Ireland: The Projects and Construction Review (Ireland)

By Conor Owens, Mary Dunne and Michael Kennedy¹

I INTRODUCTION

Project finance is a well understood and widely used model for carrying out infrastructure projects in Ireland across all sectors including health, education, roads, rail, waste, water, IT and energy.

PPPs are the most widely used model of project finance in Ireland. The government set up the National Development Finance Agency ('the NDFA') in 2006 to procure all infrastructure projects with a capital value in excess of €30 million. The NDFA procures all PPP projects other than in the transport and water sectors.

Roads projects are carried out by the National Roads Authority ('the NRA') and rail projects are carried out by the Railway Procurement Agency or by Iarnród Ã0ireann. Project finance is also widely used in the energy sector, particularly on renewable energy projects such as wind farms. This is not the PPP model but is a very typical structure where finance is secured by way of a power purchase agreement.

II THE YEAR IN REVIEW

Ireland has gone through a deep recession in recent years and has correspondingly seen the number of construction and project transactions diminish. Banks are not lending and the government has cut back its capital spending as part of the austerity package agreed with the IMF and ECB.

Residential construction has been the biggest area of decline. Large commercial projects and infrastructure projects are still being developed, but at a slower pace.

Banks are still lending for 25-year periods in the more straightforward PPP projects such as schools projects, but long-term finance is harder to secure for more risky projects. For example, a large number of roads PPP projects were carried out in the past decade on the basis of the user-pays PPP model, but banks will not now take a risk on traffic forecasts, and the NRA are currently developing PPP projects using the availability PPP model.

III DOCUMENTS AND TRANSACTIONAL STRUCTURES

i Transactional structures

By far the most predominant model for project finance in Ireland is the PPP model, whereby the private sector PPP company designs, builds, finances and operates or maintains the asset. In almost all cases of public infrastructure, however, the PPP company at no point owns the asset. It is usually granted a licence by the procuring entity to occupy and operate the land and asset for the length of the project finance deal - typically 25 years, or such time as is necessary to recoup the costs of construction, operation and financing, and to return a profit to the equity investors. At the end of this period the licence terminates at the same time as the project agreement, and the asset remains at all times in the ownership of the procuring public body.

The reason for the use of this model, rather than a BOT or BOL model, is to avoid landlord and tenant law in Ireland, which provides that where a tenant has leased a property and conducted a business for more than five years, it may be entitled to a perpetual lease. Furthermore, projects carried out in Ireland have typically been in the education and transport sectors, where it is desirable that the asset remains in the ownership of the state or reverst to the state.

ii Documentation

A typical suite of documents in a PPP transaction in Ireland will include the following.

Project or concession agreement

The NDFA and NRA have carried out the majority of project finance deals in Ireland by way of PPP and both have template project agreements that have been used and banked successfully for several years. They are similar to the UK standard PFI and roads concession templates with a few important differences. This means that the key London and Spanish project finance banks such as Barclays and BBVA are very comfortable investing in Irish projects and have invested more heavily than the Irish banks.

Construction documents

The Irish government has a suite of construction documents that it uses for traditional construction and engineering projects, but these are not used for project finance deals as design and construction risks must be passed down fully from the PPP company to the design and construction company, almost always by way of a lump-sum fixed price contract; therefore, a bespoke contract is used. Typically, this will include a design and construction contract between the PPP company and the design and construction company, and subcontracts between the design and construction company to the design team and construction contractors. The bank and public procuring body typically require collateral warranties from all design and construction team members.

Service provider agreement and O&M agreements

This is a bespoke contract that accepts all of the operating and maintenance risk from the project agreement.

Funding documents

This will be the typical suite of funding documents that would be expected in any project finance deal: facility agreement, syndication documents, account documents, hedging agreement and funder direct agreements.

Equity and shareholder documents

These will consist of a joint venture agreement between the investing consortium that will be replaced by a shareholder agreement governing ownership of shares in the PPP company SPV. Unlike in the United Kingdom, the Irish government does not take shareholdings in PPP companies and so this is simply a standard company established under Irish company law with articles and a memorandum of understanding.

Corporate documents

These relate to the establishment of the various companies involved in the transaction.

