UK: HFW Client Briefing - Evaluating The Options

Last Updated: 5 October 2009
Article by Connie Chen and Samantha Roberts

This article first appeared in the September 2009 issue of Port Strategy.

With the global credit crunch and the ensuing contraction in international trade, many container terminal operators are seeing a dramatic decline in volume and revenue figures.

According to HSBC Global Research, the predicted fall for container throughput for 2009 is 3% for ports globally and 7% for ports in China. As a result, many terminal operating companies are reviewing their existing portfolios and investment strategies.

Some terminal operators will wish to take a 'wait and see' approach to projects where no binding commitments have been made - the downside of which is that a grantor may not be prepared to wait and may prefer to move forward with a competitor instead. However, if the project is still desirable, savvy operators may wish to use this as an opportunity to negotiate more favorable terms with the port authority and/or government agencies.

For example, it was common in the People's Republic of China (PRC) for foreign terminal operators to obtain 50-year concessions from the port authorities. This has been reduced to 30 years in recent concessions to allow the port authorities and government agencies to counter the high demand for deepwater container terminals. The current economic climate may facilitate the reversal of this trend.

It may also be possible for a terminal operator to negotiate a lower investment for participation in a port project.

Once a binding commitment has been given for a project, it can be difficult to renegotiate the terms of the concession agreement. It may, however, be possible to obtain some form of relief for capital injections, if they have not yet been made.

In the current economic climate, concessionaires may be faced with difficulties securing finance for contractual investment commitments and therefore wish to negotiate with their joint venture partners, port authority or local government for an extension of payment obligations.

In some jurisdictions, governments have officially granted relief to investors in financial difficulties. For example, the Chinese government issued a guideline in February 2009 giving extensions to those companies having difficulties meeting their payment obligations. These companies have until end of 2009 to meet the capital requirements.

The guideline was issued in response to some foreign investors unlawfully fleeing from the country without properly following the liquidation procedures leaving many workers unemployed and causing social instability.

If capital contributions have already been made, an investor may wish to repatriate part of the capital already injected back to its headquarters. This is possible financially, if the cash flow of the operating company allows, and legally, if the requirements can be met.

One way to improve the cash flow of the operating company is to convert the structure of the investment from a "transfer" to a "lease" model. This means that instead of paying an upfront lump sum fee for the terminal assets and concessionary rights, the investor will pay for these assets and rights in installments over the duration of the concession agreement.

While the overall profitability of the project may be reduced under the lease model (a potential downside), this will help to minimise the need for a large initial capital outlay. If the investment is already in a leasing arrangement, it may be possible to renegotiate longer or postponed payment terms, payments in arrears, or monthly rather than yearly advanced payments. Cooperation from joint venture partners and, in most instances, approval from government agencies will be required.

In some jurisdictions, a reduction in capital is only permitted in extreme circumstances and special governmental approval is required. Investors also have to provide satisfactory explanations on why a reduction in capital contributions is necessary.

With limited liquidity in the financial markets, investors have to be creative with their transactions. One way is to make the investments using share capital in other companies or by a share swap. For companies interested in the Chinese market, the PRC government has recently issued a regulation formalising the making of capital contributions using equity held in other companies.

For competing terminal operators which have complementary portfolios, a full or partial share swap may help to enhance both operators' presence in a region or operational control in a joint venture despite the lack of finance available in the current economic climate.

A terminal operator may wish to reduce its shareholding in an existing port project to boost its cash reserve or to streamline the operation. Whilst the current bleak economy means that it may be difficult to find a willing buyer, there are a number of parties that may be interested in investing despite the challenging conditions.

Likely buyers could include joint venture partners that wish to increase their shareholdings; companies which have no presence in the region but want to enter the relevant market; or players that are looking for existing facilities with quick returns and immediate cash flows. In actual fact, the current market presents unprecedented opportunities for those companies who, in the past, could not enter the market because the competition was too fierce or the price was unrealistic.

Whether the sale is to a joint venture partner or to a third party, cooperation from other joint venture partners during the sale process is important. Not only may they have the right of first refusal, they may also use other reasons to block the sale if they do not like the newcomer by arguing that the newcomer does not have the financial capability to step into the shoes of the transferor, or the ability to assume those obligations peculiar to the transferor. Approvals from port authorities and/or government agencies may also be required in some jurisdictions.

If it is no longer desirable to stay in the venture, a terminal operator may decide to exit from an already committed port project. It is possible to do so by either divesting the entire share capital, as discussed above, or by requesting an early termination of the operating company.

Usually, both the concession agreement and governing law provide grounds for termination. Companies will need to navigate through these grounds carefully to see if a termination is justified. An unlawful termination may give the counterparty a right to make a claim for repudiation.

Some common grounds available for termination under the current economic climate include significant accumulated losses suffered by the company; operation of the venture being discontinued for a consecutive period; the company's inability to pay debts when due; the continued existence of the company being no longer justified; or the venture having doubtful future prospects.

While these grounds may be available, a terminal operator usually has to overcome certain obstacles and meet certain criteria before termination can be justified. For example, the losses have to reach a certain percentage of the original investment of the company or the investors have to prove that the continued existence of the company would severely damage the interests of the shareholders.

As most companies have only started to see a drop in volume and revenue since the end of 2008, it may be premature for many investors to request early termination. Terminal operators would then need to study the concession agreement and governing law to see if anticipated future losses would justify early termination.

In most jurisdictions, approval from port authorities and government agencies are required for early termination. It is also important that the liquidation procedures set out in the concession agreement and governing law are properly followed to allow for a smooth recovery of the capital.

While the global economic downturn proves a challenge for many companies, it presents a valuable period for companies to improve the cost structure, streamline operations, enter into markets where it was traditionally difficult to break into, or seize opportunities at realistic prices. For companies which can turn challenging conditions into advantages, a softening market means unprecedented opportunities.

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.

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