets developed/procured for the project.

Lenders Step-in rights and direct agreements are fairly common in project finance transactions in Nigeria and will normally form part of the bouquet of documents. The capital funding for the project will generally be provided through non- recourse lending, secured against the income streams of the project company.

Offtake agreements will be required where the output of a project, such as oil, gas or power (electricity), is to be supplied to a particular customer. Minimum revenue generation through offtake agreements may be a key requirement of the project company in order for it to service its debt. Separate support agreements may be required where specific licensing or financial support is required.

iii Delivery methods and standard forms

We reiterate that to-date no models contracts have been developed in Nigeria. Nonetheless, primarily, Engineering-Procurement-Construction (EPC), design and build (D&B), and Engineering-Procurement-Construction-Installation (EPCI) contracts are primarily used for project finance-based transactions in order to deliver maximum risk transfer to construction contractors. Under such contracts, the contractor will be responsible for the entire design and construction of the works, usually on a lump- sum basis, with the contractor liable for liquidated damages in the event of delayed completion.

The specific form of construction contract utilised will depend upon the nature and location of the project. Where standard forms such as FIDIC (International Federation of Consulting Engineers) are used, these are often subject to substantial amendment in order to reflect the required risk profile. Many construction contracts used in transactions involving project finance are, tailored to suit the specific characteristics of the project in question.

RISK ALLOCATION AND MANAGEMENT

The approach to risk management and allocation in project finance transactions in Nigeria tends to generally mirror that in more advanced markets with parties aiming to allocate risks to the party best suited to bear them. As regards government projects, current policies of the Infrastructure Concession Regulatory Commission (the main federal PPP agency) provide that government will aim to optimize rather than maximize, the transfer of project risks to the investor. In practice, this approach leads to the same outcome of risks being allocated to the party better suited to bear them.

In practice, the project company will normally look to limit its risks as much as possible, ensuring that where any deliverables are dependent on third parties then, as a minimum, a back-to-back commitment is obtained from the relevant third party to cover such risk. In addition, there will normally also be outright caps on liability (with the relevant acceptable exclusions which may be extended beyond the norm, based primarily on the risk appetite and risk allocation mechanism of the parties), delay and performance liquidated damages and other compensatory payments. In this regard, the rule against the imposition of penalties is also applicable under Nigerian law with the recognized exception for genuine pre-estimate of losses such as liquidated damages. Although there is no significant recent case law on these points, Nigerian courts will generally be guided by current English law rules in determining whether or not a liquidated damages clause in a contract is enforceable. However, on the flip side, it is noteworthy that there are currently no limits to the instances in which liability could be excluded and or limited. This means that in theory, an investor could still exclude liability in respect of fraud or gross misconduct, in a contract governed by Nigerian law, which in practice, will involve counterparties to any such contract insisting on there being no cap in respect of liabilities of this nature.

Given its frontier market status and the limited number of thriving long term private infrastructure projects, political risk tends to be a major concern for private investors looking to invest in infrastructure projects in Nigeria. To hedge against such risks, in instances where contracts are being signed with government entities or agencies, investors will normally seek to execute some form of support or guarantee documentation with the relevant government itself to give additional comfort. The grant of such support/guaranties tends to be restricted under applicable PPP laws and will normally require some additional governmental approval.

SECURITY AND COLLATERAL

To a large extent, the applicable security structure and collateral accepted by lenders tends to vary with the nature of the project. To ensure complete protection in any project finance transaction, lenders will normally seek several levels of security including: direct security over the project assets – typically in the form of a mortgage, debenture or legal charge; and indirect security – in the form of a charge over shares of the sponsor in the project company.

In addition to the foregoing, and depending on the nature of the project, where there are offtake contracts, lenders will also typically seek to take a security assignment of the offtake contracts. There could also be charges over project accounts, assuming that these were not already covered under the debenture. Owing to the current stamp duty and filing fee rates applicable in Nigeria, a great deal of time is spent structuring security arrangements in Nigeria, not just to ensure that lenders are adequately secured, but also to minimize costs. Current security perfection costs will normally be in the region of 1.375% (assuming there is no legal mortgage of real estate). Where however, the security package includes a legal mortgage over real estate, costs could rise to as much as 2.5% of the amount secured.

Aside from adjusting the amount of security required, an additional layer of efforts deployed by parties to minimize costs, typically include adopting an “upstamping mechanism”. This entails the payment of reduced/nominal perfection fees in the first instance based on a limited secured amount with trigger events upon the occurrence of which the lenders could then quickly perfect the security for the full amount and proceed to realize their security. Whilst the up-stamping mechanism is not without its risk, it should be noted that same is an increasing popular tool employed by financiers and project developers alike. It is currently featured in Nigerian financing model documentation and, it would be rare to find a project finance transaction in which the mechanism was not at least considered.

Aside from the foregoing and as noted above, direct agreements giving lenders the right to step into a concession or other project document are generally common place in Nigeria.

Nigerian Chapter authored by one of B&I’s partners and published in the 5th Edition of “The Projects and Construction Review” by Julio Cesar Bueno (Editor).

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