Property documents

These relate to the ownership of the land being developed.

iii Delivery methods and standard forms

A variety of standard contracts are used in Ireland for private sector construction including FIDIC, JCT, NEC, MF1 and IChemE. The Royal Institute of Architects of Ireland produces its own template documents, which are also used, but modified as necessary.

Public construction contracts are carried out using a suite of standard government design, construction and engineering contracts. These have been controversial since their introduction in 2007, as they transfer most of the cost and time overrun risk to the private sector, they are cumbersome to use, and no amendment of the contracts is permitted.

IV RISK ALLOCATION AND MANAGEMENT

i Management of risks

The risk allocation in a PPP project in Ireland is shown in the table following. In terms of design and construction risk, the PPP company is responsible for the design, construction, integration, installation, testing, commissioning, operation, maintenance and ultimate performance of any asset procured or developed for the purposes of meeting the requirements of the output specification.

ii Limitation of liability

Many construction and project agreements will have a limitation of liability clause, which is applicable in Ireland except in the case of death, personal injury or fraud.

Other than this, the parties are free to agree to exclude whatever heads of liability they choose. Risks that parties commonly attempt to exclude are those associated with indirect or economic losses, which is permissible under Irish contract law.

iii Political risks

Traditionally, political risk in respect of project finance has not been a cause for concern in the Republic of Ireland. The economic downturn, however, which caused relatively minor political disruption and the nationalisation of some of the major banks in Ireland, together with the formation of the National Asset Management Agency ('NAMA'), has caused some concern on the part of international project sponsors entering the domestic market. Accordingly, a private insurance market exists covering political risk in the event that a party wishes to cover itself. Crucially, the type of political risk that can be insured against is fairly narrowly defined: political violence (war and revolution), the imposition of exchange controls and expropriation.

It should also be noted that within the context of cross-border projects (for example, the recently completed acute hospital in Enniskillen, Northern Ireland, 'the Enniskillen project'), insurance cover exists for the risk of loss of plant and equipment and advanced loss of profits due to government action and or political violence. Although there were no political insurance claims in respect of the aforementioned Enniskillen project (as far as we are aware), the issue has recently come to the fore in respect of the Union flag protests in Northern Ireland, which materialised after the completion of the Enniskillen project. Data in respect of finance projects affected by the recent Union flag protests is not currently available at the time of writing.

In addition to private political risk insurance, project sponsors can also obtain political risk insurance from the Multilateral Investment Guarantee Agency. Following on from this, political risk insurance is also provided on behalf of the Irish government through the OECD. This scheme is similar to the widely documented United States OPIC programme.

V SECURITY AND COLLATERAL

In project finance transactions in Ireland, as with everywhere else, the project cash flow is secured by way of a contract securing cash flow over time (such as a power purchase agreement) at a fixed price over a minimum period or a contract with a government entity to buy a service for a period of time at a known price. This is combined with a rigorous compensation-on-termination clause to ensure that in the event of the contract terminating early, the debt is repaid.

In traditionally funded projects or projects where the cash flow is not entirely guaranteed, more traditional security is sought. Funders will undoubtedly conduct due diligence in respect of the financial soundness of both the project itself and the main parties to the project. As part of this due diligence, the funders will require evidence of financial standing of other sponsors together with the contractors and subcontractors undertaking key works packages.

Following on from this, funders will generally seek to obtain a security package. This can include a floating charge over the assets of the developer and or the project, third-party guarantees of the developer's obligations (including cost overrun guarantees and interest shortfall guarantees), standard security over the development site (in the form of a mortgage), and the assignment of the building contract, performance bond and or another form of guarantee issued by the contractor.

In addition, developers will often provide funders with a suite of collateral warranties and direct agreements. In essence, the provision of collateral warranties will tie the sub-contractors in with the funder. For example, a subcontractor will warrant to the funder that it has complied with the terms of its subcontract. Crucially, collateral warranties will likely provide a funder with the right to step in to the place of the developer in the event of default.

Furthermore, funders may seek to impose financial covenants on contractors when providing funding. These covenants will seek to ensure that the project performs within the stipulated parameters, whether by reference to cash flow or the ability to service debt repayments on the length of a loan.

In addition to the foregoing, project funders will seek to have income that is generated upon completion of a particular project, managed through a specially created bank account that the funder will exercise a form of joint control over with the project company. Accordingly, the funder will seek to exercise priority over the income generated before any other creditors are paid.

VI BONDS AND INSURANCE

The vast majority of construction projects in Ireland include stipulations for the provision of performance bonds or parent company guarantees from the main contractor and the main sub-contractors. While historically it was uncommon for claims to be made against bonds, the recent insolvencies of some of Ireland's best-known contractors, together with insolvencies of many small to medium sized contractors, have been accompanied by a rise in claims against bonds and parent company guarantees. Accordingly, bonds are becoming increasingly difficult to obtain.

In this jurisdiction, performance bonds are often issued by insurance companies, banks or specialised bond companies (construction guarantee). Generally, performance bonds can be described as 'on demand' (claim can be made against the bond at any time) or 'default' (the bond beneficiary must establish that the contractor has breached the contract).

Currently, it is difficult for contractors to obtain on-demand bonds from insurance companies and banks. The cost of the on-demand bond to the contractor reflects the bond provider's reluctance to provide the on-demand bond. Following on from this, contractors must be careful to review the terms of a specific contract before entering same in order to establish the nature of the bond required. Indeed, the nature of the bond may ultimately prevent the contractor from entering the contract. This theme was recently addressed in the PPP Bulletin Conference held in Dublin on 21 March 2013, where discussions were held about public contracting authorities requesting bonds of up to 25 per cent of the contract price and the need to find a way of lowering the cost of construction performance bonds in order to allow the local market to respond. Ultimately, if bonds cannot be obtained, bigger retentions or letters of credit may be required and the price will increase.

In addition to bonds, guarantees may also be provided. In the Irish construction industry, guarantees will often take the form of a parent company guarantee, but guarantees can also be provided by a financially sound third party.

Guarantees are different to bonds in that they usually provide an obligation on the guarantor to guarantee the whole performance of the party on whose behalf the guarantee is provided, as opposed to a fraction of the contract sum, in the event of default. Accordingly, the intended beneficiary of the guarantee will seek to make sure the guarantor is of sufficiently sound financial standing before proceeding with the contract. Following on from this, provision of bank and or insurance guarantees in this jurisdiction are rare.

Finally, careful attention must be paid to guarantees, particularly in relation to notification requirements to the guarantor of default by the contractor and or the mechanism by which a claim under the guarantee is to be made. Strict compliance with the aforementioned requirements will often be a prerequisite to a claim being pursued successfully.

VII ENFORCEMENT OF SECURITY AND BANKRUPTCY PROCEEDINGS

In a project-financed project, insolvency will trigger termination and a compensationon- termination regime will kick in in accordance with the detailed provisions of the project agreement, essentially ensuring that debt is paid off and that the state does not receive a windfall.

In traditional projects, if the funder wishes to enforce its rights over collateral, there are a number of steps it can take outside of the context of initiating insolvency (winding-up) proceedings:

a The project funder can seek to have an examiner appointed to the company and its assets under the Companies (Amendment) Act 1990. Upon appointment, the examiner must set out its proposal in respect of the objectives of the examination of the company. The objective will be either to try to achieve the survival and rehabilitaton of the company as a going concern or to secure the most lucrative realisation of the company's assets possible. It should be noted that no steps can be taken to enforce security within the context of examinership, unless the examiner has first obtained the permission of the court.

b The project funder can seek to appoint a receiver over the company and its assets. The receiver will take possession of the assets the subject of the debenture holder's charge (the project funder in this instance). The receiver will then seek to realise those assets and discharge the debt owing to the debenture holder.

c The project funder may seek to obtain a court judgment with respect to collateral. Within the context of insolvency (winding-up) proceedings, the project funder, as a secured creditor, can initiate said proceedings via a petition to wind up the company.

The project funder's security over the asset will then crystallise and the funder will rank in accordance with the type of security it holds. In the event that the assets are realised, the funder will obtain the benefit of same prior to any unsecured creditor.

In summary, after the holders of a fixed charge have been paid, the order of payments to be made are as follows:

a liquidator's fees and expenses;

b preferential creditors' claims (which will include certain statutory tax and employee benefit liabilities);

c claims of the holders of floating charges that have not crystallised prior to the winding up;

d unsecured creditors' claims;

e deferred debts; and

f members of the company.

VIII SOCIO-ENVIRONMENTAL ISSUES

i Licensing and permits

Ireland has extensive legislation and regulation in relation to planning and environmental issues. Environmental issues will generally be dealt with as part of the planning permission process and it is common for projects to be required to produce an extensive and detailed environmental impact assessment. Ireland has many areas of cultural and historical significance, and managing areas of interest in a sympathetic way is an issue that arises frequently on many projects.

ii Equator Principles

The Equator Principles are an internationally recognised set of principles that are used for managing social and economic risk in larger-scale PFI projects. These principles have no legal status in Ireland but a number of lending institutions recognise and abide by the principles and they are introduced to projects through the lending institutions.

iii Responsibility of financial institutions

It is extremely rare in Ireland for financial institutions to accept any risk or liability in relation to socio-environmental issues. Unless and until a financial institution exercises a right over the land in question (i.e., enforcing security over the land) there is no basis for that institution to assume any liability. If, however, the financial institution enforces security over the land and effectively becomes the landowner, then the financial institution has potential liability for any issues connected with that land, such as pollution or the creation of a nuisance.

IX PPP AND OTHER PUBLIC PROCUREMENT METHODS

i PPP

PPPs are the main project finance model used in Ireland and the template is a more flexible version of the PFI model in the United Kingdom.

The Irish government introduced PPP in Ireland by way of the State Authorities (Public Private Partnership Arrangements) Act 2002. This gave a list of designated bodies the legal authority to enter into PPPs and to enter into transactions ancillary to such arrangements such as hedging agreements, land transactions and the borrowing or investing of money. The definition of PPP was deliberately broad to enable almost any combination of design, construction, finance, operation and maintenance. In fact, any operation and maintenance contract of five years falls within the definition of a PPP contract in Ireland.

The NDFA has responsibility for most sectors for PPP projects, the exception being transport.

The State Authorities Act also gives the NDFA the authority to procure PPP projects on behalf of government departments and other public entities.

A typical PPP project for a school or court house will involve the public body entering into a project agreement with a PPP company, who will set up an SPV for the purpose of carrying out the project. In such a project the public sector will produce an output specification and the PPP company will design, build, finance, maintain and partially operate the school or courthouse for a designated period, typically 25 years.

In Ireland, the public sector has kept to a minimum the extent of operations carried out by the private sector, and typically in a school it will be little more than maintenance. Hence, politically, there have been very few union or TUPE issues with PPP projects.

The PPP company will be granted a licence to occupy the land and school for the purpose of carrying out the project agreement but will at no time lease or own the project. The reason for this is described above.

PPP projects tend to be procured by way of negotiated procedure or competitive dialogue in accordance with Directives 2004/18/EC and 2004/17/EC. The tender process is rigorous and lengthy.

PPPs have continued throughout the recession but at a slower pace. It has also tended to be the less risky projects that are reaching financial close such as schools projects. In such projects, the risk on student numbers is taken by government and therefore the financial model is predictable and low risk.

In contrast, while roads PPP projects have also continued to close, the model has changed from a user-based model to an availability-based one, as the banks and contractors were simply not willing to take a risk on traffic forecasts.

ii Public procurement

Irish public procurement law is entirely compliant with EU public procurement law and enforces its processes rigorously. Directive 2004/18/EC on the award of public contracts and Directive 2004/17/EC on the award of utility contracts were transposed into Irish law by way of Statutory Instruments 329 of 2006 and 50 of 2007. Remedies Directive 2007/66/EC was transposed by way of Statutory Instrument 130 of 2010.

These rules capture best practice internationally and comply with the requirements of all major funding agencies and banks as well as OECD, etc. They are technically detailed but also overlaid with the basic EU Treaty principles of equal treatment, transparency, freedom to provide goods, works and services etc.

A challenge to a public procurement process in Ireland is by way of judicial review to the High Court. The effect of initiating proceedings is that an automatic injunction applies to the project and the public authority may only proceed with the project either by applying to have the injunction lifted or by awaiting conclusion of the judicial review.

X FOREIGN INVESTMENT AND CROSS-BORDER ISSUES

i Removal of profits and investment

There are no particular restrictions on foreign investment in Ireland which - to the contrary - is actively encouraged and supported. Ireland's low corporation tax rate has been an incentive for many foreign investors and retention of this low corporation tax rate is important going forward.

Many of the large PFI/PPP projects in Ireland over the past 10 years have involved foreign contractors who are typically a leading part in a consortium of contractors. Due to the relative size of the Irish construction industry, PFI and PPP has required the financial support of foreign contractors who generally have greater access to credit and bonding facilities.

Ireland's current financial status, its dependence on EU financial support and the issues faced by Irish banks (many of which have now been nationalised) has meant that foreign investment has become increasingly important to the Irish PFI/PPP market.

XI DISPUTE RESOLUTION

i Special jurisdiction

There are no specific courts or tribunals in Ireland that deal with either project finance transactions or construction contracts.

ii Arbitration and ADR

The principle forms of dispute resolution in Ireland in the context of private finance transactions are:

a dispute adjudication boards;

b mediation;

c arbitration; or

d litigation.

Before commenting briefly on each of these four forms of dispute resolution, it is worth noting that there is currently legislation before the Irish government that opposes the introduction of statutory adjudication into Ireland (in largely the same format as the Untied Kingdom). The introduction of the legislation and the form of that legislation is currently being debated in government, but if the legislation is passed, it would have a major impact on the resolution of disputes in private finance transactions.

Dispute adjudication boards

Most PFI/PPP forms contain a provision whereby disputes must first be referred to a dispute adjudication board. This is a consensual process whereby the parties will typically identify an industry expert (in Ireland there is usually just one individual or one organisation identified as opposed to three) to provide a recommendation in relation to any dispute that arises. The parties are free to reject the recommendation and, if they do, they then move to the next step in the dispute resolution process.

Mediation

The process of mediation in Ireland is fairly well developed and most forms of PFI contract will include a provision that requires the parties to at least attempt some form of mediation before commencing either arbitration or litigation. Mediation is a process whereby the parties will attempt to resolve any dispute that arises between them with the assistance of an independent third party and, if a resolution cannot be reached by agreement, then the process may provide for the mediator to issue a recommendation to the parties that, if not rejected, becomes binding on the parties.

Mediation in Ireland is given judicial support and there are certain judicial decisions whereby parties have been penalised as a consequence of refusing to mediate in circumstances where mediation was appropriate.

Arbitration

The arbitration process in Ireland has recently undergone a fairly radical transformation with the introduction of the Arbitration Act 2010. The purpose of this Act was to bring Irish arbitral procedures into line with the procedures generally used in international arbitration through the incorporation of the UNCITRAL Model Law ('the Model Law'). As Ireland now recognises and incorporates the Model Law, foreign investors and contractors are more comfortable with conducting their business in Ireland.

In combination with the introduction of the Model Law, the Arbitration Act 2010 severely restricts any judicial intervention in the arbitration process. The reason for this is, again, to give confidence in the process for the purposes of international contractors and investors.

Ireland does benefit from a number of high-quality arbitrators but, in recent years, the arbitration process has suffered some criticism as a consequence of a perceived increase in cost and decrease in speed.

Litigation

Since 2006 and the introduction of the Irish Commercial Court, litigation in Ireland has dramatically improved. The Commercial Court in Ireland is generally perceived as being of an extremely high quality, in a process that is case-managed in all important respects.

Any party with a commercial dispute that is valued in excess of €1 million and which dispute has been prosecuted with some degree of urgency will generally be able to avail itself of the Commercial Court.

In the event that a dispute does not meet the thresholds for entry into the Commercial Court, the dispute will be resolved in the normal High Court process. While this process is slower and more unpredictable than the Commercial Court process, it is nonetheless a process that has improved dramatically in recent years.

In terms of litigation, it is worth noting that there is a current drive towards generally reviewing litigation processes and the court system. Just some of the reforms that are currently being debated are the introduction of a separate Appeals Court that would, again, greatly improve the standard of litigation services in Ireland.

XII OUTLOOK AND CONCLUSIONS

While the PPP market in Ireland is currently difficult due to the recession, the PPP structure is seen as being the only realistic way of procuring large-scale projects in the future, mainly due to the ability of the PPP model to attract much-needed foreign investment. While foreign investors will inevitably look to less risky projects in the short to medium term, if the financial situation stabilises it is hoped that the riskier - but generally more financially rewarding - projects will return to the agenda before too long. The main concern going forward is ensuring that the confidence of foreign investors is maintained.

Footnotes

1. Conor Owens and Mary Dunne are partners and Michael Kennedy is an associate at Maples and Calder.

Originally published by Law Business Research Ltd.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.